Teekay Offshore Partners - The Dilution Continues

| About: Teekay Offshore (TOO)


Long term debt is approximately $2.6 billion but the nine month cash flow from operations is about $274 million. The refinancing schedule in the future is tight.

The company has the ability to sell up to an additional $100 million of partnership units. So far it has netted a little more than $20 million.

A sizeable equity offering was completed this spring in addition to the current sales.

Some delays, lower than expected revenue, and other challenges have created a cash flow shortfall for this leveraged company.

The beginning of asset deliveries will start to end the uncertainty regarding the schedule of the next two years of asset acquisitions.

Any thoughts of capital gains are on hold.

"In August 2016, the Partnership implemented a continuous offering program (NYSE:COP) under which the Partnership may issue new common units, representing limited partner interests, at market prices up to a maximum aggregate amount of $100 million. During the third quarter of 2016, the Partnership sold approximately 3.7 million common units under the COP, generating net proceeds of approximately $21.4 million (including the general partner's 2% proportionate capital contribution and net of offering costs). The net proceeds from the issuance of these common units are expected to be used for general partnership purposes."

As long as the partnership will be selling partnership units then the sales will keep a lid on capital gains. Previously the company, Teekay Offshore Partners LP (NYSE:TOO), had taken some fairly significant actions to "staunch the bleeding". Now there appears to be an additional five to ten percent dilution on top of the earlier equity measures shown below.

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Source: Teekay Offshore Limited Partners Equity Offering Slide, June, 2016

Supposedly, all of the events shown in the two slides above were meant to shore up the capital requirements for awhile. The hope was that no more capital would be needed for two more years, cash flow would increase, and limited partners would be happy to see their partnership shares recover. Obviously, something went wrong. Or there was a slight miscalculation that ballooned due to the financial leverage.

Cash flow from operations was about $274 million for the nine month period. Considering there is about $2.6 billion in long term debt outstanding (about 2 1/2 times equity) this company has to move quickly to answer any cash flow challenges or the debt would choke the company very fast. By many debt ratio measures the situation is tight or fairly speculative. Management does not really have much extra liquidity for challenges or accidents.

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Source: Teekay Offshore Limited Partners Equity Offering Slide, June, 2016

These last two finish summarizing the June vision. In order to figure out what happened one has to start somewhere and this is obviously the place to start. Originally, the top slide showed the cash gap filled. The bottom slide shows how the debt ratios would decrease, but the key here is that the company needed some time to take care of some idle capacity and of course take delivery of some new assets that would help with the profitability. The company made a reasonable forecast obviously hoping that nothing would materially change the schedule. However, a lot of leverage really decreases the amount that becomes material and requires management action.

The company was in the midst of a capital expansion when the commodity prices collapsed, sending the industry into a tailspin. While the business is in relatively decent shape, the partnership is leveraged, so small changes in revenue make big changes to the income. This business has a lot of fixed assets, so there is also a lot of significant operating leverage. A change in usage goes straight to the bottom line because a lot of the costs are fixed. That is before the usual writeoffs and other industry down turn adjustments that happen.

Obviously what happened here was a cash flow shortfall. That is really not that uncommon an occurrence. Especially when significantly large deliveries were forecast over the next two years. Plus industry conditions are not really that robust right now, so an occasional unexpected or lower than expected usage figure is likely to happen. so whenever management makes a guess at a long term forecast, things can happen and usually something goes awry. So in this case more cash is required. That dilutes the current partnership investors.

"Our towage segment was confronted by a particularly challenging market in the third quarter which resulted in lower than anticipated utilization.

our Petrojarl I FPSO upgrade project has experienced delays and increased upgrade costs, primarily due to larger scope of work relating to field specific requirements and the age of the unit as well as slower than expected work progress."

Here is a small sample of some of the challenges the company faced in the latest quarter. None appear extraordinary or outside the usual course of business. The third quarter is usually the company's weakest anyway, but then with a few problems piled on and financial leverage, the result meant more shareholder dilution. The company has stated liquidity of nearly $400 million. More than half of that liquidity is cash. But for the amount of debt outstanding, and the potential delays and other routine challenges, the company really needs more liquidity than that; hence the sales of more common units.

Sometimes leverage works in reverse, and then dilution is usually the preferred way out of a tight spot. The alternatives can be far worse. This company is definitely in a tight spot with more to come. The key is to get that leverage working to the advantage of the shareholders again, and make that aggressive growth plan pay off in spite of adverse market conditions.

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Source: Teekay Offshore Partners Third Quarter Earnings Call Update Slides November, 2016

The first slide shows that the timing from the original projection has not varied that much. Management even mentioned that they received several million dollars in compensation for another late delivery. But with leverage, timing of cash flows is everything and a cash flow miss can have some very significant consequences for unit holders. So the delay of an asset delivery can cost more debt, more interest, and lost revenue.

So while management is giving shareholders an optimistic, but also most likely scenario, as long as significant and large capital projects are outstanding with deliveries in the future, more costly delays are possible. Plus forecasting those kind of costs is really next to impossible. Not only that, but if things go well, management expects some key debt ratios to be lower about nine months before some necessary bonds refinancing. Those ratios will help lower refinancing costs and future debt costs. So at some point, more delays could really cost shareholders well into the future. The debt refinancing schedule is currently very tight, and a late start to the projected lower ratios could materially impact or even stop the ability to refinance some of the debt. Management referred to this issue several times on the conference call and stress how important certain delivery dates (and the ability to contract out the asset) are.

A bet on these shares is a bet that future delays will not be that material or painful. At the current time that is definitely a speculative bet. The dividend was cut to build up equity and now more units are being sold to build up equity and liquidity. So more unit dilution will be the order of the day until the future clears up. There is also a disagreement about some cancelled contracts that needs to be settled although right now, management believes it has properly reserved for this issue.

As shown above, there is about $750 million in projects. Those projects will expand this assets of this company materially. But they need to be earning an adequate return before the risk of this investment decreases. So as asset deliveries continue, the risk of this investment will define itself far more clearly. There are also some assets schedule for completion next year that need to be considered.

Right now, even though cash flow far exceeds the unit payout, the company may need all that cash flow and much more. The preferred distributions and the bonds interest payments appear very secure for the time being. But future uncertainties bear watching by all equity and debt holders. So for some investors, the securities may be not be attractive investments until the company's future becomes better defined. In the meantime, the yield on the common units is running a little high for very good reasons.

However, this issue may appeal to speculators who believe that management can reasonably navigate the company through the current challenges. That is also very possible but far from assured. Should management succeed, this stock could more than triple over the next five years as the unit distributions return to previous levels. But that will only happen if the continuing unit sales do not decrease the current excess distribution coverage or delays balloon future costs. Most investors will probably want to wait to take a common position until expected deliveries fall below $500 million, and the outcome of those remaining deliveries is fairly certain. The company has some niche business that are very profitable (there is definitely a bright future potential), but the ambitious growth plan has as much or more effect on the future of the company as current quarterly results.

Disclaimer: I am not an investment advisor and this is not a recommendation to buy or sell a security. Investors are recommended to read all of the company's filings and press releases as well as do their own research to determine if the company fits their own investment objectives and risk portfolios.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.