The sufferings of Tantalus are close to those of the value investor. The legendary Phrygian was banished to the deepest recesses of the Underworld after serving the gods a banquet made of the flesh of his own son. Tantalus’ punishment was to stand in a pool of water beneath a fruit tree with low branches. Whenever he reached for the fruit, the branches raised his intended meal from his grasp. Whenever he bent down to get a drink, the water receded before he could get any.
In a similar way, great companies often escape the value investor’s grasp. There are two reasons for that. One is that the stocks of great companies are nearly always too expensive. Their stock prices, like Tantalus’ tree branches, are always too high. As Graham notes, “the great majority of common stocks of strong companies must be considered speculative during most of the time, simply because their price is too high to warrant safety of principal in any intelligible sense of the phrase.”(1) Consider Apple (NASDAQ:AAPL), Mc Donald’s (NYSE:MCD) or Amazon.com (NASDAQ:AMZN). They are certainly great companies, but their market value arguably exceeds the value to a private owner by wide margins.
This brings us to the other Tantalic longing of the investor: a great company that he is unable to buy. This mostly applies to private companies. Who wouldn’t want to own a piece of Bloomberg? of Cargill? of Mars inc.? Well, you can’t, they are privately owned. And the business is so good that the owners will never sell.
In other instances, the business may be publicly traded, but liquidity, like the water at Tantalus’ feet, is so low that it is virtually impossible to really “get in” (at least if you have a lot of money to invest).
However, tremendous opportunities for the smaller investor can often be found in this space. After all, “liquidity is only important when you want to exit a position”(2). The small investor, if there are no low-hanging fruit, might find value by looking at the waters below.
It is such a company that I want to report about today: Independent Tankers Corporation (ITCL) (website: www.itcl.bm). I believe that (at least on the basis of the last quoted price) it is currently the cheapest share on the planet. If you have never heard about the company, don’t look up its current price. Please do so only after reading the facts that I’m going to present, and after you’ve come to your own (first) conclusions about its value. You will be very surprised. Due to its length, I have broken this article down in two parts. The first one (which you are currently reading) outlines the history and business of ITCL, and gives a first overview of its earnings profile and financial situation – which will already prove my point that ITCL’s stock market value is quite out of line. If you found this article interesting, you are encouraged to read the second part, which will give more details on ITCL’s finances and operations, as well as catalysts for value realization and outlook for the company.
What is ITCL ?
Besides the valuation, the very name of ITCL is a joke. Independent Tankers is not “independent” at all. It came to be in 1998 after Frontline (NYSE:FRO), the world’s largest oil tanker operator, bought ten oil tankers for $9.5m from Cambridge Fund Management.
The ships consisted of four Suezmax oil tankers (a tanker class that has dimensions suited for navigating the Suez Canal) and six VLCCs (an acronym for “very large crude carrier”, the largest oil tankers to navigate the seas). These ships were chartered on long-term fixed contracts to BP (NYSE:BP) and Chevron (NYSE:CVX). These contracts provided ITCL with stable, predictable income enabling it to service and progressively retire its debt, and build up equity while also depreciating the vessels. I will provide more colour on the detailed financials later.
Some ten years later (2008), Frontline decided to partially distribute shares in ITCL to its shareholders. This was done via a spin-off of 20% of ITCL’s shares to existing FRO shareholders (on a 1 to 5 basis). At that point, ITCL had a book value of $23m, meaning that FRO had compounded its original investment at an annual rate of 9.2%. Not bad. But it gets better.
The problem with the spin-off was its small absolute value. FRO shareholders only got one ITCL share having a book value of about $0.30 for five FRO shares (trading at around $45 at the time), meaning the spin-off was worth a measly $0.06 per Frontline share. To put it the other way around, you had to own $375,000 worth of Frontline stock to get $500 worth of ITCL stock (on a book-value basis). Needless to say, a plethora of FRO shareholders (myself included) were stuck with a position in ITCL that was so small that the commissions would have virtually eaten up all the proceeds from a sale. So the natural decision was not to sell, and maybe wait for a further distribution from Frontline, which still owned 80% of the shares. So much for “independent” tankers. There are some 75m shares outstanding, 61.7m shares are owned by parent Frontline (FRO) and 5.5m shares by John Fredriksen's holding company (Hemen Holding). Thus nearly 90% of the shares are with company insiders, and only 6m shares are "available" for trading (in theory). Most of these shares are probably also closely held. I know I won't sell mine.
When there are no sellers, there are no buyers either. Thus the stock became the epitome of illiquid. After a few weeks of bigger blocks changing hands, ITCL - the stock - fell into total oblivion. Meanwhile, ITCL - the company - was doing fine. The first chart shows the net income that ITCL generated every quarter in the last four years.
As you can see, ITCL’s earnings were very stable, owing to the nature of its fixed-rate contracts with the oil majors. On average, ITCL earned $3.7m every quarter for the last 15 quarters. The variation in net income in Q1 and Q2 of this year were due to the sale of a vessel, where the income and associated costs were booked in different quarters (more on that in part II). Given the steady nature of earnings, how would you value the company ? Let’s say you would put an earnings multiple of ten on this income stream of $14.8m a year (a yield of 10%), that would give you a value of $148m for the company (which would be nearly $2 per share). Feel free to use any other multiple you see fit, and remember that number.
Now, let’s look at the balance sheet. In the first quarter of 2007, one year before FRO floated it, ITCL had $14.2m in equity and total assets of nearly $800m. ITCL was leveraged nearly 60 to 1, with a mere 1,8% equity ratio. But the steady earnings that ITCL was accumulating (remember those $3.7m quarterly earnings) were slowly piling up on the balance sheet. By the time of its flotation, the equity had increased to $23m (equity ratio of 2.8%), and one year later it was $37.9m (5.4%). Look at the following figure which details the balance sheet evolution over the last 15 quarters:
ITCL has slowly but steadily been deleveraging its balance sheet. The last quarter showed $63.7m in equity and $492m in assets which corresponds to an equity ratio of nearly 13%. The assets on the balance sheet consist of cash (mostly restricted to service the mortgages on the ships) and the vessels, which are depreciated, with an useful life of 20-25 years. Details on a valuation of the ships and the structure of ITCL's cash assets will be provided in part II of this report.
The current equity ratio of 13% is still a far cry from what would generally be considered as “rock solid”, but it is on an increasing path, as can be seen from the following figure, which plots the evolution of ITCL's equity ratio over the last four years:
The book value of $64m is much smaller than the value we got from an earnings multiple of ten ($148m). It would correspond to an earnings multiple closer to four, which is arguably quite cheap. The current book value of $64m gives a book value per share of $0.85. Together with the equity ratio, the book value per share of ITCL has been increasing nicely, as can be seen in the figure below. Since its flotation nearly three years ago, ITCL has compounded book value at an incredible 46% per year. If you look at the longer time frame since 1998 when Frontline took over the vessels for $9.5m, this original investment has compounded at 17.2% per year for 12 years. Has your portfolio managed that kind of steady high return over such a long period ?
Conclusions for part I
As you will probably agree with me, based on the numbers I presented (which are all taken from ITCL’s quarterly reports available on its website, and the SEC filings of its subsidiaries [more on that in the second part]), you’d probably value ITCL – the company – somewhere between its $64m book value and $150m based on a conservative earnings multiple. That would mean between $0.85 and $2 per share. I will now allow you to look up how Mr. Market is currently pricing ITCL - the stock. ITCL trades in the U.S. under the symbol ITKSF.PK on the pink sheets. The last trade was yesterday at $0.01. One wonders what the sellers might have been thinking. Over the last six months, shares have traded in the range $0.01-$0.48. I’ll let you figure out what the corresponding P/E and P/B ratios are, and I challenge you to find a similarly mispriced security. If you want to know more about ITCL, the details of its finances, a comparison to peers and future prospects, stay tuned for part II which I will publish within the next days.
While you may have become excited about the stock, remember Tantalus and his "liquidity" drying up. ITCL is highly illiquid, and it is near impossible to find sellers (or buyers). You would love to buy the whole company at $0.01 per share, but it turns out that's impossible. As you might want to grasp for shares, they might prove elusive and disappear. However, patience is a virtue, and personally I have managed to acquire a substantial position, although it took me two years to build it. If you keep trying, you might be able to grasp a few shares at a good price (and I believe anything below $0.5 is a great price). As I will explain in the second part, this stock is only for people who are willing to hold it for a longer period of time and enjoy its compounding of book value. If it's difficult to get in it is probably impossible to get out (at least at the current time) - the $0.01 trades are probably reflecting that fact. Your time horizon should be very long.
(1) Graham & Dodd, Security Analysis, 6th edition 2009, p. 107
(2) Guy Spier, Aquamarine Fund, presentation at value investing congress 2010
Disclosure: I am long FRO, SFL, BP, GLNG.
Additional disclosure: I am long ITKSF.PK, the stock this article is about (but the system doesn't recognize).I have no position in the other stocks mentioned (GOOG, MCD, AMZN, CVX, VLCCF). I am a long-term investor and have no near-term plans to dispose of any of the stocks mentioned in the article that I currently own.