Dynagas (NYSE:DLNG) released earnings on June 5 and had its conference call on June 6. Performance was decent, yet a bit worse than expected, with distribution coverage at 1.3x (20%+ DCF yield), and $112 million in free cash available at end of quarter (before paying common and preferred dividends).
The big news was despite DCF and cash coverage ratios well above 1, Dynagas LNG Partners will probably be eliminating the common distribution as part of a deal to refinance debt coming due in October 2019. Dynagas LNG Partners' common stock plummeted 18% in response, but the preferred B (DLNG.PB) held up fairly well only dropping about 5.5%. I did my part to help produce this dichotomy, starting to soak up more preferred B shares in the high $15s and low $16s during and after the call. I could be wrong, but I continue to think the preferred quite attractive.
For those who are unfamiliar with Dynagas LNG Partners or the Dynagas LNG Partners Cumulative Preferred B shares, I suggest you read this article which discusses the company in more depth. A more cautionary stance is also available from Henrik Alex here.
Given the brief outline and links above, let's now skip forward to what I suspect most readers care about,
- Will DLNG be able to refinance its debt due this October and thus remain a separate entity?
- Will the preferred distribution need to be cut?
Debt Refinance vs. Going Private:
The big question for many investors is the looming refinance of $250 million in debt due this October and how it is likely to affect the company and more specifically the preferred shares. In the earnings press release management indicated,
The terms of the potential financing transaction, as currently contemplated, will require the Partnership to eliminate distributions on its common units until the new indebtedness is repaid."
Notice this press release didn't say equity units, or common and preferred units, it specifically just said common. Later, in a conference call held the next morning management further confirmed,
This re-financing transaction, if consummated in its contemplated form will require the partnership to make significant quarterly debt repayments, restrict us from using part of our cash and eliminate distribution to common unit holders, but will not affect the distribution to the Series A and Series B preferred unit holders." (my emphasis added)
Thus the currently contemplated refinance deal includes a common distribution cut to $0 but no preferred distribution cut.
The refinance being contemplated includes both the $250 million in notes due in October, and also $470 in term debt that wasn't due until May 2023. A consortium of 3 lead banks plus up to 7 secondary banks are involved (10 total) with some of those being "new" to DLNG. Management expressed the complexity and size of the deal as well as the number and newness of some of the banks involved are part of the reasons this refinance is taking longer than normal. According to management, the deal is now out to the consortium of individual banks for approval, a process which could take up to another two months.
This latter comment, the deal being out to secondary banks for approval, is important in my mind. It implies the 3 lead banks and management have already agreed upon terms. You don't normally shop a deal around to secondary banks otherwise. While no deal is final until it is final, the term sheet being shopped around to secondary banks does not include a preferred distribution cut.
So far this is along the lines of what I previously expected. However, to be fair, many people whose opinion I highly respect thought I was being too positive when I wrote that article and still think I'm being too positive today. They continue to fear the parent Dynagas Holdings may buy back its MLP and delist the preferred in the process. Also after Teekay (TK) refinanced its unsecured notes on worse terms than expected, 9.25%, I must admit I too started getting pretty nervous. Thus, while I do continue to think DLNG.pB an investment where the pot odds are on our side, I am not considering it a high confidence position.
Comparing the DLNG refinance with other firms:
The important thing to realize about the DLNG refinance vs. the TK refinance is that DLNG enjoys a much more stable cash flow stream than TK. Fundamentally, DLNG cash flows come from highly in demand, ice-breaking LNG ships on long-term charters to solid counterparties. DLNG should produce about $85 million in excess cash flow per year from these contracts after paying all expenses and preferred dividends. This $85 million cash flow stream is also pretty predictable as all these ships are already booked out for the next 24 months. Even after mid-2021, 5 of its 6 ships remain fully booked for the long term, with the 6th being an in-demand, ice class LNG ship which Equinor (NYSE:EQNR) has an option to retain. So overall, the fleet currently enjoys very predictable cash flows stemming from fixed rate charters average of 9.3 years in duration.
Source: Company Presentation
Unlike TK, banks are therefore lending to a company with predictable incoming cash flows that will service both operations, interest, and the preferred. Indeed, in this respect DLNG more closely resembles TK's child, Teekay LNG Partners (TGP), another LNG ship leasing firm which also enjoys lots of long-term, fixed-fee contracts. I therefore expect the rate charged for DLNG's refinance to be at least a bit more attractive than TK's. Maybe 8.5% instead of the 9.25% TK had to pay?
The amortization terms on these new notes may, however, be very aggressive (4-5 years?). Management hinted its intention was to use almost all of the $85 million in excess cash flow per year for interest and reduction of principle. This, if it occurs, should make the DLNG preferred more attractive over time. Lots of excess cash flow being used to pay off debt higher on the capital stack reduces both the default and non-payment risk for the preferred.
The Potential Reward:
DLNG preferred Bs are 8.75% coupon cumulative preferred whose rate switches to floating at L+5.6% in November 2023. This floating rate aspect significantly reduces long-term interest rate risk. At the current price ($16) this equates to a 13.7% simple yield on cost, plus another 36% in potential capital gains if the shares eventually return to $25 par.
Were the debt to get successfully refinanced and the firm not be taken over by the parent, this preferred is going to look pretty attractive. While I think investors need to assume there will be no common dividend buffer for at least the next three years, that should be the only meaningful negative. If the debt deal does go through, eventually perception will start focusing more on the coverage provided by 9.3 years of fixed fee, contracted cash flows, and declining debt balances. There is still risk, however.
1.) As alluded to above, the common distribution being eliminated removes an important buffer for the preferred.
Preferred dividends can't be cut while even 1¢ in common is being paid. Now that the common payout will be zero, the preferred dividends can also be cut. Offsetting this meaningful risk is management telling us the current debt deal under consideration does not include a preferred cut.
Additionally, these preferred dividends are cumulative. This means if the company skips a payment, it still owes it, and thus any cash flow benefit is temporary. The company must catch up and bring all lapsed preferred payments current before a dime can be paid out to common shareholders (including the parent). In the case of these particular preferreds, there is also an important clause indicating if no payments are made for 6 quarters, preferred shareholders get to elect directors to the board. This latter clause is typically a bigger deal to management than some individual investors seem to realize.
Preferred shareholders electing directors to the board is something most management teams will avoid with a passion. These directors after all are not beholding to management in any way, and can't be replaced by management. Instead, they represent a bunch of pissed off preferred shareholders who haven't been paid in a year and a half. These preferred directors could, for instance, throw a wrench into everything management tries to do until the preferred gets paid. Potential examples include exposing whatever they wish to about the board meetings, push for management compensation cuts and layoffs, pushing for the sale of significant assets or of the whole company, etc.
2.) Probably, the biggest risk with the Dynagas preferred is if the following occurred:
- No debt refinance gets done
- Dynagas Holdings decides to take DLNG back private and delists the preferred
- It further decides to eliminate the preferred distribution for 6 quarters
- Then Dynagas Holdings makes a lowball offer to buy out the preferred
This would be a quite duplicitous Dynagas Holdings strategy, and a list of what ifs with each item dependent on the one before, but it could happen. If it does, one has to wonder what the further downside might be? What the eventual preferred takeover offer from management might be, and how that would compare to today's current price ($16)?
I don't know the answer to this, but would welcome any previous examples other investors care to share in the comments below. If we can quantify a few previous situations where preferred dividends weren't paid for an extended period, then the company made a buyout offer, we might be able to better quantify our worst-case scenario.
Realize however while this worst-case scenario is a risk, there are also reasons why it is not the most likely scenario. These reasons include:
- Dynagas Holdings may not have the cash necessary to take DLNG private, or may have other things it would prefer to do with its capital.
- Dynagas Holdings originally set up DLNG because it wanted an entity willing to pay full price for a ship with a long-term charter attached. This allows the parent to potentially make extra profits trading ships and managing those ships for the child than what it otherwise would be able to do on its own. If Dynagas Holdings can eventually get that drop-down model working again, it's something it would probably like to keep.
- Taking DLNG private and playing fast and loose with the preferred would damage Dynagas Holdings' reputation. It is unknown what ramifications this could have for them, but limiting future access to capital and making it more costly is likely. If the child's shareholders are seen as having been treated inappropriately, it could make it difficult for Dynagas Holdings to float a new spin-off or otherwise access the capital markets for a number of years. Eventually memories fade, but in the meantime access to capital, the lifeblood of firm, would be affected.
- Were Dynagas Holdings to take DLNG private, Tony Lauritzen would likely lose his CEO position. Mr. Lauritzen was the 36-year-old former commercial manager of Dynagas Holdings LNG activities before he got tapped for this CEO position. It is his first job in that role. He has to be aware that CEOs who fail with their first chance, rarely get a second to head a company.
- Were Dynagas Holdings to take DLNG private, management members' options and common shares would likely become near worthless. Currently there's at least a faint hope management shares will recover one day, and more importantly for management, any new grants it gets are likely to be at very attractive prices. However, if DLNG no longer exists, it doesn't get those attractively priced new equity packages.
Why didn't the parent step in earlier?
First let me just restate the obvious, it is possible Dynagas Holdings is reluctant to step in either because it doesn't have or doesn't want to tie up the necessary cash flow. It's also possible the company is reluctant to increase equity ownership given it is already a 44% holder of the child. Additionally, DLNG already has a low 20 million share float worth $32 million; reducing it further would only exacerbate a thinly traded market cap problem they already suffer.
Further reading into the situation, I think it worthwhile to note Mr. Lauritzen's personal motivations may also have something to do with the matter. I'm just guessing, but Mr. Lauritzen may not be a member of the Dynagas Holdings executive team. He didn't have a C-suite title prior to being tapped for this CEO role. Thus, politically he may be reluctant to go to the parent for help. He may prefer to show that he can lead DLNG to succeed without parental help. Putting together an outside consortium of banks to deal with current challenges is exactly the kind of thing that helps prove senior management is worthy of running its own firm.
DLNG.pB has risks which we need to acknowledge, but I'd say the risk is worth the potential reward. A debt deal term sheet including continuing payment to the preferred is out to secondary lenders. This puts the pot odds in our favor.
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Disclosure: I am/we are long DLNG.PB, TGP.PB, TK. 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.
Additional disclosure: This article discusses thinly traded investments in the volatile shipping industry. I do not know your goals, risk tolerance, or particular situation; therefore, I cannot recommend any specific investment to you. Please do your own additional due diligence.