Brief Background & Executive Summary
Teekay Corp. (TK) is the general partner and largest unitholder in Teekay LNG Partners (TGP). Both firms have been heavily embattled since a major distribution cut in late-2015. TGP was forced to slash their dividend payout from $0.70 to $0.14 for 3-years in order to self-fund the entirety of their massive growth program. They have now concluded nearly $3B of newbuild financing and debt refinancing and the growth program will be fully complete within the next 4-5 months.
TGP controls the world's largest and most modern publicly traded LNG shipping fleet. They have a backlog of $10B of highly lucrative contracts. There is very little uncertainty in future revenues as TGP has locked up 96% of their LNG fleet on strong employment through the end of 2021, and a high proportion of their fleet is employed for a decade or longer. TGP is a world-class company and trades at a significant discount to its closest comp, GasLog Partners (GLOP) despite owning a vastly superior fleet and touting a revenue backlog that is over 700% larger.
TGP is a phenomenal value and future income play, and it is one of my larger positions; however, the most significant upside rests with the parent Teekay Corporation. TK has practically complete control of TGP via their general partner stake, which comes with incentive distribution rights ("IDR"). These rights entitle TK to a large slice of TGP's future payouts, which could theoretically resume as soon as TGP finishes delivering their growth program.
Tremendous Upside Via the GP/IDR
At a current pricing of $3.45/sh, the market is ascribing nearly zero value to the GP/IDR. With FPSOs valued at $150M (a massive haircut from valuations in the $400M range just a few years ago) and owned Teekay Tankers (TNK) shares and TGP units carried at market, TK would be worth around $3.10/sh.
The market is giving TK about a $30M valuation for what is arguably their most valuable asset. I've previously argued there is significant value here and we've reviewed over a dozen midstream transactions that prove our case. However, we've previously lacked a direct maritime MLP comp... until now.
In two transactions, executed in November 2018 and June 2019, GasLog Partners has bought out their IDR from parent GasLog (GLOG). The valuation methodology used to justify the transaction was:
Immediately accretive to distributable cash flow per LP unit
Utilizing the exact same valuation multiples from the GasLog transaction and applying them to Teekay LNG Partners implies a mid-2020 Teekay IDR exchange valuation of between $500-$700M. To meet the mandate of immediate per-unit DCF accretion, the deal should likely be structured as a combination of a cash payment to TK and the issuance of new TGP units.
The Teekay exchange is likely to be an even better deal for TGP than the GasLog comparison to GLOP because I expect Teekay to completely eliminate the GP holding and transition into a full C-Corp structure. This would differentiate Teekay from its peers and arguably drive premium valuations.
TGP Trades at a Steep Discount to GLOP
Even without a premium for a superior corporate structure, if TGP was simply valued on the exact same DCF multiple as GLOP, the units would trade near $25 now and at $30 in 2020. If we utilize an EV/EBITDA multiple (which normalizes for higher leverage), then TGP would trade near $27 today and into the upper-$30s in 2020 (see assumptions below).
GLOP must be a far superior firm to TGP right? A casual reader could be forgiven for making this assumption, but the only advantage GLOP currently offers is its high payout ratio and distribution. Teekay has the far superior fleet size, fleet modernity, and contract backlog. Additionally, TGP self-funds all of its growth while GLOP is captive to GP dropdowns at premium prices. If TGP hits even the lowest GLOP comps, they have nearly 70% upside.
TGP: '19/'20 EBITDA- $650/$725M, Net Debt- $4.6/$4.2B, DCF- $240/$290M
GLOP: EBITDA- $230/$240M, Net Debt- $1.13/$1.1B, DCF- $230/$240M
Despite the plethora of evidence I've presented about the proper full valuation of GP/IDRs, there have been two major critiques from skeptics of Teekay:
- The majority of these comp transactions have been pipelines or other longer-lived land-based assets, not shipping (ignoring the Golar reset).
- Teekay deal would be based on DCF, not actual payout levels.
Critics of Teekay's valuations claim the IDR is wildly out of the money, but this ignores the fact that payouts are simply a capital allocation decision and TGP is taking a conservative route for now. Those who subscribe to this logic would say that if TGP paid $0.19/qtr, the IDR is worthless, but if TGP raised their payout to $0.70/qtr the next quarter, then the IDR is worth around $400M? Wild isn't it? Sadly some analysts actually think (and model) firms this way.
Our view has always been that in a buyout/exchange transaction, IDRs should be based on the potential for payouts rather than the trailing distribution. This is the logical way to value the rights to a future stream of cash flow.
TGP Upside & TK Implications
We've proven that TGP is significantly undervalued to its closest comp despite having the superior structure, fleet, and contract backlog. This is due to a temporary dislocation caused by income investors who haven't looked much deeper than the current yield. These same investors are naturally skeptical of Teekay due to their poor communication and forward guidance clarity.
TK already owns 25.2M common units of TGP. If TGP reached even the lowest-tier of its valuation comps ($25.22), TK would gain over $2.50/sh in value (forward value of nearly $6/sh for TK). If Teekay further exchanges its GP/IDR on the same exact metrics as GasLog, I anticipate they could realize between $500-$700M in value (detailed calculations further below). Even the lowest end of the IDR valuation drives a potential mid-2020 TK valuation in excess of $10/sh, nearly 200% upside.
With GasLog paving the way, Teekay recently resetting the TGP Board, and CEO Hvid pointing towards "maximizing the value of the IDR," I expect we'll see a favorable resolution much sooner than previously expected.
IDR Valuation Methodologies
The rest of this report takes a technical turn to review the specifics of the GP/IDR exchange deals and to drive a direct comparison to the recent GasLog deal. It makes sense to first review the TGP IDR to illustrate TK's potential future right to significant cash flow. As shown below, the more TGP pays out in the future, the higher the proportion received by TK. The real bonanza kicks in when distributions exceed $0.65/qtr.
Source: Teekay LNG Partners, 2018 Annual Report, 20-F page 73
If we project DCF through 2020 and 2021, TGP could easily pay close to $0.75/qtr if they utilized the same payout levels as GLOP. I expect TGP to produce a baseline average of $280-$300M of DCF, starting in 2020 and running to at least 2022. With 75M units and a 95% DCF payout from the midrange DCF ($290 x 95%), TGP could theoretically pay out $275M per year. This payout zone is referenced below with the yellow shading. In this scenario, TK would receive $48M per year from its IDR alone.
If LPG rates improve further and interest rates trend lower, the higher-end of DCF could reach a peak of $310-$320M during 2021-2022. This high-end potential is referenced by the green shading and TK would receive over $63M.
Source: Internal calculations by Value Investor's Edge, IDR info per 2018 20-F
A Shift in Tide, Almost all Firms Abandoning IDRs
The GP/LP and IDR structure have lost favor with most investors and the majority of companies have eliminated these arrangements via an 'IDR buyout' structure. There have been dozens of these transactions across the past 2-3 years. The average paid multiple has been 12-16x IDR flows on peak payouts. If these exact same multiples were applied to Teekay, we would see the following valuations. Even applying a super conservative 10x multiple to the $0.75 payout still results in nearly $500M.
Source: Internal calculations by Value Investor's Edge, IDR info per 2018 20-F
These aren't wild hypotheticals. There are dozens of transactions to look through. Virtually every MLP deal on record has comped on this range, and a recent presentation by Antero Midstream (AM) illustrates this trend. GasLog and Teekay were some of the last holdouts and GasLog has now moved.
Source: Antero Midstream, May 2019 Presentation, Slide 32
The Perfect Comp Arrives: GasLog Deal
Although those two critiques have carried weight with the market, the recent IDR payout by GasLog has completely shattered these mythical views. GasLog first reduced the top-tier of their IDR from 48% to 23% (effective 50% to 25% including the 2% GP interest) in exchange for a $25M cash payment last November. On 24 June, GLOG announced the receipt of 2.53M units and 2.49M Class-B units in exchange for eliminating the remainder of the IDRs. The GasLog 'defense' and rationalization of this deal is shown below:
Source: GLOG, 24 June 2019 Press Release, highlights added
This deal directly attacks the final two roadblocks for properly valuing TK:
- Clear Comp: GasLog is a "marine MLP," it is impossible to get closer.
- Structure/Logic: "Accretive to distributable cash flow per LP unit"
GasLog Valuation Multiples
GLOP paid a combination of cash and new units:
- $25M Cash
- 2,532,911 Common Units - $53.1M @ $20.96 close
- 2,490,000 Class-B Units - $52.2M @ $20.96 close
- Deferred/Missed Payouts - Negative $19.2M over 6-years (0% discount)
The 0% discount rate is extremely generous and, in theory, would be the same 2-4% to match guidance for future raises, but I'm doing my best to not overstate the discounted comp valuation of $111.1M ($25 + $53.1 + $52.2 - $19.2). Without adjusting for future payouts the comp would have an undiscounted value of $130.3M.
How does this compare to GLOG's share of DCF? First, let's review their own incentive distribution structure prior to recent changes:
Source: GasLog Partners, 2017 Annual Report, 20-F Form, page F-26
GLOP's latest reported DCF (Q1-19) was $27.5M and the Q4-18 reported DCF was $31.4M. If we account for one-time adjustments and slight forward growth (GLOP guided 1.13x proforma coverage versus $27.5M at 1.03x), GLOP could arguably produce forward annualized DCF of about $120-$121M prior to new dropdowns.
As of 31 March, GLOP had 45.35M common units and 927.5k GP units. If they distributed the full $121M forward payout, this would be $30.25M per quarter:
- Minimum to First Target: $0.43125 x 45.35M / 98% = $19.96M Total
- 2nd Target: ($0.46875 - $0.43125) x 45.35M / 85% = $2M Total
- 3rd Target: ($0.5625 - $0.46875) x 45.35M / 75% = $5.67M Total
- Balance for Thereafter: $30.25 - ($19.96+$2+$5.67) = $2.62 Total
The GasLog transaction does not eliminate the 2% GP share, so we only look at the 13% slice of $2M ($260k to IDR), 23% slice of $5.67M ($1.3M to IDR), and 48% slice of $2.62M ($1.26M to IDR).
GLOG's expected IDR flows under 100% of forward base DCF would be $2.82M/qtr or $11.28M/yr. The deal was done for 9.85x *peak DCF* discounted for Series-B or 11.55x without.
At first glance, we see a range of 9.85-11.55x as much lower than land-based comps in the 12-16x range; however, keep in mind this done at peak-DCF with 100% payout ranges. Also, keep in mind the GP remains intact at GLOP, unlike the majority of land-based comps which merged the parent into the daughter.
If we attempt to value the recent exchange based upon the actual current quarterly payouts of $0.55 ($5.56M to IDR), the adjusted multiple range is 19.98x to 23.43x of current IDR flows. This method is actually even higher than most land-based comps, but note the justification was clearly based on DCF, not the payout levels. As I've stated repetitively, the proper approach is via DCF (potential) because payouts are simply a capital allocation decision.
Full-Circle: TGP IDR Valuation
The GLOP deal gives us the green light for a perfect comp to TGP/TK. The DCF illustration and breakdown is irrefutable. The only point of contention is TGP's precise DCF for 2020-2021. I expect $280-$300M baseline, but TGP's TTM DCF was $178M and the Q1-19 annualized run-rate was $217M, so I realize this is contentious and accounts for high-margin DCF on remaining growth, Awilco normalization, and LPG stability.
We arguably have the perfect framework for valuing the IDR, but we do need to wait for the 'proof' of the forward DCF. This is more difficult because TGP has done a very poor job of providing forward guidance for this metric. Their reported DCF is also artificially low due to a payout deferral agreement with Awilco (ref: 2018 Report Filing, page F-22), which will expire in December.
What is TGP's IDR worth at the lowest DCF range of $280M?
$280M in annual DCF would be $70M per quarter. The TGP IDR as a reminder:
Source: Teekay LNG Partners, 2018 Annual Report, 20-F page 73
With 75M total units expected by 2020 (per active TGP repurchase), we can calculate the payout math in a similar fashion as GasLog:
- Minimum to First Target: $0.4625 x 75M / 98% = $35.4M Total
- 2nd Target: ($0.5375 - $0.4625) x 75M / 85% = $6.62M Total
- 3rd Target: ($0.65 - $0.5375) x 75 / 75% = $11.25M Total
- Balance for Thereafter: $70M - ($35.4+6.62+11.25) = $16.73 Total
With the 50/50 Split starting at $0.65, TGP could pay $0.76/unit off $280M DCF. With $300M DCF ($2.5M/qtr more for both common & GP), TGP would max out at a peak of $0.80/qtr. At $320M DCF: $0.83/qtr.
In the most conservative $280M DCF scenario, TGP would be entitled to $12.9M per quarter or $51.5M per year.
$51.5M versus the most conservative discounted 9.85x multiple? *$507M*
In the more aggressive $300M DCF versus 11.55x multiple? *710M*
Path to Exchange?
The key requirement, as dictated by the perfect GLOG/GLOP comp, is that any transaction must be accretive to per unit DCF. If we utilized the $507M comp against the current TGP pricing of $14.91 and we did a pure unit exchange, this would give 34M new units. Obviously not accretive as the GP's share of total cash flow in the $0.76/qtr payout regime would be approximately 18.2% (81.8% payout to the common units).
Thus the new units issued would be capped at 16.7M. ((75M / 81.8%) - 75M). Under the $300M DCF scenario, the split/cap would be 20.8%, which with a starting point of 75M and the same math, would result in a new unit cap of 19.7M units. Since we believe TGP units are wildly undervalued, it is clearly in TK's interests to maximize their comp into units; however, since TK is also likely to eventually wind-up their operations and they need to eventually repay their recently issued debt instruments, some measure of cash would be helpful.
The rough range of $500-$700M might make sense based on the GLOP comparison, but that deal was 77% in equity ($25M cash and $86M adj. units), and GLOP trades at steep valuations. Again, to remind readers, if TGP traded at the same valuations as GLOP, we could see the following levels:
If we take the $280M DCF exchange value of $507M and divide that by the implied 2020 TGP DCF valuation of $30/sh, then we end up with 16.9M units paid to TK. If we take the $300M DCF exchange value of $710M and divide by the peak implied TGP valuation of $37.00, then we end up with 19.7M units paid to TK.
This 16.9M aligns almost perfectly with our calculated cap of 16.7M. The 19.7M comp also lands nearly perfectly next to our 'DCF test' cap of 19.7M. GLOP's deal was also above the cap, without the funky 'Series-B' units, the exchange would have been slightly dilutive. These delayed payout units enabled the management team to make the claim that the deal was "immediately accretive to DCF." It's only accretive under the assumption that base DCF grows faster than the Series-B conversions...
So what about the cash component? We'll benchmark that perfectly also. GasLog did essentially a 77% adjusted equity component and a 23% cash component. If we take the $507M off $280M DCF, we end up with $117M cash payment ($507M x 23%) and 13M units issued ($507M x 77% / $30/unit implied TGP).
If we take the $710M off $300M DCF, we end up with $163M cash payment from TGP to TK and 14.8M units issued (at a $37/unit valuation). Both of these will pass the DCF test, both of these are fair to TK, and both of these are "immediately accretive" to DCF. In the first exchange ($280M DCF scenario), TGP's per-unit DCF would rise from $0.76 to nearly $0.80/unit ($280M DCF / 75M + 12.8M). In the second exchange ($300M DCF scenario), TGP's per unit DCF would rise from nearly $0.80 to well over $0.85/qtr.
The Significant Upside to Teekay Corporation
Thanks to the irrefutable GasLog comp, we've concretely proven that the TGP IDR carries a massive value for TK. In fact, the Teekay exchange would be worth even more than the GasLog exchange, because it would eliminate the GP completely and transition TGP into a C-Corp with zero remaining parent overhang.
As illustrated, the GP/IDR is worth between $507-$710M in notional valuation, or roughly $5-$7 per share of TK. Furthermore, TK owns 25.2M units of TGP, which we carry at $14.91 in our current models. If TGP traded up to its 'implied fair value' of $30/unit, that's another nearly $4/sh per share of TK.
I believe TK is one of the most mispriced stocks in the market today, hurt by years of struggle with their embattled offshore spin-off Teekay Offshore (TOO), distracted by the weak tanker daughter Teekay Tankers, and busy pushing TGP to the finish line. It certainly doesn't help that TK's main fully-owned assets are 3x FPSOs with questionable valuation.
Time for the One Analyst to Come Around
There is only one analyst who covers TK, Michael Webber of Wells Fargo, and he hasn't updated his models accounting for the GasLog comps yet. Once he runs the numbers, I expect he'll arrive in a similar ballpark. Michael will be able to benchmark the deal correctly and once he shifts his models from the previous view of 'current distribution' to the correct logic of 'DCF per unit,' I suspect he will come to very similar conclusions. To be fair, before the GasLog deal, it was a legitimate challenge to properly benchmark this asset.
Will analysts (analyst?) finally change their tune? Will TK management gain some charisma and get out there and get the job done? I've placed my bets and I suspect we'll see a very lucrative exchange completed no later than mid-2020. TK has all of the control here, they've recently stacked the TGP Board in their favor, and the comp valuations are extremely clear.
Risks to the Thesis?
There are three primary risks to the thesis.
- Our DCF estimates could be slightly high (I expect $280-$300M in 2020)
- Management could fail to fight for proper value and deliver mediocrity
- TGP conflicts committee could drag this on and fail to accept GLOP comps
1- Our DCF estimates could be slightly high. Although this doesn't change the idea of the comps and exchange, even $20-$30M of lower DCF makes a tremendous impact on valuations. As we noted, $280M is worth $507M while $300M is worth $710M. Under the same metrics, $250M DCF would be worth upper-$300M. Still a large value, but a few bucks of downside.
Even a big DCF undershoot still results in significant upside to TK, especially when you factor in the huge TGP unit discounts versus GLOP, but it is definitely a risk to valuations. In a $250M DCF scenario, TGP is worth closer to $25/unit and TK is worth around $8/sh.
2- Management could continue to deliver mediocrity. TK understood the value of their GP/IDR back in 2016 under Peter Evensen, but over the past few years, they have absolutely failed at public relations, lacking any spine until the very recent Board cleanout and a halfway decent statement on 14 June. It looks like they are finally turning a corner, but we've been let down before.
Source: Teekay Corporation, 14 June Press Release, highlights added
After years of silence, management finally outlined their goal, but the market yawned. Too little, too late? GasLog has literally handed them a victory on a silver platter here. Will Kenneth Hvid and crew finally step up to the plate?
3- TGP's conflicts committee could fail to agree to a fair deal. The evidence is clearly in TK's favor. Any person who rejects the idea that TGP's IDR carries massive value is shoving their head in the sand and ignoring dozens of other comps including a perfect Marine MLP transaction paved by GasLog; however, there is the general nonsense, which I've heard parroted by other analysts that "TGP's IDRs are wildly out of the money." This is only true if we look at the latest $0.19 payout and completely ignore DCF potential.
If the conflicts committee refuses to value TGP on DCF, then there's only one way out. TK will be forced to drive TGP's distributions up in late-2020 or early-2021 and then come back each quarter with a deal to exchange the GP/IDR. This isn't a healthy approach, so I expect we'll see some rationality. GasLog handled their exchange in a win-win fashion by issuing part of the units in a 6-year deferred fashion. Teekay could handle their deal by taking a larger percentage in cash or by accepting a slightly smaller ratio in good faith.
Conclusion: Fair Value Estimate (TGP- $25, TK- $9)
I believe the proper way to value TGP is either based on EV/EBTIDA or based on DCF-yield to comps. In each approach, TGP is worth $25-$27/unit today and worth $30-$37/unit in 2020. I personally hold TGP with a 'fair value estimate' of $25/unit, 69% upside.
Depending on how large of a valuation TK can achieve for the GP/IDR and where TGP eventually trades up to, TK is worth somewhere between $8 and $12/sh in 2020. This includes a lowball $150M FPSO valuation and holds TNK steady at its current valuation of $1.30. My current 'fair value estimate' for Teekay Corp is $9.00/sh, 161% upside.
Record Value Opportunity
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Disclosure: I am/we are long TK, TGP, GLOG. 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: I collaborate with James Catlin on a Marketplace service.