Blueknight Stock Offers Attractive Risk/Reward (NASDAQ:BKEP)

1.66K Followers

Summary

Blueknight, owner of various U.S. asphalt terminals, has received a non-binding offer at $3.32/unit from its General Partner.
This offer appears to undervalue the company and may not succeed.
Blueknight appears to be taking sensible actions to increase the value of the business; the infrastructure bill helps too.
The risk/reward seems favorable, the potential offer backstops the price, but there is material upside should it fail as it did in 2019.

On October 8, 2021, General Partner Ergon offers a cash purchase price of $3.32 per Common Unit (NASDAQ:BKEP) and $8.46 per Series A Preferred Unit (BKEPP) in a non-binding proposal.

A major shareholder (DG Capital Management) lists potential objections to that proposal here. The arguments, which are worth reading in full, are that the offer appears to undervalue the company, the bulk of the value appears to go to the preferreds and the offer may present conflicts of interest among other factors.

Nonetheless, though the offer may be disappointing, the setup for investors appears potentially favorable. I believe there is a non-trivial chance the offer fails and if so then Blueknight units may rally on a number of positive factors.

Will The Offer Fail?

Bear in mind that Blueknight is an MLP so unitholders have less protection than they might otherwise (and you also have to deal with a K-1 filing). Hence that maybe leans to a slightly greater chance of the deal succeeding when compared to shareholder protections in a traditional equity structure.

However, the last arguably low-ball offer from Ergon, back in 2019, was pulled a month later. Specifically, this was the explanation for pulling the offer.

After discussions with representatives of the Conflicts Committee of the Partnership regarding the Proposal, Ergon was unable to reach an agreement with the Conflicts Committee as to the transaction contemplated by the Proposal. Accordingly, Ergon withdrew the Proposal on September 11, 2019.

Note that DG Capital is again suggesting potential conflicts with the current offer among other things, though the non-binding proposal has remained for longer than last time. Three months and counting as opposed to one month.

Nonetheless, given the offer didn't proceed last time, there's a reasonable chance something similar happens again.

So let's look at what the units might be worth without an offer and with recent very positive newsflow.

Two Pieces Of Good News For Blueknight

So what is a fair price for Blueknight? Well since the non-binding proposal came in October, there have been two material, positive events for Blueknight.

Infrastructure Bill - November 2021

First off, a U.S. infrastructure bill came into law in November. If your company provides asphalt through terminals as Blueknight does, then infrastructure spend is a good thing in boosting demand.

Infrastructure means roads and runways, which generally require a lot of asphalt. The costs of the terminals are largely fixed, so more usage likely means incremental profits at improved margins.

Bolt On Acquisitions - December 2021

Secondly, Blueknight has a pretty clean balance sheet after selling its oil assets last year. That's great, but also posed worries about capital allocation.

Fortunately in December Blueknight announced plans to expand one of its terminals and buy another one. Though there isn't sufficient disclosure to assess the price paid, strategically, this is a sensible direction for the business.

They are apparently investing in more of what they know. They are leveraging existing expertise and customer relationships while building out their network. Hence capital allocation seems somewhat less of a risk than it could have been.

Valuation

Without an offer, Blueknight expects to do around $50M of EBITDA in 2021. Maybe the infrastructure bill increases that to $52M or a little more, and then maybe making use of the balance sheet for further bolt-ons improves the earnings power further:

Scenario	2021e	with infrastructure bill (passed in November)	with infrastructure bill and further bolt-ons
EBITDA	$50M	$52M	$62M
interest	$4M	$4M	$6M
capex	$6M	6M	$6M
preferred distributions	$25M	$25M	$25M
Free Cashflow	$15	$17	$25
@10% yield, 41.5M units	$3.61/unit	$4.10/unit	$6.02/unit

The above are hardly precise forecasts, but the direction is fairly clear. Given large fixed costs incremental growth disproportionately falls to unit holders. The infrastructure bill and bolt-on acquisitions make that incremental growth pretty likely.

Conclusion

So we have a situation where Blueknight common units may be acquired for $3.32/unit or may be worth a little more, to substantially more, than that if the non-binding proposal goes no further as it did in 2019.

That seems a decent setup, dead money in the base case, with a prospect of some potentially meaningful upside should no deal occur. Ideally you want to believe that there's perhaps a 30% plus chance that the offer fails for the setup to be interesting. I'm comfortable with that.

Risks

Ergon could of course pull its offer and maybe the units fall on the news. That's what happened in 2019, and indeed the market arguably wasn't rushing to fully value the units in 2021, though the price was on a clearly rising trend for much of the year.

Also, even if the deal succeeds a 2% return is definitely not worth getting excited about on its own and may present opportunity cost for investors.

Even though the December 2021 acquisitions seem strategically sensible, there's not sufficient detail to fully evaluate the price paid, management may have overpaid in a hot market or make less prudent decisions in future.

This is a relatively small company and just as small improvements help the common units, fairly small setbacks could be disproportionately painful.

Blueknight is an MLP with all the risk and complexity that that entails.

This article was written by

Rational Expectations

1.66K Followers

Value-oriented ideas and special situations, generally mid/small cap. Also, orphaned and unfashionable investment ideas, ideally with a catalyst and the prospect of asymmetric upside/downside payoffs. Contrarian tendencies. To some extent I'll go anywhere if it's cheap and I'm more influenced by momentum and quality than I used to be.

Analyst’s Disclosure: I/we have a beneficial long position in the shares of BKEP either through stock ownership, options, or other derivatives. 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.

Not intended as investment advice. Position may be updated without notice. Author's opinion only and may contain errors and inaccuracies which may not be updated. Investing involves risk of loss of capital. Seek professional advice.

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