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Finally, An Investment Idea (and not just talk about why no one is posting)

All

Since theres been a lot of argument about why no one is posting investment ideas rather than actually posting them, I thought I’d take the first leap. I have spent the last couple of days putting up an website (more like a blog) dedicated to investment purely to generating and analysing investment ideas. My first idea is not so new for most of you. Yes, Frank and Palantir, its OSG again. But atleast now that I have done a full write up on it you guys can rip it apart and tell me where my thinking went wrong and why the company is still a piece of Sh*t.

If anyone wants to become a contributor to the website, please let me know. I would be more than happy to put your ideas up there. Ill work on trying to give you user access so that you can post your own ideas at some point.

Heres a link to my website: www.thisisvalue.net

Guys, I am not joking about ripping it apart. The more brutal the better. But also dont forget give credit where its due.

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Great job on the write up. I understand that shipping is a cyclical business but how permanent is the pricing erosion in this industry? A decline of 95% in shipping rates leads me to believe there is a severe glut of capacity that will take a lot of global growth to absorb.

From a valuation perspective, unless you can buy 100% of the company and liquidate it based on the salvage values you mention, I would prefer to value the company on a cash flow basis. Do you have any forecasts of cash flow for this company?

If you are buying the company based on its salvage value, would you qualify it more as a speculation than an investment?

Thanks for the write up and posting this for others to comment on.

Good idea. I’ll look through it in detail, worst case it’ll be educational, best case, a good investment.

If I understand correctly, the cornerstone of your argument is that the value of the ships minus total liabilities is greater than the market capitalization, therefore it is a value play.

If I have that right, what sets them apart from other shipping firms? If you look at ISH or TNP or DSX it seems they all have that.

It may well be that the value of the ships is a lot less than what is listed on the B/S. These are big illiquid investments with a small market, so if all of them are on sale they may deserve a writedown.

Palantir,

You’re right. My analysis does lack some of my opinion on OSG’s size and market position. I think that is one of the keys as well. Just its ability to access credit during these times is quite a significant advantage it has. I mention in my analysis that a group of 5-6 banks are extending it a revolving credit facility of about $900m with an accordion feature to increase the line 1.25b. This is crucial in a cash intensive business like shipping where day to day operations require lots of cash.

The second aspect I didn’t cover was its diversifed revenue base. It operates diversified list of ships including crude and petroleum tankers, LNG vessels as well as a niche segment dedicated to US flag ships. The reason that segment is niche is because it is protected by the 1920’s jones act which requires all vessels carrying cargo between contiguous us ports to be US built, registered, operated and owned. It also requires the ships to be manned by US citizens and to fly the US flag. In effect it excludes all international shipping companies and ships not built in the US.

With regards to asset value - they would deserve a write down which is precisely why at 56% of the vessel value you get some margin of safety. Again, this assumes the value of joint ventures (which includes ownersship interest in 4 LNG carriers, 2 ULCC, 2 VLCC ) and investments in associated companies to be 0. It also excluded the current assets which were approximately $450m.

Finally, I should have been more explicit about my thesis and potential catalyst. Since operating ships is such a cash intensive activity many uneconomic operators lacking the financial wherewithal will probably go out of business or voluntarily put their ships in layup. Many of the new orders that are in shipyards will either be delayed or cancelled (the respective parties will find it cheaper to pay the cancellation fee than operating a vessel at below cost). Finally, the significance of escalating geopolitical tensions involving Iran and the rest of the world cannot be downplayed. It is a very real threat that has significant implications for the price of oil and by association freight rates for tankers.

are there buyers for these ships? my guess is not in the immediate or near distant future.

debt, too heavy, tough industry. yes cheap, but that is based on your assumption that these assets are even worth a fraction. stock might get cheaper. i have no expertise in this field but everything I see smells bad.

i’m impressed by your conviction. but there are at least 10 other names out there i would like more.

may the classy babes be with you.

I’m a little lost, you’re analyzing the firm both as a going concern and “dead” at the same time. Let’s divide those two scenarios.

If we’re looking at it as a “dead” company, we find that they’re a firm whose ship value - liabilities is greater than Mcap. The question is again ,what separates it from all the other firms that have this feature? Again, going by them as a “dead” company only.

Ok, lets just take a look at the others on the same basis using my definition of NAV (Vessels Value - All Liabilities).

ISH: That figure currently works out to $8.3/share which is currently selling for $22
TNP: The only one that can compete in that basis with OSG has a NAV of $14.15 and currently trading at $6.5/share
DSX - Nav figure comes to about 8.9 and it is currently trading for 8.4

Now ill explain my preference for OSG over TNP. Yes, we are looking at them from a dead company perspective but the probability of default is also a significant factor here (which is where my argument about market position and access to capital make sense). I consider a company like TNP to have a higher probability of default just because it doesn’t have the same size or access to capital that osg has (which can be vital during these market conditions). It operates just 8 tankers of which time charters on 2 are going to expire this year. That means roughly 25% of revenue might come under threat. By contrast, OSG has significant size and operates in several different markets crude, products, lng (rates here are moving in the opposite direction), us flag etc. and has massive amounts of liquidity at its disposal.

As you can see the other two just don’t have that cushion of asset value - DNX is selling at about value and ISH at about 2.5x (its share price reflects its better operating results)

Having said that, my preference of OSG is not an indictment of the other companies and my belief is that in general companies in this sector are being undervalued. However, I see OSG, one of the foremost players in its market with a better position than either Diana/ISH or TNP being valued as if it were about to go bankrupt.

Interesting enough idea. I’m still a little bit unsure of it, primarily due to my lack of knowledge about shipping - so I can’t really verify how much these ships are worth and how likely it is for this value to be realized.

If you’re really confident about this, I would submit it to Value Investors Club.

I ran across this article on Barron’s today. It sounds like Credit Suisse agrees with you.

Tanker Sector Begins to Bail Itself Out
“We are maintaining our Outperform ratings on Teekay (TK) and Overseas Shipholding Group (OSG) and our Underperform rating on Frontline (FRO).”

Full Article:
http://online.barrons.com/article/SB500014240527487049124045771732321446…

lets wait and see what happens here…..I think Uber is a convinced buyer…..

BI has a decent article on the Baltic Dry Index today:
http://www.businessinsider.com/the-truth-about-the-massive-plunge-in-the…

Oy any new small cap ideas? I’d like to order a small cap. Just a normal small cap though, no special situations.

I get the discount to NAV thesis, but I think one key you need to figure out here is whether the debt load is too large to threaten the survival of this company. Debt/Equity at over 100% is bad for any industry, and it only looks good in relative terms because shipping is such a highly leveraged sector. This is especially true for a company that is currently losing money on and cash flow on current shipping rates. Pull up a chart that shows their quarterly cash balance, debt load, equity etc and you’ll see what I mean. I’m not saying this is not a good investment but you need to figure out how long you think the shipping market will remain depressed and then check to see if OSG will be able to survive to see that. Check their contract coverage and spot exposure to shipping rates to see what the operating leverage is. If they have high contract coverage but most are rolling off this year then they are in trouble, if they have high spot coverage then things probably can’t get that much worst and probably offers more upside if the shipping market recovers (but of course if market falls further they will get toasted even faster).

Remember that asset value is not static , if shipping rates remain in the slumps, asset value will follow soon and given the highly leveraged nature of the NAV a 10% change in ship value could wipe-out a large chunk of your margin of safety.

I can name a few cases over the last 12 months where shipping companies are trading at deep discount to NAV, only to see the equity get wipe-out because asset value is declining, debt piles up, and any margin of safety gets wiped out. General Maritime, Torm, Eitzen Chemical, Frontline etc.

Zuran, good insight on checking the liquidity of the company……..

they just discontinued their Q1/12 dividend (Feb 9th) so what we were previously alluded to is comign to fruition……

yesterday the company announced a shelf registration to issue stock etc which suggests liquidity is a concern for them….

good luck to the buyer…..may the classy babes be with you….

Zuran

Solid insight. Like I have mentioned before there is no question about there being a tough environment where cash flows are negative. This points to higher liquidity needs that can only be met by higher debt levels which is standard and expected. Second, I dont expect things to go back to normal overnight i.e. this year is not going to bring any relief. Operationally I think OSG has seen its worst. For example in their tanker business from 2010 to 2011 the average revenue days per vessel operated went from 270 to 90 days which indicates that they have taken the bulk of the hit to their cash flows. While you are right about declining cash balances and debt increases there are some things that I believe protect the business.

A crucial point is that their market positions gives them much better access to liquidity than other companies in a similar situation. Like I mentioned in my write up they have secured a revolving credit facility for next year of $900m with an accordion provision to increase it to $1.25b. A group of 5 banks have offered this to them. For banks to offer such generous amounts of liquidity on unsecured terms could only be for two reasons: 1) they believe the company’s credit to be solid 2) they have more to loose from the company going under.

Recently, I spoke to a friend who works as an operations manager in a tanker company in the UK. He suggested that rates were high enough to meet operating expenses for most tankers. He went on to say that most banks grant companies holidays on their interest payments as bankruptcy would prove worse for banks than it would for the companies. 

It is important to note that this is not the first (or last) trough that has been seen by OSG or the industry in general. OSG has withstood 3 or more cycles atleast since its been a publicly listed company and has come through them. 

Another very interesting thing about OSG is their diversification of vessels and business segments. They operate not only oil tankers but LNG gas carriers (some of the highest spot rates currently) and product tankers . Another major segment of operation for them is their US flag segment which is protected by the Jones Act. Apparently, cargo being carried from one port to another in the US must be carried in ships built in the US, flying a US flag, owned by a US entity and crewed by US citizens. 

Finally, another thing I mentioned is the implied value that the principles believe the company is worth. Many of them have been buying every since $17 levels. Thats is something you cannot ignore.

you really fell in love with this company………what price did you get in on this at?

ubermench, you have done much more work on OSG than I have (basically none) so having conviction on the work you’ve done is good.

I would just point out more things you can check:
- capex commitment. Often this is hidden debt for shipping companies with a large orderbook. Sometimes credit lines are earmarked to finance the orderbook and cannot be used operationally.

i doubt at this time any of this will change his mind…he is in love with the stock….blinded by passion…

Frank,

You’re right. I have blinded myself. I think its because of all the defending I have had to do in the face of criticism. There is a very good chance that things can get worse operationally. In fact I was thinking of taking your advice and entering on the debt side. Its 2024’s are selling at 62 and 2018s at 71.5 yielding approximately 14.15% and 15.5% each. Do you think it will be a better risk than the equity? Either I will get paid or wont - that prospect is more attractive.

Zuran,

Very good observation, I will have to look at how much of their orderbook they need to pay off. 

There is a thin line between having conviction and being blinded by passion, a good investor knows how to balance between that line but most of the time it is not obvious to an outsider whether it is conviction or blindness so we need not to be so harsh on ubermensch. Seth Klarman puts it best

“An investor must have more confidence in his or her own opinion than in the combined weight of all other opinions. This borders on arrogance, the necessary arrogance that is required to make investment decisions. This arrogance must be tempered with extreme caution, giving due respect to the opinions of others, many of whom are very intelligent and hard working.”

I think that you need to be intrinsically arrogant to be an investor, aka you really need to believe you have the abilities to better everybody else in the markets, yet when you actually look at data I think you need to be pretty dispassionate. That’s part of why I don’t think it’s a great idea to grill someone about his stock picks, because the natural tendency is to get defensive and end up “pulling” for your stock.

Personally I have no idea about OSG, but I hope it works out for you.

Zuran is too a value guy like us….and very astute……

I know some ppl who put a lot of time in than refuse to let go of the idea…they tell me “i put x amount of time, and it got nowhere”….part of the game is saying “no” even after putting in a lot of time….i normally go through about 10-15 companies after filters before making a buy……..

FrankArabia wrote:

….part of the game is saying “no” even after putting in a lot of time….

This. I have maybe about 3 actionable ideas a year, that’s after searching daily……….which is probably extreme but I’m very picky.

i am in the same boat right now….i think i’ll go back into a name I bought earlier this year….TEVA….earnings came out today and its good from where i am standing…..

Teva looks promising, and they have good growth in FCF, the thing that turns me off about them is their long term trend in ROA, it’s erratic, I’d like to see it go up smoothly, which I believe to be a good indicator of management judgement in reinvesting cash.

you have to do some adjustments and understand the business to use those ratios as they’re not a one size fits all. if all you’re doing is going to the financial engine and running on ratios, that’s only 5-10% of the work. I use to do that too, look up the ratios and check to see how nice they look. high ROEs, low book, low p/e, growth in revenue etc. 

On the investment here, they have a tendency to pay high multiples for strategic assets where they believe will pay off in the long term (ratiopharm, taiyo, celp, barr). yes, they paid a lot but its to capture market share and establish themselves in a market some (including myself) feel its growing. if you look at their b/s, its filled with GW/Intangibles. essentially, this is not an “asset heavy” company though they do have distribution/manufacturing plants. the ROA is erratic due to growth in the company’s assets and the way GAAP records its earnings from M&A (inventory expenses, research in progress etc) activity. 

I dont disagree, part of why I didn’t bother to go too deep into it is because these pharma firms use (as you noted) acquisitions as a form of research. IMO then those acquisitions need to be added to CapX when calculating FCF, which makes their free cash flow a lot less impressive.

I disagree…..easy just to use standard formulas but once again, gotta understand things…..Capex is for sustaining current period results, not growing them. 

would you consider GOOG’s acq of motorola, or MSFT acquisition of SKYPE as a part of Capex? its the same thing really……getting into emerging industries, markets etc to drive growth leveragining organic fundamentals…..

Yes, I definitely consider Skype acquisition a form of Capex. I was just about to mention that as an example.

Motorola though is a different story, I wouldn’t be able to evaluate that, so I can’t say for sure.

It’s a grey area for sure, but in my view if they’re buying companies just to get a toehold into nascent markets, then it’s research.