Investment Thesis

This is a recommendation to Buy shares of Oslo-listed Aker Philadelphia Shipyard, ticker AKPS NO Equity on blooomberg.  My guess is that I wish I could received $1 for every Q&A comment on regulatory risk -- specifically the oil export ban and the Jones Act.

Aker Philadelphia Shipyard (or “Aker Philadelphia” or “AKPS”) possesses many of the attributes of a lucrative value stock:  a company majority owned and controlled by a rags-to-riches risk-taking Norwegian high school-dropout-with-Dyslexia-turned-billionaire-tycoon, accounting results that materially obfuscate the business trajectory, domestic small capitalization traded on a foreign exchange, confusing ownership structure with several brother/sister companies, still largely owned by a foreign entity (~70%), significantly underreported backlog on a contract dollar basis, shift in business model that will drive significant earnings growth – and into a business line where earnings are valued at a higher multiple, with near-term catalysts of soon-to-be-initiated dividend payments on common shares and Apollo recently acquiring 12% of shares that further tighten float given they're not traders.  Tickers are AKRRF in US OTC (very, very illiquid), and AKPS in Oslo.

Also, a profit-share agreement resulted in the entire PV of a signed thee-year charter being recognized in Q3 ’12, and no revenues thereafter until a new lease is signed at expiry, despite disclosed $2.9mm/year in cash receipts from this arranged over next 3 years (3yr lease at  ~$60,000/day rate).  This arrangement is on the two ships (17 and 18) built on spec that Crowley purchased, as the profit share is reported on a present value basis for life of the leased time charter ($3.3mm in Q4 ’12 for vessel 17 and $3.2mm for Q1 ’13 for vessel 18).  Discount rate here is roughly 10% based on investor ppt that shows $2.9mm/year total for both ships, quarterly reports indicate these were signed for 3 years.  Releasing these at $80,000 rate at the end of their term would triple annual profit share from $2.9mm to $9mm/year.

•  Ownership and control. Aker Philadelphia is 71% owned and controlled by Aker through Converto Capital Fund.  Aker is a Norwegian conglomerate largely owned and controlled (67% ownership), a Norwegian billionaire – 55-year old Kjell Rokke – ranked #458 globally on Forbes list.  Aker ASA has reported NAV of about $3.5B in USD (at USD:NOK of 0.16), with “financial investments” representing about a third of that value, or $1.2B and Aker Philadelphia representing ~$200mm at today’s ~USD $30/share (NOK 180/share).  Aker ASA has numerous investments in “Aker”-named operating and controlled financial investments.  Market cap is $320mm USD at current share price of roughly $30/share USD, given 10.7mm shares outstanding.  Other entities that Aker ASA has interest in include Aker Solutions and Aker Biosciences, and Aker ASA itself is traded in Norway as well. 

• So Who is Kjell Rokke? According to the book “Billion-Dollar Fish: The Untold Story of Alaska Pollock” by Kevin M. Bailey, Rokke grew up in Norway and was a high school drop at age 16 who suffers from Dyslexia.  As the story goes, his parents, fearing he was heading nowhere in life, landed him a job on a fishing boat.  He worked his way up the responsibility ladder and ultimately emigrated to the US and bought his first boat in 1982, utilizing Pollock fishing skills he had acquired in the Bearing Sea.  The book cites Rokke as one of the earliest to convert American built tankers to Pollock trawlers and processors (the conversion apparently was done abroad, at a cheaper cost, while still complying with US legislation once converted), which became the backbone assets of his company American Seafoods.  Rokke is described as a risk-taker:  His American Seafood company was entirely leveraged to the success of the Pollock fishing industry (Pollock is used in all fast food fish offerings: patties, fish sticks, popcorn fish, etc – no disrespect to tuna, it’s the chicken of the sea) which took off, and as another example in 2011 he recapitalized Aker Philadelphia and ordered 2 ships to be built on spec at a time when day rates and demand were so robust – this is the controlling shareholder and it should not be forgotten that he’s been both lucky and good.

• Back to Aker Philadelphia.  In 2011, Rokke installed his son, Kristina Rokke (27 yrs old at the time), as CEO of Aker Philadelphia.  Kristian Rokke is a US citizen, born in Washington state, and is currently attending Wharton’s Exec MBA program, and worked at the Shipyard in white collar roles since 2007.  His prior schooling includes Colby College for Undergrad, as well as London School of Econ and Norwegian School of Management.  He/the company is humble enough to attribute much of the company’s recent good fortunes to luck, “Some say, “Better lucky than smart.” Although we rely on in-depth analysis and hard work rather than luck, there is probably some truth to the saying in this event. Regardless, it all came together positively for our stakeholders…” (2012 Annual report, page 7) but remains committed to maximizing the opportunity by continuing to move down the cost curve with each produced vessel.  There is plenty of press on the younger Rokke, especially on his taking the helm at AKPS, here’s a decent article: http://articles.philly.com/2011-05-22/business/29571380_1_aker-asa-kjell-inge-rokke-vessels

Shipbuilding business strong, with visible trajectory -- significant backlog through 2018.  AKPS’s shipbuilding operations are backlogged through end of year 2018, with 2 container ships on order from Matson.  On a dollar basis, this backlog (including recently begun Hull 21 for the first of the 4 vessel Crowley order) represents $1.4B or $1.2B net of AKPS’s $115 in the first $500mm 4-ship order for Crowley and same math for the next 4 on option.  This is roughly half of the officially reported backlog of $654mm as of Q3.

• AKPS plans to pay a dividend out of its 2013 account and to continue that practice thereafter.  Zero sense from discussion with CFO as to how much, but company could easily support 1.5% yield on today’s market cap (~$300mm) without incurring debt and still servicing capital plans including the $115mm investment for Crowley JV.  The company has YTD FCF of $37mm and is doing $5mm-$6mm EBITDA/qtr on $50mm of revenues.  AKPS has Q3 ’13 net cash of $46mm (cash + restricted cash less customer advance, less debt, less payables & accrued expenses).  All of this is in the context of a company with a market cap of USD $300mm (at ~$29-$30/share).

• Also, Apollo acquired a 12% stake in the company in Oslo, from another financial holder (QVT Financial) – notably, not from Rokke/Aker ASA.   Apollo’s stake was mostly acquired through its Special Opportunities Managed Account or “SOMA” in its filings.

Company Overview

Aker Philadelphia shipyard is one of only two Jones Act shipyards currently capable of producing oil tanker ships.  The other is General Dynamics’ NASSCO shipyard in San Diego.  The shale-driven growth of U.S. oil production has driven down the price of LLS relative to Brent, especially as most of the supply infrastructure sends high quality crude oil from the Bakken (Jan 2014 production of 1.01mm bopd, up 32% YoY based on EIA data), Eagle Ford (Jan 2014 production of 1.25mm bopd, up 49% YoY), and Permian (product of 1.37mm, up 7% YoY)  to various Gulf Coast ports, where Refineries have already maximized their input for these oil stocks.  The Jones Act, signed into law in 1920, has for nearly a century mandated that any domestic port to domestic port shipping be conducted on U.S. owned, U.S. built, and U.S. crewed ships.  Moreover, the crude oil export ban leaves nowhere for the excess supply to go but to be shipped around to west and east coast refineries (where the product now comes in cheaper than world prices). 

Aker Philadelphia is located in the Philadelphia Navy Yard section of Philadelphia, south of center city near the sports complex district, along the Delaware River.  To refurbish the neglected yard, various government entitites collectively invested $438mm to modnernize and AKPS invested $135mm.  AKPS leases the yard on a 99-year lease, for $1/year!!! (source: http://articles.philly.com/2010-12-31/news/26356634_1_aker-philadelphia-shipyard-state-aid-navy-yard) As part of the Master Lease Agreement AKPS must maintain at least 200 employees.  As of 2012 year end the shipyard had 984 employees split roughly half between direct and subcontracted.

Then and Now… 1997 vs 2013 (with help from subsidized government money).  Any devout Eagles fan has noticed these blue davits just off I-95 near Philly sports complex section of town:

Aker Philadelphia has the capacity two build two vessels per year, with current backlogs through 2018 totaling more than $1.0B (although the company reports a backlog of half that amount given the next 4 Crowley ships, 25-28, are an option).  On 1/6/2014 the company announced commencement of construction for the Crowley JV partnership – where Aker will invest in 25% of the cost of the ship and retain half of the economic interest in future shipping revenues produced by the vessel.  The company is currently finishing the second of two Aframax vessels for Seaway (Exxon) that will be heading to the west coast to ship crude from Alaska – the two ships are being booked as a single project with 55% completed as of Sept 30, 2013, and deliveries scheduled for 2014 for both (April and December) – contract value is disclosed at $330mm or $115mm/vessel, implying $150mm remaining to be booked.  2015 and 2016 will bring the four Crowley/Aker JV ships to the market, with an option for four more (2017-2018 deliveries), and the Matson 2 ship container deal lands them booked through 2018.

The Crowley JV partnership is disclosed at $500mm contract according to the 8/9/13 press release (and reiterated 1/6/2014 via press release), and the company’s investor ppt cite $115mm for Aker’s investment in the entity.  A phone call with the CFO confirmed that Aker is paying 25% of the construction costs, owning 25% (Crowley owning 75% of the ships to comply with Jones Act), but getting 49.9% of the economic interest – basically, Aker Philly is being carried for 25% of the costs with realized 49.9% economics right out of the gate – CFO said no contingencies in the deal for Aker to gets its interest.

CFO said accounting for the JV, that is, how the company would account and book revenues and margins, was still undecided – he said it would ultimately be disclosed clearly but as it stands now they were look to book revenues on a 100% basis roughly ratably over the project period.

Like NASSCO (who uses Daewoo designs), Aker uses Hyundai Mipo Dockyard and Samsung Heavy.  CFO either actually didn’t know (confidence inspiring) or was simply honest when saying he was unsure when I asked if such agreements were exclusive (hoping that another shipyard in US cannot convert and quickly also deploy Daewoo or Samsung designs to compete).

Supply and demand overview

American Shipping company has a decent ppt on new builds and existing Jones Act tanker vessels (see pages 11 and 13 on “AMSC Company Presentation” http://www.americanshippingco.com/ ) highlighting that NASSCO is essentially booked through 2016 year end with options in place taking them through 2017.  Barclay’s cites the US DOT in counting 44 active Jones Act tankers that serve US Coastal ports, with 11 serving the Alaska-West Coast routes – most of those 11 are apparently stranded given size relative to Panama Canal and the complete opportunity cost with sending vessel around South America to re-position on east coast.  Assuming a 20 day round-trip from Gulf Coast to northeast coast, a 330,000 barrel tanker can make 18 trips and move a total of 6mm barrels per year, or 16,000/day per ship.  Through 2016 we have 4 Crowley ships coming online out of AKPS and 4 ships Seacor ships (part of the Kinder/Blackstone transaction) coming out of NASSCO.  That implies additional capacity of 128,000 barrels by vessel per day in the context of Eagle Ford oil production that grew 410,000 bopd YoY as of Jan 2014 and Bakken that grew 260,000 over the same period.  Moreover, Permian has much production on the come as significant capex on stacked pay programs is just beginning (Laredo, Pioneer, etc.), which will further increasing light crude oil flow to Gulf Coast ports.  Also, some of these tanker builds are replacement currently in construction are replacement vessels.    

Jones Act tanker Time Charter Rates

Assuming a 20-day round trip from Gulf to Northeast US Coast, water transportion costs come in at $6.70/barrel at the recent high-tick of $110,000. 

• Dec 17, 2013: Exxon releases 6-month charter at $110,000 per day, cited as 50% increase from its previous rate. (source: http://www.reuters.com/article/2013/12/17/shipping-oil-jonesact-idUSL2N0JW0SJ20131217)

• June 27, 2017: Exxon secures vessel at $100,000/day. (http://www.reuters.com/article/2013/06/27/exxonmobil-tanker-idUSL2N0F31KT20130627)

• Feb 13, 2013: $86,000 rate cited up 87% YoY, and $99,000/day for single voyage for $56,000/day a year ago for same charter. (http://gcaptain.com/jones-tankers-earn-record-rates/)

Regulatory Risks

Easily the biggest risk and biggest unknown, and making this seem a binary outcome however my opinion is any legislation change would be slow and methodical.  There has been much chatter about repealing the Jones Act (John McCain is a big proponent, for example) and also plenty of discussion on lifting the crude export ban.  The Jones Act states that shipping from US port to US port can only be conducted by US built, US owned, US flagged, and US crewed ships.  I am far from an export of political forecasting, but I am of the view that neither will happen.  Many banks are publishing research and thoughts on the debate, and Barclay’s just put out a decent 20-pager on oil exports  published Jan 7.

You’ll certainly have to draw your own opinions of the risk of Jones Act appeal and/or lifting crude oil ban, but this is how I see it:

• Crude Oil Ban.  The populace wants cheaper not more expensive gasoline and doesn’t understand that refiners are already extracting excess rents given they have buying power so our gas pump prices are already inflated.  The populace probably has no idea that regardless of input crude prices it’s now the refiners extracting additional economics that they pay for at the pump.  Lifting the crude ban would certainly close the gap between LLS and global Brent.  It would also encourage shale producers to produce more today which will naturally come at the expense of less of a finite domestic resource in the much distant future (the oil is not going anywhere so if not drilled today it will be there tomorrow).  Essentially, which argument does the populace understand more: a) we should not export crude because doing so will lift oil prices, or b) we should export crude so oil companies are encouraged to produce more and make more money which will lift oil prices but supply jobs and help improve the current account deficit?  A third argument would could also unfold is some sort of partial or quote-based export systems (there are already a few exceptions for some Alaskan production and some continental production sent to Canada, but neither are material).

• Jones Act repeal. Residents of Hawaii, Alaska, Guam, Puerto Rico have long argued that the Jones Act raises their per household cost of living by some amount (numbers come in around $3,000/household).  Similar arguments can now be made for contiguous US or at least coastal US that pays elevated prices to receive oil shipped from the Gulf Coast.  The alternative is to buy even higher priced global oil (east coast refineries historically received a lot of high grade oil from Europe as European refineries are tilted toward heavy given diesel output, so US East coast built a proportionally larger light crude refining capacity relative to its US Gulf Coast brethren).  It’s obviously cheaper to buy US Gulf Coast oil otherwise they wouldn’t be doing it, which means if Jones Act is repealed, Gulf Coast LLS prices revert back up to Brent, and the “arbitrage” is gone.  So, I’m hanging my hat on two things: 1) the Jones Act has been around for a hundred years for a reason – it’s not going away, and 2) if there were serious risk of the Jones Act being repealed would Kinder be plunking down more than $1.0B on top-dollar Jones Act ships and would Apollo be acquiring a 12% stake in the only stand-alone Jones Act shipyard with product tanker building capacity?

• On 1/23/2013 it was announced that Kinder Morgan paid more than a billion dollars to bet on the future cash flow stability of the Jones Act product tanker market.  Kinder acquired 9 product tanker ships, 5 tankers with 330,000 barrel capacity each and another 4 in construction with the same capacity to be delivered in in 2015 and 2016.  These were purchased from Blackstone.  The all-in purchase price (inclusive of future expenditures for the in-construction vessels) is $1.176B.  Kinder’s press release states that it expects combined EBITDA on all 9 ships of $140mm implying 8.4x.   Notably, Kinder waived its IDRs on the KMI waived incentive distribution rights of $16mm in ’14, $19mm in ’15, and $6mm in ’16 to facilitate transaction.  And Kinder certainly paid top dollar: cash accretive immediately and Credit Suisse estimates on an earnings basis the deal would be 1.6% to 2.7% accretive in 2017!  -- http://www.businesswire.com/news/home/20131223005125/en/Kinder-Morgan-Announces-Acquisition-Jones-Act-Shipping.

• On 1/9/2014 it was announced that Apollo Global Management had acquired nearly 12% of Philadelphia on the Oslo exchange.  Float is now a very tight 15-20% of equity share capital given its apparent that the shares were acquired from another financial holder, not from Rokke’s 71% ownership position.  (Olso Børs’s announcement on Apollo’s acquiring 11.85% ownership -- http://www.newsweb.no/newsweb/search.do?messageId=343490) and Oslo’s announcement on New York based QVT Financial selling the same exact number of shares (1,204,647) -- http://www.newsweb.no/newsweb/search.do?messageId=343481).  Most of the shares (999,700) were purchased specifically by Apollo’s Special Opportunities Managed Account, a strategy with $640mm in aum as of Sept 30, 2013 and 2007 inception date.

Valuation

AKPS shares are worth NOK 230 to 400 based on YE 2016 valuation, implying 35% to 116% on an undiscounted basis.  If you assume 3 years and 15% discount rate, that upside is haircut to -11% to 42%.  If you assume the market begins to appreciate the 2016 business toward the beginning of the year, therefore 2 years at 15% discount from the projected 2016 YE share price, upside from today is 2% to 63%.  I apply a realistic shipbuilder multiple of 5x and a multiple on the pro forma shipping economic interest of 7x to 8x (recognizing Kinder Morgan paid 8.1x for 9 ships, 4 of which are still in construction for next few years, but this figure is inclusive of all in cost to complete order).

I’m certain Shannon Pratt, Willamette, Damodoran, et al would apply all sorts of discounts related to lack of marketability, lack of control, etc.  At the same time, Aker ASA’s investor ppt show increasing interest in continuing to monetize holdings, AKPS’s ppt explicitly states intentions to begin paying dividends, and the Apollo’s acquisition of a large stake (albeit pennies for Leon Black and team) further validates that hypothesis.  Fast forward a few years, the lion’s share of earnings will come from shipping sans some sort of complete reversal in day rates.  These shipping assets will be controlled by Crowley, a highly-respected and highly-experienced operator, rather than by some hero/villain Norwegian tycoon (supposedly some Norwegians love his rags-to-riches story especially considering his risk-taking and dyslexia, others loath his historic lack of consideration for over-fishing certain areas).  

This valuation is highly dependent upon current legislation remaining roughly intact.  My opinion (far from a political analyst) is that, as detailed below, any changes would be partial rather than entirely overhauling of current regulation.