Description

Thesis:

· TK is a midstream marine company currently trading at a 33% discount to its sum of the parts (SOP) valuation of $65/share. We believe this SOP valuation has been depressed due to the current credit crunch. There are also multiple levers that will produce additional upside in the future, many of which are completely in the hands of management and are high probability events. We believe a conservative outcome is that TK increases its SOP valuation from $65 today to $100+/share within the next 3 years.

· TK operates oil and product tankers on the spot market, and shuttle tankers, FPSO’s, and LNG tankers under long-term (5-20 year) agreements for fixed-rates. More than 50% of TK’s value comes from long-term fixed-rate contracts.

Variant View:

· The market believes that TK is not that different than a typical tanker company at the whim of spot market rates. However, TK is half-way through a transformation from an asset-heavy tanker company to an asset-light manager of tanker vessels with superior returns on capital with less risk.

· The market believes that spot rates will be under pressure in 2008 and 2009 due to an overbuild of supply. The opposite has occurred in 2008 so far with spot rates near all-time highs. The supply build is in anticipation of the 2010 deadline for single-hull tankers to be taken out of the market which represents 15-20% of the world fleet. This regulation will serve as a catalyst for spot rates as it is not possible to replace the supply coming out of the market. Any softness in rates should be temporary ahead of the deadline.

· The market does not understand the potential value creation from TK’s general partnership interests in its MLP’s. We believe these GP’s could be worth $25/share in 3-5 years.

Key Investment Factors:

· Safe business – Over 50% of the value of TK is through their fixed-fee businesses (offshore and LNG). In addition the spot business, while volatile, has hard asset value through the second-hand market for tankers.

· Balance sheet – TK is conservatively levered now with $1.6 b of debt backed by $4.0 b of cash or tanker assets. However, as TK continues to drop down assets from parent into the MLP’s, the balance sheet will rapidly delever allowing management to either repurchase undervalued shares or make strategic acquisitions.

· Valuation – TK currently trades at a 33% discount to NAV of which a large part is comprised of hard assets.

· Significant growth – Through a combination of organic growth and drop downs of assets from parent into the MLP’s, TK’s FCF/share will grow significantly in the next 3 years. We believe the GP values alone could contribute an incremental $25/share of value to TK.

· Management – Excellent operators of the business proven through their strategic outsourcing relationships with large integrated oil companies and higher average day rates realized than industry average. In addition, management is one of the sharpest financial engineering teams we have encountered, evidenced by their shift to an asset-manager of tankers, value-added acquisitions, and repurchase of ~15% of the outstanding shares over the last 3 years at a significant discount to NAV. Management is also good communicators of their business through presentations highlighting how they think about operating strategy, capital allocation, and intrinsic value.

How It Plays Out:

· Management will continue to grow organically and drop-down assets into the MLP’s. TK will delever the balance sheet, increase free cash flow through the GP interests, and return excess capital to shareholders. There will also likely be additional acquisitions that support TK’s growth strategy. Every acquisition to date has been value creating.

Risks, What Would Make Us Wrong:

· Tanker market collapse – if spot rates collapsed and dragged down asset values with it, this could significantly impact NAV.

· Spike in interest rates – MLP’s cost of capital would increase hurting both future growth in the distribution and the multiple investors are willing to pay for that distribution.

· Re-contracting risk – TK’s contracts are long-term and fixed-rate, but if the counterparty had an issue there is not a liquid market for LNG vessels and re-contracting could come at a discount to prior rates. In addition when the contracts do roll-over there is additional re-contracting risk.

· Capital allocation – management is aggressive in growing the business. So far have made excellent acquisitions. However, this was during a bull market for all things energy so prospective deals may not work out.

· Terrorism/environmental – TK is insured for ~$1 b should a disaster occur involving one of their vessels, but potential liability from an oil spill or other unknown could be more than they are insured for.

· Taxation – tanker companies conduct most of their business outside a specific country (i.e. on the water) and therefore are not subject to taxation by countries. Should this tax regime change TK’s after-tax FCF would decrease by whatever taxes they are forced to pay.

Maintenance Research:

· Track spot market, LNG market, and offshore market.

· Track MLP market.

Catalyst