Tanker Investments (TIL:OMXNO) – Merger Arbitrage – 6% upside

Current Price – NOK 43.2

Expected Payout – NOK 45.65

Upside – 6%

Expiration Date – Q3 2017

Teekay Tankers (TNK) entered into definitive agreement to buy Tanker Investments (TIL). Each TIL share would be exchanged to 3.3 TNK shares – representing 6% spread at current prices and NOK/USD exchange rate. Merger has been approved by the boards of both companies as well as Special Committee of TIL independent directors. Shareholder approvals on both sides are still pending. Merger is expected to close in Q3/Q4 2017. There is plenty of borrow for TNK shares and current rate is <1%, so hedging is cheap.

TIL shares now trade at pre-announcement levels (due to continued decline in TNK shares), so it is not clear how much TIL shares would drop if the merger gets cancelled. Initial spike post announcement was +12.7%.

I will not deliberate the merits of the merger as I have too little knowledge about the tanker industry for my opinion to generate any incremental value. You can familiarize yourselves with both sides of the argument in this merger presentation,  proxy statement, as well as 13D filling by an activist investor opposing the transaction.

I think the risk of TNK or TIL walking away from the transaction is very low and the key reason for the spread to exist is uncertainty regarding shareholders’ vote as well as relative obscurity of the transaction (micro-caps, Norway and only two questions on the conference call after the merger announcement).

 

TNK shareholder approval

Approval on the TNK side is likely a done deal as Teekay Corporation (parent of TNK) owns 55.9% of the total voting power of Teekay Tankers. Thus activist shareholder’s 10% position and objection to transactions will not have any effect. The company did not even bother responding to activists arguments. Actually, the activist seems to be more concerned with TNK’s overall ‘empire building’ strategy and continued dilution rather than specifically objecting TNK/TIL transaction (only the last paragraph of 13D addresses current situation).

 

TIL shareholder approval

TIL shareholder approval is more uncertain, but I believe it is likely to pass as well. TNK and its affiliates already own c. 20% of TIL stock, however merger is conditioned on the majority of the remaining shareholders approving it. The key reason why I believe TIL shareholders are likely to be in favor is that TIL was established by Teekay back in 2014 and remains fully interlinked with it, with TIL’s operations managed by Teekay and its affiliates. From 2016 annual report (which actually has 145 mentions of Teekay):

“The Company’s primary business strategies include the following: 1. Maximize cash flow and profitability by participating in pooling and time charter-out arrangements. The Company intends that the majority of Group’s Suezmax-class tankers will operate in the spot market through the Teekay operated Suezmax revenue sharing arrangement (the Suezmax RSA) <…> The Company believes that the Group will benefit from the reputation and scope of operations of Teekay, Teekay Tankers and their affiliates. The Company also projects that the cash flow the Group may derive over time from operating the vessels in these pooling arrangements or revenue sharing arrangements will exceed the amount the Group would otherwise derive by operating these vessels outside of the pooling and revenue sharing arrangements due to higher vessel utilization and daily revenues.”

Also from merger proxy statement (merger background considerations):

The discussion included a recognition that a third party unaffiliated with Teekay Corporation or Teekay Tankers may require as a term of a possible transaction the termination of, or modification to, the TIL Management Agreement, through which Teekay Corporation and its affiliates manage the operations of TIL. The TIL Management Agreement does not provide TIL with the unilateral right to terminate the TIL Management Agreement, and therefore it was discussed that termination or modification of the TIL Management Agreement would likely require the consent of Teekay Corporation and/or the payment of a fee to Teekay Corporation. The TIL Board also considered the significant shareholdings that Teekay Tankers and its affiliate, Teekay Corporation, hold in TIL as well as that the members of TIL management are all representatives of Teekay Corporation.

This strong dependence on Teekay was also the reason why Special Committee did not manage to raise much interest from the other parties. Proxy indicates that a number both strategic and institutional investors have expressed initial interest, but non-binding offers were received only from 4 parties, and TNK’s offer was the only one with material premium (initially 15% and later increased to 30% upon request by Special Committee).

Thus, TIL’s shahreholders clearly do not have many other choices. On a more concerning side TIL trades below its IPO price just 3 years ago and 50% below its peak in 2015. Due to this some shareholders might be reluctant to approve the merger at lower price. However, this share price slump was mostly driven by industry wide cyclicality  and  oil price drop. Those hoping for recovery, could hold on to their TNK shares received during the merger.

29 COMMENTS

  1. work 22

    Can you point out where it shows that TNK is 55.9% owned by Teekay? On Bloomberg it shows 13.74%, versus the 10.34% owned by Huber Capital (the activist). thanks!

      1. work 22

        great thanks dt. So its that one super share of Series A-2 that makes the difference! thanks

  2. Michael

    I have two questions after reading this article. First, what is the expected return of this investment. Does a 6% return in case of a successful merger compensate for the risk of non-approval or cancellation? How does the 6% discount compare to typical, comparable merger situations? Second, the acquiring company (TNK) appears to have its own share of problems these days, most importantly anticipated potential liquidity problems. To top if off, TNK appears to be the “milking cow” in a typical general partner / limited partner relationship between TK and TNK, where the interests of the majority shareholder and the partnership are – carefully said – “marginally aligned”, as to alluded to with your remark about TNK’s activist shareholders. As a result, the question arises whether expected returns of a TK investment (the controlling shareholder) might be higher and less complicated than an attempted arbitrage play involving a partnership which serves the primary goal of enriching the controlling shareholders and owners of incentive rights.

    1. dt

      Answers to your two questions:

      1) Expected pay-off. As I do know neither the likelihood of the deal getting approved by shareholders nor the downside if the merger gets rejected (shares currently at pre-announcement levels) any estimate of the NPV would be a pure guess work. The spread of 6% is not uncommon for the micro cap M&A where the definitive merger agreement has been signed, but shareholders have yet to approve deal. My edge here is that I believe market is overestimating the risk of the transaction getting rejected by shareholders as I think TIL shareholders do not really have a choice besides merging with TNK.

      2) TNK problems – I have not analysed TNK closely, but from superficial look it seems that operations are cashflow positive and company is deleveraging by repaying debt (part of the repayments financed by asset leasebacks). Management expects 2017 to be tough year due to industry wide headwinds. If these headwinds continue longer then as you suggest company might face liquidity issues. In any case I would expect Teekay Corporation to step in if such situation arises. However, for my M&A case the only thing that matters from TNK performance perspective is whether TNK will be sufficiently strong to complete the announced merger. And from what I am seeing currently there do not seem to be any indications that TNK is already in distress.

      3) TK vs TIL investment – you might be absolutely right regarding the merits of TK investment. However, that is a completely different investment type. The outlined TIL merger case is a binary special situation that is not dependent on fundamental performance of the company or industry trends. Whereas investment in TK would be a fundamentals based long position. So I do not think it makes sense to compare these two potential investments.

      1. Michael

        Thanks for your detailed answer. Regarding your answer (3), I agree with you, if we assume that one invests in the arbitrage play with long/short positions. I invested in most of the arbitrage plays of your special situations newsletter by incorporating the “long” positions (only) into the equity portion of my asset allocation. Due to the inherent financing and transaction costs of shorting in a long/short strategy, I am hoping to thereby improve the expected risk/return characteristics of my overall portfolio, vs. having a separate equity and long/short asset allocation. I am not sure if my strategy is right nor can I quantify the rationale. As you pointed out, in case of perceived below-market returns of long-short pairs (disregarding the arbitrage benefit), the short position should actually be entered into.

        1. Ben

          IMO long/short is a somewhat risky strategy in general. It makes more sense for a fund, with the resources to do proper risk control and limit each short position to 1 – 2% of the portfolio, but if you’re an individual investor taking 5 – 10% positions in small caps, there’s always a risk you get wiped out by a short squeeze. Remember VW/Porsche in 2008…

  3. Freedomist

    How many shares of TNK should I sell to hedge for 1 share of TIL?

    1. dt

      Dates of shareholder meetings have not been announced yet – at least I have not seen anything yet.

  4. Federico Flom

    In addition to shareholder votes, do you see any regulatory risk here ?

    1. dt

      IB. It allows trading on OMXNO and one can buy TLI this way as well. No bid/ask is shown, but it seems that orders are simply redirected to OSE.

  5. Fa

    Do you think you will be able to participate to the offer if you bought your shares on OMXNO and not OSE?

    1. dt

      Absolutely. I think it is the same exchange and orders get redirected – my position is shown under ‘@OSE’ after the purchase, even though I am able to trade only at ‘@OMXNO’.

  6. Freedomist

    Now TNK trades @ $1.52, using exchange rate of 1:3.3, one share of TIL will be changed into 3.3 shares of TNK which equals $5.016 or 40.82kr (using 8.1385 currency ex rate). Now TIL trades @40.2kr, very close to 40.82kr. So there’s no room for profit already if I do not have a short position on TNK, am I right?

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