Overseas Shipping Group (OSG) – Expected Better Offer – 50%+ Upside

Offer Price: $2.68

Expected Offer Price: $4.00+ (current offer is $3.00/share)

Upside: 50%

Expiration Date: TBD

This idea was shared by Jimmy.

Open letter to shareholders

 

On the 30th of June, Overseas Shipping Group received a non-binding preliminary offer from its second-largest shareholder Saltchuk (17.5%) to acquire the remaining OSG shares at a $3/share – a 12% upside if a better offer does not materialize. Management has started a strategic review and is unlikely to approve the transaction at the current offer price. This acquisition comes as a play on the expected major recovery of the oil/petroleum shipping industry in H2’21. Saltchuk’s intentions here look very firm and we’ve heard rumors that it has already engaged Pareto Securities to find a minority partner to take OSG private. An improved offer – either from Saltchuk or another competing bidder – is likely. Peer valuations and industry M&A suggest that acquisition at $4/share or higher offer (50%+ upside) would still be a bargain for the buyer.

Saltchuk’s offer comes at 5.1x adj. EBITDA 2020. OSG undervaluation thesis was nicely summed up by the analyst, who correctly predicted the upcoming takeover

From the April’s call:

But your share price has been languishing along with COVID-19 headwinds and whatnot. We just saw privatization of one of your peers. Actually, they just hit the two-thirds tender required it looks like this morning, on SEACOR Holdings getting taken out by AIP. And if you apply a similar EBITDA multiple to OSG, you get valuations in $6, $7, $8 share range. Of course, that’s normalized EBITDA, so maybe not first half this year. But if you look back last year, maybe 2022 normalized, you also have a major shareholder who keeps adding to their position getting up in 16%, 17% range. We had a lot of volume Monday, so we have to see if they added more there. Is there any sort of consideration to – like a poison pill or some sort of move that you can do to protect shareholder value? Because it just seems like OSG is trading at such a ridiculously low valuation, and it could be subject – especially with things like the filing delay that just happened, it could be subject to a takeover offer, which does not properly value this company. So can you talk about that at all? Any sort of big picture strategic views on stuff the company can do to make sure you’re getting proper valuations?

May’s call:

The only frustrating thing here is that you guys trade — if you normalize the EBITDA, you guys traded about 5x, 5. 5x enterprise value to EBITDA. Every single one of your peer comps, U.S. transportation, U.S. energy, logistics, whatever you want to slice and dice it, they’re all 8x, 9x, 10x, 11x, right? And you guys are at 5x.

The above-mentioned peer Seacor was acquired by AIP in April’21 at around 9.8x EBITDA 2020 (capitalizing drydock expenses), whereas another peer Kirby (KEX) trades at 13.3x. Both peers have been negatively impacted in 2020, so the normalized multiples would be closer to 8-9x for Seacor and 10-11x for KEX. Assuming that OSG is worth at least 6x normalized (2020) adj. EBITDA results in a price target of around $4/share. 6x multiple could be too conservative here, especially if the industry recovers as expected.

TBV valuation comparison reflects a very similar situation – OSG offer comes at 0.8x TBV ($3.74/share), whereas Seacor was acquired at 1.1x TBV and KEX trades at 1.46x TBV, leaving plenty of room for an improved offer.

Honestly, the current spread – especially given the potential of an increased bid – seems quite strange and maybe I am missing something here. If not, some other potential reasons could be the micro-cap size of the company, zero analyst coverage, non-binding offer, poor historical share price performance (flat for many years), previous bankruptcy making the stock visually less attractive as well as uncertainty regarding the recovery of the shipping industry.

 

OSG and industry background

The company owns and operates a fleet of oceangoing transportation vessels for crude oil and petroleum products. Currently, it operates 25 vessels (mostly Jones Act) – 13 wholly-owned and 12 chartered, totaling 1.7m DWT. More background on OSG business can be found here.

Oil/petroleum shipping industry largely depends on the oil/petroleum demand and utilization rate of the refineries. In 2020 the industry experienced a significant hit as the shipping demand fell sharply due to the pandemic, OPEC production cuts, fall in transportation and jet fuel demand and ramping global fuel inventory (less demand for the fresh product transportation). Q1’21 and first half in general, was difficult as the demand did not yet recover to pre-pandemic levels and the industry got hit once again by the Texas freeze (refinery utilization rates shortly dropped even below COVID-peak levels). However, the most recent data (see charts below) shows that the situation is recovering quite fast and, actually refinery utilization rate is already above Feb’20 levels, transportation fuel demand has reached pre-pandemic levels, while gasoline inventory dropped below 5-year historical range after the Texas freeze (now fluctuates at the lower limit of the range).

US refinery utilization rate:

US gasoline demand:

US gasoline inventory:

OSG management has stated multiple times (April-May calls) that the industry is in early stages of recovery and that they expect a full recovery in H2’21. As indicated by the data above, so far the situation keeps quickly moving to the direction. April’21 call:

In looking at the recent trends in all of these data points, our conclusion is that we are still very much in the early stages of a recovery. […] But the recent data show a substantial reduction in inventories from the highest seen in the peak last summer, improving crack spreads and high and rising end-user demand. These set the stage from an uptick in refinery utilization rates as the summer approaches. […] Our short-term forward planning anticipates a return of increased demand for time charter transportation capacity during the second half of this year.

End of May’21 call:

It is clear to us that we remain in the early stages of emerging recovery, which, we anticipate, will become more fully apparent as the year progresses. We believe that as our customers’ visibility and confidence in the future returns, more typical customer behavior and time charter activity will rebound, leading to improved financial performance for OSG. […] The steep backwardation in crude oil future markets is a pricing signal that the market wants and needs more oil and the demand to transport this oil should follow. Our short-term forward planning anticipates a return of demand for our time charter transportation capacity during the second half of this year.
Availability of acceptable vessels with Jones Act will remain static at worst and most likely will tighten in the years ahead. […] We continue in our firm belief that the recovery in our markets is a question of time, not one of if. We expect to see demand return during the second half of 2021 with the expectation of significant operating improvement, coupled with substantial strengthening of adjusted EBITDA.

For OSG specifically, 2020 was not as bad compared to most peers and operational performance actually improved YoY (revenues +18%, adj. EBITDA +36%) due to the increased number of vessels and deep time charter book covering 75% of the whole 2020 (contracts have since ended and 6 vessels are laid out as of Q1’21). Aside from covid impact, the 2020 results were negatively affected by heavy investments in fleet maintenance with 393 drydocking days ($43m maintenance expenses, capitalized) vs 50 in 2019 ($23m). Estimated off-hire lost revenue was $19m compared to $2.9m in 2019. 2021 maintenance expenses are expected to drop closer to 2019 levels – $30m, which means less non-operational days for the vessels and higher revenues once the demand normalizes. In 2020 during the COVID peak, the company also acquired 3 Alaskan tankers, which only partially contributed to 2020 results.

 

Management’s intentions and major shareholders

Management is unlikely to sell at the current price and will try to push the offer up significantly higher. The strategic review was started right after Saltchuk’s offer hit the table. This signals that they want a bigger price and will possibly try to turn this into a bidding war.

Moreover, responding to the undervaluation comments from the analyst (above), management has said that they are aware of the undervaluation, however, the board is apparently focused on the long-term value realization of the business rather than short-term share price fluctuations. The largest shareholder, Cyrus Capital (owns 24%) was mentioned to have the same view as well. With that in mind, there’s virtually no chance that management and Cyrus will agree to sell the company at the dawn of industry recovery for this price. April’s call:

It’s not really up to the Board to figure out on day-to-day trading value, how that stock price moves. Their interests are in the longer term realization of the value of the business. I would point out as well that among the Board members is one of the larger – it’s actually the largest shareholder, representative from Cyrus Capital. They clearly have an interest in seeing that shareholder value is realized over the long-term, and are active participants in Board discussions and Board decisions around strategic issues. So I think the balance of considerations that the Board is working on in their regular discussions about these things is very heavily weighted towards making sure that the right outcome for all shareholders is achieved…. But I can say that the Board is very much aware of its obligations to ensure that the proper value of the business is realized in the long run, and in the context of the other shareholders outside of the principal large shareholder that sits on the Board.

In its letter, Saltchuk also stated that they are open to discussion regarding a potential rollover of major OSG shareholders, subject to some sizing and regulatory conditions. However, given the prompt launch of strategic review, it seems that the management/Cyrus (has one director on the board) might be more likely willing to auction the company than to comply with the sizing conditions of the current offer.

Major shareholders:

• Cyrus Capital Partners (investment advisory firm) – owns 24% at a cost basis of $9.35/share. Holds OSG shares since 2014.
• Paulson & Co (hedge fund with $9bn AUM) – owns 7.3%. Holds shares since 2014. In 2018 and 2020 sold 2% (combined) at around $2.50-$3.32/share price.
• Blackrock – 5%.
• Management – 5%. CEO owns 3.5% or 3m shares, which is a considerable amount relative to his $425k annual salary. Given the current setup, the management is highly incentivized to push for an increased offer price and look for other potential suitors.

 

Saltchuk

Saltchuk is a large holding company for a group of transportation and distribution companies. It is also one of the largest family-owned businesses in Washington. One of its holdings includes a domestic shipping company Tote (2x the revenues of OSG). The buyer claims that it has been following OSG for a long time and is “aware” of the current industry situation:

Saltchuk has the benefit of having significant experience and great confidence in the future of the Jones Act and the benefits it serves our Country.  In fact, over the last 20 years, Saltchuk has invested well over a billion dollars in new Jones Act vessels. […] We, along with our team of advisors, have followed the Company closely and are familiar with its operations, assets, and, more generally, with Jones Act shipping. We are keenly aware of the challenges of the current operating environment facing OSG.

Saltchuk started buying OSG shares in March’20 – 13D filing showed over 13% at around $2.50/share price. Since then it acquired more shares and recently (Feb’21-April’21) increased the stake from 16.4% to 17.5% at a low $2/share price.