Fair Value – >S$4.00, currently trading at S$1.35
Thesis
STX OSV (STX) is currently stuck in the mud because of pending rumours of a fire-sale to an Italian Ship Builder (Fincantieri). While the EV/EBITDA multiples and high ROE suggest that STX is worth significantly more than its current price (>S$4.00), rumors circulating surrounding the sale are suggesting that the sale could go ahead for 900bn KRW, which would only represent ~S$1.60 vs the current price of S$1.35.
While a fire-sale is unlikely because of the improving financial condition of the parent company (STX Offshore Shipbuilding) and presence of Och-Ziff Asset Management (OZAM), the overhang from the potential transaction prevents this investment from having a large enough margin of safety for me to recommend it to readers.
Introduction
STX is a global shipbuilder, operating in Norway, Romania, Brazil and Vietnam. It constructs vessels used in the offshore oil and gas exploration and production as well as other specialised vessels. Find out more about the business here and on the investor relations page.
Issues
To save time and space, the details and time line surrounding the potential transaction have been summarised here. The main issue facing STX OSV is the extent of the financial distress that the Korean parent (STX Offshore Shipbuilding) is facing, a dire situation could likely result in pricing that will reflect a fire-sale. If the situation is bad but manageable then shareholders who sit and wait could be handsomely rewarded. Presently, OZAM is sitting in there with a 21% shareholding, which could further alleviate the potential of a fire-sale being affected without a bit of a furore.
STX Offshore Shipbuilding, which has a majority 51% stake, is the entity that has been experiencing cash flow and debt management problems – see the group structure below.
STX OSV – Group Structure
The debt ratios and servicing ability of the parent, STX Offshore Shipbuilding, are getting down to more manageable levels following a capital raising and some tighter working capital initiatives in the past few years. However, with global shipping in a rut it’s unlikely that things are going to get much better in the near future for shipbuilders.
STX OSV – Debt to Equity
STX OSV – Debt Servicing
Overall, the level of leverage and recent improvements in the financial condition suggest that a fire-sale won’t be as likely as it was at the beginning of the year, when it the rumours of a sale were first mentioned in the media in May 2012.
Key Shareholders
OZAM received an 18.3% stake at S$1.33 in placement in July 2011 and subsequently topped the position up to 21.0% with on-market transactions. It’s claimed that the placement was made to “improve trading liquidity” but in all likelihood the placement was made so OZAM could block any potential takeover approaches.
STX OSV – Shareholders
OZAM saw value in STX, when it purchased the stake at similar levels to where it’s currently trading, so it’s unlikely that it’ll let the stake go for a similar amount (even after considering the 21 cents in dividends that have been paid out over the past year).
Valuation
Based on takeover multiples and current market multiples STX is worth >S$4.00. STX continues to have a strong and growing pipeline of ship orders for the next few years. There’s always the issue of large buyers delaying purchases or payments now that funding and business conditions are tighter. However, the management team has been capable of handling the business cycle so far. I believe that STX will be able to continue generating earnings at similar or growing levels in the future, which makes the current multiples look really low vs peers.
The recent acquisitions in the Asian shipbuilding space suggest that STX should trade on an EV/EBITDA multiple of 11x vs the current multiple of <3x.
STX OSV – Transaction Valuation
Using a market multiple approach, STX is again trading at ½ of the peers.
STX OSV – CompCo Valuation
Combining the two methods together I come to my price target of S$4.12, which is >2x the current market price.
STX OSV – Combined Valuation
Since the P/BV looks high compared to the peers, it’s worth taking into consideration the company’s ability generate returns from those assets. The P/BV vs ROE chart below shows that, while STX is more expensive on a P/BV basis this is justified by the returns it’s able to create.
STX OSV – PBV Valuation
Conclusion
If the sale doesn’t materialise then it’s possible that STX could re-rate and trade in line with its peers. In the meanwhile any investors would be paid a 5% dividend, which could be considered princely when compared against the current interest rate environment in Singapore and the quality of the company. At current levels, if the M&A does materialise within the next 12 months then the returns would still outweigh what an investor could get by parking money on the sidelines.
Overall, there are offsetting factors at play and significant uncertainty around whether a deal will materialise. The point of this blog is to find and discuss investments in solid companies and not speculate on potential M&A activity. While this investment could be better than sitting in the sidelines, the potential M&A activity could limit the potential upside which skews the risk / return consideration.
As at writing I have a position in STX OSV and may make other transactions within the next 30 days. If you’re considering investing, please do your own due diligence.
n.b. I decided to take a position for 2 reasons -1) to follow my proprietary system with skin in the game so I could see how things play out, and 2) to give the portfolio some added market exposure while I search for other investments that are more suitable.
Subsequent Events 21/12/2012
Fincantieri has offered to buy 51% of STX OSV from STX Europe for S$1.22 (vs last close of S$1.40, at a 13% discount). The deal will help STX Group (based in Korea) meet their goal of raising US$2.3bn to repay debts.
OZAM now holds 12% of STX OSV. Since Fincantieri has made an offer for >30% of STX OSV, it has made an offer for the remaining shares to the minority shareholders, as required under Singapore regulations.
Additional information:
My site was hacked recently so this comment is a record of previous comments left for this post:
I like the angle. Looking at downsides though. The order book is looking weaker going into next year plus capacity is increasing with a new plant being built. What are the order books for competitors looking like? Is STX OSV in a strong competitive position or have competitors caught up with their premium products?
Need to get some more comfort that the fundamentals wont drop away to match the industry average.
Response:
Agree that the order book is a risk but what I’ve found is that the orders will come through (if you build it, they will come – similar to The Field of Dreams), albeit at a slower pace than previously. Looking at the past year, for 3Q2011 there were NOK5.1bn (14 vessels) of new orders on the books, STX finished off the year with NOK11.1bn (28 vessels) of new vessel orders on the books. This year the existing order book (NOK16.3bn) is at a similar level to the close of 2011 (NOK16.7bn) and it managed to find NOK8.2bn of new orders in the first 9 months. So STX is doing better than most in the current environment.
Considering the overall industry dynamics; enjoying orders that have been in discussions for a while, STX may be winning market share, or managing to stay away from the turmoil because of the nature of the vessels it produces. Check out slides 11/12 for the Eagle Shipping 3Q2012 results (http://www.eagleships.com/phoenix.zhtml?c=189576&p=irol-presentations). While the focus is on the freight market, it shows that overall new builds are decreasing but the scrapping at record levels is helping to return the balance to equilibrium. I’d expect STX would be experiencing similar dynamics because of the global macro situation.
My hypothesis is that, as long as the quality of both the vessels and management doesn’t diminish then STX will still be a leader in the field. While orders may recede in the short-medium term, STX will be better placed to weather the storm. When things begin to look up again STX will be at the front of the pack blazing ahead.
Overall, it’d be best to wait until the overhang from the potential sale is gone before looking at it on the fundamentals because any potential sale (if done at the speculated prices) would limit the upside and makes the risk / return proposition significantly less attractive.