We were recently introduced to exploration and production services provider, Tidewater, and we purchased their bonds. There were appealing qualities and circumstances about the company that recently emerged from bankruptcy. First, the bankruptcy process tends to understate the enterprise value of the company before the judge in order to improve recovery-of-value lost as a result of bankruptcy. Second, the fresh-start accounting and financial proforma tend to be based on the economic value of the underlying assets – with intent to not attract outside equity capital (hence no need to over-promise). So, the other day we were shown to Tidewater bonds (TDW 8% 8/1/22). What attracted us is that the bonds were unrated, which creates opportunity by limiting buyer base, as many bond market participants are constrained by credit ratings. Also, perhaps most importantly, the bonds are senior (high-ranking of legal claim) AND they are secured – with all the company’s assets.
For any investment decision, we tend to go through the process outlined below. Our process starts with information gathering – both business and financial. In this case, we had three primary sources of information:
1. Company presentations – Specifically, TDW management’s presentation to investors on Sept 15, 2017
2. Court filings – In particular, there are two documents, which are the Plan of Reorganization and Disclosure Statement. – The latter walks through the financial model and assumptions around each financial category
3. SEC Filings – here we look at 10Q (quarterly report) and 10Ks (annual report)
After spending some time in these documents and putting together some notes and spreadsheets, we like to test our thoughts against other opinions. We do this, not only to test our understanding of the business side, but to also test ourselves on the security side as well – does this security provide the protection we think it does, is there a better point in the capital structure to invest, et cetera. To conduct this test on a small and somewhat obscure company, we made one call. We spoke with a street analyst. (Street analysts tend to cover the company, but they also speak with investors, such as insurance accounts, money managers and funds.) In this case, we spoke with Patrick Fitzgerald, a distressed credit analyst at R.W. Baird, which is a large bank. The reason we spoke with him is that we have a relationship with Baird, and the distressed debt trader who was showing us the bonds was a Baird trader. Therefore, the analyst had reason to speak with us (he would otherwise be difficult to engage with), but also an incentive to get a transaction done. To the latter point, we critically evaluate the analyst’s assessments and ask questions to root-out incentive from knowledge.
After the analyst conversation, we regroup and discuss three things – (1) the company’s business, (2) the security which attaches us to the company and (3) the price at which the security can be purchased.
Here are some high-level thoughts from that perspective:
1. Business: TDW is among the world’s largest off-shore service providers. Its customers include RD Shell, Saudi Aramco, Petrobras, and other major oil companies. It provides services around the world (think Gulf of Mexico, North Sea, Persian Gulf, West coast of Africa, etc.). Customers contract with TDW to shuttle people and supplies to off-shore rigs – both for exploration and production (think people, drill bits, large pipes, etc.). The ships that perform these services are $50mm new, and TDW owns about 240 of these boats.
2. Security: The security at hand is an unrated, first-lien security and is issued to former creditors as part of the bankruptcy process. The amount outstanding is $350 million, and it carries an 8% coupon that pays quarterly. The common stock trades publicly (ticker: TDW) at around $25 per share, implying an equity market cap of $750mm. Therefore, you basically have a company with $1.2 billion capitalization comprised of $750mm of equity and with $450mm of debt. The company owns about $800mm (GAAP basis) long-term assets. At the recent quarter, TDW had $460mn of cash on-hand – this represents a net cash position, or cash balance exceeding debt outstanding. Therefore, we think of the debt as fairly secured from a downside protection standpoint.
3. Price: The bonds were offered just above $103 price, which is approximately a 7.5% yield. So, earning 7.5%, we could own a secured interest in the ships, or we could own the stock which pays no dividend (and may or may not be worth $25 because it is secured by nothing). Of course, management forecast is for improving conditions several years out, but this is difficult to accept as base-case, especially given the cap that onshore shale production seems to have placed on the price of oil. Offshore market activity and relevant operating statistics are so far off previous highs [and remain in relative oversupply (weak utilization rates)] that it is difficult to assess exactly when the market (and TDW) will re-establish baseline and support higher equity prices.
Many of our clients will notice Tidewater 8% 8/1/22 as a new line-item in their accounts. There was additional analysis done prior to making the final decision. However, this write-up is intended to illustrate, at a high level, our process in regard to sourcing, analyzing and purchasing an investment. This is the type of process and thinking Ballast does on behalf of our clients.
We discussed Business, Security, and Price, above, but for those of you that are intrigued and want a little bit more to think about, continue reading for the fourth point we are considering for Tidewater.
A fourth item discussed (and one that we continue to evaluate) is using the publicly traded warrants of TDW as a potential return enhancement. Warrants act like stock options in that for a low upfront “premium” the holder effectively has the option to capture future price appreciation above a stated strike-price and before an expiration date. An investor in the warrants could conceivably earn a multiple of return on a low cost basis if the underlying stock appreciates substantially. If the stock price does not appreciate substantially (to above the strike price), the warrant expires worthless. For this reason, investing in warrants (and options) on their own can be dangerous. The trade we are evaluating, as relates to TDW, would be to enhance the bond position by buying the Series A warrants to add TDW equity upside exposure – without taking direct equity risk (buying the stock), which includes substantial downside risk. For 2-points of first year bond cash flow, the investor would hold the bond yielding 7.5%, as well as the warrant, to buy the stock at $57.06 (currently around $25). Given our confidence in the bonds, we view the downside scenario of this full position as a net 7.0% yield to maturity, where the warrants expire worthless. In an upside scenario – and this is purely hypothetical – if the stock price appreciates to $87, the warrants would be worth $30, and this would take the overall position return to 12%. The cost would be 0.50% of downside (the yield consumed by the warrant from the bond) for some return greater than 7.0% (not necessarily the 12% presented). The greatest consideration for this fourth point (and we continue to evaluate this) is whether it is reasonable to expect the stock price to exceed the strike price by expiration date in July 2023. If it is unreasonable then it is simply not worth the two points of cash flow (0.50% yield) for the option. Stay tuned.
