Thursday, April 28, 2016

Par Pacific Holdings: Update, Distressed Energy M&A Thesis

I received the Par Pacific Holdings (PARR) annual report in the mail this week and thought it made sense to revisit my initial thesis in an updated post now that I've spent more time on the company in the past 20 months I've owned it.  Last fall Par Pacific changed the holding company's name from Par Petroleum, and renamed their Hawaiian operations Par Petroleum, which coincided with Bill Pate being appointed CEO and signaling the future direction of the company.  Par Pacific traces its roots back to 2012 when it was known as Delta Petroleum, a failed natural gas producer that went through bankruptcy and ended up in the hands of creditors, the largest of which was Sam Zell's organization through the Zell Credit Opportunities Fund.  In the reorg, $265MM in debt was converted to equity and the $1.4B in net operating losses were preserved giving Par a significant tax shield as they pursue an acquisition strategy.

Sam Zell built his reputation and wealth as a distressed investor, and with much of the energy industry in distress, Par Pacific Holdings is a way to invest alongside him and his management team in an environment that should see plenty of attractive deal opportunities.  The bulk of Par Pacific today was created through two acquisitions of refining and retail assets in Hawaii.  In 2013, they bought Tesoro's Hawaiian operations for $75MM plus a $40MM earn out and in 2015 they paid $120MM for Mid Pac Petroleum (primarily retail locations).  Last year alone these assets generated $110MM in EBITDA.  Distress in the upstream oil and gas sector is migrating down to pipeline and retail players, Par Pacific's main focus going forward.

In current form, the company has three primary assets: Par Petroleum (Hawaiian downstream business), Laramie Energy (Colorado based natural gas E&P), and the tax assets.

Par Petroleum: Refinery, retail distribution network and related logistics assets located in Hawaii.
  • Tesoro had mothballed their Hawaiian refinery and related assets, running them as an import, storage and distribution terminal while running an asset sale.  Most everyone passed, Tesoro wrote down the refinery to nothing, and then eventually Par came along and scooped it up for $75MM plus working capital/inventory.  Why did Par get a deal?  Tesoro made the strategic decision to exit Hawaii and focus on a new large acquisition it made with BP's old refinery in Southern California that could be operationally leveraged with Tesoro's in the same vicinity.  The Hawaiian business provided limited operational synergies and was a small piece of Tesoro's overall refinery business.  With no other buyers, Tesoro was able to effectively reallocate $325MM of net working capital to a more productive project for them with Par as the beneficiary.
  • Being isolated in the Pacific Ocean, in order to drive profitability Par needed to increase it's on island sales otherwise it's expensive to ship refined product to either the west coast or Asia ($6 per barrel).  In 2014/2015 Par announced and closed on the acquisition of Mid-Pac Petroleum - 80 retail sites throughout the Hawaiian Islands.  The Mid Pac deal helps Par sell their refined product locally and internalizes consumption allowing Par to get both retail and refinery margins.  On a standalone basis the price wasn't outstanding, but the operational synergies Par will be able to squeeze out of their refinery makes it a transformational one.  They also own the land under 20 of the retail locations, so they have the ability to do a sale leaseback in the future.  With the Mid Pac retail locations, Par currently has 91 locations under the Tesoro and 76 brands, about 20% of the overall Hawaiian market.
  • Management still believes there are acquisition opportunities in Hawaii, most likely additional retail to further drive the on island sales to match the output at the refinery, limiting the need to export.
  • Later this year they will need to spend $30-35MM in maintenance capex at the refinery.  I assume/hope they will do their best to run at peak capacity around the scheduled down time in order to minimize impact.  Management has guided that the refinery will run at 1/2-2/3 capacity in the 3rd and 4th quarters.
  • The refinery competes with one other in Hawaii, also located on Oahu, it was previously owned by Chevron and had shopped extensively until it was recently acquired by a private equity firm this month.  It's about half the size and Par was optimistically thought to potentially be a buyer of some Chevron assets, but regulators probably wouldn't have it.  The sale is likely just neutral for Par until we know more about the new owner's intentions.
  • Par recently started breaking out their logistics assets as a separate reporting segment even though all sales are inter-company transactions and consolidated for reporting purposes.  But this change potentially signals further midstream acquisitions and in a distant future where MLPs make sense again they could sponsor their own and drop assets down.
  • The combined Par Petroleum segment did about $110MM in 2015 EBITDA, which will probably come down some in 2016 with crack spreads coming in and the planned downtime at the refinery.
Laramie Energy: A minority interest in a privately own natural gas exploration and production company located in the Piceance Basin in Colorado.  This started as a legacy asset of Par's predecessor Delta Petroleum.
  • In March, Laramie Energy completed a bolt on acquisition of nearby acreage for $157.5MM with Par contributing $55MM.  As a result of the deal, Par Pacific now owns 42% of the common equity and accounts for the position using the equity method.  Par's additional investment essentially created their own balance sheet write-down as of 12/31/15, the better the deal for Par the larger the write-down they needed to take.  But proforma for the acquisition, Laramie has a book value of $131MM.
  • The timing of when the new acreage came up for sale wasn't ideal, management had been out in the investor community discussing mid and downstream acquisition targets but since this was adjacent to their existing JV the deal had a lot of strategic/operational value similar to what Mid Pac accomplished in Hawaii.  They know the area, and can spread their overhead costs over a larger asset base giving them additional leverage if the natural gas market recovers.
  • Bob Boswell runs Laramie Energy, he's an industry veteran, currently serves on the board of Cabot Oil & Gas and has a history of starting and selling oil and gas producers.  In 2007, the first iteration of Laramie Energy was sold to Plains Exploration and Production for $1B, three years after the company was setup for $200MM (plus bank loan debt).
  • Management seems realistic about this asset and has limited drilling planned for the near future.  They've also hedged much of Laramie's production through 2018, giving it the ability to wait out the cycle for a few more years.  It's mostly an upside option on natural gas prices.
NOL Tax Asset: $1.4B in net operating losses that can be used to offset future taxable income.
  • Why do I like NOLs?  They attract long term investors that understand the importance of capital allocation and generally create an incentive to purchase cheap free cash flow businesses in order to monetize the NOL quickly.  The sooner the NOL is used up, the more valuable it becomes.
  • Having the NOL reduces Par Pacific's cost of capital allowing them to be more competitive (pay a higher price) for acquisitions.  It also gives them additional flexibility in an asset sale (Laramie Energy for instance) where they could be more agreeable to a deal well above their cost basis knowing they have an NOL in place to shield capital gains.
  • It is slightly tough having energy assets in an NOL heavy corporate structure, many energy businesses have built in tax shields to their business.  Par hasn't made much, if any, progress yet in monetizing the NOL, they're going to need a couple sizable acquisitions in coming years to start making a dent.
Below is a quick and dirty valuation for Par Pacific, refiners trade for 4-6x EBITDA, midstream trades 12-15x EBITDA, and retail seems to trade around 8x EBITDA.  For Laramie Energy, it's probably simplest to use the equity method book value; I'm thoroughly ignorant to how oil and gas companies are valued.  If anyone has any specific thoughts on Laramie's value, I'd love to hear them. 
At current prices, you're paying a cheap to fair price for the current assets and you get the acquisition runway/management as an upside option.  But I understand if non-shareholders would want to wait to see the next acquisition, it could create a better buying opportunity especially if it's paired with a rights offering.

Additionally, it seems like once a year the stock tanks for no apparent reason, in the summer of 2015 the company filed a shelf registration per the Shareholder Rights Agreement with Zell and other large shareholders which gave them the option to sell, but didn't actually mean they were going to, the stock sold off as if everyone was exiting and it went on to recover fairly quickly.  Shareholder Rights Agreements are one of those filing events to look for as some people sell first and ask questions later.

  • Hawaii - The state is a difficult place to do business, its heavily regulated and communal, they don't like outsiders running critical businesses in their state as can be seen with the Hawaiian Electric - NextEra merger drama.  Politically the state has a long term plan to move away from fossil fuels and have their energy needs provided 100% by renewable energy sources by 2045.  I would assume its safe to say that the military, tourism and other industries will still require refined products but there might not be room for two refineries long term if Hawaii meets its renewable energy mandate.
  • Roll-up/Acquisition Strategy - Par Pacific describes itself as a growth company and most of that growth will come from repeated acquisitions funded through repeated capital raises.  The serial acquisition platform companies of the recent cycle have made roll-ups a dirty word as cheap debt and giddy equity markets led to some questionable deals and following meltdowns.  With Par Pacific you must believe in management's ability to identify attractive deals and not overpay for them.
  • Equity Raises - Par Pacific will be a serial issuer of private placements or stapled rights offerings to fund its larger acquisitions in order to maintain the NOL asset.  Rights offerings are usually done at a discount, so shareholders will need to participate in them or be diluted.  I don't have any evidence to back this up, but it also seems to create a ceiling on the share price as investors become concerned that as the share price rises that management will use it as an opportunity to issue more equity.
  • Natural Gas - After the recent bolt on acquisition, Laramie Energy is now a larger part of the company at a time when natural gas is as cheap and abundant as it has been in a long time.  Many oil and gas companies are going bankrupt, others have pulled way back on production, maybe at some point in the distant future natural gas prices will rise again, but they're likely to stay low for the foreseeable future.
Disclosure: I own shares of PARR

Wednesday, April 6, 2016

Interval Leisure Group: Reverse Morris Trust with Starwood

The bidding war for Starwood Hotels (HOT) between Marriott International (MAR) and Chinese insurance company Anbang grabbed a lot of headlines in the past month as Marriott eventually won after Anbang mysteriously dropped out. Caught up in the bidding war and subsequent merger arb trading are shares of timeshare vacation company Interval Leisure Group ("ILG" shares trade under IILG).  ILG struck a separate deal on October 28, 2015 for Starwood's timeshare subsidiary named Vistana Signature Experiences (previously set to be spunoff by Starwood) in a reverse morris trust transaction where Starwood would spinoff Vistana and immediately merge it with ILG.  The transaction will be tax free to Starwood shareholders, and after the merger, Starwood shareholders will own 55% of the new ILG with pre-deal ILG shareholders owning the remaining 45% of the shares.

The two Starwood deals happening parallel creates two technical, maybe non-economic, reasons why ILG's share price has fallen 35% since the deal announcement (there are other reasons discussed below as well): 1) if a Starwood shareholder was going to sell the Vistana spinoff anyway, well now they have a currency in ILG stock to do so before the spin date, essentially pulling forward some of the typical spinoff selling dynamics, 2) merger arbitrage investors are shorting ILG along with Marriott shares to capture the Starwood/Marriott spread.  While in both cases, the ILG shares sold short will be covered with new shares issued at the end of April when the deal closes, thus not creating a short squeeze, but after the deal is completed investors will begin to look forward and see a cheap company trading at ~7x EBITDA while its closest peers trade 9-10x EBITDA.

Any timeshare related bull thesis has to first acknowledge this is an industry with a questionable end value to its customers.  Most timeshares are sold, not bought, via free seminars where high pressure salespeople pitch people while they're on vacation to drop tens of thousands of dollars on a timeshare so they can relive their vacation year after year in perpetuity.  For most travelers this transaction is dubious, but maybe for a small subset who want to return to a resort year after year and stay in a suite larger than your typical two queen hotel room, a timeshare might make some sense.  But for many I suspect that they fall for the romanticism of owning a tiny piece of paradise without fully considering the annual maintenance fees and quickly depreciating (in many cases to $0) initial investment, it's a vacation home for people who can't afford vacation homes.  Even so, billions worth of timeshares are sold annually and the business of servicing and managing those timeshare units can be a good profitable one.
Interval Leisure Group was a 2008 spinoff of Barry Dillar's IAC which at the time was 30% owned by John Malone's Liberty Media, that ILG ownership has since been transferred to Liberty Ventures (LVNTA, a tracking stock of Liberty Interactive).  Historically, ILG has operated in the asset lite timeshare exchange business where they run Interval International, the second largest exchange behind Wyndham's RCI, allowing timeshare owners who pay a $89-129 annual subscription fee to trade their weeks/points with other timeshare owners.  Developers sign up with Interval International and often pay the initial year or two subscription in order to sweeten the pot and make timeshare ownership a bit more appealing to buyers by giving them flexibility to visit other locations/resorts.  This is a sticky business with a 90% annual renewal rate.

Over the past several years, ILG has also gotten into the vacation rental business (primarily in Hawaii) and other attractive management fee revenue businesses around the timeshare ecosystem.  In 2014, they purchased the timeshare development and management business from Hyatt where they have a licensing agreement to use the Hyatt name to develop and manage more timeshares, they build resorts and sell off the timeshare units while collecting an ongoing management fee.  As the timeshare industry has continued to consolidate, ILG's exchange business has faced competitive pressures as larger developers create their own internal/closed exchange network and don't sign up with ILG.  In order to feed the exchange and management contract businesses, ILG needed to increase their development/sales arm as more timeshare companies become vertically integrated.

Vistana -  Starwood's timeshare resorts under the Sheraton, Westin, St. Regis brands - will give ILG exactly that, it dramatically increases the timeshare (vacation ownership) sales piece of ILG.  Timeshare sales is a capital intensive and cyclical business, much more so than the legacy ILG business, so this feels like a defensive merger to quickly vertically integrate and protect the fee revenue businesses going forward.
The less enticing reason why ILG has fallen significantly since the merger announcement is the market believes they overpaid, at least when looking at near term multiples.  It's a stock for stock deal, but at the time of the press release the deal was valuing Vistana at $1.5B on only $125MM of EBITDA, at least two turns above where peers were trading and it looked to dilute ILG shareholders.  But in order to get comfortable with the multiple paid you have look a little longer term, Vistana includes over $500MM in timeshare mortgages that could be securitized and turned into cash, 5 standard hotel resorts that will be refashioned into timeshare properties, and additional development opportunities at Vistana's 22 current resorts.  All in, they estimate that Vistana comes with $5.5B in future timeshare inventory that can be sold, and then added to ILG's recurring fee ecosystem.

Tucked away in the merger documents (page 98) Vistana breaks out their long term projections all the way out to 2024, likely in response to the market's reaction to the sticker price, but also to show the value in the inventory pipeline:
Be a little skeptical but it provides some perspective on the headline price tag.

To keep things relatively simple, ILG is expected to do $185MM in EBITDA in 2016, Vistana is expected to do $148MM (both from the most recent prospectus), assuming no deal synergies (guided to $26MM annually after 5 years) and subtracting out $18MM of stock based compensation gets a proforma 2016 EBITDA run rate of $315MM.  The new share count will be just under a 130 million, at $13.35 per share, that's a market cap of $1.733 billion, the new ILG will have $464MM in net debt (ignoring non-recourse securitizations).

Proforma EV/EBITDA = ~7x

Marriott's timeshare business, Marriott Vacations Worldwide (VAC), is a good comparable for ILG, both will be a mixture of recurring management/exchange fees and development sales, both operate on the higher end of timeshare brands, and they're both pure play vertically integrated companies.  Marriott Vacations trades for ~9x 2015 EBITDA, at the same valuation using my EBITDA estimates gets you to a $18.35 share price for Interval shares, or 36% higher than today which would just about make up the difference in performance between Marriott Vacations and ILG shares since the 10/28 Vistana deal announcement.

  • Regulatory - The Consumer Financial Protection Bureau (CFPB) is investigating timeshare operator Westgate, shining a light on the industry's sales practices.  Diamond Resorts is in a similar situation and was recently profiled in a long New York Times piece.
  • AirBnB/HomeAway - Condo/homeowners in vacation towns can compete more effectively with timeshare developers thanks to AirBnB and HomeAway, provides a similar room option without the upfront and ongoing expense.
  • Secondary Market - Most timeshares can be purchased at significant discounts to developer pricing in the secondary market which puts a lid on new unit pricing and/or really shows unsavory nature of the sales process.
  • ILG shareholders still need to approve the deal, there's a shareholder meeting set for 4/20/16, Liberty and management have already agreed to vote for the deal.
Disclosure: I own shares of IILG