CGI Doug

CGI Doug

When I was new at the investing game, I ran from any company with a bankruptcy in its history.  Hey, if it goes under once, why won’t it go under again?

Seems logical doesn’t it? I mean, really, who doesn’t think we will never see another airline go under?  After all, there are certain industries — especially the cyclical and the leveraged — that just attract bankruptcies.

Yet, other industries really don’t have many bankruptcies. You can put a lot of debt on a stable company, and it will continue to pay its bills, even in the worst economies.  I don’t care how hard times get; Americans aren’t going to give up their TV, electricity, or beer.  They might cut back, but they aren’t going to go cold turkey — so you can put a fair bit of debt on your business if you’re a cable company, power producer, or brewery, and still pay your creditors in a downturn.

You’d figure that a gas pipeline operator would fall right in line with these safe examples, because people like living in a warm house in the winter.  And you’d be right unless the pipeline company’s management did something really stupid.

Granted, pipeline companies that take custody of the gas in their gathering system assume a small amount of commodity risk, but that can generally be hedged. If the company hedges a little and the hedges don’t work out, the company will lose a little money. When the company hedges a lot, however, and not for the purpose of offsetting what they own, but because they are riverboat gamblers and they lose, the company will go bankrupt. Case in point, SemGroup® Corporation (SEMG) of Tulsa, OK, and its 2008 bankruptcy filing.

The nice thing about a bankruptcy is that you get a fresh start, and that’s what SemGroup got in November 2009. It emerged 95% owned by the creditors, who put in a new management team that is dull, boring, and does not gamble. Last fall, it resumed operations as a public company with a listing on the New York Stock Exchange with ticker, SEMG.

The new SemGroup emerged as a smaller company, and with some debt, but also with some nice large energy infrastructure assets that generate cash.  Normally, a company like SemGroup would be structured as a Master Limited Partnership (MLP) to maximize the value of the depreciation of the long-lived assets, and increase cash payouts to shareholders. But, as a practical matter, one doesn’t exit bankruptcy as a partnership, but as a corporation.  Had it tried to leave as an MLP, it would probably still be in court today explaining the differences between an MLP and a C Corporation.  As for myself, I will just refer you to Wikipedia.

Not surprisingly, SemGroup is investigating converting to an MLP format. It is promising an answer on conversion plans by June 30, 2011.  The answer will be “yes,” as the real question isn’t if it will convert and start sending out those MLP distributions, but when. At that point, it will also start showing up on the list of top paying dividend stocks, so that brokers will sell this stock to yield hogs and generate capital gains for me.

Besides the MLP conversion, another catalyst for SemGroup is that it’s in the process of refinancing its post-bankruptcy debt of $310 million @ 9% with a more competitive rate. Management is expecting its new debt and revolver terms to drop its financing charges in half.

So what is SemGroup worth?

On the most recent quarter conference call, management made an earnings before interest, taxes, depreciation, and amortization (EBITDA) projection of $120 to $140 million for next year.  Now, in general, I hate companies that spout EBITDA numbers to me, because ignoring depreciation is like ignoring management’s options package — but pipelines are different.

A pipeline in the right market should be good for 40 years, and the cost of maintenance capital is infinitesimal compared to the accounting department’s depreciation calculations. With a market cap at $1 billion, and an enterprise value (EV) of $1.2 billion, EV/EBITDA would be 10. For a corporation, a pre-tax ratio of 10 isn’t bad, but it doesn’t get me too excited. However, for an entity like an MLP that doesn’t pay corporate income taxes and isn’t overly leveraged, a post-tax ratio of 10 implies that the future could support healthy cash distributions to its owners.

The size of distributable cash for an MLP is roughly its EBITDA minus maintenance capital, or about $100 million in the case of SemGroup.  Maybe that’s too simplistic but, frankly, $10 million in either direction doesn’t really matter. If my investments require precision, I find new investments.

I will, however, be excluding the not unsubstantial $80 million for new capital expenditures. Almost all MLPs fund their new projects with sales of new partnership units, and I would expect SemGroup to do the same.  Since the new investments should, in theory, have a stable projected return over the cost of capital, this should increase the partnership’s value.

At $100 million, if SemGroup were an MLP, it would need to distribute about $2.40 per share on the 42 million shares outstanding. That’s a 9.6% yield on today’s $25/share price. Once this gets known, Mr. Market will probably choose something closer to 7.5%, which implies $32/share. But I’ve used low estimates and ignored the growth prospects, so the potential for more is good.

Furthermore, the downside protection is strong, as there are many MLPs with low cost capital that would be happy to buy this cash flow below their 6% to 7% cost of capital, so we should be fairly well covered on the downside, as well.

Fire away and let me know what you think.


Disclosure: I have a position in SEMG.

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