How Teekay Offshore Partners LP Got Into This Mess – Seeking Alpha

Last year, Teekay Offshore Partners L.P. (TOO) reached a financing arrangement with the banks that resulted in a significant equity raise.

Source: Teekay Offshore Partners June, 2016, Equity Raise Presentation

The company raised about $200 million in preferred and common equity, and combined that with some new bank loans to fund the major commitments through the end of 2017. As shown above, there was some extra liquidity projected above the minimum requirements of the banks.

But a "straw in the wind" was the "at the market" sales of common units that persisted for months after this arrangement. So as definite as management sounded, the financing was not quite as secure as management was stating in the presentation. Persistent at the market sales of common units can be used for many reasons. But a company that has just patched together a financing initiative should not have needed more financing. That method of financing breaks even if it works and loses when it does not. This company needed a few things to go right for this solution to hold. Management needs a much better binary choice.

Source: Teekay Offshore Partners June, 2016, Equity Raise Presentation

Stock market valuations and capital market pricing have a strong correlation. Debt pricing and market favoritism appear to go together. The more out of favor a company appears to be, the more costly will be the debt (and probably equity). Therefore, the company needs to plan ahead and have a sizable cushion when conditions deteriorate. Banks often expect companies to solve their own problems when an industry is out of favor. At the very least the banker will demand more security, possibly more covenants, and probably a higher loan rate.

One example of this outside the industry would be Kinder Morgan (KMI) and Buckeye Partners L.P. (BPL). Kinder Morgan needed to delever the balance sheet. Many subsequent articles covered that process as the company struggled to maintain its credit rating. This company announced a debt to adjusted EBITDA ratio of 5.2. That ratio was ahead of many expectations on the way to 5.0 while the company found a way to finance the Trans Mountain Expansion project. But there was a distribution cut initially as well as some material asset sales to get the job done. Management had to get moving to solve the problem and did get moving.

Source: Buckeye Partners L.P. Annual Meeting Presentation, June 6, 2017

Buckeye Partners, on the other hand, has run things a little bit differently. The key ratio (long term debt to EBITDA) was well under the goal that Kinder Morgan management worked all year to achieve. As a result, the credit markets were open to Buckeye. Buckeye was fairly choosy for awhile, but as the markets opened up, Buckeye was a prime beneficiary and made a decent acquisition. Equity was sold by means of a shelf registration and the debt was negotiated without much fanfare. Mission easily accomplished. The partnership had no distribution cut nor did management worry about the deteriorating debt market conditions.

There is an article out about Teekay Offshore competitor Knot Offshore Partners L.P. (NYSE:KNOP). Knot is not as diversified as Teekay. But right now that diversification does not appear to be much of an advantage to Teekay. The debt markets appear to be wide open for Knot while Teekay Offshore appears to be on the outside looking in. Right now Knot is more profitable and banks love profits. So if a company is going to be dependent on the debt market, then the company needs financial cushions for those cyclical deterioration periods. In Knot's case, the company just avoided any weak markets completely so far.

Teekay Offshore management could have accomplished the same thing by selling the interests in all the relevant ships. Management could have decreased the partnership exposure to less desirable areas.

Source: Teekay Offshore Partners June, 2016, Equity Raise Presentation

Source: Teekay Offshore Partners Fourth Quarter, 2016 Earnings Presentation

The top slide shows the original schedule. But some of the projects began to show cost overruns. Plus, the Arendal Spirit contract payments ceased with a performance dispute. This was happening while the capital markets deteriorated for the company. That Arendal Spirit contract would later be canceled in the current year. But even before that, management had a priority of some asset sales and joint ventures to raise money and decrease risk.

To maintain its credit rating, Kinder Morgan management promptly started selling assets and achieving goals set to get to the final objective. Teekay Offshore management has been noticeably silent about raising cash through joint ventures and partial asset sales despite an announced priority a few months back. That is going to make Mr. Market wonder if those methods of raising cash are available.

One thing that always crosses industry lines is the signals sent by management through inaction. Here those signals may be critical. Martin Midstream (MMLP) sold some assets with investors screaming about the low price. Then came an equity offering and now the company appears to be on the road to recovery. The fact is that Teekay Offshore partners have had several months to show the market that the financing issues can be resolved.

Last June was a start. But management treated it officially as the end of the problem. There is no way so much debt should be due within a year at the current time after last year's solution. The debt due within a year represents about 20% of the total partnership debt. That is plain crazy when management stated that the capital markets were deteriorating.

So the recent market reaction to management silence is more than understandable. Teekay Offshore partners has now had several months to reassure the market and it has not happened. Management could have demonstrated a proactive strategy last year but did not. The end of the "at the market" sale of common units combined with the recent price decline of those units embodies the market fears due to management inaction.

Source: Teekay Corporation First Quarter, 2017, Earnings Results

One thing the parent company, Teekay Corporation (TK) has done is allowed Teekay Offshore to pay the limited partner interests, general partner interests, and preferred dividends shown above in the form of common units. These units should be saleable (or other equivalent units in the holdings of Teekay should be saleable) for the units to show on a cash flow statement above. However, it should be pointed out that Non-GAAP statements have no standard meaning within the accounting world and may not even be audited. So they can be used for whatever purposes the reporting company wishes. Comparisons of Non-GAAP statements needed to be very carefully done.

As shown above, Teekay Corporation has so far elected to keep the new shares received. That in-effect decreases the cash flow shown above. But it also means that at some point Teekay Offshore will have to begin paying all those distributions in cash. That is an extra $5 million or so that will need to be recovered in more cash flow above and beyond future cash flow needs.

"As of March 31, 2017, the Partnership had total liquidity of $216.7 million (comprised of $193.4 million in cash and cash equivalents and $23.3 million in undrawn credit facilities), excluding $60 million included in restricted cash relating to amounts deposited in escrow to pre-fund a portion of the remaining Petrojarl I FPSO upgrade costs. "

Source: Teekay Offshore First Quarter, 2017, Earnings Results

Banks hate missed forecasts. The very first slide forecast more liquidity than this. Admittedly, this liquidity is above the required minimum, but not by much. It appears to fit in with the management attitude of planning financing needs "almost exactly" without a sufficient cushion. This latest liquidity reflects something that is satisfactory at best but does not show a desire to excel. Banks like customers such as Kinder Morgan. Kinder Morgan management stated their deleveraging goals and then beat those goals.

The Teekay Offshore equivalent would have been to raise some money and stop running to the banker with every little financing need. Management appears to depend upon the banks too much. That attitude of depending upon the banks for financing could reverberate throughout the organization and have some unintended (and unfavorable) side effects.

Source: Teekay Offshore First Quarter, 2017, Earnings Results

The change in non-cash working capital accounts caused cash flow to surge the year before. Otherwise, both cash flow and earnings showed improvement over the previous year. It should be noted that an unrealized gain in derivative instruments accounts for the earnings posted for December 2016. An earnings increase combined with a cash flow decrease can be a sign of aggressive (but legal) accounting that can be anathema to lenders. Here, the relation of cash flow to earnings should allay any such fears.

Even so, cash flow of $98 million is not sufficient for a company with more than $3 billion in debt. $620 million of that debt is due within a year. At some point, total cash flow to total debt matters. That point may be now. Sometimes new construction or renovations no longer qualify as an excuse. The financing last year should have foreseen that debt coming due and proactively solved that refinancing. This partnership needed to skate through the capital market deterioration without financing needs. Capital markets were deteriorating as noted at the beginning of the article. Management further stated that no debt markets needed to be tapped until 2018 or so.

But management never considered that the banks might get a little antsy as the markets deteriorated. So not only is debt coming due in excess of the cash balance and expected cash flow, but cost overruns and a contract cancellation have to be dealt with as well. But management knew a year ago that the bankers attitude could be less than helpful. That is part of what deteriorating capital markets mean.

If there is a pattern here, it is a lack of proactive management action to prevent some of these challenges. That is how the company got into this mess. That is also how companies such as Kinder Morgan, Buckeye Partners, and probably competitor Knot Offshore Partners have managed to avoid these kinds of problems. Things happen to well run companies also, but because they have thought ahead, shareholders do not even realize there was a problem. That is good management. Teekay Offshore management needs a few lessons in proactive management. Until then, this stock is not going anywhere long term except maybe down.

Disclaimer: I am not a registered investment advisor and this article is not advice to buy or sell stock in any company. The investor needs to do his own independent investigation that includes reading the company governmental filings and press releases, as well as anything else relevant to determining if this company fits the investor's risk profile.

Disclosure: I am/we are long MMLP.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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How Teekay Offshore Partners LP Got Into This Mess - Seeking Alpha