Will Frontline Survive? (Part 1)
Chris is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Frontline (NYSE: FRO) is one of the largest crude oil shipping companies in the world. There are lots of folks betting against Frontline. According to Yahoo! Finance, there were over 10M Frontline shares being shorted in June 2012, and about 9.58M shares sold short in mid-July 2012. That's about 12-13% of Frontline's outstanding shares.
In early June 2012, another blogger wrote an article that was critical of Frontline. The blogger, Richard N. Davis, indicated he was making a paired bet in the crude tanker sector- shorting FRO, going long on tanker company DHT Maritime, Inc (NYSE: DHT). Mr Davis summarized his case in this fashion--
"We are short a company that has no chance to survive/generate any profits to its shareholders (and also its founder does not believe in it as it looks) and long a company that has been restructured and has cash for expansion. In addition, we have hedged the tanker market risk and our position is generating dividends."
Let me first offer this background about Frontline and set the table, if you will. Back in Nov 2011, when Frontline released Q3 2011 results, their management team indicated that if market conditions were similar to Q3 2011, Frontline would run out of cash in Q1 2012. The management team indicated the company was looking at restructuring, and that founder and major shareholder, i.e. John Fredriksen, had given his approval to such a course of action. Via family trusts, Fredriksen owned about 1/3 of Frontline's shares back then. According to Frontline's 20F filing for 2011, Fredriksen-related trusts still own 33.78% of Frontline shares as of March 31, 2012. So Fredriksen has not changed his ownership stake in Frontline.
There were three major pieces to this restructuring:
1. The creation of a new, separate entity named Frontline 2012 that took over the newer Frontline vessels and most of the newbuild vessels. Frontline 2012 also took with it the associated debt, bank financing obligations and most of the newbuild capex requirements.
2. An adjustment in the charter terms with most of Frontline's partners, totaling $293M, and that was spread over periods ranging from four months to four years.
3. A much larger commercially-managed fleet of tankers.
One other event coincides with Frontline's restructuring- the creation of a Suezmax tanker pool, Orion tanker pool. Since its formation was mentioned prior to the restructuring events, I do not consider the Orion tanker pool a direct part of the restructuring. However, it does have a tie-in, especially with respect to whether Fredriksen has any concern for Frontline. The relevance will become clear shortly.
After the restructuring, FRO's fleet consisted of:
- 29 Double-Hull (DH) Very Large Crude Carrier (VLCC) tankers
- 3 Single-Hull (SH) VLCCs
- 5 Oil-Bulk-Ore (OBO) vessels
- 11 Suezmax tankers
- 1 "for sale" Suezmax tanker
- 2 Suezmax newbuilds,
or 48 vessels, 1 "for sale" vessel, and 2 newbuilds.
Frontline would also commercially-manage a fairly large group of vessels- 12 VLCCs and 4 Suezmax tankers. This is up significantly from just 3 VLCCs in early Dec 2011.
Mr Davis makes the claim that John Fredriksen didn't care much about the restructured Frontline. That couldn't be further from the truth, for at least five reasons.
1. As pointed out earlier, Fredriksen had not changed his ownership stake in Frontline during the restructuring of the company.
2. John Fredriksen's trusts own a huge stake (about 44%) of Ship Finance International (NYSE: SFL), a separate company that contributes a majority (more than 60%) of vessels to the restructured Frontline fleet.
3. Frontline was allocated an 8.8% ownership slice in the new entity, Frontline 2012.
4. Frontline commercially-manage all the vessels of the Frontline 2012 entity.
5. Frontline manages the Orion tanker pool.
If Fredriksen didn't care about Frontline, then wouldn't the logical course have been to sell, or at least reduce, his stake in Frontline? But, he didn't. And why give the new entity almost the same name as the old one? And if the restructured company was indeed a dead man walking, why has Frontline managed the vessels of the new entity? In early 2012, the Orion tanker pool scored a major win snagging ExxonMobil as a customer for worldwide crude oil delivery. There were a couple of existing Suezmax tanker pools e.g. Gemini, Heidmar, with reasonably-sized Suezmax tanker pools. Why would an oil major like Exxon opt to do business with a new tanker pool, especially a pool managed by a supposedly dead company?
Okay, most of the newer assets moved over to Frontline 2012. But then, so did a signficant chunk of debt and financing requirements. On the surface, not having the newer vessels seems to have restrained Frontline's future. But, would keeping Frontline intact and pumping more cash or equity have worked? Perhaps. We know market conditions improved each successive quarter after Q3 2011. But what if market conditions had not improved? Then a more diluted Frontline would find itself in a similar position as before, with maybe a little extra cash.
Frontline got through Q1 2012 in reasonable shape. Q2 results should be out sometime in August. Q3 is typically the weakest quarter in any given year. The TD3 VLCC rates started deteriorating in June 2012, so the miserable cycle has started over again. To understand if Frontline can survive, one needs to dig deeper into the company.
To be continued ...
Hohum777 has positions in FRO, DHT, and SFL. The Motley Fool has no positions in the stocks mentioned above. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.