Analysts believe Scorpio Bulkers would benefit from selling its $100m stake in Scorpio Tankers as it reaps significant upside from a deal that was widely denounced last autumn.
Scorpio Bulkers should transfer the success of the Scorpio Tankers' investment to its shareholders by either selling the interest or spinning it off, Noble Capital Markets analyst Poe Fratt said, referring to Scorpio Bulkers by its ticker symbol of SALT.
"While the refined product tanker market looks good, the market is very volatile and there is no guarantee that SALT shareholders will actually realise the benefit," he told TradeWinds.
"Selling the shares would lock in the gain and benefit SALT shareholders, and spinning it out would enable SALT shareholders to decide whether or not to sell."
Scorpio Bulkers' shares closed on Wednesday at $6.02, down 20.1% since 8 October, the day before the deal was announced. Scorpio Tankers shares, however, have surged 37% to $28.63 over the same period.
A move by the New York-listed bulker owner to divest its stake in its sister tanker company would benefit because the stock's "notable underperformance" could allow for major value creation opportunities, Deutsche Bank analyst Amit Mehrotra said.
"For example, we estimate SALT’s equity trades at less than half of net asset value when excluding its stake in STNG, easily the cheapest among dry bulk peers," he wrote in a research note, referring to Scorpio Tankers by its ticker symbol of STNG.
"Monetising SALT’s stake in STNG would be positive on several fronts."
Mehrotra further said the sale would “crystalise” an unrealised gain and create shareholder value not seen since the company’s inception in 2010.
He added that it would also put more Scorpio Tankers’ shares on the market for investors looking to profit from IMO 2020.
'Valid in theory'
He conceded, however, that his assessment is "likely more valid in theory than practice" given Scorpio Bulkers' consolidated share capital base.
"But the broader investment points are highly valid, in our view — that there is significant dislocation between market and intrinsic values of SALT shares, with opportunities for management to capture this dislocation for the benefit of both SALT and STNG shareholders," Mehrotra said.
Selling out of Scorpio Tankers would actually present pros and cons for both Emanuel Lauro-led companies, according to Jefferies analyst Randy Giveans.
"Selling its Scorpio Tankers position would be beneficial to Scorpio Bulkers if it uses the cash to repurchase its own shares, but it could also be taken as a lack of confidence in the further upside of Scorpio Tankers," he told TradeWinds.
"Bugbee has been clear that this is an investment, not a trade, and that he believes Scorpio Tankers has much higher to go over the next 12 to 18 months."
He said selling those shares may be a good idea but it is still a “tough call” because Scorpio Tankers’ shares appear to have room to grow over the next several quarters.
“Maybe the best strategy is to sell one million shares each quarter over the next five quarters, with 50% of the proceeds going to Scorpio Bulkers’ share repurchases and 50% of the proceeds going to Scorpio Bulkers’ debt repayment,” he said.
"But that’s just my conservative viewpoint on how they can methodically unwind the position without management having to pick what’s better — Scorpio Bulkers or Scorpio Tankers."
Mixed views
The deal is still getting hot and cold reviews, nine months after it was aired to much criticism.
Mehrotra pointed out on Wednesday that Scorpio Bulkers realised a 55% return from the $100m investment, saying it should boost second-quarter earnings, to be reported next week.
Deutsche Bank maintains buy ratings on both stocks, with Scorpio Tankers being "one of our top ways to investment in IMO 2020 regulation", he said.
Giveans supported Mehrotra's positive view, given the 55% return in nine months, but said forcing tanker exposure upon a pureplay bulker owner presented a downside.
Giveans told TradeWinds “it raised some eyebrows regarding how separate the two companies were and are” last autumn with regard to governance issues.
Mehrotra's position stood out as bullish amid sharp criticism for the deal as shares for both companies dropped following its announcement at a New York finance conference.
He said then that the move “could be the best investment management has made to date” since Scorpio Bulkers was founded in 2013.
Robert Bugbee, president of both companies, agrees with Mehrotra's outlook — but only partially.
"We would go further to say it's the best," he told TradeWinds.
"We agree that the investment in Scorpio Tankers has turned out to be quite successful, and we again have strong bias and enthusiasm for Scorpio Tankers' shares for the future."
Fratt shared Bugbee's and Mehrotra's views, calling it Scorpio Bulkers' best investment ever, evidenced by the 55% investment return.
"It will boost earnings because Scorpio Tankers was up 49% in the second quarter of 2019 and Scorpio Bulkers has to recognise the $52.3m gain on the income statement," he told TradeWinds.
"It is non-cash but it will have a positive impact, and most analysts don't include it in earnings per share or Ebitda estimates."
However, other analysts heavily criticised the deal back in October over issues related to governance and Scorpio Bulkers’ pureplay status — and one still does.
"You should go back and read research around the timing of the initial investment and do a comparison of what views were then," BTIG analyst Greg Lewis told TradeWinds.
"I don’t believe many people were constructive on the transaction at the time."
The 55% return on investment is only on paper — not actual cash earnings — because it has nothing to do with operating the business, he said.
