Niche MLP Focused on Natural Gas Floating Storage and Regasification Units; Strong Dropdown Growth Potential and Experienced Sponsor
Hoegh LNG Partners LP (NYSE: HMLP; hereinafter “Hoegh MLP”) was a spinoff from parent/sponsor Hoegh LNG Holdings Ltd. (Hoegh LNG) as a master limited partnership (MLP). Hoegh MLP will initially own three Natural Gas Floating Storage and Regasification Units (FSRUs) that have an average remaining contract term of 17 years, with steady predictable revenue and cash flow that is ideally suited to deliver quarterly distributions in an MLP format. Over time, Hoegh MLP will receive additional FSRU dropdowns and could also receive the parent’s LNG transportation and liquefaction units. Under an omnibus agreement, Hoegh has the right to purchase any of its sponsors floating assets that are under a charter of five or more years.
Hoegh MLP is a distribution income and growth play, with capital appreciation upside as assets are dropped down.
IPO Raises $192 Million; Proceeds Paid to Sponsor
On August 7, 2014, Hoegh MLP went public with 9.6 million common units sold at $20 (the midpoint of its original filing range of $19 – $21) and raised $192 million. Units closed the day at $22.25, up 11.25%, giving the company a market capitalization of $585.4 million on 26.3 million units outstanding (2.4x book value; 15x NTM cash available for distributions).
Adjusted for the offering, Hoegh MLP has a book value of $244.5 million and total capitalization of $469.5 million including the $140 million loan to its sponsor and $25 million in cash and equivalents.
At $22.25 per unit, new investors face immediate dilution based on pro forma net tangible book value of $9.29 per unit.
Underwriters have the standard 15% overallotment option on 1.44 million common units which likely has been filled with shares already in the money.
The company expects to receive net proceeds of about $176.3 million after underwriting discounts, fees and offering expenses. It plans to lend $140 million to its sponsor in exchange for a note bearing interest at 5.88% per annum; the note is repayable on demand or can be used to finance future purchases. Hoegh MLP will retain $20 million for general partnership uses and will use the remaining $16.3 million to make a cash distribution to its sponsor as partial consideration for vessels in the initial fleet.
Net proceeds of approximately $27 million from full exercise of overallotment will be paid to the sponsor.
$0.3375 Minimum Quarterly Distribution ($1.35 Annually) Offers 6% with Yield Upside
Hoegh MLP plans to distribute at least $0.3375 per unit, quarterly ($1.35 annualized), with a distribution yield of 6% with units at $22.25 after their first day of trading (08/07/2014). Distributions should grow over time as new FSRUs come on line and dropdowns further increase long-term fee-based revenue.
Incentive Distribution Rights (IDRs) will only get paid if distributions to common unit holders exceed $0.388125 per unit; so distribution could total $1.5525 annually and possibly deliver a 7% yield in year-one because the sponsor is incentivized to receive IDR distributions.
MLP Structure and Initial Assets
As the sponsor, Hoegh LNG Holdings, itself a publicly traded company in Norway, will own 63.5% of all common units in Hoegh LNG Partners (Hoegh MLP), 13.16 million subordinated units and 100% of all incentive distribution rights (IDRs). Post IPO, the public will own 36.5% of all common units (not counting overallotment). The General Partner (Hoegh LNG GP LLC) does not have an economic interest in the MLP.
Hoegh LNG Partners owns 100% of Hoegh LNG Partners Operating LLC which, in turn, owns the MLP’s assets. Hoegh MLP has outsourced all asset operations to its sponsor, which has over 40 years of industry experience.
The MLP’s initial fleet of assets include three modern FSRUs – the GDF Suez Neptune (50% ownership), the GDF Suez Cape Ann (50% ownership) and the PGN FSRU Lampung (100%) ownership. In addition, the MLP owns various moorings and related assets and the Hoegh LNG Services subsidiary.
The GDF Suez Neptune
FSRU was built in 2009 and is under charter with GDF Suez S.A., a quasi-governmental electric utility in France and the leading LNG importer in Europe in 2012; the current charter expires in 2029 and can be extended for two additional consecutive 5-year terms.
The GDF Suez Cape Ann
FSRU was built in 2010 and is also under charter with GDF Suez; the charter expires in 2030 and can be extended for two additional consecutive 5-year terms.
The PGN FSRU Lampung is brand new; it commenced operations in July 2014 under a time charter with PGN, an Indonesian, government-controlled gas and energy company; the charter expires in 2034 and can be extended for two additional consecutive 5-year terms.
Hoegh MLP is structured with its own dedicated CEO and CFO, which reflects a strong commitment to corporate governance. The company is structured as a C-Corp. and distributions will be reported on Form 1099 which is simpler for individuals to report than a Form K-1(for Partnership Income).
Investment Highlights – Cash Flow Stability
Hoegh MLP’s initial assets have an average remaining contract life of 17 years with creditworthy counterparties. The company’s floating LNG infrastructure assets are of critical importance to its clients amidst favorable demand, and Hoegh MLP’s demonstrated operational track record will deliver cash flow stability.
Compelling industry dynamics and the increasing strategic importance of energy multi-sourcing – in light of unrest across the globe, notably in Russia and Arab oil and gas producing nations such as Libya, Syria and Iraq – have increased the value of Hoegh MLP’s floating LNG regasification assets.
Clear Growth Pipeline Backed by Omnibus Acquisition Rights
In addition, Hoegh has the right to purchase three FSRU new builds – the Independence, Hoegh Gallant and Hull No. 2551 – over the next few years; this gives investors a visible growth pipeline, with further growth potential from additional parent assets such as LNG carriers and Floating LNG liquefaction units under contract terms of five years or more. Acquisitions will be accretive dropdowns, subject to Hoegh MLP’s ability to finance these purchases. Will the Independence is under contract with a subsidiary of the Government of Lithuania, the other two vessels are still under construction with expected delivery in August 2014 and March 2015.
This potential dropdown growth is expected to drive higher distributions per unit.
Strong Relationship with Sponsor
Hoegh LNG, the parent/sponsor company, has been in the floating LNG business since 1973 with in-house operations, engineering and training. As a result, Hoegh LNG has strong customer and partner relationships, and a solid industry reputation that strengthens its competitive position in winning long-term contracts. Hoegh is a publicly-traded company with a solid operating and financial history, and access to financing from multiple sources that are comfortable with LNG FSRU financings, including private and public debt and equity markets. This relationship, and the omnibus agreement, underpin Hoegh MLP’s “distribution growth” premise.
Favorable Industry Dynamics
Analysts project that gas supply will
exceed 110 million tons per annum (MTPA) by 2020 on new supplies from Australia and Papua New Guinea, medium term potential for U.S. exports, and longer term growth from Russia (Yamal / Sakhalin II) and East Africa (Mozambique and Tanzania). Natural gas is projected to be the fastest growing fossil fuel due to its low carbon intensity and clean burning characteristics, an abundance of reserves, market deregulation and global economic growth. The number of countries importing natural gas has more than doubled from 12 in 2000 to 29 in 2013. Regional price differences increase the attractiveness of and make LNG imports an important part of national energy strategy.
This increase in supply will drive demand for FSRUs because of the operational flexibility and speed that FSRUs offer over land-based facilities to cover fluctuating demand for peak energy capacity and supply diversification (where FSRUs can easily source supply from different regions but land-based facilities cannot). FSRUs allow nations to diversify supply and contribute to energy security.
LNG is expected to capture much of this growth in demand. As the graph below shows, pipeline share of global natural gas imports has dropped while LNG’s share has risen because of its more efficient portability. LNG’s share of total imports is expected to continue to rise through 2035 and this bodes well for Hoegh, one of only three top global providers of FSRUs.
This projected increase in LNG import share also boosts the chances of long-term charters on new builds and renewals on existing vessels at favorable rates.
The map below shows importing and producing regions, and the blue and red dots represent FSRU projects, with proposed projects (blue dots) rapidly converting into under-construction projects (red dots). This global distribution of dots represents widespread demand for LNG imports that require FSRU capabilities and supports Hoegh’s FSRU growth story.
High Barriers to Entry
FSRUs offer several advantages over land-based LNG plants. FSRUs take half the time to build, at half the cost, and can be moved to different locations or trade as LNG transport vessels. With FSRUs, importers can quickly react to demand and LNG price differentials.
The floating LNG and FSRU industry segment has high barriers to entry because tenders require strong operational history and technical expertise. Moreover, new vessels are expensive to build and are unattractive investments as market entry vehicles for inexperienced players.
Experienced Management Team with Dedicated CEO/CFO for MLP
Hoegh LNG, the sponsor, will operate assets for Hoegh MLP, and has an experienced operations and management team with decades of relevant industry experience. Svienung Stohle, President and CEO of the sponsor, will concurrently serve as Chairman of Hoegh LNG Partners while Richard Tyrell will hold joint responsibility as dedicated CEO and CFO of the MLP. Steffen Foreid, CFO at the sponsor, will be a Director at the MLP.
Business Strategies Focus on Distribution Growth
Hoegh MLP’s primary business objective is to increase quarterly distributions per unit by focusing on FSRU new building acquisitions on long-term charters. The company favors new builds over retrofitted first generation LNG carriers because new building vessels offer the greatest flexibility, have superior fuel efficiency, improved storage performance and larger capacity than retrofitted first generation LNG carriers. Their larger capacity allows for the full cargo from a comparably sized modern day LNG carrier to be offloaded in a single transfer, and this streamlines logistics.
Hoegh MLP works alongside customers on vessel design needs and maintains at least one uncontracted new building vessel so it can provide an FSRU with minimum lead time, making it an operator of choice for projects that require rapid execution, complex engineering or unique specifications.
The company plans to capitalize on opportunities emerging from the global expansion of LNG production activity and the need to provide flexible regasification solutions in areas which require natural gas imports.
The company intends to maintain and grow cash flow by focusing on strong customer relationships and actively seeking the extension and renewal of existing charters, entering into new long-term charters with current customers and identifying new business opportunities with other creditworthy charterers. Its customer relationships are enhanced by in-house engineering that is directly involved in clients’ project development processes.
Business Risks – Minimal; Limited Asset Base Is a Concern
Realistic risks include the company’s reliance on just two customers for its initial fleet; an outage on one or more of its vessels that might require lengthy and expensive delays, diminish its prospects on future contracts and materially impact cash flow; its inability to grow the asset base for financial or other reasons; and fluctuations in natural gas industry dynamics such as changes in price or overall demand that might impact future contract prices and durations.
Attractive industry prospects have resulted in several new build FSRU orders in the pipeline which could increase competition and contract pricing down the road.
Public unit holders have limited voting rights and are not in a position to demand changes to protect their interests.
Proven Cash Flow, Low Financial Risk
Hoegh MLP has stable cash flows from long-term fixed rate charters with strong counterparties, and plans to maintain high asset utilization to preserve the stability of cash flows. It will structure time charters with provisions that allow the pass-through of operating expenses and docking charges to customers.
The MLP will maintain its balance sheet for maximum capital structure flexibility to support acquisition of new FSRUs, and has an $85 million undrawn credit facility with its sponsor. On an adjusted basis, the company has 0.9x debt leverage relative to adjusted EBITDA on total debt of $217 million, so its balance sheet is not overly leveraged relative to its industry.
While its current three vessel fleet will deliver sufficient cash to cover distributions to common and subordinated shares, Hoegh MLP plans to pursue strategic and accretive acquisitions with its sponsor, and enhance and diversify its revenue and customer base.
For the next twelve months ending September 30, 2015, the company expects adjusted revenue of $88.9 million, adjusted EBITDA of $69.2 million and CAFD of $38.2 million which will provide 1.075x coverage for distributions. The company expects to pay $14.2 million in vessel operating expenses, most of which it plans to pass through to customers in addition to dry dock expenses. As good fiscal housekeeping, the company plans to set aside $10.2 million to grow its cash reserve to purchase additional FSRUs units as replacement capex.
Hoegh LNG Partners LP has a modern, technologically-advanced fleet and long-term contracts that are well suited to an MLP structure. Its business is propelled by strong growth prospects and favorable industry dynamics, and backed by solid operational expertise. Its sponsor is well established and offers visible growth opportunities through FSRU and other LNG dropdowns. Management is prudent in setting aside replacement cash reserves to minimize financial stress. As a result, distributions are conservative, with excellent growth prospects. Moreover, units currently trade at a favorable valuation with a 6% yield, and should trade higher as the operation adds more assets. Overall, there is virtually no downside on distributions over the next 17 years – the average remaining term on signed contracts. This in itself makes units very compelling. However, the company’s limited asset base is a risk because an outage could severely diminish cash flow and distributions; this risk will diminish as the asset base expands.