Jeremy Raper on the event driven market July 2022

Episode Summary

Executive Summary: In this podcast, host Andrew Walker and guest Jeremy Raper discuss the current special situations and event-driven investing environment, focusing on several small-cap names. They emphasize the attractiveness of papered deals with strategic buyers over financial buyers, given the low historical failure rate of signed merger agreements. Key investments analyzed include Shell Midstream Partners (SHLX), Turquoise Hill Resources (TRQ), Spirit Airlines (SAVE), Vertex Energy (VTNR), and Calumet (CLMT). The conversation highlights asymmetric risk-reward profiles, catalysts for value realization, and the importance of management incentives and strategic fit.

Main Topics: Event-Driven Investing Environment (Priority: 5/5): Discussion of the current juicy special situations environment, comparing it to March 2020 but noting key differences. Emphasis on the low failure rate of signed merger agreements (under 5% in 2008) and the importance of focusing on papered deals with strategic buyers. Shell Midstream Partners (SHLX) (Priority: 5/5): Analysis of Shell's bid to buy out minorities in SHLX at $12.89 per share. The stock trades above the bid due to expectations of a bump. Key points include Shell's incentives to close, the conflicts committee negotiation, and the quality of offshore pipeline assets. Turquoise Hill Resources (TRQ) (Priority: 4/5): Rio Tinto's bid to acquire the minority stake in TRQ at C$34 per share. The discussion covers the strategic importance of the Oyu Tolgoi copper mine, the negotiation dynamics, and the potential for a higher bid despite recent copper price declines. Spirit Airlines (SAVE) Merger Triangle (Priority: 4/5): The complex three-way battle between Spirit, Frontier, and JetBlue. JetBlue's creative tactics, including a reverse breakup fee and appraisal rights suggestion, are highlighted. The vote on the Frontier deal is imminent, with uncertainty about the outcome. Vertex Energy (VTNR) (Priority: 3/5): Vertex's acquisition of Shell's Mobile refinery for $75 million, now generating massive profits due to high crack spreads. The stock trades at ~2x earnings with a clean balance sheet. The renewable diesel transition adds optionality but is not the current driver. Calumet (CLMT) (Priority: 4/5): A levered MLP with a renewable diesel asset (Montana) expected to start production in September. The sum-of-the-parts valuation suggests significant upside, but the stock is depressed due to leverage and illiquidity. A potential sale of the renewable diesel asset could unlock value. FAR Limited (Priority: 3/5): Jeremy's largest position, an Australian company with cash and an earn-out from Woodside. The stock trades at a discount to conservative net asset value, with a catalyst for capital returns. Jeremy owns over 3% of the company.

Key Arguments: Focus on papered deals with strategic buyers, not financial buyers, as strategics have longer time horizons and are less likely to walk away. The base rate of signed merger agreements failing is very low (under 5% in 2008), even in stressed environments. Shell Midstream: Shell has strong incentives to close the deal, including financial arbitrage and strategic fit. The conflicts committee is likely to extract a bump. Turquoise Hill: Rio Tinto wants to buy out minorities at a discount to fair value, but minority shareholders are pushing for a higher price. The recent copper price decline may shift negotiating power. Spirit Airlines: JetBlue's creative tactics (reverse breakup fee, appraisal rights suggestion) signal they are serious and unlikely to walk away. The market is underpricing the probability of a JetBlue overbid. Vertex Energy: The stock is cheap at 2x earnings with no debt, but the market is skeptical of earnings sustainability. The renewable diesel transition is a long-term catalyst. Calumet: The renewable diesel asset (Montana) could be worth $2 billion or more, covering the entire enterprise value. A sale or partial sale could unlock significant value for equity holders. FAR Limited: The stock trades at a discount to conservative net asset value, with a clear path to capital returns. Management signals suggest an unwind is likely.

Data Points: Failure rate of signed merger agreements in 2008: Under 5% - Jeremy Raper citing a statistic from Julian Yochko about the low failure rate of announced paper deals. Shell Midstream initial bid price: $12.89 per share - Shell's bid to buy out minorities in SHLX, announced in February. Shell Midstream current stock price: Just over $14 - Trading at a premium to the bid, indicating expectations of a bump. Turquoise Hill bid price: C$34 per share - Rio Tinto's bid for the minority stake in TRQ. Turquoise Hill minority shareholder asking price: $60 per share - Some minority shareholders believe the fair value is higher, citing Rio's invested cost. Vertex Energy acquisition price for Shell refinery: $75 million plus working capital - Vertex bought the Mobile, Alabama refinery from Shell. Vertex Energy EPS estimate for this year: $4 to $4.50 - Jeremy's estimate based on current crack spreads. Calumet debt: $1.4 billion - Total debt of the company, with $1.1 billion recourse. Calumet market cap: $700 million (approx) - Current market capitalization at $9 per share. Calumet renewable diesel EBITDA potential: $200-250 million - Jeremy's base case estimate for the Montana renewable diesel asset. FAR Limited stock price: 75-80 cents - Current trading price of FAR Limited. FAR Limited cash per share: 50 cents - Cash on the balance sheet per share. FAR Limited earn-out value per share: 70 cents - Deep in-the-money earn-out from Woodside.

Pivotal Quotes: "The amount of uncertainty being priced into a lot of these deals is frankly mind-boggling for event, I mean, as it should be, a signed definitive merger agreement in most all states of the world will close." — Jeremy Raper: Discussing the wide spreads in merger arbitrage opportunities and the low probability of deal failure. "I have a huge preference for one paper deals, not rumored deals or in negotiation deals, right? I don't think you need to, as we saw with Kohl's, for example, but there's been a few other examples like Alphamin, right? There's this no, you're not getting paid to bet really on unannounced, unpapered deals." — Jeremy Raper: Emphasizing the importance of focusing on signed merger agreements to avoid unnecessary risk. "If you're a strategic who's buying an asset for 10, 20 years, you can live with that much easier than if you're a polo trying to squeeze out a few couple of squeezes of the lemon before you dump this in three, four years." — Jeremy Raper: Explaining why strategic buyers are preferable to financial buyers in merger arbitrage.

Implications: Investors should focus on papered deals with strategic buyers, as they offer asymmetric risk-reward. The current environment provides numerous opportunities in special situations, but careful analysis of deal terms, management incentives, and catalysts is crucial. Small-cap event-driven investing can generate high returns but requires deep due diligence.