Eneti (and Cadeler): Offshore Oppurtunity

Jul 27, 2023

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Note: All currency is in Euros

Overview

In this week’s edition we’ll dive into (pun very much intended) one of my favorite, though often hard to find, investing setups: a special situation acting as a boon to a high-quality company that can turn into a long term compounder. While many in the finance field love to invest in, or catalyze, special situations, most tend to lean towards the cigar butt style of investing. In plain English this means extracting value from a company in one way or another and moving on to the next one. For various reasons I prefer to look for companies I can own for the long-term, making most of these situations that come across my radar a quick pass. That said, the opportunity to buy a great company with the added bonus of a special situation to quickly add value is an extremely attractive proposition. It’s at this crossroads that I found Eneti, the company formerly known as Scorpio Bulkers. For some context, let's quickly dive into the history of how we got to where the company is today. As Scorpio Bulkers, the company was in the business of drybulk commodity transportation, and, like the cargo it carried, was a commodity. Realizing this and seeing opportunity on the horizon, management divested their main business line and bought Atlantis Investorco Limited, the parent company of a wind turbine installation vessel (WTIV) business called Seajacks in August of 2021. We’ll discuss exactly what a WTIV is in a little bit, but for now we’ll focus on the (special) situation. After less than two years as a standalone company, the newly rebranded Eneti announced a merger with Cadeler, another WTIV company based out of Copenhagen, in June of this year. With the deal months away from closing, the combined company is poised to be by far the most dominant player in an industry with various tailwinds (yes, I know I’m on a roll with the puns) for years to come.

Offshore Wind Industry

I want to start by discussing the offshore wind opportunity that is powering (last pun, I promise) the demand for WTIV’s. Regardless of how you feel about climate change, the energy transition, or offshore wind in particular, one thing is quite clear: the investments are being made. Before diving into the numbers (sorry, I couldn’t help myself), it’s important to caveat them by clarifying that they do not include China. While today China makes up almost 45% of the global offshore wind turbine market by gigawatt (GW) capacity, they largely operate as a walled garden. With this in mind, there is currently about 31 GW of offshore wind power available across the globe today, with major growth seeming all but inevitable. Backed by nearly all of the world’s major governments, already announced initiatives and goals total 195 GW by 2030 through bills such as the Inflation Reduction Act, REPowereEU, and the British Energy Security Strategy. This is more than a 6x increase in seven years, or a CAGR of nearly 36% per year - a massive undertaking that will be intimately intertwined with the growth of the WTIV industry.

WTIV Industry

Installing gargantuan wind turbines in treacherous ocean waters is not exactly an easy task. It requires prefabrication of pieces of the wind turbines, followed by the shipping and installation of these parts at sea. This can only be accomplished by high-cost, highly-specialized ships, with expert engineers working together across the value chain. This is what makes WTIV’s a secretly great business. While it may not seem obvious these dynamics contribute to various moats: scarcity, of both ships and engineers, intellectual property, of this small set of highly skilled, highly knowledgeable engineers, and switching costs, as projects are planned in conjunction with the WTIV’s. This manifests itself into 40% and 35% operating margins for Eneti and Cadeler respectively.

The Merger

The merger will be an all stock deal. Eneti shareholders will receive 3.409 Cadeler shares for every 1 Eneti share they own, coming out to about 40% ownership of the combined company. Cadeler CEO Mikkel Gleerup and CFO Peter Brogaard Hansen will stay in their roles, with Eneti CEO Emmanuel A. Lauro becoming Vice-Chairman. Importantly, key Cadeler shareholder Andreas Sohmen-Pao will remain as Chairman. Establishing a global footprint will be key to the combined company’s strategy. Its headquarters will stay in Copenhagen, in addition to maintaining various other offices in Europe, North America, and Asia. It will also look to add a presence in South America. This will be essential as the full fleet comes online by 2026. This combined fleet will consist of four current ships, two from both companies, as well as six additions from already ordered newbuilds, of which four are from the Cadeler side and two from Eneti. Using available information on order backlogs, which have a multi-year lead time, this ten ship fleet will comfortably be the world's largest, accounting for more than 20% of the global ships on the water.

Though it is highly unlikely that the deal falls apart, it is worth noting that if it did, owning either company on a standalone basis still presents a great opportunity, making the situation even more attractive. That said, I believe Eneti offers the better setup of the two companies, trading at less than half the EV/EBITDA multiple. It is also better capitalized, with a net cash position compared to Cadeler’s net debt position, though Cadeler does have more newbuild ships on the way.

Valuation

We’ll start with the special situation side. Given that it is an all stock deal, with various currencies involved (Cadeler trades in Norwegian Kroner, while Eneti trades in USD) this is not an exact science. So far, the merger arbitrage gap has ranged from about 15-25% at any given time. With a fourth quarter close on the docket, this should produce a solid, quick return, though long-term ownership is where I expect the real money is going to be made.

In 2022 the two companies did a combined $155M in EBITDA. Though I tend to be skeptical of expected synergies in acquisitions, as many management teams make grand promises that never seem to come to fruition, cross selling, increased utilization, and a reduction in redundant costs at the corporate level seem to all carry merit, so I’ll take management at their word of $106M in synergies. From there, we’ll add in newbuilds. While leasing rates fluctuate, using a normal, though wide, range of $240-320K per day you end up with EBITDA in the range of $631-780M in 2027 - more than 4x increase in EBITDA. A quadruple in EBITDA as the lower bound of the range in a four year time frame should bring with it an exceptional return, and more importantly provide a huge margin of safety. On top of this, the company has already restructured improved debt terms upon the closing of the deal and plans to sell three non-core ships from Eneti. Both of these actions will result in straight cash to the corporate account. In addition, there is the possibility of an increased multiple due to the larger size of the company and lower cost of capital, though I think Cadeler’s current EV/EBITDA multiple of 14.5x is about fair.

Other Items of Note

It is not something I pay huge credence too, but both companies have very large order backlogs in place, which combined total more than $1.6B in revenue.
As mentioned before, building WTIVs has long lead times. Ships takes multiple years to build, which, in conjunction with the massive ramp up in projects, will lead to a supply constraint for multiple years.

Summary

While exciting opportunities stemming from the energy transition is a theme that is often enthusiastically discussed in the investing world, it seems that the politically anointed offshore wind sector flys (or swims) under the radar of most investors. This push presents a great opportunity for investors to get in on a secularly growing industry, backed by governments around the globe. Sitting in the best part of the value chain, I believe Eneti is an exceptional opportunity to play this growth, with the combination of a special situation and soon to be dominant market position.

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