AUSTIN, Texas--On Nov. 9th, 2016 Capital Family Holdings Inc. (“CFH”) addressed the following letter to the Conflicts Committee of SunCoke Energy regarding the recent proposal from SunCoke Energy, Inc. (“SXC”) to acquire all of the independently held units of SunCoke Energy Partners, L.P. (“SXCP”).
To our knowledge, CFH is a top-10 unit holder of SXCP, and we view the offer as deeply inadequate and find it troubling that the management team of SunCoke would pursue such an offer.
CFH is a long term investor in SXCP. We believe in the company’s future and invested with the intent to own the business for a decade or longer, and we thus felt it was important to share our perspective on the proposal. To the extent that others have concerns on the proposed transaction, we encourage them to contact the Conflicts Committee via the information below. We are aware that several other institutional investors have written the committee to voice their concerns, and we believe it is valuable for unit holders, no matter the size of their position, to send a brief note to the committee to share concerns regarding the offer.
The Conflicts Committee can be reached via SunCoke Investor Relations by writing to firstname.lastname@example.org and request that your message be shared with the Conflicts Committee.
We hope you find the following letter valuable, and we expect SXC management to fulfill their fiduciary duty to SXCP by either cancelling the current offer or raising the implied SXCP valuation to be in-line with the Alerian MLP Index.
Capital Family Holdings, Inc. (“CFH”) is a family-owned corporation based in Austin, TX. CFH has both private and publicly traded business and real estate interests and we opportunistically invest across various industries and assets. As a wholly owned company with significant liquidity, we utilize a patient, flexible, and opportunistic approach to investing, and generally invest with an indefinite holding period.
CFH reserves the rights to change its mind at any time as to the merits of the proposed transaction and to buy or sell any direct or derivative securities of SXC, SXCP, or related entities at any time. CFH, its principal ownership, and its employees do not hold any positions of employment, directorship, or consultancy with SXC or SXCP. The above mentioned letter is not a recommendation to buy or sell shares or units in SXC or SXCP.
|November 9, 2016|
|TO:||The Conflicts Committee of the Board of Directors for SunCoke Energy Partners GP LLC|
C. Scott Hobbs
Wayne L. Moore
Nancy M. Snyder
|CC:||Hunton & Williams LLP|
|The Board of Directors for SunCoke Energy Partners GP LLC|
To the members of the above parties,
This letter is in response to the proposal on Oct. 31, 2016 from SunCoke Energy, Inc. (“SXC”) to acquire all of the independently held units of SunCoke Energy Partners, L.P. (“SXCP”) for an exchange rate of approximately 1.65 SXC shares per 1 SXCP unit. Capital Family Holdings Inc. and its various members (“CFH”) are long term investors in SXCP, and to our knowledge CFH is a top-10 unit holder of SXCP.
We believe the offer is deeply inadequate, and we find it worrisome that SXC would pursue an offer that is so clearly unacceptable for SXCP. The Conflicts Committee should reject the current offer as no honest fiduciary could approve the outstanding proposal.
Written below is (1) our argument as to why we believe the offer to be inadequate, (2) what we would deem to be an acceptable price, and (3) alternative actions that SXC and SXCP could take.
CFH invested in SXC and SXCP hoping to own the companies for a decade or more because we believe SunCoke can continue to grow its share of the domestic coke making industry. Given our thesis and long term commitment to the company, we increased our position in SXCP during the challenges in the last year. However we have been thoroughly disappointed in the management of our business. This letter will focus on the aforementioned proposal, but given it reflects the mindset of SXC’s management team, we felt several of their actions to-date must be highlighted.
- Time and again, mgmt. has ignored feedback from key shareholders and unit holders at SXC and SXCP, and it was a major driver of the loss of several long term investors.
- Mgmt. has made poor investments and acquisitions (let us consider India and Convent, which was one of the worst uses of capital we have seen).
- India JV: Invested $67mm of capital that has been written down to $0.
- Convent Marine Terminal (“CMT”): There are numerous issues with CMT acquisition (including providing an earn-out structure to the seller for future growth). However, the core problem is that mgmt. chose to fully lever SXCP to acquire peak volumes and EBITDA that have since meaningfully declined and were at risk of nearly disappearing during Foresight’s restructuring.
- Mgmt. has proven themselves to be wildly optimistic on Indiana Harbor as well as the coal mining asset sale. On both assets mgmt. has been forced to meaningfully adjust down expectations that they themselves established.
To date, management has done little to be impressed with, and much to be concerned for. The proposed transaction would not only further impair value, but force independent unit holders to sell our business at a deeply discounted price. The Conflicts Committee and SXC must fulfill their duties and either cancel the current offer or adjust it to a fair price. Although we do not believe it is advisable to collapse the current capital structure into one entity, we would consider it if SXC adjusts to a fair offer.
I. The current offer
Below is CFH’s analysis of how the current offer stacks up:
- Taxable transaction. SXCP unit holders who had faith in the business and acquired while the units were down will be forced to sell at a taxable gain.
- From distributions to dividends. Not only is the proposed yield lower, but the tax treatment for dividends is more punitive than distributions. Again, a clear negative.
- Distribution Yield. The current offer values SXCP near a 13% distribution yield, more than 500 basis points higher than the Alerian MLP Index. The current offer would force SXCP unit holders to sell at a material discount to fair value.
- EBITDA contribution.
- The midpoint of Consolidated Adj. EBITDA 2016 mgmt. guidance is $223mm, while the midpoint of SXCP Adj. EBITDA 2016 mgmt. guidance is $212mm. SXCP contributes 95% of the consolidated EBITDA and virtually all of the free cash flow.
- Yet SXC has proposed that the portion of the combined company that SXCP should have is only 34.9%. Independent SXCP unit holders currently own 46.1% of this cash flow – what is the justification to reduce our stake?
- Arguments for how transaction benefits SXCP.
- Cash flow synergies of $16mm.
- First, this would benefit the combined entity, so both SXC and SXCP gain.
- Second, this is inconsequential given the tax implications and incomprehensible conversion rate.
- Simplifies the corporate structure. We can assure mgmt. that we are not confused on what an MLP is and how dropdowns works, and we doubt others are as well.
- Indiana Harbor improvement?
- After years of unwarranted hope and forecasting of improvement from mgmt. (we can provide the transcripts if necessary), it is deeply optimistic to place Indiana Harbor EBITDA improvement into a pro-forma analysis.
- If one was to be optimistic enough to forecast Indiana Harbor improvement then they should count future volume and EBITDA growth at CMT. This is something SXCP would bring to the table and thus, from a conversation ratio perspective, offset any benefits SXC brings via a theoretical Indiana Harbor improvement.
- Faster deleveraging.
- The deleveraging at SXCP is moving along fine. Before the deal was announced the bonds were trading in the mid-90s. Further, one could accelerate deleveraging by temporarily cutting the distribution. No doubt this would have a negative effect on the unit price in the short run, but the short term impact would be far less harmful than selling SXCP at a double digit distribution yield and swapping partnership distributions for a lower level of taxable income.
- Acquisitions. Since SXCP is not currently a functional currency for transactions, it is reasonable to assume that combining SXC and SXCP would increase mgmt.’s ability to execute transactions. However, it is deeply flawed to argue this would be beneficial for SXCP unit holders.
- SXC has nearly $60mm of cash, a net cash position, and the ability to access capital markets. Thus the firm is perfectly capable of executing acquisitions on its own. SXC can execute acquisitions and prove to the market and SXCP unit holders that it can make (1) accretive acquisitions and (2) can provide a valuable dropdown pipeline that will allow the SunCoke complex to grow and diversify. SXC has the ability to make acquisitions – prove that mgmt. can invest it wisely before SXCP is asked to fund anymore experiments.
- Mgmt.’s acquisition track record is clearly poor. Unless, of course, writing down $67mm of assets to $0 and purchasing a highly risky coal logistics company at peak EBITDA and volumes is considered a successful strategy.
- Cash flow synergies of $16mm.
To sum up the current offer:
- SXCP unit holders will bring the youngest and best assets in the SunCoke fleet in exchange for older more challenged ones.
- SXCP will bring virtually all the EBITDA and cash flow.
- SXCP unit holders will be taxed on the transaction and their distribution rate will decline and become dividends.
- In exchange for all of this SXCP will get a minority share in SXC and will have a mgmt. team with a poor record able to conduct further investment mistakes on our behalf.
In what world is this a good deal?
II. Proposed Revised Offer
The Alerian MLP Index yields 7.8%, has a Net Debt to EBITDA ratio of roughly 3.85x, and a distribution coverage ratio of roughly 1.2x. SXCP has a roughly 13% distribution yield, a Net Debt to EBITDA ratio of roughly 3.65x, and a distribution coverage ratio of roughly 1.4x. Through the current offer, mgmt. of SXC is implicitly validating this undervaluation by the market, and forcing SXCP unit holders to sell at a deep discount.
Should SXCP be forced to sell itself, it should be valued on its MLP peer distribution yield of roughly 8%. At a comparable yield, SXCP is worth $29.70 per unit, or 64% higher than the current price. This shows the massive gap between the poor offer from SXC and the fair value of the units.
III. Alternative Actions
Simply leave the structure as it is. If properly managed, SunCoke can continue to function and grow as hoped for when the MLP structure was created. To do so, several actions can be taken at the SXC and SXCP level.
At SXC, mgmt. can make acquisitions to prove-out that they are capable of making valuable investments that have comparable or better characteristics as the coke battery fleet. Should they succeed with the SXC balance sheet, then SXCP should trade-up to a yield that allows it to be a functional currency, and dropdowns can occur.
Most importantly, mgmt. will have to prove to the MLP investment community that rather than attempting to take advantage of the partnership they will respect and work to support it. This proposed transaction, along with previous actions, has engendered distrust. This lack of trust can be corrected, but changes must be made. Otherwise it is reasonable and perfectly logical that SXCP should continue to trade at a distribution yield that prohibits further dropdowns.
At the SXCP level, not much needs to change. As stated above, the company has largely gotten leverage under control. The fundamental of the business have improved since the bottom, and CMT’s customers are off the brink.
As we have discussed with mgmt. multiple times, if one takes the long-term view of SXCP, we are fine with a temporary distribution cut if it means more rapid debt pay down (however, this is no longer necessary) or to buy back units. As long as SXCP trades above an 8% distribution yield, it is not a functional currency. If mgmt. wishes to correct this they can cut the distribution and use the cash flow to buy back units. This would increase distributable cash flow per unit (benefits both SXC and SXCP) and as the partnership moves from weak hands to stronger ones, the security will trade up to the implied desired yield. At that point the distribution can be re-instated and acquisitions can occur. Most MLPs cut their distributions due to weakness – SXCP has an opportunity to do so out of strength. However, this should not be a sign that SXCP unit holders would support a distribution cut to fund any further dropdowns and/or acquisitions. In no way would we advocate such an action.
Overall, we strongly believe that the current structure can function as is, and there is no need to combine the entities. The market is rationally reacting to mgmt.’s track record. Show improvement, and the yield will decline. Buy back units, and in the long run, the yield will decline. Trying to acquire SXCP at a discounted valuation is comparable to not liking the score and changing the rules of the game because of it. Improve your actions, and the score should improve.
IV. Closing Commentary
The current proposal is plainly an awful deal for SXCP unit holders, and the Conflicts Committee should fulfill their fiduciary duty and reject it.
SXCP would bring the youngest assets, virtually all of the EBITDA and free cash flow to the proposed combined enterprise, would become fully taxed and receive a lower distribution, and would provide the EBITDA base for further acquisitions that mgmt. desires. SXCP brings virtually everything to the table and should be adequately compensated for that.
SXCP unit holders have endured the recent challenges of the steel industry, and challenges of the coal industry that were forced upon them due to the CMT acquisition. There are currently high expectations of increased infrastructure spending, a repatriation of industrialization in the United States, and the reduction of environmental regulations on the coal industry. Additionally, the North American coke battery fleet continues to age, and SunCoke’s assets and future-build potential continues to look superior to other alternatives for the steel industry. All of these should be beneficial to SXCP, and unit holders should not be forced to sell in light of the expected tailwinds ahead.
CFH is a long-term investor in SunCoke, and believes in the future of the company. As mgmt. knows, we have deep relationships in the steel industry, and we have advocated to critical participants for SunCoke in the past. We are long term owners of the company and want what is best for our business. We expect the Conflicts Committee to reject the current offer and either continue to operate SunCoke under the existing structure, or attain a deal that values SXCP in-line with the Alerian MLP index.
Head of Investment Division
Capital Family Holdings Inc.