Maximilien Dufau
Oil tanker shipping companies Frontline Ltd. (FRO) and Euronav NV (NYSE:EURN) have signed an all-stock merger deal. Euronav shareholders are getting 1.45 Frontline shares for every Euronav share. Euronav CEO Mr. Hugo De Stoop will become CEO of the combined group. The companies think they can achieve $60 million in synergies. Frontline is relocating to Cyprus and will likely tender for all shares in Q4 of 2022.
There’s currently upside to the Frontline share price towards the Euronav share price of 3.68%. Theoretically, a short Frontline and long Euronav position would result in this return. The deal will close most likely before the end of 2022. Frontline is only allowed to pay a dividend equal to $0.15 per share under the merger agreement. This has been declared, and the record date has passed. By my count, Euronav could still dividend out $0.06 per share. If this were to occur, which is not guaranteed, the upside slightly exceeds 4%. One caveat is more dividends are more likely to occur as the process drags on, which is not necessarily a great thing from a return-on-investment perspective.
Belgium’s withholding taxes are high at around 30%. Please be advised, I am not a tax expert, but I could see these withholding taxes go down substantially (zero would be great). As Euronav has always paid out large amounts of its positive cash flow, and we’re moving into a very interesting period for tanker earnings, I’d think shareholders will generally favor this transaction. Unless, that is, the merger undervalues Euronav assets come tender offer, then there’s always the option of declining that offer. However, if 75% of shareholders accept, you get squeezed out.
Here’s what Frontline said on its recent earnings call:
So let’s move over to Slide 13. We are – although it’s been fairly quiet from Frontline in this respect for the last couple of months or actually not months last month, I would say. Frontline and Euronav combination is on rails. We are moving forward, basically, the part of the process we are in now is led by legal and it’s more a regulatory job towards the regulators, and we’re working towards a Frontline relocation filing to – for the relocation of – from platform Bermuda to Cyprus. That will be followed by a tender offer. We expect that to happen in Q4 this year.
There has always been discussions around the various outcomes of this tender offer. I’ve left the achieving less than 50% acceptance out of this. But obviously, if that should happen, we don’t believe it will. We think this is an industrial solution the market wants, but I just left that out. If we get above 75% acceptance amongst the Euronav shareholders, we will go directly to a merger with Euronav. Should we, in the case end up between 50.1% and 75%, the outcome is more or less the same. Frontline gains control of Euronav and a combination of the two complementary platforms will be created will perform basically as one company, although Euronav will be veridically a subsidiary of Frontline.
I guess there’s a slim chance Frontline could up its offer slightly once it tenders. Given its share price performance, however, I put low odds on that happening. Both companies own a lot of tankers on spot rates. Both companies own a lot of VLCC, which are the largest type of crude carriers.
Rates seem to have taken a breather, perhaps because of a mix of recession risk, hurricane Ian shutting down refinery capacity, and the floated OPEC+ production cuts. Less supply means less transportation required.
However, in the medium term to long term, prospects are quite attractive. Sanctions on Russia should be a powerful catalyst. These should be starting to impact the market from December 2022. According to the Frontline CEO, on the last earnings call, this is already having an impact on how trading is structured:
Well, first, I would like to say that the European and U.S. sanctions on Russian crude has not affected the Russian flows per se, but it’s altered the trading pattern. So, basically, what we see right now is that Russian crude oil and Russian products is sailing past Europe and to Asia. And at the same time, Europe has had to change their purchase patterns and are importing to a much larger degree feedstock and products from Middle East, West Africa and the U.S. So – and this is what created this highly inefficient trading pattern.
So, it has – kind of the sanctions has stopped Russian crude to enter Europe just as far as we see it. With regards to the VLCC, that’s a very kind of recent development. And I think it’s more related to the U.S. production and the U.S. SPR release and their export capacities. So – and as you know, and as I have described this before, on previous calls that the oil market is a bit like a toothpaste tube. If you press it, the toothpaste will pop out somewhere. And basically, U.S. crude oil has then priced itself to go far east, basically by the share price itself to go far east, basically by the share volume being offered. So that, I think is the game changer here.
I also think not to be too technical, the flattening of the oil curves in a very, very steep backwardated market, it’s quite expensive to hold large volumes of crude oil over a long voyage is basically unhedgeable. But obviously, with the flat structure in the crude oil market. It’s easy to hedge your exposure over the 60 days you need in order to transport crude from say U.S. Gulf to China.
There is a chance the sanctions on Russia are really going to bite. It all depends on how routes end up, how demand evolves as central banks pressure economies through interest rates, and how governments up their energy subsidies (and thus demand) to bail out citizens and industry as they’re getting squeezed by energy prices.
One-year charter rates for VLCCs seem to lie close to $40k/day. That’s a profitable rate, but given both Frontline and Euronav are keeping most vessels in spot markets, they think there’s momentum to the charter rate.
I think the arbitrage of long Euronav and short Frontline is more than fine, given it likely closes before the end of 2022. However, I already held a small Euronav position before the merger announcement because the medium to long-term VLCC shipping prospects seemed rather attractive. That’s why I’m sticking to that initial investment thesis, and I’m happy to receive shares of the combined company instead. However, I imagine someone who doesn’t like outright shipping exposure could still be interested in the arbitrage with the much shorter timeframe here.
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