I made an U-turn today and sold Aker Philadelphia Shipyard after initiating the position exactly a month ago. In this period the price of the stock has gone up more than 35% while I realized that I significantly overestimated the value of the company.
The biggest source of error is the accounting of the variable revenue from the profit sharing agreement. When you see $3.3 million in revenue in Q1 2013 from the profit sharing agreement it makes sense, at first sight, to assume that this is their part of the income generated with the ships in that quarter. Rule #1 in accrual accounting is that revenue should be recognized in the period it was generated. But from the perspective of Aker Philadelphia Shipyard this wasn’t revenue that they earned during the quarter, this was revenue that they earned while building and selling the ships. So what they recognize is the net present value all future revenue that can be reliable estimated. Note 11 in the Q3 2012 report confirms this clearly:
The company has recognized $3.3 million in variable revenue for each vessel, and expects more than $35 million in revenue over the life of each vessel (estimated to be more than 25 years). If you assume $1.35 million in revenue per year and a 10% discount rate the NPV of a 3 year charter agreement would be $3.3 million and the total revenue over a 25 year period would be $34 million. The length of the charter agreement could of course be slightly different, or they could have used a different discount rate, but this seems close enough.
If the first 3 years of revenue from the profit sharing agreement is already recognized the NPV of the remaining amount is far less than I originally estimated. If you assume $1.35 million in revenue per year per ship from year 4 till year 25 the NPV of this cash flow is just $10 million (assuming a 10% discount rate and a 35% tax rate).
I think my estimate of the value of the operating business was also a bit on the high side (see the discussion here in the comments), so an updated rough approximation of the value of the sum-of-the-parts would be:
- $46 million (cash + current project)
- $26 million ($3.7 million in income from operating business with a 7x multiple)
- $13 million ($10 million NPV of future profit sharing + $3 million from last quarter)
This would give us a value of $86 million versus a market cap of roughly $62 million. This is still a ~27% discount to intrinsic value, but this would not pass my hurdle for new investments so I’ve sold. In addition I already have exposure to the shipbuilding industry through Conrad, and I also have various other names in the industry on my watchlist that are probably cheaper.
No position in Aker Philadelphia Shipyard anymore
Why does accounting have to be so complicated 😉
Cant complain when your mistakes make 35% profit though, got to love Mr Market sometimes!
Wouldn’t call it a real mistake. Even after correcting my IV estimate it would still have been cheap at original price. Bought with margin of safety imo 🙂
I think you might underestimate the NPV of the future profit sharing, as it is said that it might be a lot higher than $35 mill if the rates increase. And they certainly have….
Yes, but they need to stay high for years before AKPS will see a positive impact since the ships are already chartered for a 3 year period. That’s too uncertain for me to bet on.
Fair enough. However I also think you are a bit conservative on the NPV of the running operations. AKPS should be in a position to negotiate profitable contracts in the years to come:
From MJLF & Associates: The brokerage believes the trend will continue over the next decade, which means domestic yards like Aker Philadelphia and General Dynamics NASSCO could benefit from heightened demand, but claims US yards lack the capacity to build enough units to plug the gap that is starting to take shape.
“By 2018, if both Aker and NASSCO operate at 100% tanker newbuild utilisation, there could be roughly 10 to 14 new bluewater tankers in the fleet,” it said. “This falls well below the estimated 27 product tankers that would be required to fill the void between rail deliveries and imports to the US Atlantic Coast.”
Probably true, but given how much the price has gone up the past two days (sold early once again…) I’d say that AKPS is currently trading very close to fair value (market cap is now basically my fair value estimate above). Not a whole lot of upside left anymore even if you count on higher rates after 3 years and better than historical profitability.