Shipper DHT Should 'Just Say No' to Frontline Deal

 | Jan 30, 2017 | 2:00 PM EST
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I wrote a bullish piece on DHT Holdings (DHT) for Real Money on Jan. 18 -- the stock closed that day at $4.23. This morning, DHT announced that it had been the subject of a takeover offer from Frontline  (FRO) . DHT shares are currently trading at $4.74. That's a nice little trade, huh?

While I'm not going to scoff at a 12% pop in two weeks, this deal is not a great one for DHT shareholders for a number of different reasons. I can't even count the number of columns I've written on shipping for Real Money in the past 12 months, many focusing on my Real Money "Best Idea" -- preferred shares of shipper Navios Holdings (NM) .

In doing all that research, however, the one thing I've learned about shipping stocks is that they are subject to massive undervaluation at certain points in the shipping cycle. Not to be Captain Obvious, but that's when you should buy. If you had done so exactly one year ago today -- when commodities were being jettisoned, along with the stocks of the companies whose ships carry those commodities -- you would have made a bundle, and my firm did so.

Pats on the back aside, if I have described when to buy shipping stocks, I surely can't leave you hanging without an answer to the question, "when does one sell?"

I have to give a Justice Potter Stewart-like answer to that one. I can't really define "peak shipping," but I know what it is when I see it. I am not seeing it now. Not even close. Thus, I don't think this is a good time for DHT management to sell out to Frontline -- and there are a number of specific reasons why this deal is suboptimal.

  1. It's an all-stock deal, specifically 0.725 shares of FRO for each share of DHT.
  2. Frontline's shares have been terrible performers, and shipping magnate John Fredriksen's large ownership position in FRO gives me pause as a small investor.
  3. While extreme seasonality and basis differences make it difficult to delineate the tanker cycle in the short term, it is quite clear that we are nowhere near the top of the cycle. In a recent business update (DHT is scheduled to report fourth-quarter results tomorrow), DHT management noted that 4Q spot earnings for its VLCC fleet were $34,300/day versus the $58,600 average for 4Q 2015 -- hardly a sign of cyclical strength.
  4. The inherent cyclical risk in shipping stocks means that to buy them one must seek asymmetric returns. Put another way, I don't buy shipping stocks for 12% returns. I'm looking for at least 10x that amount -- and hoping I possess enough wisdom to sell at the right time.

So, this is not the right time to sell. With DHT shares having closed 2015 at above $8 a share, it's hard to explain why DHT management would want to sell out at $5.09 (the implied value of the FRO offer as of Friday's close) a mere 13 months later.

To their credit, DHT management announced this morning the implementation of a "poison pill" plan that would allow them to issue preferred shares in the case of an outsider accumulation. Obviously, this doesn't apply to the 16.4% stake in DHT that FRO announced this morning, but it will keep FRO from accumulating an even larger stake through open-market transactions.

It is my fervent hope that DHT management holds out for a better deal. In this case, that may mean no deal at all. As Billy Beane said in Moneyball "Sometimes, the best trades are the ones you don't make."

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