Vodafone: the only deal that makes sense

I read with a sort of resigned alarm that Vodafone is considering selling its stake in Verizon Wireless. This is absurd - and if it happens it will mark an important part of the British business establishment (and the entire Vodafone board) as both venal and incompetent. Vodafone is our third biggest position at Bronte: this matters to us.

Background

Vodafone has - for the last decade or so - been a collection of modest success and abject failures - made good by one spectacular success. The spectacular success is that they own 45 percent of Verizon Wireless - the best performed wireless carrier in the US.

The failures range from grotesquely overpaying for spectrum in the tech bubble (and hence crippling the balance sheet for a decade) to incompetently stuffing up the most America-like (hence desirable) market out there (my home market of Australia).

The Australian melt-down of Vodafail has been well documented on this blog - but 18 months after the video below - and 18 months after they declared the problem fixed - Vodafone is still the butt of television jokes in Australia:





Vodafone has had some modest successes - eg Turkey - but even their home market has been so unprofitable that Vodafail has been questioned for paying no domestic corporate tax. Of course they should not pay tax if they are not required to do so - but as a shareholder I would prefer them be highly profitable and with big tax bills.

India - which should have been OK - has also been difficult for tax reasons - caused it seems in part by inept management.

There has however been one success - a marvelous success. They own - but do not control Verizon Wireless. It has been a good - no a fantastic asset - and their stake is now worth more than the entirety of Vodafone.

Pointedly this one great success is the one asset they do not manage.

This record has a consequence. Almost all long-term shareholders of Vodafone are not showing substantial gains - and selling their stake would result in only a modest capital gains tax bill - if any bill at all.

However because Verizon Wireless has been so successful selling Verizon Wireless would result in a massive tax bill.

This makes it far more tax efficient for Verizon to buy Vodafone in its entirety than to buy Verizon Wireless. Tens of billions of dollars more efficient.

Any deal where Vodafone sells its Verizon Wireless stake rather than selling itself starts with a tens-of-billions of dollars disadvantage in post-tax shareholder value. It would be insane.

The only justification for such a deal is that shareholders trust Vodafone management to be tens of billions of dollars better with the shareholder money than the shareholders would be themselves.

And sorry - Vodafone management has not earned and does not deserve that sort of trust.

Bluntly, if Vodafone management pursue any deal to resolve the Verizon Wireless issue then the entire Vodafone board should be sacked for venal and costly incompetence.

The best outcome would be the sale of the whole of Vodafone at a good price. (I would be happy with a combination of cash and Verizon stock.) The next best outcome is no deal at all. At least the good asset is well managed by Verizon.

But with the demonstrated record of failure of Vodafone over the past decade Vodafone has surrendered its right to make a deal - any deal - which leaves management to squander the proceeds from the best asset they have - the only asset they did not manage.




John

Alliance Resource Partners long term changes

This is the second post in my Alliance Resources series. The first post is here. 

When I get researching a company I have been known to read very old filings just to see how business has changed over time. In a case like Alliance Resource Partners this is critical. ARLP is by-far the best performed coal mining company in America and it has had the same management team since the late 1990s. The changes since that time have all be wrought by management and circumstance.

This company's record is so extraordinary that it is worth understanding it in a very long term manner.

So I started with the oldest Alliance Resources 10-K in the SEC database.

From the form 10-K for the fiscal year 1999 here are the balance sheet:

And the P&L

You will see that gross plant and equipment was $278 million with $103 million of accumulated depreciation.

Here is the production data as given from the same form 10-K.

In 1999, we produced 14.1 million tons of coal and sold 15.0 million tons of coal. The coal we produced in 1999 was 19.9% low-sulfur coal, 19.9% medium-sulfur coal and 60.2% high-sulfur coal. In 1999, approximately 85% of our medium- and high-sulfur coal was sold to utility plants with installed pollution control devices, also known as "scrubbers," to remove sulfur dioxide.

We can work out that they thus produced 2.8 million tons of low sulfur coal, 2.8 million tons of medium sulfur coal and 8.5 million tons of high sulfur coal.

The gross plant and equipment needed to produce a ton of coal was (278/14.1=) $19.7. In other words each ton of production required $19.7 worth of property plant and equipment at cost.

The above mentioned 10-K gave us some operating data as well:

In those days revenue per ton of coal was $23.12 and costs per ton was $18.75. The margin was just under $6 per ton. Maintenance capital expenditure was $6 million - or about 43c per ton of coal produced.

Depreciation, depletion and amortization was $39.7 million or $2.82 per ton.

The company also gave employment data:

EMPLOYEES 

We have approximately 1,360 employees, including 100 corporate employees and 1,260 employees involved in active mining operations. Our work-force is entirely union-free. Relations with our employees are generally good, and there have been no recent work stoppages or union organizing campaigns among our employees.

You can work out from this that each employee produced 10,367 tons of coal annually, each mine employee roughly 11,200 tons of coal annually.

To see the changes wrought we need to compare to the latest 10-K.

Here is the most recent balance sheet:

CONSOLIDATED BALANCE SHEETS DECEMBER 31, 2012 AND 2011 (In thousands, except unit data)

		December 31,
		2012			2011
ASSETS
CURRENT ASSETS:
Cash and cash equivalents		$	28,283		$	273,528
Trade receivables			172,724			128,643
Other receivables			1,019			3,525
Due from affiliates			658			5,116
Inventories			46,660			33,837
Advance royalties			11,492			7,560
Prepaid expenses and other assets			20,476			11,945
Total current assets			281,312			464,154
PROPERTY, PLANT AND EQUIPMENT:
Property, plant and equipment, at cost			2,361,863			1,974,520
Less accumulated depreciation, depletion and amortization			(832,293	)		(793,200	)
Total property, plant and equipment, net			1,529,570			1,181,320
OTHER ASSETS:
Advance royalties			23,267			27,916
Due from affiliate			3,084			—
Equity investments in affiliates			88,513			40,118
Other long-term assets			30,226			18,010
Total other assets			145,090			86,044
TOTAL ASSETS		$	1,955,972		$	1,731,518
LIABILITIES AND PARTNERS' CAPITAL
CURRENT LIABILITIES:
Accounts payable		$	100,174		$	96,869
Due to affiliates			327			494
Accrued taxes other than income taxes			19,998			15,873
Accrued payroll and related expenses			38,501			35,876
Accrued interest			1,435			2,195
Workers' compensation and pneumoconiosis benefits			9,320			9,511
Current capital lease obligations			1,000			676
Other current liabilities			19,572			15,326
Current maturities, long-term debt			18,000			18,000
Total current liabilities			208,327			194,820
LONG-TERM LIABILITIES:
Long-term debt, excluding current maturities			773,000			686,000
Pneumoconiosis benefits			59,931			54,775
Accrued pension benefit			31,078			27,538
Workers' compensation			68,786			64,520
Asset retirement obligations			81,644			70,836
Long-term capital lease obligations			18,613			2,497
Other liabilities			9,147			6,774
Total long-term liabilities			1,042,199			912,940
Total liabilities			1,250,526			1,107,760
COMMITMENTS AND CONTINGENCIES
PARTNERS' CAPITAL:
Limited Partners—Common Unitholders 36,874,949 and 36,775,741 units outstanding, respectively			1,020,823			943,325
General Partners' deficit			(273,113	)		(279,107	)
Accumulated other comprehensive loss			(42,264	)		(40,460	)
Total Partners' Capital			705,446			623,758
TOTAL LIABILITIES AND PARTNERS' CAPITAL		$	1,955,972		$	1,731,518

   

And here is the most recent P&L statement:

CONSOLIDATED STATEMENTS OF INCOME FOR THE YEARS ENDED DECEMBER 31, 2012, 2011 AND 2010 (In thousands, except unit and per unit data)

		Year Ended December 31,
		2012			2011			2010
SALES AND OPERATING REVENUES:
Coal sales		$	1,979,437		$	1,786,089		$	1,551,539
Transportation revenues			22,034			31,939			33,584
Other sales and operating revenues			32,830			25,532			24,942
Total revenues			2,034,301			1,843,560			1,610,065
EXPENSES:
Operating expenses (excluding depreciation, depletion and amortization)			1,303,291			1,131,750			1,009,935
Transportation expenses			22,034			31,939			33,584
Outside coal purchases			38,607			54,280			17,078
General and administrative			58,737			52,334			50,818
Depreciation, depletion and amortization			218,122			160,335			146,881
Asset impairment charge			19,031			—			—
Total operating expenses			1,659,822			1,430,638			1,258,296
INCOME FROM OPERATIONS			374,479			412,922			351,769
Interest expense (net of interest capitalized of $8,436, $14,797 and $888, respectively)			(28,684	)		(21,954	)		(30,062	)
Interest income			229			375			200
Equity in loss of affiliates, net			(14,650	)		(3,404	)		—
Other income			3,115			983			851
INCOME BEFORE INCOME TAXES			334,489			388,922			322,758
INCOME TAX EXPENSE (BENEFIT)			(1,082	)		(431	)		1,741
NET INCOME		$	335,571		$	389,353		$	321,017
GENERAL PARTNERS' INTEREST IN NET INCOME		$	106,837		$	86,251		$	73,172
LIMITED PARTNERS' INTEREST IN NET INCOME		$	228,734		$	303,102		$	247,845
BASIC AND DILUTED NET INCOME PER LIMITED PARTNER UNIT		$	6.12		$	8.13		$	6.68
DISTRIBUTIONS PAID PER LIMITED PARTNER UNIT		$	4.1625		$	3.6275		$	3.205
WEIGHTED AVERAGE NUMBER OF UNITS OUTSTANDING—BASIC AND DILUTED			36,863,022			36,769,126			36,710,431

   

And here is the production data:

 In 2012, we sold a record 35.2 million tons of coal and produced a record 34.8 million tons of coal, of which 3.8% was low-sulfur coal, 18.8% was medium-sulfur coal and 77.4% was high-sulfur coal. In 2012, we sold 93.1% of our total tons to electric utilities, of which 98.7% was sold to utility plants with installed pollution control devices.

Again we can work out that they produced 1.3 million tons of low sulfur coal, 6.5 million tons of medium sulfur coal and 26.9 million tons of high sulfur coal.

Note that the (high value) low sulfur coal has declined in both relative and absolute terms and this has become almost entirely a high-sulfur coal company company dependent on plants with sulfur scrubbers.

The most profound change is just how capital intensive this business has become. The company has now employed $2,362 million in gross property, plant and equipment with accumulated depreciation of 823 million.

Bluntly - the amount of capital employed here has risen enormously. The gross property, plant and equipment per ton of coal produced is now $67.87 - up a long way from $19.70 per ton.

The last 12 years in the US have not been a period of massive inflation - and the rise in capital intensity of this business is - well - surprising. The capital intensity of this business has gone up 345 percent. The capital employed per incremental ton of capacity is very large indeed.

Here are the employee numbers from the last form 10-K:

To conduct our operations, as of February 1, 2013, we employed 4,345 full-time employees, including 4,091 employees involved in active mining operations, 86 employees in other operations, and 168 corporate employees. Our work force is entirely union-free. We believe that relations with our employees are generally good.

From this we see what I think is the most unusual thing about all the giant capital spend at Alliance Resource Partners. The huge capital equipment spend has not improved labor productivity. Production is now 8009 tons per employee per year - and about 8500 tons per mining employee per year.

Despite all that capital equipment spend labor productivity has dropped by more than 20 percent. Strange.

Moreover the non-mine employees have risen from to 100 to 254 - a rise somewhat faster than the total production has grown. Labor productivity has dropped and the company has become more bureaucratic white-collar heavy.

The company also publishes a long list of operating metrics in the 10-K.

 Our historical financial data below were derived from our audited consolidated financial statements as of and for the years ended December 31, 2012, 2011, 2010, 2009 and 2008.

		Year Ended December 31,
(in millions, except unit, per unit and per ton data)		2012			2011			2010			2009			2008
Statements of Income
Sales and operating revenues:
Coal sales		$	1,979.4		$	1,786.1		$	1,551.5		$	1,163.9		$	1,093.1
Transportation revenues			22.0			31.9			33.6			45.7			44.7
Other sales and operating revenues			32.9			25.6			24.9			21.4			18.7
Total revenues			2,034.3			1,843.6			1,610.0			1,231.0			1,156.5
Expenses:
Operating expenses (excluding depreciation, depletion and amortization)			1,303.3			1,131.8			1,009.9			797.6			801.9
Transportation expenses			22.0			31.9			33.6			45.7			44.7
Outside coal purchases			38.6			54.3			17.1			7.5			23.8
General and administrative			58.8			52.3			50.8			41.1			37.2
Depreciation, depletion and amortization			218.1			160.3			146.9			117.5			105.3
Asset impairment charge			19.0			—			—			—			—
Gain from sale of coal reserves			—			—			—			—			(5.2	)
Net gain from insurance settlement and other(1)			—			—			—			—			(2.8	)
Total operating expenses			1,659.8			1,430.6			1,258.3			1,009.4			1,004.9
Income from operations			374.5			413.0			351.7			221.6			151.6
Interest expense (net of interest capitalized)			(28.7	)		(22.0	)		(30.1	)		(30.8	)		(22.1	)
Interest income			0.2			0.4			0.2			1.0			3.7
Equity in loss of affiliates, net			(14.7	)		(3.4	)		—			—			—
Other income			3.2			1.0			0.9			1.3			0.9
Income before income taxes			334.5			389.0			322.7			193.1			134.1
Income tax expense (benefit)			(1.1	)		(0.4	)		1.7			0.7			(0.5	)
Net income		$	335.6		$	389.4		$	321.0		$	192.4		$	134.6
Less: Net loss attributable to noncontrolling interest			—			—			—			(0.2	)		(0.4	)
Net income attributable to Alliance Resource Partners, L.P. ("Net Income of ARLP")		$	335.6		$	389.4		$	321.0		$	192.2		$	134.2
General Partners' interest in Net Income of ARLP		$	106.8		$	86.3		$	73.2		$	60.7		$	45.7
Limited Partners' interest in Net Income of ARLP		$	228.8		$	303.1		$	247.8		$	131.5		$	88.5
Basic and diluted net income of ARLP per limited partner unit(2)		$	6.12		$	8.13		$	6.68		$	3.56		$	2.39
Distributions paid per limited partner unit		$	4.1625		$	3.6275		$	3.205		$	2.95		$	2.53
Weighted average number of units outstanding-basic and diluted			36,863,022			36,769,126			36,710,431			36,655,555			36,604,707
Balance Sheet Data:
Working capital		$	73.0		$	269.3		$	348.7		$	54.9		$	239.8
Total assets			1,956.0			1,731.5			1,501.3			1,051.4			1,030.6
Long-term obligations(3)			791.6			688.5			704.2			422.5			440.8
Total liabilities(4)			1,250.5			1,107.8			1,045.5			730.4			740.4
Partners' capital(4)		$	705.5		$	623.7		$	455.8		$	321.0		$	290.2
Other Operating Data:
Tons sold			35.2			31.9			30.3			25.0			27.2
Tons produced			34.8			30.8			28.9			25.8			26.4
Coal sales per ton sold(5)		$	56.28		$	55.95		$	51.21		$	46.60		$	40.23
Cost per ton sold(6)		$	38.15		$	37.15		$	33.90		$	32.23		$	30.39
Other Financial Data:
Net cash provided by operating activities		$	555.9		$	574.0		$	520.6		$	282.7		$	261.0
Net cash used in investing activities			(623.4	)		(401.1	)		(295.0	)		(320.1	)		(184.1	)
Net cash provided by (used in) financing activities			(177.7	)		(238.9	)		92.7			(186.6	)		166.8
EBITDA(7)			581.1			570.8			499.5			340.4			257.8
Maintenance capital expenditures(8)			282.6			192.7			90.5			96.1			77.7

We can work out a few more things here - for instance the maintenance capital expenditures are now 282.6 million dollars annually. That is $8.12 per ton produced per year. Back in 1999 maintenance capital expenditure was only 43c per ton produced per year.

That is an 18 fold increase in maintenance requirements per ton produced per year.

An unmitigated record of operational failure

This is very puzzling indeed. Financially this is the best performed coal operation in North America - the stock price is near the all time high. The distributions paid by this MLP are large and increasing. People sing the praises of this management team (particularly on Seeking Alpha but also in the comments on my blog).

But the operational facts on the ground tell a radically different story. This management team demonstrate unparalleled operational failure. The company has radically increased its capital expenditure - and the capital intensity of the business has gone up roughly 350 percent. This is a big-spending management team.

Despite that (and despite their non-unionized workforce) labor productivity has dropped more than 20 percent. And the workforce has become more bureaucratic.

Finally all this new - and seemingly expensive machinery - needs to be maintained. And the maintenance expenditure which was once only 43c per ton per year (less than 2 percent of the price received per ton of coal) is now over $8 per ton of output (over 14 percent of the price received per ton). This business is way more expensive to maintain.

On an operational level this is seemingly the worst run mining operation in the United States (and I am including the bankrupt Patriot Coal). And yet the company has had unparalleled financial success.

Why this might be is the subject of a few more posts.






John