Capital Family Holdings: In Light of IRS Reg, SXC Offer Continues to Be Inadequate

AUSTIN, Texas--(BUSINESS WIRE)--On Feb. 2^nd, 2017 Capital Family Holdings Inc. (“CFH”) addressed a follow-up letter to the Conflicts Committee of SunCoke Energy regarding the 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, and we are long term investors of SXCP. Given the effects of the recent IRS regulation, we felt it was important to update our analysis and perspective on any potential deal with SXC. In summary, we continue to find the offer deeply inadequate, and believe there is no reason for SXCP to sell or exchange units at the current offering.

To the extent that others have concerns on the proposed transaction, we continue to encourage them to contact the Conflicts Committee via [e-mail] and request that your message be shared with the Conflicts Committee.

We hope you find the following letter valuable and we expect SXC mgmt. to fulfill their fiduciary duty to SXCP by either cancelling the current offer or raise it to a fair price as highlighted in the attached letter.

Capital Family Holdings, Inc. (“CFH”) is a family-owned corporation based in Austin, TX. CFH has both private and publicly traded businesses 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.

February 2, 2017
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 a follow-up to our November letter regarding the proposal from SunCoke Energy, Inc. (“SXC”) to acquire all of the independently held units of SunCoke Energy Partners, L.P. (“SXCP”). Given the potential impact of the recent IRS regulation, we are writing to share our updated opinion on both the deal and the valuation. As previously stated, CFH and its various members are long term investors in SXCP, and to our knowledge CFH is a top-10 unit holder of SXCP.

As we will highlight below, the recent IRS regulation does lower the fair value of SXCP (although not materially), and it also increases the merit of a combination transaction. However, increasing the merit does not make it logical – it just makes it less absurd than it previously was. SXCP still has valuable assets, still brings everything to the table for any deal with SXC, can wait years to do a transaction or can just do a C-Corp conversion. Even factoring in the recent regulation, SXCP is still materially more valuable than the current market price or implied transaction price.

We are relatively more amenable to a combination with SXC, but above all else, the offer price must make sense. If SXC cannot offer a fair price then SXCP independent unit holders are better off as an independent entity. As described below we can collect eleven years of partnership status cash flow, have optionality to challenge the IRS regulation, and can either convert to a C-Corp or sell the company at a different date (to SXC or a different suitor).

I. IRS Regulation and Implications

• Comment on Regulation. Although we are disappointed in the regulation and believe that it can be challenged, as of now we have updated our analysis to contemplate its impact. We believe that SunCoke can, and should, challenge the regulation and bring their concerns directly to the Treasury Department and the new administration for consideration in future changes to the tax code. SunCoke is a valuable player in the domestic steel industry, and would be benefited from an amendment to the recent regulation to include coke processing as qualifying income.
• Immediate Implications. We have spoken with officials at the IRS, and it was clear that SXCP should qualify for the 10-year transition period of partnership status. Further, the IRS informed us that the transition period would begin the year after the one in which the regulation went into effect. So SXCP will effectively have eleven years of partnership status.

II. Updated Valuation

• The valuation below illustrates the value that SXCP has even if it loses its partnership status. The income and cash flow figures below are based on 2016 results and conservatively do not contemplate any benefit from CMT volume growth from that time, any other kind of future growth, no distribution increases, debt pay down, or excess cash payments.
• The valuation is based on eleven years of partnership status income and a terminal value as a C-Corp.

Discount Rate	10%
Quarterly Distribution	$0.594
	1	2	3	4	5	6	7	8	9	10	11
	2017	2018	2019	2020	2021	2022	2023	2024	2025	2026	2027
Partnership Status Income
Distribution	$2.38	$2.38	$2.38	$2.38	$2.38	$2.38	$2.38	$2.38	$2.38	$2.38	$2.38
Discounted Value	$2.16	$1.96	$1.79	$1.62	$1.48	$1.34	$1.22	$1.11	$1.01	$0.92	$0.83
Net Present Value/Unit	$15.43
Terminal C-Corp Value
Figures based on 2016 results
Net Income	$119										$119
35% Tax Effect											$42
After-Tax Income											$77
Plus Depreciation											$78
Minus Maint. + Accrual CapEx											$22
Net Cash Flow											$133
Cash Flow Multiple											10x
Valuation											$1,331
Discounted Value											$467
Net Present Value/Unit	$10.10
Total Value
Partnership Income	$15.43
Terminal Value	$10.10
Total	$25.53

• It is notable that as of the close on Feb. 2, 2017 SXC traded at $9.02/share. Based on the proposed 1.65x exchange ratio that would value SXCP at $14.88/unit. The present value of the transition status distributions alone are worth $15.43. The current offer is not justifiable to independent SXCP unit holders. Even with the impact of the C-Corp conversion, SXCP is worth roughly $25/unit.

III. Proposed Transaction with SXC

The fundamentals of converting SXCP to a C-Corp have clearly gained merit. However, there are still several large concerns with the proposal.

• Valuation. Valuation continues to be a gaping concern. As stated in our previous letter, “SXCP would bring the youngest assets, virtually all of the EBITDA and cash flow to the proposed combined enterprise…and would provide the EBITDA base for further acquisitions that mgmt. desires.” The valuation above points out the clear gap between not only the current trading price and fair value, but more importantly the proposed transaction and the fair value. There is no reason for SXCP unit holders to accept an offer that does not value it near $25/unit.
• IRS Regulation. Executing the transaction today would not allow SunCoke the opportunity to challenge the recent IRS regulation. The regulation can and should be challenged.
• Mgmt. and Transaction History. We continue to have concerns about management’s transaction history and the distrust that their actions have engendered with us and many other independent SXCP unit holders.

SXCP unit holders should be well compensated to take on these risks, and there is little logic to selling unless the price is near $25/unit.

IV. Alternative Actions

• Independent entity. SXCP can stand independently. If a deal cannot be done at a fair price, then SXCP could pursue a transaction at a later date (with SXC or another suitor) or convert to a C-Corp.
• Buy back units. Additionally, as stated in our previous letter, if one takes a long-term view of SXCP, then the firm could cut the distribution and use the cash flow to buy back units. This would undoubtedly cause dislocation in the unit price in the short run, but in the long term it would allow long term holders to effectively acquire back units at a discounted rate, and increase the distributable cash flow per unit. Once the distribution is raised this would benefit both SXC and SXCP and the IDR value to SXC. As previously stated, most MLPs cut their distributions due to weakness – SXCP has an opportunity to do so out of strength.
• Other suitors. Large diversified MLPs could benefit from the stable cash flow and assets of SXCP and as long as the contribution from SXCP is below 10% of their activities they could still treat it as qualified income even under the new IRS regulations. SXCP could also be a natural fit for infrastructure partnerships or utility companies. Several utilities in the US and Canada own or have owned similar assets (such as DTE Energy).

V. Closing Commentary

To quote our previous letter,

“The current proposal is plainly an awful deal for SXCP unit holders, and the Conflicts Committee should fulfill their fiduciary duty and reject it.

...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.”

As stated, in-light of the IRS regulation, there is increased merit to consummating a transaction – but only at a fair price. If SXC cannot fairly value SXCP, then the company is more valuable and better off as a stand-alone entity.

Sincerely,
Simon Zolotarev
Head of Investment Division
Capital Family Holdings Inc.