Teekay shares or Teekay PEPS? An Investor’s Perspective

By Lambros Papaeconomou, of Mallory, Jones, Lynch, Flynn & Associates,

Borrower: Teekay Shipping Corporation

Security Type: PEPS

Total Amount Borrowed: $125,000,000

Unit Price: $25.00

Dividend: 7.25%

Date Interest Commences Accruing: February 16, 2003

1st Dividend Payable on: May 16, 2003

Maturity: May 16, 2006

Moody’s Rating: Ba3

S&P Rating: BB

Chart 1

Suppose on February 12, 2003 you were considering investing $25 for 3 years in Teekay Shipping (NYSE:TK). You could purchase either 0.6941 TK shares (stock symbol: TK) at $36.02 (the day’s closing price), or one TK Premium Equity Participating Security (TK PEPS) – (stock symbol: TK_PA), Teekay Shipping’s offering of convertible securities that was priced and sold that day. Would you invest in TK shares or TK PEPS? Under what circumstances would your investment in TK shares be more profitable than TK PEPS and vice versa? How were TK PEPS priced vis-à-vis TK shares? Did arbitrage opportunities exist? In this article we will attempt to answer above questions by analyzing, in depth, Teekay’s recent offering of convertible securities.

TK PEPS earn an annual dividend of 7.25% (or $1.8125 per unit) and are automatically converted into TK shares after 3 years as per the conversion formula described in Chart 2. TK shares earn an annual dividend of $0.86 per share which, at the purchase price of $36.02 per share, is equivalent to an annual dividend yield of 2.39 For a $25 capital investment, investors in TK shares would own 0.6941 shares that will pay them an annual dividend of $0.5969, whereas investors in TK PEPS would own one unit that will earn an annual dividend of $ 1.8125. Therefore investors in TK PEPS will earn an extra $1.2156 per annum. However, as described above and also shown in graph 1, the number and value of TK shares they will receive after 3 years could be the same or lower than those owned by investors in TK shares, and would depend on the stock price of TK shares after 3 years (referred to as “future stock price”).

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Ship finance in Turkey – the Real Opportunities

By Ilhan Yirmibesoglu

FOR more than thirty years the Turkish ship- ping industry has primarily operated older vessels and small locally-constructed vessels financed mainly through a limited number of state-owned banks. Only one international bank, Hamburgische Landesbank (HLB), has been consistently active in Turkey over the last decade. Now HLB is reducing exposure and Turkish banks are no longer in the picture. Therefore further fleet expansion will depend mostly on the availability of funding from international financing institutions. There are both risks and opportunities for new players looking at the Turkish ship finance market.

The trend (at least for the major players) now is away from small, old vessels and local construction and towards a bigger, more modern fleet built internationally. For the first time in their history, in 1999, Turkish shipowners started placing orders at Japanese and Korean shipyards for suezmax, aframax and handysize tankers as well as super handymax bulkers. This can be attributed mostly to the fact that the newer generation of shipowners, which has now largely taken over their family-controlled business, has realised that the future lies with more modern vessels better suited to meet the requirements of modern international trade. The creation of the Turkish International Ship Registry (TIS) has also assisted the industry in attracting outsiders to invest in shipping. TIS has made shipping a unique sector within Turkey because it offers corporate and income tax exemptions both on profits from activities as well as capital gains.

Local investors have realised that despite their ability to be competitive by running vessels at low costs, their chances of expansion based on older or locally built small-size tonnage (the type they mostly control) would be limited. An additional complication is the fact that it would almost be impossible to raise financing for these types of vessels from international financiers and they cannot turn to Turkish banks, because they are no longer looking at shipping.

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FRENCH TONNAGE TAX LONG AWAITED LEGISLATION

By Alain Gautron & Stéphane Salou,Orrick, Paris

Following in the footsteps of many of its fellow European countries (U.K, Norway, Ireland, etc…) France has finally decided to adopt its own tonnage tax legislation. The desire to encourage a sizeable French shipping industry whilst not granting advantages which would be frowned upon by the European Commission has made the French government cautious in the crafting of this piece of legislation. As a result, there has been considerable debate between the French government and the French shipowning community as to the features which this law should contain in order to be attractive.

In preparing this legislation, France has had the advantage of being able to analyse the tonnage tax legislation adopted in other countries (and in particular the United Kingdom). It has chosen certain features from various other jurisdictions albeit retaining a very French flavour to the law being implemented. Although the framework of the law exists today, a decree giving further details concerning the application of the law, should be issued soon. Perhaps some of the questions raised by it today will be answered.

The United Kingdom is now adopting amendments which will change its tonnage tax regime. These changes are reported to potentially reduce its attractiveness for foreign shipping groups. The new French tonnage tax regime is therefore a welcome new arrival in this arena that could offer a significant alternative to the shipowners seeking a favourable tonnage tax jurisdiction.

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Shipping and Oil Service Investments A Hedge Fund’s Approach

By Jonas Andreasson, oceanic Hedge Fund

Shipping and certain sectors of the oil service industry are notoriously cyclical. These industries are seemingly forever tied to the boom and bust cycle of over capacity brought on by the over exuberance of new investment during the dramatic but all too brief good times. With an industry that is generally fragmented, with low entry barriers, the few well managed companies that exist struggle to escape from the destructive behaviour brought on by the lemming like behaviour of the multitude of investors who, each in turn, believe they hold the secret to success of outwitting the rest of the market.

The nature of the market has meant that few companies have taken the public route and opted for open stock listings. Those that have have generally provided the investor with zero, if not negative returns over the cycle. Some sectors have created some value and these tend to be the con soli- dated sectors of industrialised shipping such as car carriers. There are also signs that this is happening in the tanker sector. But overall the picture is a rather depressing one of destroyed shareholder value and companies trading below net asset value over the cycle.

For the investor who decides to buy and hold a share in a shipping or oil drilling company the success has therefore depended entirely on the timing of the entry and exit of the investment. Just as the investor in vessels has created his wealth by buying low and selling high, so too has the stock investor. This has made the long only approach of the mutual fund a rather inappropriate way to extract wealth out of this market. First of all the small size of the market has meant that few of the large institutional investors bother to understand the mechanics that drive the sectors and only invest on diversification grounds. Second, with the down part of the cycles being equal in length to the up part, the long only approach means that investments have only benefited from half the cycle. Any such gains are fully wiped out by the next down cycle.

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CRITICAL FILING DEADLINES FOR MORGTGAGEES OF US FLAG FISHING INDUSTRYVESSELS

By Bruce A. King & Stephen B. Johnson

Under regulations published in the Federal Register on February 4, 2003 (68 Fed. Reg. 5564, et seq.), all lenders holding preferred mortgages on U.S. flag fishing industry vessels 100 feet or more in registered length have a short deadline to file proof of their eligibility to hold their mortgages, failing which the preferred status of their mortgages will be jeopardized, and, depending on the circumstances, other adverse consequences could ensue. For many mortgagees the deadline to file is March 31, 2003, and for others the deadline is the first date on or after April 1, 2003 that a vessel in their loan portfolio must renew its certificate of documentation. The regulations implement the ship mortgage provisions of the American Fisheries Act of 1998, as amended (the “AFA”).

Under these new statutory and regulatory provisions, as of April 1, many lenders will no longer qualify to hold their own mortgages on the affected vessels. Such lenders will be required to assign their mortgages and related debt instruments to a qualified “Westhampton” mortgage trustee. In some instances, the trust agreement and loan documents will also have to be approved by the Maritime Administration (“MARAD”) to confirm that the transaction documents do not confer excessive control on non-citizen lenders.

How did this come about? The AFA is the culmination of a series of federal enactments over the past fifteen years to “Americanize” the U.S. fisheries. The result is that now, with a few exceptions (mainly in fisheries in the western Pacific Ocean), the owner of a fishing industry vessel must meet U.S. citizen ownership standards that are stricter than those that apply to the U.S. coastwise trade. In the case of a corporation, for example, in addition to being a U.S. entity with U.S. citizens acting in senior executive positions and controlling the board of directors, seventy-five percent of the shares of the vessel owning corporation must be owned by U.S. citizens, “at each tier of ownership of such entity and in the aggregate.” The “in the aggregate” test is more restrictive of foreign ownership than the seventy- five percent U.S. citizen ownership standard that applies in the coastwise trade. Further, Congress directed MARAD to give “rigorous” scrutiny to financing documents and other contractual arrangements affecting control of fishing industry vessels 100 feet or more in registered length. These requirements have been in effect since October 1, 2001.

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Confluence: New build in g, Prices and Interest Rates

By Jerry Lichtblau of MJLF

The combination of current newbuilding contract prices and borrowing costs provide owners a, perhaps, once in a lifetime opportunity to be largely shielded from the down cycles of the market while still being able to take advantage of the upside volatility.

Cost Reduction

The level of NB prices is similar to the level that existed in 1999 (lower in some sectors not in others), which are the lowest in the double-hull lifecycle, but current interest rates are nearly 400 basis points lower than they were during the bottom of the 1999 NB market. For those with a navigational bent the comparison of 2002 with 1999 can be described that in 1999 these two factors were in opposition while conversely they are now in conjunction. In other words: (a) the stars are now aligned and (b) for those old enough to remember the play Hair – the moon is in the seventh house. This result is estimated financing costs¹ being lower than they were in 1999 by:

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Deal of the Year – 2002Public Debt

“It is the rare item that inspires a bargain hunter to pay a premium. That’s why when CP Ships, whose very identity is defined by buying out-of-favor companies on the cheap, marched up to the Wall Street counter and ordered $200m worth of bonds yielding 10.75%, the ship finance industry was momentarily in shock.”Marine Money, June 2002

Like all capital markets, the public debt market opens and closes as unpredictably and as inexplicably as the shipping markets rise and fall. As one bond underwriter in New York said, “the high yield bond market is only about twice a year, so companies need to be ready and execution needs to be perfect.”

Although slipping gracefully through an open window, as JP Morgan did for Stena and Morgan Stanley did for Seacor, is a pretty thought, the reality is that the capital needs of companies generally don’t coincide with the few and fleeting moments that the bond window is open. This scenario sometimes leaves issuers with an unfortunate task – jumping through a closed window, and hoping they don’t get too bloodied along the way. That’s exactly what happened in the case of thisyear’s award winner.

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WHO’S WHO IN SHIP FINANCE 2003

Financing the US Market via the CCF

By H. Clayton Cook, Jr.

SUMMARY

While the U.S. commercial shipbuilding industry outperformed the U.S. economy between 1992 and 2001, this period witnessed the construction of barely a dozen large ocean going vessels for our U.S. domestic trades with an aggregate cost of not much more than $500 million. In contrast, U. S. national transportation needs for the current decade will require the construction of four to five dozen such commercial vessels which, taken together with the building of smaller vessels to meet our other domestic needs, will involve shipbuilding contracts in excess of $6 to $7 billion. The majority of this work is federally mandated by the Oil Pollution Act of 1990, or involves the replacement of vessels in our U.S. noncontiguous trades that have reached the end of their useful lives. The balance is driven by U.S. population growth and environmental concerns that are not likely to abate. These U.S. national transportation needs are clear and immediate. However, the means for financing the vessels to meet these needs remains uncertain.

Some of these transactions will be accomplished by the purchaser and shipyard acting alone. However, the majority will involve third party financing and the retention of financial advisors. In these situations qualified advisors will wish to earn their place at the table by demonstrating that their services will add substantial value to the transaction. During the last such period of major U.S. shipbuilding activity two programs supervised by the U.S. Maritime Administration (“MARAD”) under Title VI and Title XI of the Merchant Marine Act, 1936, and its more recent amendments, were employed to meet vessel financing needs. To date, in this current decade, there has been only limited recourse to these programs. The MARAD Title XI Financing Guarantee program is reasonably well known, but it has fallen onto disfavor in part as the result of FY 2002 and FY 2003 controversies between the Bush Administration and the U.S. Congress. The MARAD Title VI Capital Construction Fund (“CCF”) program is less well known. Thus far, the CCF program has escaped such controversy, and MARAD has recently proposed a significant program expansion. Perhaps it is time to examine the potential financing opportunities which the MARAD CCF program may offer?

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Comparative TCE Earnings Analysis

By David J. Saginaw of McQuilling Services, LLC

During any given period the relative health of the tanker freight spot market, and the corresponding general well-being of tanker owners, is typically assessed by a review of the average time charter equivalent (TCE) earnings, expressed in $/day for the period for a given class of tankers. As is well understood by industry watchers and participants, this parameter is arrived at by transforming spot market rates expressed in terms of Worldscale to daily rates expressed in terms of ($/day) through simple voyage economics calculations. In the general case, these calculations assume a round trip voyage assumption, that is, a ballast voyage transit from the discharge port to the load port and a laden voyage transit from the load port to the discharge port.

In certain tanker sectors (Handy, Products, Panamax), owners and operators have historically scheduled vessels such that ballast legs are reduced through triangulation or backhauls or other techniques commonly referred to as ‘tramping”. More recently, these techniques have been more and more frequently applied in the deployment of larger vessels, up to and including VLCC’s. Therefore, it is likely, and more so now than in the past, that the assumption of round trip voyage economics in transforming spot market rates to TCE’s understates the actual earnings implied by spot market levels. In short, while tanker spot freight markets are anything but healthy at the moment, things may not be as bad as they appear for tanker owners and may actually be quite a bit better than supposed. As described above, this is because actual vessel voyage histories reflect more optimized routing than that implied by round trip assumptions.

Given the nature of our industry and the understandable reluctance for full disclosure by the tanker owning community, demonstrating proof of this has been difficult. Thanks to reporting standards required of companies listed on U.S. stock exchanges and recent listings of a reasonable cross-section of tanker companies, quantitative data is now available to investigate whether actual earnings levels exceed those implied by spot market levels. Continue Reading