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Constructing & Destructing Balance Sheets
With earning’s season reporting upon us, companies are disclosing the steps they are taking to bolster their balance sheets as well as recording the destructive efforts of the accountants. Companies are trying to strengthen their balance sheets in light of macro events, weak markets, leverage as well as future capex obligations. On the other hand, investments by shipping tycoons have also proved unsuccessful leading to mark to market write downs proscribed by accountants which diminish equity although they are non-cash charges. In no specific order, we highlight the following:
Paper or Steel?
Meridian 10 and the German KG Market
While in Hamburg, we had the opportunity to meet with the management of Meridian 10 (“M10”) who took the time to explain their business model to us. The opportunity they seek to exploit is in the German KG or closed-end fund market with a particular focus on the secondary market.
The primary market for KG funds is huge. In 2007, for example total placed equity amounted to €12.7 billion. Driven by the exceptional development of the shipping market, placement volumes in shipping reached an all time high that year, growing 38% y-o-y to € 3.6 billion while cumulative placed equity since 1993 amounts to € 30.9 billion.
WKSI No More
Perhaps one of the least painful but aggravating aspects of the share price collapse of the shipping stocks is the loss of one’s “well-known seasoned issuer” or WKSI qualification. When the company’s market cap falls below $700 million, the company no longer is a universal filer but must register as you go. For perspective, as of Tuesday, only Teekay, Teekay LNG, Nordic American Tankers, Diana Shipping and Alexander & Baldwin were qualified. OSG just missed at $641 million.
Secondary Opportunity
The German Ship Finance Forum followed last years’ pattern of commencing with a half-day seminar. This year’s topic was focused on opportunities in secondary markets. Chairman Michel Bourgery of DVB started things off with a brief overview of the markets. Based upon his successful prognostications in the past, we listened carefully as he suggested that listed companies would be taken private. He bases this upon the fact that there is no re-cycling of equity and they are locked-in loss making position. Moreover, limited visibility and overall pessimism are also factors. For those who have no fear, he suggested taking a position in the tanker market was too early as the one-year t/c rate is greater than the three year. For bulkers, the time to go shopping will be this summer.
Dr. Albrecht Gundermann of Salomon Invest took the audience through the secondary market in KG funds, which is relatively new. Historically, once you joined the party you could not leave it. Trading remains limited but there is a real market with real prices. Right now it is a buyers’ market. With a total market of EUR 30 billion, only 4% has been traded.
Pareto’s Peter Wallace next gave his insights into the IS/SPC (formerly the K/S) market. The size of the market is approximately $15 billion and is split evenly between shipping and offshore. The basic structure is a limited partnership which has both paid-in and uncalled capital. No longer tax-driven, this product is extremely flexible and can be designed in any form that makes economic sense to the participants. It is an ideal alternative when public equity is difficult or expensive or when the asset is trading below NAV. Investors like it because:
• There is no management risk
• You can pick the asset you want
• The structure is transparent
• A trigger clause allows the holders of 15-25% to cause a sale
• There is a liquid secondary market
• The price to put the project in the market is relatively cheap at 3-4% of the cost of capital
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Bright Spots
On the positive side, we can report on two deals that were announced this week.
Navios Clears Up Uncertainty
Navios Maritime Holdings shored up its balance sheet and cleared up any concerns about its ability to finance its remaining acquisitions. Despite difficult credit conditions, the company obtained $353.5 million in debt financing with favorable terms.
The financing includes:
• 10-year term financing for $120.0 million, secured at 60% of original vessel values and interest at LIBOR plus 190 bps to partially finance the acquisition of two Capesize newbuildings;
• 3-year term convertible debt for $33.5 million with a coupon of 2% and a conversion price of $11.00 per share (Wednesday’s mid-day price $2.37) to partially finance the acquisition of the Navios Vega (delivered this month); and
• 2-year revolver for $200.0 million in total, with interest at LIBOR plus 275 bps to be used for general corporate purposes.
And even with this new debt in place, Navios still has the ability to return capital to its shareholders in the form of dividends and buybacks. If by chance we had any doubts, we certainly feel vindicated in nominating Ms. Frangou and her team as dealmaker of the year.
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Heard on the Street – Hamburg Special
This week we are in Hamburg for our 8th Annual German Ship Finance Forum and, as one might expect, this small in size but large in importance shipping center is undoubtedly feeling the pain. Largely focused on container shipping, the KG model, which is the unique and dominant financial product here, benefited from the buoyancy of the credit and shipping markets and is now exhibiting weakness and is in need of repair. But the situation cannot be described simply in black and white terms. Although the problems are prevalent and the continuous flow of bad news exacerbates it, there is an underlying belief that the problems will be solved and there is a future, albeit different. And whether that future is good or bad is irrelevant, it will be dealt with in Germanic style. Nevertheless there still remains uncertainty, some palpable fear, but hope also.
There were recurring themes in our discussions but it remains difficult to paint a clear picture. The following vignettes will hopefully provide you a sense or feeling of the mood and what is happening in this beautiful city where unexpectedly the sun was even shining on Tuesday.
My Name is “Banker” and I Cannot Lend (At Least for the Moment)
The moment of catharsis is upon us. The inability to lend, at least in terms of new business, is now generally acknowledged and with that the first step to the cure has been taken. For months, no one has been willing to acknowledge this simple truth which in many cases suspended belief and made many institutions the brunt of jokes. As they say, the truth will set you free.
With that issue set aside, there remains the question of the banks honoring commitments. The majority of banks are living up to their commitments but there are rumors of some banks behaving badly. From one borrower we heard that one of the largest banks, despite its well-known difficulties has stepped up and continues to abide with its agreements. In the interest of full disclosure we must, however, admit that this borrower is a major shipowner here in Hamburg. Here we suspect the law of the jungle applies and those owners not so well placed are the ones not faring as well with their banks. Banks should be wary for owners’ memories are long and when the market turns those that behaved badly will most certainly be left out.
The Highest Stakes Poker Game In the World
In the German world series of poker, there are four players left, the owners/charterers, the emissionshauset, the banks and the shipyards in Korea and China where many newbuilding containerships are being or scheduled to be built. Perhaps in the background is the government acting as a kibitzer1 for the moment but who may have to take a seat if the impasse between the parties continues. Billions of Euros are at risk as owners seek to renegotiate the shipbuilding contracts with an eye on postponing or deferring deliveries. No one has spoken yet of cancellation, as far as we know.
Loose credit and booming shipping markets are too blame for this problem. Like drugs, it is hard to say no once hooked. In this instance, the emissionhauset joined forces with the sponsors to order newbuilding containerships in the main against long-term charters. The banks financed 100% of these projects, which utilized SPVs, by agreeing not only to provide the mortgage debt but also funding the equity, including capitalized interest, as yard installments were due. Securing the latter were equity bridge guarantees given with the expectation that the equity for the transaction would be sold within the year. Unfortunately the credit crisis and the resulting economic recession intervened. The freight market collapsed and equity all but disappeared.
Although we were reminded that financial crisis had previous roles in historic economic crisis, none have been of this magnitude. So unable to find a solution domestically, daily flights to Asia from Hamburg began to be filled with owners, initiators, lawyers and advisors in an effort to renegotiate the contracts. Unfortunately, they were not welcomed with open arms by the Chinese and Korean shipbuilders.
Although we understand the Chinese to be somewhat more accommodating, the Koreans thus far have been slower to come to terms, which is understandable for a number of reasons. First and foremost, these are contracts, which the parties are obligated to fulfill. Historically, the Koreans have been strict in fulfilling their obligations. One need only be reminded that many of these very same contracts were signed based upon significantly lower steel prices which subsequently soared through the roof and have only recently returned to earth. No one from Asia jumped on a plane to ask for a price adjustment. On a higher level this is about culture and honor. There may even be pressure from the Korean government and banks to hold the line. But perhaps even more significant is the risk of cutting a deal with just one. All would have to be treated equally leading to a flood of renegotiations.
In the interim, all the funds guarantees are being restructured with the bridge loans being extended against additional security. We can picture a smoke-filled room with the players trying to figure out who is bluffing. Unfortunately the reality is there is no equity, the banks are stretched and the only way to salvage the situation and to come out close to whole with the least pain is to defer deliveries. Neither cancellations nor intransigence gain anything in the long run. On the other hand, massive cancellations, as some predict, would have an immediate positive impact on the market in the short-term. We would, however, expect that this action would impair these relationships in the long run. However a bull market has been known to cure all. And we have seen in the recent cycle that institutions are subject to periods of short-term memory loss and life may very well go on.
Term of Art
In America, the expression is “too big to fail.” Here in Germany they use “system relevant”, which to us is more appropriate, understated and to the point. As of now the banks are supporting the initiators including the three largest, HCI, MPC and Lloyd Fonds. The unanswered question is whether the banks have the wherewithal to support these key players on their own? As the deals done were non-recourse, there is little choice in the matter but the question of capacity overhangs the situation.
As is the case in America, government intervention, if necessary and available, will have to deal with the hot political issue of salvaging a system that benefits high net worth individuals, which represent a minority (~20%) of the population.
KG Kaput?
The answer quite simply and resoundingly is no. There is just too much liquidity in Germany and the KG investment, with its asset focus, holds an important position in the investment portfolio of wealthy individuals. And perhaps even more importantly, these closed end funds have retained more value than other investments although dividends are certainly coming down. On the other hand, do not look for annual placement volume of EUR 3 billion+ in shipping in the future.
As described above, the issue, for the moment, seems to be restricted to newbuilding projects. Although the consensus suggests the equity markets are dead, others say deals are being placed but at a very slow pace. It depends on with whom one is speaking.
What is certain however, provided the current experience is not forgotten and institutional memory remains in place, is that financial structures for newbuildings will be different. On a superficial level we would surmise that deals will no longer be 100% financed without a larger degree of recourse, leverage on the mortgage loan will decline, the fee structure will be modified and perhaps investors will even look at blind pools. In short, risk sharing will be adjusted.
Truth, Justice and the Old Fashioned Way
In the midst of doom and gloom, there are rays of sunshine. We had the opportunity to meet with a small privately held bank whose loan book represents approximately 16% of its total assets with the balance largely customer deposits. Funding clearly is not an issue. There are no interbank loans, no syndication and no capital markets activity. The ROE is an astounding 37%.
As this is Hamburg, ship lending is an important activity and they approach it, as you might expect conservatively. They are relationship bankers and their main focus is on the owner, which they define as the user of the vessel as opposed to for instance a financial owner, and asset life. They don’t do newbuildings and syndication is not part of their strategy. As a result, the loan book comprises mainly bilateral loans of second-hand tonnage.
If all bankers had stuck to their knitting, as this institution has, the world might be a different place today.
A Different World
We were reminded in a wide-ranging discussion with the principal of an Emissionshaus that markets have to be put in perspective. There is no new paradigm we have learned, however looking at markets historically and out of their context may not be correct. In this instance we were discussing the extraordinarily low freight market of the 1980s. We were gently admonished that the world has changed drastically in the intervening period. World population has grown exponentially and consequently there are more consumers consuming more. In this context is looking back at the 1980s or 1990s for future guidance particularly relevant? Clearly, it is on the supply side but recovery is demand driven. We remain uncertain but the future
may very well bear him out.
Be Careful What You Wish For
Over the past several weeks Worldyards visited a number of greenfield shipyards and “potential (virtual/under construction)” shipyards in China. It is not a pretty sight. Not a lot is happening in some giant greenfield yards, either because of the cashflow constraints on part of the shipyards or shipyard wanna-bes, or on the part of ship-owners of the ships being constructed in the facilities. The premises of the “potential” yards are typically huge, strategically located and blessed with great natural conditions. We see giant holes of what are meant to be giant drydocks. But little in terms of new construction is going on and very little machinery. We are talking more than 10 VLCC drydocks at varying degrees of completeness.
There has never been a shortage of goldilocks cheerleaders in any kind of markets. The recent surge in BDI has let them to proclaim that the worst is over. They also take comfort in the increased pace of bank lending in China in January, Chinese PMI as evidence that we have bottomed out. Continue Reading
Korea Line on Thin Ice
Troubled Korea Line has successfully renegotiated its existing time charter agreement for a 50,326 dwt Supramax with Hellenic Carriers at a reduced time charter rate of USD 35,000 per day. The new rate is close to 38% lower than the previous charter rate. Continue Reading
Malaysia: Challenges and Opportunities
Marine Money Asia hits the road this week as we head to Kuala Lumpur to present at the Maritime Financing Seminar 2009 put together by our friend Nazery Khalid at the Maritime Institute of Malaysia (“MIMA”) with the sponsor OCBC Bank. More than any other cities in the country, Kuala Lumpur represents the focal point of Malaysia in many aspects and the same can be said for ship financing. The two day seminar gathered an impressive list of over 80 delegates to discuss the current state and the opportunities for the growing Malaysian shipping industry. In his opening address, Director General Dato Cheah Kong Wai from MIMA highlighted some of Malaysia’s achievements in the maritime sector. Today, Malaysia is ranked by UNCTAD as the 18th most important nation in terms of its 1.2% contribution to the world’s merchant fleet in 2008. In addition to two world class container ports – Port Klang and Pelabuhan Tanjung Pelepas, Malaysia’s national carrier MISC is the world’s largest owner-operator of LNG tankers with a fleet of 27 vessels. The nation is also the world’s 13th largest producer of natural gas and 24th largest in crude oil production which explains the vibrancy of its domestic oil and gas sector. Continue Reading
Earnings Season – Bask in the Glory!
As the global economy lurches from shaky economic measure to even shakier economic indicators and the public markets collectively hold their breaths prior to any major earnings release, shipping square in the middle of its own earnings season is proving to be a stellar financial performer. Who would ever have thought that?!
While Diana was punished for missing analyst estimates by 2 cents, the more important fact is that the direction of earnings is still upwards with year on year improvements, dividends are being increased and the forward book of business seems likely to assure that 2008 will be another hugely successful financial year.
Some representative quotes may say it best:
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