Thursday, December 18, 2008

OCNF - The perils of shifting market risks to counterparties: pros and cons in time-charter employment

Time-charters are helpful in securing cashflow, but they are not an absolute panacea for investors and bankers. Shipping companies retain performance risk. There is normally a hire adjustment annually on actual speed and fuel consumption as a opposed to the notional figures in the charter party agreement. If the vessel is in any way not fit for service, hire payment can be suspended. In bad markets, Charterers have increased bargaining power given the scarcity of employment alternatives for Owners. Charter rates can be negotiated downwards. This is risk for all shipping companies currently as long as this downturn persists, especially in sectors like dry bulk and containers where the underlying freight rates have fallen to very low levels and Charterers may be under financial pressure.

As TradeWinds reported Monday, OceanFreight suspended dividend payments in an effort to preserve capital and to possibly jump on new opportunities. Notably the company reported that its 70,000-dwt August (built 1996) will now fetch a lower rate of $16,000 per day, down from $42,100, on an existing three-year charter.

Given the current low spot rates, many listed shipping companies face the potential risk of renegotated charter rates as the market weakness persists. As an example, TOPS bought a number of bulkers at the top of the market in 2007, which they put on period time charter to cover the premium paid in the prices. EXM entered into a sizeable merger deal in the fall of 2007 at premium price levels with Quintana, who had many units on time-charter. This was heavily financed by bank debt.

Both Natasha Boyden of Cantor, Fitzgerald and Scott Burke of Oppenheimer downgraded OCNF. It was not clear whether they were more influenced by the dividend cut or the charterparty renegotiation.

Time-charters are very different from lease-model employment. Often investment presentations are misleading on this matter. Owners must maintain the units to specified standards, provide crew and supplies and are liable for related agency expenses. If the vessel cannot perform for Charterers, they have the right to suspend charter payment. If vessel performances are overstated, charterers can make claims on the vessel. In case of Charterer insolvency, Owners are obliged to deliver cargo and often to settle the unpaid voyage accounts that are Charterers' debts.

In weak markets, Charterers frequently request hire reductions. Owners are often obliged to accept these reductions for lack of other employment alternatives.

Chartering companies are a margin-based business. They may occur losses if underlying voyage results are lower than their hire obligations, making it difficult for them to carry the vessel. Charterers demand increasing discounts for the length of the charter for the risk and uncertainty of carrying the vessel.

Banks and financiers often make unrealistic and commercially imprudent demands on Owners to employ vessels on long period time charters to cover dividends and loan payments. This may result in poor risk assessment as well as impair Owners' business plans in creating shareholder value.

In any case, employment profile must be carefully assessed for each company on a case by case basis.

Monday, December 15, 2008

DryShips: Intercompany transactions, management style and potential moral hazard

US equity analyst Natasha Boyden of Cantor Fitzgerald has called "punitive" Economou's price for allowing Nasdaq-listed DryShips to cancel an order for four panamax bulkers slated for purchase from his Cardiff Maritime. In DryShips, George Economou holds the positions of CEO, CFO as well as Chairman of the BoD. 40% of DryShips is held by insiders and owners. Economou appears to have a predominate role in BoD appointments. SEC rules apparently give DRYS their blessings. Indeed it is frequent practice that major US corporations are run by friendly BoD's with close connections to management in similar fashion. This system reduces diversity in decision-making and limits shareholder rights even for major institutional investors. It appears that there is a high risk of moral hazard in this type of management and BoD structure.

George Economou frequently initiates transactions in Cardiff, his private shipping group, that he passes on to DryShips. This allows him to move quickly to enter into new business. It creates a compensation mechanism between his publicly-listed company and his private group. At a later stage, he obtains DryShips BoD approval and DryShips assumes the financing as well as the ultimate profits and liabilities of the business at a marked-up prices. These are acceptable Wall Street business practices.

In a rising market, this has benefitted greatly DryShips, which has out performed nearly all other conventional listed peer companies in P+L results. Now under present market conditions where there are serious prospects of sizeable losses, these methods open questions should the possible losses fall on investors in the public company from these transactions. Already DRYS has rolled up some substantial real losses in one such transaction and there is risk of loss in another.

Just a month ago, the DRYS BoD approved a controversial deal to acquire nine Capesize units for US$1,17 bio (in cash and shares) and two drill ships from companies reportedly under Economou control.

Now DRYS has forfeited a US$55 mio deposit to cancel the purchase of four bulk-carriers on a previous intercompany deal. DRYS has paid out an additional US$105 mio taking its total outlay on the deal to US$160 mio. All four bulkers appear to be from an Economou order at Shanghai´s Hudong-Zhonghua Shipbuilding.

reports that Economou paid around US$36 mio each for the earlier units and US$50 mio each for the two later ones, at an average cost of around $43m apiece. They maintain that Economou has thus essentially recouped that cost with the US$40 mio per vessel DryShips has paid to date.

Natasha Boyden, an analyst a Cantor Fitzgerald, raises serious questions about the deal, which saw the company pay $105m for purchase options on the vessels, which are reportedly owned by interests associated with Economou. She said: “We believe the terms of the cancelation are punitive and this transaction, in combination with the nine capesize deal in October 2008, raises serious questions in our minds as to the ability of DryShips to finance further transactions.”

The question is how major investment banks will advise their clients on risks in investments like this case.

Tuesday, December 9, 2008

TeeKay LPG Partners (TGP) and its prospects

TGP is a spin off in Wall Street fashion the last few years. OSG and FRO have also done spin-offs. In this case, the parent company is very much in control.TK is a major world player in the tanker sector. They shun the VLCC market. Their concentration is Suezmax and Aframax units. They are also active in the product sector. The gas business is a relatively new segment of their operation, started in 2004. TK is also in the offshore business. In TGP, their concentration is in LNG units and secondarily LPG units (mainly small vessels on order). They have combined this fleet with a flush of 8 Suezmax tankers.

The LNG market traditionally has been plagued by excessive expectations. The saving grace is the high entry cost and needs for operational expertise that keep the number of players restricted. Nearly all the vessels are on long term charter. The spot market is very small but expected to grow to about 30% of the fleet over the next five years. The charterers are major oil companies so counterparty risk is minimal. The spot market is small.

LNG ships are immense capital investments. The LNG industry is based largely on a series of virtually self-contained projects made up of interlinking chains of large-scale facilities, requiring huge capital investments, bound together by complex, long-term contracts, and subject to intense oversight by host governments and international organizations at every state of the process.

Global LNG demand and demand projections generally remain strong, with base case demand projected to grow by more than 70% from 2007 to 2012, and supply projected to grow by more than 80% over the same period. Average annual trade volume growth to 2012 is 9% for low case, 12% for base case, and 16% for the high case scenario. In the short term, the limiting factor on LNG trade continues to be tight supply. LNG supply project development might be slowed down by this financial crisis. The large amount of new liquefaction capacity is scheduled to come online in 2009-10 and there is danger of excess supply, hopefully of short duration but subject to the fall out of the current economic mess, plunging energy prices and spreading recession.

2008 will set a new record for LNG tanker fleet growth, with 55 or 56 newbuilding deliveries. Most 2009 delivery slots are filled, and yard capacity is becoming tight for 2010 deliveries as well. We can assume moderate additional ordering of up to 4 million m3 capacity (20 vessels) for delivery in 2010, and slightly more for 2011. These are exceptionally difficult contracts to cancel.

So far tanker rates have not suffered the catastrophic plunge of the dry cargo and container sectors. In fact, tanker rates are currently firming with seasonal demand. The LNG/ LPG rates are also steady. What has plagued the sector and particularly TNG is inflation in operational expenses (crew costs and repairs). Whatever the external environment, most of TGP’s fleet is contracted on period rates with escalation provisions for operating costs. Also important is financial expense with their large capital commitments. TGP management seems to have done a good job in containing these expenses and planning their FCF; but in the current financial turmoil, this is an area of risk.

Last August, S&P dropped Teekay’s corporate credit rating from “BB-plus” to the next lowest rating of “BB”, signalling that the company faces major long-term uncertainties but is less vulnerable in the near-term. Not unexpectedly, it is the LNG and Offshore business that is the major source of this debt due enormous capital requirements.

In TGP, there is both bank debt and lease commitments. TGP has a very conservative employment profile matching the debt obligations with long-term employment contracts with first-class charterers. They also have negotiated a very good debt profile as well as covered their financing needs for their newbuilding commitments. They seem to have reasonable margins for debt coverage obligations and in any case, it is less likely that these specialized units will be prone to the same collapse in value as commodity tonnage like bulk carriers. The real risk in asset depreciation is the thin resale market especially in distress situations should the contract commitments be impaired – which is the case for all specialized tonnage.

All in all, TGP has an attractive fleet, good employment and management. Shares are trading at very low levels. The major risk is the impact of the financial crisis on future product demand, especially in view of the fall in energy prices. It is also a potential M&A candidate given the entry barriers in the sector.

EXM and debt covenants after the QMAR merger - conflicts between Wall Street IPO structuring and longer term business-building

Capital markets have brought substantial benefits to Greek Shipping. Quintana was a successful dry cargo startup that was sold at a very good time. The business model suffered from the restraints of capital market IPO's, but it was very well managed within these limitations. IPO investor strategy is generally very short term. There are substantial conflicts between the investor appeal and creation of a sound business. The acquiring firm Excel Maritime EXM is now facing the longer term challenges of establishing a sound business. Its first priority is to deal with the high leverage from the LBO in the face of substantial decline of asset prices and a dismal freight market.

Quintana was the ideal combination of commercial and financial partners. The major driver was a well-established US coal trader, who had an existing relationship with a major private equity firm.

Shortly after some initial bulk carrier purchases, the company launched an initial IPO. Some months later, the company entered into a massive scaling up operation, acquiring a large fleet. They chose to finance this with a PIPE offering investors discounted share price to buy into the operation. The issue was structured with high dividend payout against long term employment. Growth was achieved largely by financial engineering rather than free cash flow and commercial market penetration, which would have certainly taken longer.

Timing proved auspicious and the market in 2007 sharply exceeded expectations. Share price rose in excess of actual earnings and FCF. QMAR reaped less benefit in the P+L than share price. The fleet was on fixed rates albeit with some profit sharing. Typically the time charter earning were a fraction of the prevailing spot rates; whilst operating expenses were rising sharply with the boom times.

The major shareholders put the company up for sale to cash out. They got attractive terms from Excel Maritime with a nice cash payout and exchange of shares in Excel, accompanied by BoD and management positions. In turn Excel financed the deal with heavy debt finance. Currently EXM is said to being carrying US$ 1,6 billion in debt.

Currently Excel must manage this debt in severe market downturn and sharp fall in vessel values.

There are real conflicts between Wall Street desire for quick profits and sound business principles. The challenge is to reconcile these conflicts to build a sound business.

Monday, November 24, 2008

Over optimism on a quick reversal of the dry bulk market downturn

Whilst it is true that there are numerous cancellations in the pipeline, the impact depends on the size range of the tonnage. In the end, however, the markets will not return to health until greater demand for cargo carried.

The easiest size range for optimism are the smaller units ordered in the 'Greenfields' yards. The yards themselves may never be in a position to execute the orders. The larger sizes are being built in stronger, larger yards.

Cancellations mean losing deposit money. In some cases, companies will make forfeits; in other cases, they will prefer renegations pushing out delivery dates and perhaps substituting for other type tonnage.Scrapping prospects are also uneven. The prospects are brighter for smaller size tonnage because of the higher age profile.

The bargaining positions are now reversed in supply-chain management where it is a buyers' market. The buyers can pick and choose their suppliers and negotiate freight costs. The decline of export markets seems to be affecting the Far East more than originally anticipated. Domectic demand is not soaking up excess production.

I believe in a cautious approach ahead.

TOP Ships revisited after its 3th Quarter 2008 Earnings Conference

TOP Ships has done some very timely restructuring over the past few months, selling vessels restructuring debt and terminating lease obligations. They have improved liquidity and contained leverage. They have increased secured employment cover.

Given that TOPS was in technical loan default with their asset coverage ratio's from the beginning of the year and there was pressure from activist shareholders due poor results, this served as an early warning system that has put them in an improved condition to face the current shipping slump. TOPS also succeeded to finance their newbuilding commitments backed with bareboat employment commitments for seven years.

Profits are still fragile, however, and the situation after financial expense would be close to break without the profits from vessel sales. The forward risks are decline in fleet value, problems with loan coverage obligations and potential charter renegotiations (and even defaults) in the weak shipping markets.

The tanker market picked up considerably from December 2007 especially in the Suexmax sector where TOPS had vessels open. Expected better operating results were slow to appear for TOPS until the latest third quarter earnings results. With the sale of their Suezmax fleet, TOPS is losing the benefit of the volatility and earnings in this sector of the market, which is so far faring better than dry bulk. The vessels, however, were mainly older units and needed replacement. The sales were timely. The biggest benefit of these sales came from the unwinding of their lease commitments.

TOPS has followed a conservative employment strategy reducing exposure in the spot market and increasing time-charter cover. This has allowed them to hedge their position with the bulk carrier acquisitions made at the peak of the dry bulk market last year. Prices and charter rates for these units have recently plummetted as one of the hardest hit sectors in the current shipping slump. On the new-building handymax product carriers TOPS has leased them to another operator on a bareboat basis for the first seven years from delivery so they carry no operational or market risk.

Of course, TOPS does carry counterparty employment risk on both the time charters and lease agreements that could come to roost if market conditions remain weak for a prolonged period ahead, but it would be hard to fault them for their timely efforts to increase secured income in view of their level of debt and newbuilding commitments.

Costs at TOPS remain high. Latest accounts show continuing increases. With a smaller, leaner fleet and tough times; this is definitely an area where management should focus.Another area of weakness in the past has been investor relations.

Looking from the outside, it appears that relations with activist shareholders were not the best. Perhaps these investors would have reacted differently if TOPS had taken a different approach. TOPS might even have benefitted by some new outside BoD members. More diversity on the BoD and in their management could potential assist in strengthening their strategic commerical outlook and opening new opportunities ahead.

I have been envisaging the possibility of a share repurchase program with the very low level of their share price. TOPS officially announced a US$ 20 mio program over the next twelve months. This seems a very sensible solution, reducing the considerable share dilution from the two efforts to raise capital over the past 12 months and taking advantage of very low share price.

Generally it has been a constructive year for TOPS and the management performance has improved considerably.

Tuesday, November 11, 2008

Will Eagle cut dividends?

Eagle has an ambitious newbuilding program ahead in a weakening freight markets and tight credit conditions. It has maintained a generous dividend policy, which is conditional to meeting its debt covenants. It should look to strengthen its balance sheet in current market conditions and the brewing world-wide recession. It should consider seriously cutting dividends until market conditions improve.

Eagle is a well managed group that specializes in the handymax/ supramax sector of the dry bulk market. It has a modern fleet and favorable break-even levels compared to competitors.

This sector of the market has less rate volatility than the larger Panamax and Capesizes. The vessels carry a wider spectrum of cargoes. They serve emerging economies, where growth is likely to remain relatively high.

The tonnage supply situation is more balanced here. The age profile of the world fleet in this size is the highest in the dry bulk sector. There is better potential for scrapping, especially in poorer markets. There are also better prospects for newbuilding cancellations. Many smaller 'Greenfields' yards service this sector. These yard may not have the financial capacity to delivery. There is a higher probability of order cancellations than the larger vessels.

Eagle's latest earnings report (5 November 2008) was very positive. Profits increased 50% over the second quarter with a growing fleet. On the other hand, cash was down from US$ 153 mio to 33 mio due investing activities (newbuilding tonnage).

Eagle is carrying a considerable amount of debit (US$ 858 mio revolving credit facility). It has heavy newbuilding obligations (34 Supramax vessels which will be delivered between 2008 and 2012). This is more than double the current fleet of 21 units. It has a conservative employment policy with period time-charters, but this is prone to risks of charter rate renegation and even possible Charterer defaults in bad shipping markets.

For this reasons, my view is that Eagle would be best served to reduce or even cut entirely its dividends, using its free cash flow to support its asset investing activities, until market conditions improve.

Britannia in senior debt loan default negotiations and receivership

Nordea and Lloyds TSB, which agreed the $170m deal in May on five bulkers, appear to have alleged that “certain events of default” have taken place, including its financial condition changing for the worse. They are said to have provided cash for daily operations and requested vessels to be sold. Shortly thereafter, the company went into receivership, appointing an administrator.

The lenders are top-tier shipping banks with a big experience factor in this cyclical industry. Normally banks work closely with the clients in bad markets, supporting them until conditions improve. Declaring loan default is a very drastic action that banks generally avoid unless the risks of loan losses are very high and/ or their confidence in management is very low.

For these reasons, there appears to be more behind these events than we know. I have previously written on DWT: Britannia Bulk: Perils of leverage, COA's and chartered in vessels on the 29th October, where I lay down in detail the possible factors in Britannia's plight.

Selling vessels under present market conditions is likely to be at distress prices. Older bulker units at record high prices just months ago are not likely now to fetch more than scrap, which is also falling in price. No doubt the units mortgaged to these banks are fairly young, but Britannia is not likely to get much relief unless market conditions improve.

Their banks would appear to believe that Britannia does not have much resilience to survive the downturn. Britannia decided to appoint an administrator under UK law, putting the company effectively under bankruptcy protection.

Britannia Bulk: Perils of leverage, COA's and chartered in vessels

Britannia was one of a very few shipping IPO's this year. It had a rocky start from inception. The original purpose of the IPO was to refinance existing corporate debt. The initial issue did not go well and it has been a downwards trajectory every since. Presently it is caught in a potential liquidity bind with falling fleet utilization, falling charter rates in the spot market, and operating losses in the face of high leverage and ambitious fleet expansion plans. The company has a fleet of mainly older handy-sized bulk carriers and a fleet of five iced-class Panamax units on order for which it has leveraged up its balance sheet to finance.

Britannia specializes in the transport of coal in Europe, trading heavily in the Baltic where ice-classed units are important in the winter. Its employment portfolio is mainly COA's. In addition the company has significant time chartered in tonnage (45 units as opposed to owned fleet of 22 units as per its share prospectus) to service these COA's.

It is fundamentally a logistics operation that is a margin-based business on turnover. They appear to have made a bad timing decision to leverage up and expand the shipowning aspect so late in the game.

The company is exposed to margin compression (and even potential cash deficits) in its chartering business, where it needs to restructure its chartered-in fleet. It is overleveraged in its owned fleet in a falling market. Many of its units are advanced in age with vessel values severely impaired due the precipitous drop in the dry cargo freight rates. It will struggle to take delivery of the new units in the future.

With its shares currently trading at 25 cents to the dollar, Britannia is in a distress situation. If the employment portfolio has any value, it could be a take-over candidate in a merger deal for the contract book. Britannia is in a fight for survival.

Shipping markets and commodities in the financial crisis

The sharp correction in the commodities markets has tipped the supply/ demand balance in favor of the buyers. The buyers are now in a position to pick and choose. They now have far more room than previously to manage their supply chain logistics. Commodities exporting nations like Russia and Brazil are now facing the music.

For the past five years, the demands in emerging markets for commodities like oil, coal and iron ore have outpaced supply. The primary issue was to secure supply for production. This took precedent over other matters like price and delivery costs.

With slackening demand in the current economic downdurn, supply is now exceeding demand. This is changing the structure of the supply chain relations. Matters such as price and delivery cost have come to fore as buyers now have a choice of alternatives. The commodities sellers can no longer impose their terms in the market. For shipping, this is a negative development because it means fewer shipments and very likely shorter distances. Both freight rates and utilization is dropping.

The container ships were the first to be affected. Now the bulk carriers are also under pressure. The tanker sector is suffering, too but there is so far a better supply-demand balance in this sector.

Sunday, May 25, 2008

Window of opportunity

My belief is that the coming TOPS quarterly earnings report should show improved results due the bulk carrier deliveries and especially the firmer tanker markets since 4th quarter 2007. The recent PIPE will improve the company liquidity with a new cash injection. The transaction costs will probably fall in the next quarterly report. The recent vessel sales, albeit at often disappointing price levels, allow some fleet consolidation that mitigates the rapid expansion.

TOPS faces significant future challenges. They have on order 6 product carriers coming up soon for delivery. Many forecasters express concern about the size of the order book and predict a fragile market prone to rate deterioration. The product sector is open to the risks of a more severe than expected US recession as well as possible 'cannibalization' of the product tanker market in the ME with increased use of local feedstock for chemical production at higher margins. TOPS has a relatively high cost structure that needs to be streamlined to be competitive with other operators. Their fleet of Suezmax, which is an important profit center, needs replacement and renewal. Finally TOPS has significant problems in its relations with institutional investors that need to be resolved. These risks can lead to rewards if properly managed.

For fundamental improvement in shareholder value, the TOPS management has a significant opportunity to prove themselves, take advantage of a growing experience curve and turn things around. Perhaps the expanded financial involvement of George Economou with his uncanny market instincts will assist in improving earnings. Hopefully TOPS will resolve outstanding issues with institutional investors and seek to revamp its BoD to reverse the generally mixed brand image of the company.

Management should recognize that improved financial performance and better shareholder value will increase the financial independence of the company. It will also reduce cost of capital hopefully leading to a premium instead of discount in raising new equity for future needs.

TOPS stands at a critical crossroads presently for its future. Its management should seize the opportunity!

Friday, April 25, 2008

Are Analyst Shipping Stock Valuations ‘Objective’? - case study of TOPS

Top Ships is a company that has startled capital market pundits time and again from its July 2004 IPO. Nobody could believe that a 30-year old son of a Greek construction contractor with with a fresh CV together and a financial director of similar age both with limited prior shipping experience could entice Wall Street investors for multimillion dollar funding. TOPS was one of the first Greek IPO’s of many to follow. It was a first in shipping for Cantor Fitzgerald who did the issue. Marc Blazer had no prior shipping industry involvement and relied heavily on Anthony Argyropoulos, who was eager to develop business at DvB bank after his departure from Jefferies only months previously.

At the time of the issue, the stock was widely touted as ‘attractive’ and ‘hot buy’. Retail investors were wooed by various websites to invest in the company. The investment thesis was essentially market-driven and lacked clear business guidelines. Simply the company had tankers and tankers were going to be a booming market. There was certainly a grain of the truth about the tanker market and the timing proved good, but what was not revealed to investors was anything remotely related to the company fundamentals.

Nobody took the time to mention a Board of Directors with mainly a banking and insurance orientation and untested senior management team. Since then, these matters were made even more problematic with a ‘poison’ pill that protects both the BoD and management from shareholder wrath, keeping them firmly in their chairs no matter what the company performance is.

Shareholders have had little joy since then. The company management has a demonstrated track record of class action shareholder suits, auditor resignations, and value destruction in share price. The company shares have been in steady decline since early 2005. Over the last few months, the company has rolled up significant operating losses, dividends have been cut and the stock has contracted to a third of its value.

Just a simple glance at company financials shows significantly higher administrative and operating expenses than other peer shipping companies. The company customer base is very limited, the employment profile is problematical. There are serious financial problems. Leverage is high. The company has a number of operating leases creating cash deficits. It paid out a huge extraordinary dividend from the lease sale transaction effectively leveraging up the balance sheet.

Last year in the face of a decline in the tanker market and financial woes, the company suddenly embarked on an expansion plan for bulker carriers. Since they lacked liquidity, they financed the purchases by bridge loans to be paid off by an increase in capital last December. The supplementary share offering did not go well and resulted in a steep 20% discount and bail out by underwriters taking up over allotments. Since then, the company has been selling ships at reputedly low prices to make way for the remaining bulker carrier acquisitions. This company also has 6 new product carriers soon falling due for delivery.

The last few days, the company arranged a new private placement at a 15% discount, which is heavily financed by George Economou of DRYS, who already holds a large stake in the group though a related investment company. Economou was reputedly involved in the sale transaction of their six vessel bulk carrier fleet that created them the very financing woes that now require this new capital infusion. The discount further dilutes the shareholding of the other investors, precluding any independent BoD representation and is open to the interpretation of possibly forcing financial interests deemed undesirable out of the company. The PIPE has angered QVT, a major hedge fund shareholder.

There is an image problem that was created by prior auditor/ accounting issues and the now settled shareholder class action suit. This situation continues to fester with numerous (but unverified) rumors circulating about the company over potential ethics issues. Natasha Boyden recently made a NAV valuation analysis on which she based a new ‘Buy’ recommendation. She demonstrates that the company shares are trading well below net asset value. She seems to tout the proverbial turn around story due to an expected improvement in the tanker market. There may be some truth in her argument short-term, but the company appears to have deeper problems.

What about the business guidelines, plans for market penetration, shareholder value creation, corporate responsibility and customer satisfaction? Where is the brand image, where is the breakthough performance? Where are the good results and shareholder rewards in this company?

TOPS appears to have serious deficiencies in all these regards.

The CEO needs to pull things together with better vision and more coherent business guidelines. It is not clear how he is balancing his own personal interests with earning money for shareholders. Institutional shareholders are unhappy and he needs to improve investor relations. The CFO seems in need of more proactive financial management, quantifying the implications of management decisions and planning ahead for the necessary financial resources on competitive terms. The COO and technical management need to control quality and mitigate costs for a more competitive cost structure.

What is very clear on Wall Street in this Greek tragedy is the steep current discount in share price. Analysts like Natasha Boyden do not seem to have factored in the risks and expectations that have been priced into the stock under the present circumstances. The market has an uncanny ability over time to filter in such risk factors. Was not there an inexplicable decline over many months in the value of ENRON shares before collapse despite fervent analyst views to the contrary? Normally companies fail over a period of time that leads to final collapse. TOPS is currently a high risk operation at a critical juncture and risks demand a discount!

Miracles can happen; markets can turn bringing windfall profits even for the worst management. Perhaps the new Economou involvement will shake up the present management. The company management needs to demonstrate its firm commitment in creating value for outside shareholders in addition to making money for themselves. Financial investors are losing patience. The ENRON management was clearly out for themselves only. It is up to the TOPS management to reestablish its credibility with tangible results that improve company share value and restore its stock dividend payouts.

Monday, February 18, 2008

Comments on DryShips DRYS

If one looks at the current graph of the DRYS at the time this article is posted, it appears a bubble situation. A lot of bubble has already evaporated. Peter Georgiopoulos of Genmar/ Genco recently challenged George Economou, saying that the market has to separate the 'goats from the sheep'. He was angered by the sudden Economou move to the oil rig business contrary to the purported mission of DRYS and rumors about a finder's fee for the bring the business to the company. Against this backdrop, let me comment on DRYS:
  • George Economou is a veteran very successful, but maverick ship owner. In the bond boom of the late 1990's, Economou did a controversial bond issue with aging bulk carrier assets that then led to a default on the first payment. He renegotiated and the bondholders took losses. Since then he made a tremendous comeback.
  • Economou gives the impression of the traditional private entrepreneur who has unbeatable instinct and does as he pleases, rather than the corporate manager who operates by mutual consent. Right now, he holds most of the officer positions in DRYS – CEO, CFO, etc. The BoD members evidently do not play a strong role. Privately he is seeking to fill these positions and restructure his management team.
  • Economou maintains a private company shipping Cardiff as well as being CEO in DRYS. This is a common situation in Greece. The Greek owners often have both a private shipping company, a management company and a publicly-traded company. There are potential conflict of interest issues with both the private shipping company and the management company, which manages the vessels in the public company. Tsakos (TEN), for example, has had for years a similar structure with a private management company and has succeeded to establish a high level of investor confidence.
  • DRYS has enjoyed a large profit margins in 2007 for two reasons: there are many units spot enjoying good rates and there have been good at resale profits. The company performance in 2007 is to be commended. Economou succeeded to get the timing right for the bulk carrier boom. Shareholders have benefited, but there is no guarantee of future performance.
  • On the other hand, with the company leverage rising, there is increased default risk if the market suddenly turns sour. Finally, it is possible that DRYS is expanding faster than their free cash and this may lead to growing liquidity problems. These last points are from third-party sources and subject to further examination.

As a postscript to this article, DRYS has recently enjoyed a recovery in share price. Latest quarterly results show a doubling of profits, which is excellent for free cash flow and will lower leverage so long as this lasts. One of the benefits of having a large number of units in the spot market is the advantage of higher earnings from the rate volatility.

Economou seems to be making some smart moves, particularly the acquisition of Heidmar for a broader commercial base. With current high oil prices, the oil rig business gambit may eventually pay off .

Challenges ahead for Stock Exchange listed Greek shipping companies

With the Tradewinds recently reporting a count of 24 publicly listed shipping companies in Greece, I firmly believe that we are moving to a period of consolidation, mergers and restructuring over the next few years. Some companies will grow and prosper and evolve into world-class businesses. Others will fail and cease to exist.

Common statistics for US stock exchange IPO's are that up to 75% of these companies cease to exist over the first years from inception. For Greek companies coming from a culture where even 10-15 years ago, many business men had difficulties with balance sheets and relied on their bank account statement for their financial position, this poses some formidable challenges ahead.
Most businesses in Greece are small, closed family owned operations. Greek managers are not used to having to operate under an arms-length board with US-style corporate governance. The traditional management style has been highly centralized even to the point of physical limits. Often all decisions are concentrated to one key person and there is little tradition in delegation of responsibilities. Decision making is often very much like a line manager with quick decisions based on limited information rather than a corporate integrated style based on a team approach.

Institutional regulation in the domestic Greek Stock exchange has been notoriously lax. The notion of maintaining share value or management accountability are new concepts in Greece. The notion of hostile take-overs and management changes due bad performance is virtually unheard of.
US-listed Greek shipping companies appear to be exempt of the direct requirement of the Sarbanes-Oxley Act, but there is a system of self-policing where they are required to have an audit committee and report any material non-compliances.
Most Greek IPO’s tell more or less the same story:
  • The BoD’s are very often friends of the management with little industry scope and little weight in corporate oversight on business and financial decisions: lawyers, average adjusters, retired bankers. Rarely do you see Boards with strong independent shipping figures. There are exceptions, of course. Stelmar before being taken over by OSG had a chairman, who was a Major Oil company executive. This added value to the stock and led to a better payout in the eventual sale of the company. More recently, Aegean ANW has a well constructed BoD due in part to the involvement of Hamish Norton in the IPO and Peter Georgiopoulos as major shareholder. Unfortunately many other cases are weak and this is not good for effective oversight that could enhance company performance and share value. There is serious shortage of qualified people for board positions as well as most other senior management positions in shipping these days.
  • Management are often relatives and friends. but outside professional managers are becoming more common. Stelmar above led the way with a professional management team that organized the company. This poses an increasing management talent demand for listed-companies. Some like Diana DXS have turned to managers from multinational companies outside of shipping.
  • Of course, it is not only the titles. The people have to be productive and have something to offer. There has to be some real accountability of management to the BoD and BoD/ management to shareholders. Since Greek management comes mainly from closed, family businesses, this is often a new world for them. They are used to imposing their decisions on their subordinates. They are not accustomed to selling ideas internally, working integratively nor to accounting for past performance. Not unexpectedly, some shelter themselves with elaborate "poison pills." This can have a negative effect on share performance.
  • Greek companies often suffer from lack a productive corporate culture. Little attention is paid how to organize these companies with motivated staff that is efficient and gets results. Most local shipping companies have fairly formalistic ISM systems. Frequently in practice, there are seldom clear job responsibilities. People do not have objectives, etc. Insufficient money is spent for training and continuing education. The worst part of it is that in many larger companies in such environments with weak corporate culture, people can start to work for himself. This can easily degenerate into corruption. A number of large shipping companies in Greece have failed in the past because they lost control for these reasons.
  • The business model is ship provider. The listed company does the technical management and provides the crew and the vessels. Effectively the commercial part is outsourced as the vessels are mainly time-chartered. The companies do not control their market. They often have no direct relations with end-users. Some companies, of course, do have units spot or do profit sharing deals. Even in this case there is no really coherent market strategy. What markets to develop? What kind of customer base to build? There is often a great deal of dependency on a few Charterer customers.
  • The logistical concept of cargo systems or pooling where the Norwegians thrive is still rare among Greeks. The Greeks are mainly looking to play the market speculatively. Greeks have an excellent good track record in this regard, This is very different from building a service transport business with value and recurrent earnings. It is more like a hedge fund of steel commodity assets where profits are mostly from speculative and non-recurrent operations. With the size and affluence of Greek Shipping now in capital markets, this is gradually changing. Greek firms are buying into traditional cargo operators. George Economou of DRYS is buying out Heidmar from Morgan Stanley. Gabriel Panayiotides of EXM is the major shareholder of Torm.
  • The future earning multiples are generated by fleet expansion. The qualitative value element is insufficient. There no concept of brand image or breakthrough performance. Market penetration and customer base is secondary. Internal capacity to take on new business and cash flow generation to support growth is often underestimated. The primary goal is having a huge fleet as soon as possible. The risks in this strategy are liquidity pressures and uncompetitive cost structure that leads to insufficient sustainable competitive advantage in the market place and declining share value.

The concept of listed companies is good for Greek Shipping. The challenges serve as a catalyst for professional management on new level of sophistication and corporate accountablity. There is real evidence of some new world-class companies on the rise. Shipping has lived through an incredible period the last few years, riding a massive boom in commodities world-wide. With the prospects of a US recession looming in 2008 and the dry-bulk market boom fueled by port congestion and infrastructure problems, the coming years are likely to be challenging times. On the other hand, most Greek shipping companies are far more liquid and much better prepared for the years ahead than ever before.

In building value in business, the whole is not the sum of the parts

Private equity firms often seem mesmerised by DCF analysis and financial models. This emphasis is counterproductive to their notional requirements and even proper risk analysis of the project. Theoretically PE groups want a credible business plan in a framework of three to seven years that is going to generate double digit returns. This is inevitably dependent on future earnings multiples. They move into the business to finance strategic acquisitions to generate these earnings multiples and get them to their exit strategy. Some deals work well, some less so as events evolve.

Admittedly the industry needs high returns to build and keep their investor base and to compensate management in their role in the business. Yet nominal returns on projected earnings are little more than a snapshot based on estimations that change rapidly according to market conditions and forward revenue forecasts. Making good projections requires considerable skill and instinct, but this just scratches the surface. Building value in a firm that generates attractive earnings multiples is a complex job.

Harvard Business School recently sent me a prospectus for a new course they are developing on this subject. The headings are useful in illustrating that DCF analysis means little in itself. Management plays the key role. Starting, developing and executing a business plan that generates healthy earning multiples is not a simple accounting exercise. There are a lot of intangible factors. Fundamentally, it all begins with vision and commitment.

As a case study, Quintana - a successful start up in the dry cargo market - would not even have got off the ground without the vision and leadership of Corbin Robertson, the founder. Clearly his client relationship with First Reserve and position as a US-based commodity trader played a big role in the evolution of this vision, but he did not start investing in vessels because of DCF figures. He had a vision and he committed himself to go into the dry cargo sector. The market prospects were not all that clear when he funded the first vessel acquisitions back in 2005 in a volatile, choppy freight rates environment.. In effect, he led the investors into the business with an initial personal commitment and the returns evolved as the business took form. First Reserve, the PE firm concerned, would never have done this on their own. This is fundamental aspect of any business
Lets consider below a few of headings in HBS course summary, which clearly demonstrate that good earnings multiples and successful business performance is anything but a simple mathematical number crunching game:


  • Providing energy and vision for the corporation

  • Overseeing the selection and recruitment of the company's corporate-level and potential leaders

  • Managing the ongoing professional development and career advancement of all corporate executives

  • Understanding the role that succession plays in an organization's corporate strategy


  • Designing and managing the business- and country-unit portfolio to add value, while developing and managing business growth based on cross-unit or entirely new activity
  • Creating effective corporate-division relationships
  • Overseeing the organic development of new businesses
  • Managing mergers and acquisitions to ensure that they contribute strategically to the company's overall mission


  • Funding strategic initiatives and managing both access to capital and cost of capital
    Understanding balance-sheet structure, the pattern of earnings, dividend policy, resource allocation, and relations with financial markets
  • Meeting the special financial challenges associated with multinational activity


  • Maintaining productive relationships among owners, managers, and other stakeholders
    Leveraging the role of the corporate board to ensure accountability, responsibility, and ethical business practices
  • Evaluating the impact of governance structures on compensation and incentive systems

Note how little emphasis HBS gives on those dogged DCF calculations over which PE partners so often dwell over in cold call road show presentations. Too often they flood you with questions on minute details that overshadow the basic critical issues in the business guidelines that you are eager to discuss with them and exchange views! Most of the emphasis in the HBS course is on the human element and relationships, which is central in business where quality of relationships is critical to financial results.

In reality, businesses grow and prosper as they evolve. Asset investments to get into the market place for initial positioning may actually have nominally mediocre returns. These first asset investments are simply stepping stones in an overall strategy. A lot of initial effort in business development goes into positioning and building of relationships with customers, banks and investors. Also very important is building viable infrastructure for good execution that ensures customer satisfaction. This requires organizational development skills to find the right people, keep them motivated and provide them the means to perform well in their jobs. Commercial power in the market place is a factor of market position and scale. It grows over time as the business develops and reputation spreads, opening new opportunities that are not necessarily visible or accessible at outset.
In short, what actions you take today bring results tomorrow. You have to be willing to learn to walk before you can run. Those attractive earning multiples that PE firms adore cannot necessarily happen instantaneously nor do DCF calculations really tell much of the story. This is why vision and commitment in business are such important elements of success. You may well have to sacrifice today in taking risks and committing yourself to a lot of hard work to get those impressive results down the line that seem in retrospect so obvious. There is no free ride here.

The challenge for PE firms is to provide the support and effective financial engineering for the business to grow. They need to make more effort to know their clients and understand their business guidelines in deal formation. Conversely since they hold majority share generally, it very important that there is good match for the prospective client and a mutual understanding of the business risks involved in the transaction so as to facilitate the underlying commercial relationships in the project.

Lausanne Shipping Forum

Let me recommend the Lausanne Shipping Forum, which takes place this year 12-13 September, 2008 at IMD in Lausanne: . IMD is a very fine business school, whose President Peter Lorange is a world-wide authority on the shipping industry. The seminar is co-sponsored by Marsoft, which is an excellent marine consulting firm in Boston:

This forum attracts senior industry executives from leading firms in all sectors of the shipping industry world-wide. I can confirm that this a very high quality seminar, where there is unusual opportunity to discuss shipping matters with some major players in the industry.

IMD is located in Ouchy section of Lausanne on the shores of Lake Geneva. Apart from the excellent program, it is also a very enjoyable experience.

Crewing Crisis

Having had my maritime career mainly in Greece, I can say that this problem is a major issue for the future that is likely to have far reaching consequences.

The Past and Present:

The Greek shipping business model is primarily a vessel provider, rather than cargo operator. Greek shipping always had a competitive edge in service because of the close relation between the office and the ship, which gave superior operational strength and capacity. Traditionally, the older major shipping companies used extensively crew from their islands who were friends and even relatives. They cared for their families in a paternalistic spirit. Their offices were staffed by ex-seamen, which gave them great strength in managing both the deck cargo operations and the technical condition of the vessel.

Because of the early retirement of seamen, Greek offices locally are staffed by older deck officers and engineers, who assume middle management port captain and port engineer functions. The early retirement works as an indirect subsidy on office costs and overheads for small and medium size operators. Today this office staff is gradually becoming more and more elderly due insufficient replacement. For those who go to sea, they serve much less than in the past and leave. The younger staff has limited or no sea service whatsoever. This process risks a decline in the experience factor and quality of the shore-ship link that is a great traditional strength in Greek shipping.

Originally foreign seamen were used only for rating positions and all officers were Greek. In the shipping crisis of the 1980's, companies started to use full foreign crews and lay off the Greeks. At the same time, the Greek government offered subsidies to build rooms, hotels etc to promote tourism, which led many families to move to this sector and abandon the sea. The private schools for seamen all closed. Gradually the enrollment in the state schools diminished. Generally the Greek government has always under invested in education. They have not given technical education sufficient emphasis. Only recently has there any discussion about revamping the Greek educational system nationally and improving standards to which there has been recently considerable local resistance to change and modernization.

Another adverse factor has been the mismanagement of the Greek Seamen's Pension Fund. The Greek seamen unions were ideologically opposed the use of professional fund managers to improve the endowment. The Greek Governments in the 1980's extended the Seamen's pension funds to cover pensions to refugee families from Eastern Europe from the Greek Civil War era. This undermined the economics of the fund and increased dramatically the contribution liabilities on Greek flag vessels. Many smaller and middle size shipping companies were simply not in an economic position to take on these open-ended pension liabilities and were forced to flag out. Ultimately Greek seamen suffered the consequences in diminishing benefits and the need to work on foreign flag vessels. The European Union has encouraged the Greek Government to reform and unify its pension system and progress is slowly being made.

Today with the anti-terror measures shore time is more and more restricted. Immigration formalities are burdensome and onerous for seafarers. Government Authorities have too often shown callous disregard in offering refuge to distressed tonnage. There is a nasty tend in the penalization of accidents, where Masters and senior officers are increasingly exposed to jail and penal trials. One of the ugliest examples was the Spanish Government in the case of the Prestige, where the Spanish Authorities exposed the crew to danger of their lives in refusing refuge and put the Master on an extended jail sentence after surviving the ordeal and seeing his crew to safety, refusing for months to release him on bail.

Governmental considerations for the future:

Governments need to find ways to ease traveling and immigration formalities for seamen and allow them their due on shore leave, so they have more time to let off steam from long voyages and enjoy the ports that they visit when they are off duty. Travel and seeing the world has always been an incentive for young people to go to sea.

Governments need a more rational unified response plan in case of accidents. It would be good to have the jurisdiction in case of accidents and emergencies given exclusively to shipping professionals similar to the US Coastguard and preclude any involvement of political figures whatsoever. The matter of shore refuge for vessels in distress needs to be reviewed and made more professional, so seamen have the security that the shore authorities are there in case of trouble. Some countries are a lot more advanced and professional than others on these matters. The EU should consider these issues carefully.

The matter of penal liabilities in case of accidents has to be reviewed and modernized. The Master and senior officers should not be held in jail or charged for criminal liabilities without cause, which has to be established by proper inquiry in specialized maritime legal units - perhaps similar to US Coastguard accident inquiries, etc.

Management Considerations:

Crew group pension and medical benefits that reward those who make the choice of a seagoing career with a company.

Shore job opportunities that reward sea-going experience and integrate sea-going staff with office staff.

Continuing education benefits for high training standards, reduction of accidents and better shipboard management.

Highly trained shore staff who ensure good communication, support and co-operation to the crew.

Unfortunately this process tends to favor larger companies, who have the critical mass and resources to support these overhead expenses that improve quality and productivity. On the other hand, those companies who show personal interest in their units and crews tend to get better results. Ships do not run well by remote control.

Over the past few years, salaries levels have risen enormously. For senior officers, there is gradually an international convergence of remuneration irrespective of crew nationality. Also the fleet today is much newer, communications have improved with Internet. Life on board is less isolated and more comfortable that it has ever been before. Oil company vetting and safety standards are much higher so ships and sailing are safer than ever in the past.

Hopefully attitudes will change and more people will be drawn to a sea-going career.