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.

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