Saturday, January 17, 2009

EGLE: Conflicts between sound business principles and Wall Street 'value-building' concepts

Short-term Wall Street objectives can conflict with longer term goals to build a sound business. Being solely a vessel-provider and relying on a customer base of a limited number of charterers can lead to a high degree of counter party risk. High dividend pay-outs secured by time charter employment comes with a price as there is a trade-off to building value by a broader commercial base and a higher cost of funds for growth. Expansion is necessary to build up a company but buying deals from others with a mark-up is not always the most productive means to create business with value.

Eagle Bulk has been generally a well run business. The timing of Sophocles Zoullas was very good to enter the market and start this business. He chose the most conservative sector of the dry cargo market where there is the need for more industry consolidation and tonnage renewal was indisputable.

The weaknesses of the investment proposition are in the massive scaling up at premium asset prices and the vessel-provider model, out-sourcing the commercial side to time-charterers without trying to build some presence with end users. Admittedly there are established groups in this sector who do have their own contract base and direct relations with end-users, but this only adds to the weakness of the investment proposition as far as the commercial aspect is concerned in the competitive landscape. The company shifts rate risk to charterers at a price but it cannot escape counter party risk in adverse market conditions. Further EGLE chose to scale up at the peak of the market on the basis of these charters.

According the latest 'Tradewinds' article, the company does not give out the names of its charterers. This is not helpful to investors in assessing counter party risk. 'Tradewinds' states that an October 2007 loan agreement with RBS shows four Dwt 53,000 units and nine Dwt 58,000 units going on charter to KLC, which is now staving off bankruptcy and renegotiating rates. The question is whether these are charters on actual vessels under EGLE operation or new buildings to be delivered. Further EGLE has recently taken steps to cancel a number of its newbuilding contracts.

The Wall Street firm, who backed Zoullas with investment funds, was strongly oriented to time-charter income. EGLE had little option but to try to build up their company with time-charter employment. Further they had to maintain high dividend payments to satisfy their investors. This capped their earnings in the strong markets that ensued. It prevented them from moving into the operational and commercial side of the business and kept them at a distance from end-users. It also left them with limited free cash flow for further asset acquisitions, forcing them to raise additional capital and leverage up into order to expand their fleet.

Whilst US financial firms stress 'value' in their investments, I never understood how buying a deal like EGLE did in 2007 from Alba Maritime did much in that respect. After all Alba placed the orders for the bulk carriers and - according to 'Tradewinds' - even negotiated time charter employment with KLC, which is now struggling to avoid bankruptcy, that they passed on the EGLE as part of the deal. EGLE could have considered doing something similar themselves. Instead they bought the business from Alba and paid them a handsome profit as a US$ 1,1 billion deal. The scaling up did inflate expectations and share value for a while, but was this solid business building? Time will tell.

Now in this weak market, EGLE has been obliged to cancel a number of new building contracts. KLC is looking to renegotiate down the charter rates for their own survival. For the time being, Eagle has a limited customer base with counter party exposure in the aftermath of a large scaling up at high asset values. In the end, it depends on the strength of their charterers to carry the existing contracts in this difficult market.

It is not any easy situation for any dry bulk owner ahead.

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