Tuesday, September 7, 2010

Seaspan's China gambit

Seaspan is a non-operating containership owner with a very ambitious fleet expansion plan. They have been struggling since the 2008 GFC to finance their aggressive CAPEX program. Their business plan is highly dependent on continued Chinese export growth. The two top customers are Coscon and CSCL  (70% total revenue) both Chinese state owned enterprises.  90% of their contracted revenue is from China and Japan. The company is highly leveraged and has recently filed a shelf registration for a new share issue.

Seaspan is a vessel provider business model. It owns and operates container vessels with long term charters to major liner companies. It has no container logistical system of its own as do the major liner companies like Maersk, CSCL, MSC, CMA-CGM, Neptune Orient and Orient Overseas. It is largely an asset play backed by long term charter parties with substantial rate discounts and subject to earnings margin pressures over time from inflation, currency fluctuations and increased repair costs as the fleet ages.

It has a very impressive Board of Directors, including Graham Porter (Chairman of the Tiger Group), John Hsu (partner of Ajia Partners, one of Asia's largest privately-owned alternative investment firms), Peter Lorange (former President of IMD) and Peter Shaerf (managing director at AMA Capital Partners). Seaspan's CEO Gerry Wang appears to have very good personal contacts with the Chinese SOE's in shipping. He is always been extremely bullish on Chinese growth prospects.

The container sector was one of the most sharply hit by the sudden and deep economic slowdown in 2008 GFC. The major liner companies suffered heavy losses in 2009, with aggregate industry losses running into tens of billions of dollars. As an effect of industry wide losses, the liner companies heavily cut capacity, idling their own capacity and returned the chartered tonnage to non-operating owners. Normally, most liner companies own approximately 50% of their tonnage and charter in the remainder to cover their cargo volume projections.

These major operators made substantial adjustments in terms of order cancellations and deferrals of newbuilding deliveries well into 2011-2013. There was probably more speculative vessel ordering in the container sector than any other sector of the shipping market. A very large part of the orderbook are the large post Panamax size vessels for long haul routes.

The great attraction for non operating owners' investment has been the term charter cover from the liner companies. The current order book stands at 30% of the current fleet, down from about 55% at its peak in mid 2008. It is important to understand the current order book mix in terms of the owners.  The German KG market and asset providers in non-operating owners like Danaos Shipping and Seaspan constitute greater than 50% of the current order book, remaining is covered by the liner operators like Maersk, APL, and CMA CGM etc, who actually control the underlying commercial business with end-users in the sector.

Seaspan fared well in 2009 closing the year with record profits of US$ 145 mio as opposed to the losses of the two prior years: 2008 (US$ 199) mio and 2007 (US$ 10) mio. They reported no charterer default or renegotiation problems. This year for the 1 H, Seaspan is again in loss position, but due to sizeable changes in fair value of financial instruments resulting in a loss of $223.2 million for the six months ended June 30, 2010 compared to a gain of $92.5 million in 2009. The change in fair value loss for was due to decreases in the forward LIBOR curve and overall market changes in credit risk.

As of their annual report filed last March, Seaspan had contractual CAPEX obligations on an additional 26 containerships over the next 30 months over an in addition to the existing fleet of 42 vessel in operation. Whilst there have been rumors of possible new order cancellations, Seaspan so far has maintained its orderbook.  It appears that they are highly dependent on COSCO in chartering this new tonnage. The employment contracts with their two Chinese SOE charterers are subject Chinese law and dependent ultimately on the Chinese legal system for enforcement. Indeed, this year, they turned aggressive and also added one additional new acquisition chartered to United Arab Shipping Company for two years and Gerry Wang has made statements about opportunities to pick up units in the troubled German KG markets.

Considering the industry environment with the major liner companies cancelling orders and lately reletting larger post-Panamax tonnage, this represents a remarkable contrarian business strategy with backing from a BoD of major industry figures, who apparently believe strongly in a robust world economic recovery with shipping markets bouncing back to former levels in the near future, ostensibly driven by renewed Chinese export growth and internal infrastructure development as a return the pre-2008 GCF situation.

Financing this program has not been easy. The total purchase price of the 21 vessels was estimated to be approximately US$ 2.6 billion. The remaining five units were covered by leasing arrangements with Peony Leasing Limited, or Peony, an affiliate of Bank of Scotland plc and Lloyds Banking Group. As these units were contracted during the market boom, Seaspan faces a valuation problem with the decline in prices for new orders today. They have "gearing” covenants in their senior debt that prohibit them from incurring total borrowings in an amount greater than 65% of our total assets. Further they were blocked from drawing the remaining approximately US$ 267 million available under their US$ 1.3 billion Credit Agreement on which they were relying heavily to support their CAPEX program.

In May 2010, Seaspan issued 260,000 Series B Preferred Shares for US$ 26 million to Jaccar Holdings Limited, an investor related to Zhejiang Shipbuilding Co., Ltd. of China ("Zhejiang"). These preferred shares are perpetual and not convertible into common shares. They carry an annual dividend rate of 5% until June 30, 2012, 8% from July 1, 2012 to June 30, 2013 and 10% from July 1, 2013 thereafter and are redeemable by the Company at any time for US $26 million plus accrued and unpaid dividends. This appears to be a shipyard-extended credit facility for their reported two orders in this yard.

Compare this to established liner-owner operators like Neptune Orient Lines (NOL) and Orient Overseas (OOIL), integrated logistics players with proven container shipping capabilities available at attractive valuations. For example, OOIL's three principal business activities are segmented under International container transport and logistics services (OOCL, OOCL Logistics, and China Domestic), Ports and Terminals (Kaohsiung and Long Beach) and Property Investments (Wall Street Plaza in New York and Beijing Oriental Plaza in Beijing). OOIL’s container shipping operations is amongst the most cost effective in the container shipping industry with the Company consistently outperforming its peers with the highest profit margin among major container line operators.

OOIL has always had one of the most conservative and strongest balance sheets in the container shipping industry and has consistently kept the net gearing to the lowest. The company has no major issues in meeting its capital commitments and capital expenditure. At the end of FY 2009, OOIL had vessel capital commitments of US$ 712 mio and US$ 1.27 billion in free cash. It's capital gearing is 58%.

Seaspan's second quarter earnings conference presented a very rosy picture of a company with a low debt ratio, impressive built-in future growth revenue of US$ 7 billion and fantastic compound annual growth rate (CAGR) of 40%. Suffice this to be based entirely on their assumptions of a V-shaped world economic recovery and deeming their situation a few years ahead. . Their present leverage is very high and they would be not going through the trouble and expense of a shelf registration if they were not concerned about the need to raise equity to maintain their covenant obligations and cover their CAPEX needs. Indeed, one can presume it likely that this is an exercise to woo potential interest for a possible IPO offering.

The issue is whether peer companies like NOL and OOIL offer more value to investors because of their integrated logistics business models, their diversity of revenues sources, and their stronger balance sheets. All this is in the context of an uncertain environment in terms of economic recovery and rebalancing of trade flows. All these companies are dependent on continued emerging market growth in the Far East.

1 comment:

  1. Let me add as an afterthought, the issue of slow steaming that I have discussed in previous articles on the container industry. Demand earlier this year was rebalanced in part artificially by the decision of the major liner companies to put their tonnage on slow steaming to take capacity out of the market. Normally container vessels are designed for speeds of 22 knots. The major liner companies have put their vessels on speeds as low as 14 knots, but on the average the world container fleet is currently operating at 18 knots. This temporary measure greatly assisted in generating rate improvements for the industry. Some major players like Maersk are even suggesting that slow steaming becomes permanent.

    The slow steaming means that the major liner companies need less units for their service and theoretically impacts negatively non-operating owners, who are totally dependent on the liner companies for the employment of their vessels. This is particularly an acute problem for those companies with a large containership orderbook. The tonnage overhang for the post-Panamax size units is substantial.

    Seaspan has been relying heavily on COSCO to employ their new buildings. It seems that COSCO is willing to take on additional tonnage in these market conditions. Ostensibly, this defies current market fundamentals. Whether this will prove a sustainable long-term strategy depends on resumption of Chinese export trades. COSCO as a Chinese SOE does not have to observe the same market discipline of a private sector company since it does not carry the same default risk.

    Many institutional investors and hedge funds are again looking for placements in the container sector for this reason: SOE charterers that remove any market risk from the normal supply-demand restraints. Whether this is healthy investment and productive allocation of resources remains to be seen.