Sunday, January 23, 2011

Seaspan eyes Tiger scheme: structural change in Chinese container market

Seapan's move to raise capital by a US$ 250 mio preferred shares together with a proposed US$ 75-100 mio minority stake in a containership venture with Tiger Group are raising eyebrows. Aside from possible Clayton Act violations stemming from Seaspan CEO Gerry Wang also running the new fund which may invest in competitive container companies, the nature of the fund illustrates Chinese policy to maximize its future container transport needs though Chinese-built vessels and Chinese liner companies.

Seaspan announced recently (January 21), a public offering of 9.5% Series C Cumulative Redeemable Perpetual Preferred Shares. The company had been examining for some time alternatives to raise capital to cover their ambitious CAPEX program. The use of preferred shares appears to be a means of raising capital with minimum dilution to shareholders.

The Tiger investment fund vehicle would invest in container shipping assets, primarily newbuilding vessels strategic to China. Seaspan is placing its future in Chinese liner trades, which now represent more than 70% of their fleet employment.

Seaspan told investors:

“We also anticipate that we would have a right of first refusal for some negotiated duration with respect to any containership asset opportunities that are developed by the vehicle. We believe that any investment by us in the vehicle could enhance our ability to pursue current growth opportunities in the container shipping market by leveraging the vehicle’s access to capital and customer relationships. We also believe that an investment in the vehicle would allow us to continue to increase the scale of our business and realize volume discounts for newbuilding orders that we would not otherwise be able to achieve.”

The role of Gerry Wang, the Seaspan CEO who is going to also run the new fund which may invest in competitive container companies is confusing. Whilst Seaspan is based in Hong Kong, it is a US-listed company subject to the Clayton Act.

The Clayton Act states: "No person shall, at the same time, serve as director or officer in any two corporations that are, by virtue of their business and location of operation, competitors..."

The other aspect of these moves is that Chinese policy seems to be moving more to a Japanese "Keiretsu" model of interlocking business relationships and shareholdings and Seaspan is following along with this trend. We have already began to see a similar direction in the Capesize trades, where a growing share of the iron-ore business is going under long-term contracts including transport and less emphasis on spot markets. Key suppliers like Vale are building their own fleets. Further the Chinese are very keen on supporting their domestic shipbuilding industries, who have increased dramatically their capacity over the last few years to become major players.

Finally, this system depend on perpetually high growth rates in the Chinese export model, where money is constantly being channeled into new capacity. Already there are signs of overheating. Seaspan has a franchise on special relations with China, but should there be a downturn where expectations are disappointed, Seaspan will be affected with such concentration in this market.

For the time being the 'smart money' continues to give strong support to this group. Wells Fargo Securities" Michael Webber upgraded Seaspan to “outperform”, calling the company “best of breed” within the containership sector(among vessel providers to liner companies, as Seaspan has no cargo system of its own and depends on liner companies to employ its vessels):

“Seaspan currently has 11 vessels scheduled for delivery in 2011 and three in 2012, which are fully financed and will increase its capacity by 53% to over 400,000-teu,” he told clients, adding: “We believe Seaspan will have capacity to materially increase its dividend and potentially fund additional growth and pay down debt, as we expect Seaspan to generate roughly US $412 mio and US$ 528 mio in Ebitda in 2011 and 2012, up 43% and 28% [year to year], respectively.”

This mirrors the China growth story with aggressive growth and high returns on growth of multiples. The underlying investment returns on DCF with residual asset value are much lower. Seaspan's asset-heavy vessel provider business model with long-term time charters is by nature a low margin business, where higher returns can only be generated by high capital gearing and rapid growth. What makes this especially appealing is that Chinese business is considered virtually "risk free" counter party risk.

Wednesday, January 19, 2011

DryShips again in the limelight on possible conflict of interest issues

George Economou’s DryShips caused some surprise announcing a US $770 mio order for six suezmax and six aframax tankers. That was nothing compared to the reaction to market speculation when Morgan Stanley analysts Ole Slorer and Fotis Giannakoulis downgraded the stock raising concerns about increasing potential conflicts of interest between the public and private companies of DryShip's chairman George Economou. Economou had previously announced a firewall between Cardiff and DryShips.

Morgan Stanley Research suggests that DryShips may have overpaid by about US$ 50 mio for the six suezmax and six aframax tankers and warns that it expects tanker prices to further decline. This was a very sensitive remark because of previous concerns back in the fall of 2008 concerning the transfer of some Capesize dry bulk orders from Cardiff to the public company in view of subsequent cancelations and accompanying write-offs.

DryShips’s finance chief Ziad Nakhleh vehemently denied these allegations, asserting that not only were the orders done directly between the yard and DryShips but that Cardiff did not have any tankers on order from the yard in question. According to a well-known shipping publication," the denial sparked thinly disguised incredulity on the part of some, since during 2010 Cardiff was widely reported to have built up an orderbook of at least six aframaxes and five capesizes at South Korea’s Samsung Heavy Industries."

Prior the Morgan Stanley hiccup, DrysShip's shares had been rising on increased optimism about their CAPEX offshore funding and announcements of rig employment contracts. There has been speculation for some time about DryShip's spinning off their offshore activities at a premium for its shareholders.

Since then, DryShip's shares have stabilized at US$ 5.25 - not a very exciting level but still considerably better than the July 2010 low of US$ 3.28. DryShips was a star in the bull markets prior the 2008 meltdown with peak share levels close to US$ 130. In 2009, the company entered into a series of ATM offerings that led to massive dilution to deal with bank covenant issues.

Genmar muddles through

Genmar recently found reprieve in Northern Shipping funds, selling three product carriers and leasing them back for seven years at US$ 6.500 per day that will rise to US$ 10.000 per day after two years. The group has been fighting a shortfall on the US$ 620 mio Metrostar deal for some time and needed the cash to repay a short-term loan. Northern participation reflects increased interest in this financial sector to book shipping transactions.

Northern - composed of mainly ex-NFC (DvB Bank leasing venture, who lost a lot of people in the 2008 meltdown) executives like Sean Durkin and Nikos Stratis - has been looking for leasing business and Peter G/ Genmar is a too big to fail company and ideal client.

Peter G did the Metrostar deal in the spring of 2010 on the euphoria of tanker market revival, taking advantage of the funding window opened in capital markets. He was constrained to do a large block deal for a follow-on offering with investors. Metrostar got a premium price on their units because of the time needed as well as the uncertainly to complete the deal with share underwriting and bank lending. In the end, the Genmar follow on offering was very successful with only marginal discount and their banks happy granted them a large loan facility to support the acquisition.

Since then the tanker markets have deteriorated and values are under pressure. This year the crude market has started badly with a nasty tonnage overhang and slack cargo demand, mainly driven by the Far East and Western economies much weaker. The products market is faring better with firmer rates, but still historically low levels.

The pricing of this deal with US$ 6.500 leasing rates in the first two years reflects current market conditions, leaving Genmar barely above water with two of their units chartered at US$ 15.000 per day and the third unit at US$ 16.000 per day. This is comparatively better than other leasing deals with hard pressed owners where sometimes there is even a burn rate that has to be funded in such transactions whereas Genmar has a surplus. The lease rate structure, however, is probably insufficient to provide acceptable investor return; thus, the US$ 10.000 rate increase in later years. We do not know, of course, how residual value is shared. NFC was normally quite aggressive on this with owners as it is key factor in lease profitability.

Northern is counting on a revival of the product tanker sector in later years, which is probably a reasonable bet. With Western governments pushing the 'green' energy revolution and adopting policies hostile to offshore drilling and domestic refineries, the main growth in the crude sector is coming from China and the Far East, but the products markets may get a substantial boost from the numerous Middle East refinery projects, where Gulf Oil producers are looking for more valued-added content in their economies.

Producing oil products at source will give them a big competitive advantage. The shift to longer trading routes will hopefully result on more tonnage soaked up to resolve the supply overhang. The product tanker orderbook situation is only slightly more favorable than the crude sector, but there is a lot more growth potential in the product sector.

The product tankers in this package are handy-sized where there has been the most ordering recently, but also more potential for scrapping due the age of the existing fleet (older, smaller units) and the larger cargo lots. Genmar had previously been trying to market a sale-lease back deal with Pareto for several VLCC's, but this did not work out well with the collapse in the spot market for this tonnage class.

Note that Genmar investors have been lately taking it in the chin with a 53% decline in market value in 2010 (not including follow-on offerings during the year) according to a recent Dahlman Rose study. TeeKay was one of the best performers among listed tanker operators with a 44% increase in market value. Teekay's business model incorporates more added value and is less dependent on asset speculation for profits. Genmar has higher financial and operating leverage making them an attractive turn-around investment should there be an unexpected and early revival in the tanker market.

Genmar capitalization, however, is closer to US$ 310 mio rather than the US$ 188 mio figure in Dahlman's study because of their follow on offering. Genmar's shares are presently trading around US$ 3,25 whereas investors purchased at double these levels in the follow-on offering so they have been badly burned in the transaction.