Thursday, October 6, 2011

Eagle Bulk once a Wall Street darling now facing forced sales

At the outside of the 2008 meltdown, Eagle Bulk with its emphasis in handymax tonnage was considered one of the safest bets of shipping stocks. Sophocles Zoullas was well-regarded in NY financial circles. Kelso, who originally banked the venture, had made very good money. Yet the business model had flaws and this is now coming to light.

Eagle Bulk concentrated on supramaxes, where there has been excessive ordering. The smaller vessels in handy sector with more flexibility in port access and variety of cargoes are outperforming.

It was a start-up company with little initial intrinsic value. It has been heavily dependent on charterer counter parties for fleet employment. Only recently has it been developing a commercial department for a contract base. Eagle has always been very secretive about its management, vessels and employment compared to peer companies. Early this year Eagle received considerable adverse publicity when it was discovered the company had significant exposure to Korean Lines, a major charterer who went bust, declaring reorganization.

Shipping is a capital and labor-intensive business with basically low returns on asset. The historical benchmark has been between 10-15% with leveraging. The challenge is how to bring this up to acceptable levels for investors, who are looking for 20-30%. Since shipping is a cyclical business, this can be done in part with timely investment and divestment decisions.

Capital cost is very important. These dry bulk issues, however, were structured with generous dividend payouts, precluding significant reinvestment of free cash flow. New business had to be financed by costly new equity raises. Eagle had few options but a large block purchase strategy to scale up and claim accretitive returns on multiples from a rapidly growing fleet.

The company chose to buy the business from another owner who had ordered a large block of vessels and wanted to resell them at a considerable premium for profit. The expectations from the transaction propelled Eagle’s share price to new highs. This was very good for Kelso, the private equity firm, which sold off shares in timely fashion; but not very good value for investors who bought into low margin business with marginal returns on residual value.

When conditions changed from fall 2008, Eagle had a high cost asset base and too much debt. This precluded any bargain hunting for vessels at lower prices. They put their efforts trying to rearrange and rationalize their order book, where they were over exposed. They had the financial capacity to do new business only through a joint venture through Kelso.

Eagle has a high break-even for its vessels due mainly to very high administrative expenses and interest cost. Executive compensation has been lavish over the years. Despite this, the Group managed to stay in the black until recently. The bad market conditions this year have depressed asset values leading to loan covenant violations. At present, their net worth is close to negative. Presumably the pressure from lenders is to encourage timely recapitalization or asset sales to reduce debt. Oaktree recently bought a small share. Eagle has got a long and risky road ahead of them for recovery.

1 comment:

  1. Thanks for the blog.

    so what do you see for the industry? people are mentioning consolidation, but does this make sense for industry such as shipping? so basically ship owners will buy distressed owners and the problem would be still too many ships. so when people talk about consolidation doe snot mean anything without increase in scrapping?

    the other issue is cost of capital will be higher than what it was and given that shipping has very low ROIC, how do you see it creating value?