Wednesday, November 30, 2011

Danaos exposed to counterparty credit risk with large exposure to some of the financially weakest liner companies

Danaos has been a perennially weak stock since the 2008 meltdown. The company suffers from high bank leverage and a heavy capex budget. Earnings have been marginal at best. In 2010, it racked up a whopping loss of US$ 101 million. This year, Danaos negotiated an excellent restructuring agreement with its senior lenders that also covers its future capex needs. It has significant long term charter cover. Is Danaos now out of the woods?

Danaos has a fleet with an attractive age profile. It has kept pace with changing industry dynamics, with almost 50% of its fleet capacity in the 8,000+ TEU range. Its fleet’s average age is 6.27 years and it has a new building program of 13 containerships to be delivered through mid-2012.

Danaos recently carried out a massive restructuring of its debt. The company raised in excess of $1 billion through a $200 million equity issue and new debt commitments of $818 million. Further, Danaos announced formal completion of the restructuring of its new building capex finance obligations. Fortunately, Danaos is a listed company and has the size and clout to pull off this this operation, underscoring the resilience of the publicly listed shipping company business model.

The fleet is heavily contracted with average length charters between 8 to 10 years. This employment profile facilitated the loan restructuring and capex commitments. Needless to say, the loan repayment was tailored to this cash flow with no bullet payments until 2019. Interest expenses are not negligible with projections of $191/$202/$234 million in years 2011/ 2012/ 2013 respectively, which represent about 50% of anticipated EBITDA (US$ 317/ 433/ 442 million respectively).

The weakest element here would appear to be the 29% exposure to Hyundai Merchant Marine (HMM) and 28% exposure to CMA-CGM as charterers. HMM has a gearing of three times debt to equity. It announced heavy losses of $ 205.080 million for the first semester of 2011. It is a smaller liner company vulnerable to pricing pressures from larger operators like Maerk in the fight for market share.

CMA CGM was downgraded by Fitch to BBB- with negative outlook and then Fitch ceased coverage. Their first semester 2011 profits were down 72% to $237 million from 2010. CMA CGM has been selling vessels at a discount to complete the reorganizing of $7 billion-worth of debt overseen by French court authorities, part of which involved Turkey’s Yildirim Group injecting $500 million into the company in exchange for shares.

Liner companies are generally considered too big to fail (TBTF) businesses. Should a major liner company go into bankruptcy, the fall-out would be substantial given that these companies charter about half their fleet from vessel provider companies like Danaos.

Alternatively, with a deepening recessionary environment, there are prospects of charter party renegotiation as occurs normally in shipping sectors like tankers and dry cargo. Theoretically, liner companies would have substantial negotiating power given the concentration of the industry and total dependence of vessel providers on them for employment.

Will the Maersk gambit succeed in gaining pricing power over the Asia-Europe head haul container route?

Whilst volume on the Asia-Europe container route is dropping off and competitors are struggling, Maersk is doubling up its efforts to dominate this trade in coming years by placing new building orders for large E class (15.000 TEU) and triple E class (18.000 TEU) ships. Maersk is highly dependent on its container division with almost 40% of its total volume carried coming from Asia-Europe trade. Its strategy is to benefit from better supply-demand fundamentals in late 2012 and into 2013.

Container shipping is increasingly a game of larger vessels with an emphasis on lowering slot costs. The one who has the lowest cost structure is able to garner higher volumes by out-pricing competition.

Maersk Line is the world’s largest container line. At the end of H1 2011 it controlled more than 600 vessels – 245 owned and 376 chartered container vessels – with a total capacity of 2.4m TEU. It also operates a major global port, terminal and inland services business – APM Terminals - operating a geographically diverse portfolio of 61 ports and terminals in 33 countries. It has 16 new terminal development or expansion projects underway and 132 inland services locations in 48 countries.

In the container shipping downturn of 2008-09, Maersk carried out a major restructuring drive in its container shipping division. The goal was to target more than $1 billion in cost savings to provide better operating efficiencies and minimize losses. Reduction and stabilization in unit cost is the key operating matrix in the container industry.

Maersk’s major competitors are Neptune Orient Lines (NOL), Hapag Lloyd and OOIL. Each has more than 7% of the greater than 12,000 TEU orderbook and stand to benefit as they are able to lower the slot costs and improve margins even if freight rates are just seen improving marginally. Maersk has the largest share at 13% whereas the each of competitors holds a 7% share. NOL, presently under pressure of earnings losses, is struggling with a very large capex budget and may be obliged to postpone some new buildings.

The second largest player, MSC, is more or less absent in the larger vessel category, which will help Maersk extend its lead further in coming years.

Hanjin Shipping, Hyundai Merchant Marine (HMM) and CMA CGM are highly leveraged. The two Korean line (Hanjin and HMM) have a gearing of three and two-times debt to equity, respectively. In Europe, the focus is on CMA CGM, which bond-market pundits expect to breach its debt covenants in the near future. It is undergoing considerable debt restructuring.

The long haul market will increasingly be dominated by fewer players with stronger standing and prowess, even in a depressed freight rate environment with very large containerships and low unit costs. The smaller peer operators do not have enough large vessels on order and will have to stick with smaller and less competitive tonnage or pull out of the trades completely.

Maersk Line is making an open gambit to gain the pre-eminent position on the Asia-Europe trade beginning in late 2012. It could out-price competitors and even potentially become a price setter on these trades.

Monday, November 28, 2011

Is Frontline headed for Chapter 11, following Genmar?

Frontline bills itself as the ‘world’s largest tanker company.” This is definitely not the place to be these days with tanker earnings barely covering operating expenses. After the General Maritime Chapter 11 filing, attention has turned to Frontline and its dismal Q3 results: a loss of $ 166.47 million. Frontline, however, is quite a different story that Genmar. The John Fredriksen shipping empire has far more resources than Peter Georgiopoulos.

Unlike General Maritime, Frontline has not yet run out of cash, but the odds of cash crunch in 2012 are substantial. Most market experts don’t expect a significant recovery until 2013. Platou Capital Markets projects accumulated capex totals of $451 million by the end of 2013 with only $147 million bank debt committed. The group is highly leveraged with term debt of $ 1.163 billion and capital lease obligations of $ 1.173 billion but total equity of only $ 557 million. Frontline’s fleet market value is just at par with the term debt and the trend is downwards on vessel values. Frontline’s operating losses in Q3 (net of substantial vessel impairment charges) were $14.4 million with an interest expense of US$ 32.5 million uncovered.

Ironically, the Frontline Suezmax vessels that created its asset impairment charges were ex-Top Ships vessels that Fredriksen had purchased just before the 2008 meltdown in mistaken hopes of an expanding market for this category of tanker. This transaction saved Top Ships from bankruptcy at the time. They were first generation double hull tankers without transversal bulkheads that raised controversial stability problems. Bulkheads are critical for tanker stability.

The Frontline fleet has a large number of older 1990’s-built tankers that are currently at scrap-level prices. Major oil companies have tightened their age criteria to ten years, creating pressure on these older units. This was reported to be one of the factors that led to the departure of Frontline from the TeeKay managed Gemini Suezmax tanker pool. Frontline and Nordic America had older units and they have now gone off to create a pool of their own.

Frontline Chairman John Fredriksen, nevertheless, has resources that he can bring in to restructure Frontline if he wishes. He remains the wealthiest man in Norway (although he has now taken Cypriot nationality for tax relief). Indeed his investment interest had been waning in the Frontline for a few years as he focuses on more profitable ventures like Golar LNG. The related downstream company Ship Finance International, which leases tonnage to Frontline, is invested in a variety of shipping sectors as well as off-shore drilling rigs.

Already Frontline is selling older vessels to raise cash. Like Eitzen, which was initially in trouble in 2009, Frontline is currently airing a number of alternative restructuring ideas. It is considering splitting the company by separating the trading fleet from the new building orderbook. There is also talk about renegotiating the lease payments to Ship Finance with lower payments now and larger payments in the future.

Generally, “Big John” seems relaxed about the situation. The market is counting on Fredriksen to come up with a creative solution to restructure the company.

Wednesday, November 23, 2011

General Maritime and Omega Navigation: Two very different approaches to Chapter 11

This week has seen substantial developments for both General Maritime, which recently filed for Chapter 11 reorganization, and Omega Navigation, which filed some months ago. The companies’ approaches are radically different.

General Maritime (Genmar) and Omega Navigation (Omega) have been ailing for some time. Both incorrectly believed growth would save them.

Omega was the smaller company. It had an expensive asset base and was caught during the 2008 meltdown with loan covenant violations. It tried to grow itself out of its problems with a joint venture with Glencore, but that did not work out. Management was not proactive in increasing outside capital and the company’s small size imposed constraints for institutional investors. As a means of dealing with its senior lenders, Omega took on more debt with second mortgages from NIB Capital and BTMU. This year Omega got into an impasse with the lenders and filed Chapter 11 as a shield.

Genmar was a larger and more mature company with access to capital markets. It entered into the market downturn in 2008 with somewhat high leverage (75%) and some loan covenant violations. It did an unsecured bond offering to improve liquidity. Ultimately, it chose a large block deal with Metrostar that enabled it to raise a substantial amount of capital in 2010 from investors at par without discount and obtain additional bank credit. Unfortunately, the timing and size of the transaction proved disastrous.

The two companies diverge substantially in their approach to restructuring and dealing with creditors. Omega chose to declare open war on its lenders with a dramatic trial alleging that its lenders broke agreements on restructuring. This seems dubious prima-facie, given the way banks normally work in these cases. Omega’s New York legal team seems no less bombastic with this week’s heated exchange between bank and company lawyers over alleged intimidation of Omega directors. Where Omega and their legal counsel seem absent so far is putting forth any coherent plan to reorganize, raise new capital or restructure its debt. In the meantime, Omega’s financial condition seems parlous and with heavy legal fees, consuming valuable company cash flow and mounting unpaid debt service increasing their already negative net worth. NIB Capital and BTMU risk losing their entire loan outstandings.

Genmar, by contrast, is focussed on working with its senior lenders. Earlier this year, Genmar secured an equity injection from Oaktree Capital, which organized a very professional debt restructuring as part of the deal. Genmar also sought to raise capital with a follow-on equity offering. Unfortunately, their operating losses grew and the increased interest costs from the restructuring put severe pressure on their liquidity. This week, Genmar entered Chapter 11 with agreements for additional support from both Oaktree and their lenders paving the way for reorganization. Unsecured bondholders, however, are in a nasty position, facing substantial losses. It will be interesting to see how these approaches fare in coming months. Omega would appear to have much to learn from Genmar.

Friday, November 4, 2011

Ship-owner refuge in Chapter 11 proceedings may prove a game-changer in bank foreclosure actions

Several high profile moves by beleaguered shipping companies dealing with their lenders by filing Chapter 11 proceedings in US courts may put shipping banks in a difficult position. In both the Marco Polo and Omega cases, the companies have succeeded to hold their senior lenders at bay. Faced with paying large professional fees that eat into depreciating equity on secured vessels already below loan outstandings puts banks in an extremely difficult position with few options.

If one goes by the book, Chapter 11 requires a company to file a credible plan for reorganization, failing that the lenders can move to Chapter 7 for dissolution of the company and disposal of the assets. The problem is that courts in this situation will give distressed owners considerable leeway and are ill equipped to assess the underlying economics. They regard the process as a means of pressing the parties to an amicable solution. In the meantime, the distressed company can finance the legal expenses from having ceased entirely loan payments. On the other side, the senior lenders are forced into high transaction costs in legal expenses.

One asks himself how US courts would have jurisdiction over these cases of foreign senior lenders and shipping companies with vessels under foreign flags on the high seas in the first place? To the shock of Credit Agricole and Royal Bank of Scotland (RBS) last week in the Marco Polo case, the US Court in New York retained jurisdiction, making Chapter 11 viable for international ship-owners even if they have minimal contacts in the US.

The New York law firm, Bracewell & Giuliani, as counsel for both the Omega and Marco Polo cases, have made a franchise in these actions. The US courts and legal profession have suddenly opened up a new bonanza.

Alternatively, the senior lenders could sell off their loans, but the market for distressed shipping debt has been very limited. Loans made under English law generally require ship-owner consent for any transfer of the debt to a party other than a shipping lender.

There are hedge funds and distressed asset investors, who have shown interest in bank portfolios, but at a steep discount. So banks and potential buyers are presently very far apart on price ideas. For distressed asset investors, English law on transfer of debt limits their ability to get control of the assets. Chapter 11 is now a new potential obstacle to this end as well.

Hedge funds increasingly have been scheduling sit downs with distressed owners offering to inject capital into the ailing company in return for an equity stake and a commitment by senior lenders to write down the loans by 10%. It is possible that this might offer a credible means for distressed shipping companies to recapitalize under Chapter 11 proceedings.

What needs to be clarified in the future is how effective US courts prove in facilitating company reorganization under Chapter 11 or they just prolong hopeless cases and make them worse by ‘pretend and extend’ and the US legal profession profits in the value destruction.

Challenges ahead for Greek Shipping

I recently had an opportunity to address the ICS 7th Annual Forum “Navigating through the Economic Storm – Setting a route in difficult time” in the questions and answers session and wish to share my thoughts on two major structural issues that could drastically reduce the competitive advantages the Greek market in years ahead, starving it of valuable human resources and entrepreneurial incubation.

Greek shipping faces two fundamental and interrelated challenges to competitiveness.

First, Greeks are no longer going to sea. The Greek government and the Greek shipping industry have been entirely indifferent to this and done nothing about it. The accession to the European Union and government policies that encouraged tourism in the islands with subsidies for rented room provided an alternative for Greeks, who normally would have chosen careers in the merchant marine. Social changes in Greece discouraged people from going to sea. Euro accession put Greek seaman at severe cost disadvantage for companies.

Greece once had numerous maritime academies, often in the islands. It also had many private marine schools in Piraeus. Today only one marine academy is still functioning at Aspropyrgos. All the private schools are closed. Greek families of marine tradition are now sending their children to US merchant marine schools for proper education that is not available in Greece. All this is very sad for a country that was one of the greatest seafaring nations in history.

30 years ago Greek ships due crew costs were cheaper on the average than peer Norwegian or Japanese operators. Now Greek companies use the same crewing resources as their peers. Far East and Indian crews with sometimes Russian or East European officers. Their costs are identical.

The Greek crews were a source of middle management for the Greek offices that gave them an unbeatable operational advantage as vessel providers with an indelible bond between the office and the vessel. Today, with fewer and fewer Greek seafarers, the labor pool for middle manager Port Captains and Port Engineers is drying up and is increasing elderly in age. Some Greek companies are beginning to use Indians from abroad, for example, in their headquarters, so why not management from Dubai or Singapore?

Second, Greek medium. small companies are now shut out of bank finance with the Greek banking system locked up in Greek sovereign debt crisis. Typically these companies have small fleets of older units, mainly bulk carriers. They buy elderly tonnage close to scrap-level, trade them a few years, building up net worth. They then roll over their fleets, buying somewhat newer units and selling the older units for scrap. Greek banks were specialists in this kind of lending with higher pricing and shorter tenor. These companies are too small for foreign bank finance and their vessels do not meet bank age criteria.

These companies are a critical entrepreneurial incubation crucible for a continuing renewal of Greek Shipping community. The best of crop become ultimately the Greek shipping powerhouses of the future. The offices are a major source of office employment in Greece. They contribute to the support of a large marine service industry in Greece.

Without the human resources of seafarers and the entrepreneurial incubation of new companies, the future of Greek shipping may well be in jeopardy. Shipping in Greece risks the danger of a mature industry that consolidates with a few major players, but a much smaller base than previously where Far East and other competitors become the growth area of the industry in the future.