Monday, August 6, 2012

OSG in the doldrums: Is Morten Arntzen really one of the worst CEO’s in any industry?

Overseas Shipholding Group (OSG) is a blue chip tanker company that is currently in crisis with 13 quarters of operating losses, plummeting share value, rating downgrades (CCC+) and ominously its unsecured bond debt trading far below nominal value. Morten Arntzen claimed in the recent 2nd quarter earnings conference that OSG defensively drew to the maximum its current US$ 1,5 billion liquidity facility. With current market fixation on this facility expiring in February next year to be replaced by a smaller US$ 900 million facility, Arntzen did not provide much comfort to investors. To add insult to injury, Motley Fool named him one of the worst CEO's for the dismal stock performance and sizeable investor losses over the past year.

OSG is one of the oldest US tanker listings. It was founded back in 1948 by the Recanati family and listed in the US stock exchange in 1973. The Recanati are American Israeli with origin from Italy where they took their family name. Two of the Recanati family remain on the Board of Directors: Ariel and Oudi Recanati. Aside from shipping the family has a long tradition in banking and finance, having founded the Israel Discount Bank.

Morten Arntzen became CEO in 2004, coming from a banking background in New York. He ran the global transportation group for Chase Manhattan and Chemical Bank. Then he served as CEO for American Marine Advisers, a boutique NY marine merchant bank group with close associations with OSG and the Recanati family. Arntzen and the OSG finance director, Miles Itkin are mature executives both getting on in age and this is probably the first time that they ever been in an underdog crisis situation. Their strategy so far seems to have been to ride out the storm, hoping for a market improvement rather than making any serious sacrifices. At time goes on without market improvement, OSG’s alternatives get more costly and unpleasant so it is a difficult wager.

On the other hand, with over US$ 2 billion in debt, OSG has considerable debtor leverage. Given lenders accommodative stand towards lame duck shipping companies like Eagle Bulk and Berlian Laju Tankers, a “blue-chip” lame duck like OSG should merit equal or better treatment. This may be a fact that Arntzen is playing strongly behind the scenes.

OSG compared to peer tanker operators was slow to diversify into higher growth alternative marine investments like LNG or the offshore sector with better profit margins. To his credit, Arntzen succeeded early on as CEO in a merger with Stelmar that allowed the group a sizeable position in the product tanker sector in addition to their large fleet in crude oil. OSG’s investments in LNG and offshore have been timid and very conservative. In both cases, they opted for joint ventures and their position is relatively small. In fact, OSG has staked a lot in the US domestic tanker market, which until recently was making losses and limited in prospects.

Under US cabotage, the market is sort of an oligopoly with a limited number of operators, but several of them barely eking out an existence struggling with Chapter 11 reorganization. Lately with the Motiva Refinery project in Houston and US shale oil developments, the US domestic market has started to pick up, but Motiva is now shut down due construction problems.

OSG is counting on substantial MARAD Title 11 money for their US fleet that has been delayed. This subsidized loan money cannot be commingled in their overseas operation, but it is a very valuable resource in an exceeding difficult credit market conditions. Indeed, MARAD created recently some stir by its rejection of rival American Petroleum Tankers' (APT) application for Title 11 loan guarantees despite the company backing from Blackstone.  With the difficult conditions in the OSG international fleet, however, the profit from the US flag operation is unlikely to compensate and cover for the losses even with improved rates.

There is a lot of optimism for a turnaround in the product tanker sector. OSG is concentrated mainly in the MR size with focus on trans-Atlantic trades, but this sector has underperformed expectations. In the end, if new refinery projects come on stream and there is an increase in tonnage miles, it is possible that the LR size will benefit more than the smaller vessels.  Both Blackstone and the Prime/ Perella Weinberg Partners are concentrating on these larger units.  So is Scorpio Tankers, a financially much healthier company than OSG.

Otherwise, OSG share price currently around US$ 5 is not an attractive level to raise fresh equity and this would likely entail substantial share dilution in current Wall Street conditions. A bond issue would be expensive with OSG’s credit downgrade and require security given the current discount on its unsecured bond debt. OSG could sell and lease- back some of their unencumbered units, but this will be very expensive and the lease payments will weight on their cash flow and liquidity. Finally OSG could sell out its share in its LNG and FSO joint ventures.

Is it any surprise that Arntzen stresses over and over again that the tanker markets have reached their floor? He could be correct and in fact OSG 1st quarter results gave some comfort in this direction, but losses widened in the 2nd quarter.

Undoubtedly, it would be a big blow for Arntzen and Itken with their stature and age to be compelled to actual sacrifices, should tanker markets continue in the doldrums and OSG liquidity dries out. I believe, nevertheless, that OSG still has substantial support from its lenders, who will bend over backwards to keep them afloat until better days come.

Whether it is a profitable to own OSC common stock or take a position in its unsecured debt right now is another story. This depends on how quickly one expects a global turnaround in shipping markets. If freight markets remain at present levels into 2013, OSG will face some stressful times.

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