Sunday, August 18, 2013

Seaspan’s Yang Ming moment

Gerry Wang, Seaspan’s ebullient CEO, frequently refers to his business model as a ‘leasing” operation.  I have long questioned this.  In fact, Seaspan is a conventional vessel provider to liner companies.  Their contractual relations are long-term time charters with performance risk.  Yet this latest deal to order 14.000 TEU mega-ships and then charter them to Yang Ming Transport Corporation for their liner service has many interesting parallels to the ship leasing business that are illustrative of the business risks and rewards in the Seaspan business strategy.

Yang Ming recently announced consecutive losses TWD 2.6 billion (US$ 87 million) in the 2nd quarter 2013 earnings conference.  Revenue for the quarter was TWD 30 billion, a year-on-year decline of 14%, but a small quarter-on-quarter bounce of 9%.  The poor performance was blamed on depressed freight rates for the Asia-to-Europe trade lane from which Yang Ming derived about 27% of its revenue in 2012.

Yang Ming suffers from an over-leveraged balance sheet with too much debt and is struggling to shed assets for liquidity by selling off terminal operations and leasing them back.

Consequently, they are in no position to contract 14.000 containerships.  So they have now entered into an agreement to charter in ten additional 14,000-teu containerships from Seaspan, which are slated for delivery in 2015-16.  The logic is the usual in this business of ever-declining margins and over capacity:  “These mega vessels are expected to be deployed on the Asia-Europe route and are expected to bring unit costs to down better complement the fleet of the CKYH alliance,”  according to Jon Windham, a Barclay analyst covering them.

Seaspan initially ordered speculatively these mega-ships, paying US$ 110 million per unit at Hyundai Heavy Industries. With ten new units now committed to Yang Ming, Seaspan is now turning to Taiwan’s CSBC Corporation for five additional 14,000-teu vessels on the same price terms as the earlier Hyundai order as an added sweetener to this Taiwan deal.

No doubt, Seapan is offering Yang Ming a considerable service with these units that they could not afford to contract themselves.  Yang Ming is paying them a rate of US$ 46.000 per day upon delivery for the next ten years.

All this, however, cannot eradicate the bare facts that Seaspan is openly speculating in assets against charters often to financially weak liner companies in an industry that is suffering chronic overcapacity.  They wagering on an eventual cyclical market turn-around with increased box traffic.  Yet the heavy ordering of megaships contributes to over capacity. Unless there is real turn around in terms of increased container traffic and demand for box slots, this almost resembles a Ponzi scheme.

Of course, nobody can deny the tenacity of Gerry Wang and business standing of Seaspan in the liner industry.  Greek-listed container vessel companies like Danaos, Box Ships and Diana containers pale in comparison as poor relatives and much weaker management teams. 

The only really strong and healthy listed Greek containership company is  Costamare, whose largest vessels are 9.000 TEU.  They have a history of sustained profitability and they have not rushed into the megaships.  Many of their units are employed in feeder services, which are a growing and generally profitable subsector due larger ships on head haul routes, use of hub ports and increasing demand for distribution of boxes to smaller ports.

The business risks for Seaspan are similar to finance leasing companies in their business of high cost finance generally to a clientele of financially weaker shipping companies.  Sometimes the companies have liquidity problems and are looking to sell assets and lease them back.     Other times, they are expanding rapidly and have exhausted conventional lower cost bank finance.  The leasing companies bet on company turnaround and stronger markets to prop up their financially weak clients. 

Seaspan’s prime universe for these mega-ships is financially weak liner companies without the resources to order directly the vessels themselves.  Success of the venture depends critically on a market turn around.  Should this growth even finally level off with Far East trade rebalancing and slow recovery in Western economies leading to a belated and major shakeup in the Liner industry with few companies, some major bankruptcies, etc., then Seaspan might find itself badly exposed with such aggressive ordering.

So far Seaspan has managed to weather well the shock back in 2008 without a single order cancellation and is continuing its aggressive growth.

Landmark shareholder victory against Eagle Bulk management and directors for abusive and excessive executive compensation

Eagle Bulk Shipping has been one of the poorest performing shipping stocks in its peer group.  From lofty levels in excess of US$ 100 per share in its salad days, the stock crashed below US$ 20 in the fall of 2008.  From then on, it has been a slow attrition with charter party defaults, bank covenant violations and loan restructuring agreements with the stock presently trading at US$ 3,56.  Latest quarterly results were losses of US$ 3 million for the 2nd quarter 2013.  Yet its management sat at or near the top of shipping’s executive pay lists  for years.  Its directors who were earning more than their counterparts at large Fortune 500 companies without offering any oversight.  Shareholders who have lost literally their shirts appear to have succeeded to force Sophocles Zoullas and his management team to roll back their pay to more reasonable levels, albeit still quite high for such miserable value destruction and bad performance.

I have signaled Eagle Bulk at a very early stage back in January 2009 as a potentially problematic company: “EGLE: Conflicts between sound business principles and Wall Street 'value-building' concepts”

Its management followed an antiquated vessel provider business model with heavy dependency on third party charterer counter risk.  They scaled up their fleet at lofty values in large block deals, exposing the company to serious problems with loan to value covenants when the shipping markets crashed.  Eagle Bulk was badly exposed to the Korean Lines bankruptcy, with little transparency for years as to their charterers and counter party risk profile. 

If Eagle survives today as a zombie shipping company, this is by the mercy and desperation of their bankers, particularly the Royal Bank of Scotland, who did a trend-setting debt for equity swap last year to keep them alive.

Miraculously, tenacious shareholders managed to rebuff Eagle’s attempts to have their legal action thrown out by summary judgment in November 2011 and despite the high hurdles facing plaintiffs under Marshall Islands law. Eagle Bulk management executive pay practices were so abusive and egregious that facts suggested a “quid pro quo” arrangement may have existed between Eagle officers and directors, thus barring Eagle from using a so-called “business judgment” defense.  This has led to the present compromise agreement with Eagle management pending final court approval. 

The major bullet points are truly eye-opening in terms of the money and benefits that management had been extracting from the company despite its dire financial condition with its creditors and serious operating losses:

•    Cancellation of all stock options (180.704) granted to Eagle officers and directors between 2008 and 2011.
•    Shortening the expiration to five years from 10 for 1.4 million options granted to the Zoullas brothers in 2012, with an estimated US$ 1 million savings to Eagle.
•    Limiting average compensation to non-management directors to US$ 240.000 through 2015, compared to US$ 432.000 in 2011.
•    Limiting executive compensation through 2015 to the average paid by five peer companies — Dryships, Diana Shipping, Excel Maritime, Navios and Genco Shipping — rather than “prior practice of paying at the top of the industry”.
•    Requiring Eagle to bill Zoullas’ private Delphin Shipping US$ 237.000 for services it has rendered, and tightening dealings between the two “to ensure that Mr Zoullas does not derive an unfair advantage.”
•    Terminating the 2011 equity incentive plan and 4.3 million shares that could have been issued under it.

Among other practices in Eagle Bulk adding insult to injury is Zoullas appointing his brother Alexis as President making this listed company a family affair.

Lenders and other shareholders should rejoice, as Eagle still faces a difficult struggle to stay alive with continuing operating losses until dry bulk markets recover. 

Here below is a comparative graph of Eagle Bulk share performance with peer dry-bulk companies over the last five years:

Eagle is one of those at the bottom of the chart. 

This case reinforces my concerns about a competitiveness problem for Greek listed shipping companies compared to non-Greek peers in terms of return on investment.  Pacific Basin, for example, in Hong Kong makes Eagle management look rather ridiculous and amateurish, not even worth their revised remuneration levels.  The best performing Greek peer company is Angeliki Frangou’s Navios Holdings, one of the very bright exceptions in the Greek market.