Monday, November 2, 2015

Pyxis reverse merger: an imaginative capital market entry with big challenges

Pyxis marked the first time a Greek managed shipping company became publicly listed via a reverse merger.  They are merging with a San Francisco-based tech outfit LookSmart, already listed.

It was a novel entry to public markets by a small product tanker company, who failed to develop sufficient interest in a previous attempt to do an initial public offering. Will this entry allow them to raise capital in public markets as they would like, or will it prove in the end nothing more a Pyrrhic victory that simply increases administrative expenses for the public listing without any benefits to capital markets access for fund raising?

Present conditions in capital markets this year have not been easy for fund raising in shipping ventures. Enthusiasm and interest among institutional investors to put money on shipping assets has waned considerably over the past two years. Funding for expansion has reverted again to traditional bank financing. The market has become generally very selective on shipping projects.

Investors have been burned by bad positions in dry cargo shipping companies, where the markets turned against them, ship values have declined and these companies are making substantial operating losses. Even in the tanker sector, which is doing quite well this year with resurgence in freight rates and cargo volumes, investor interest is limited only to a handful of large tanker companies. Conversely, a number of private equity joint ventures are putting their tanker assets on the market for sale to monetize their positions.

Pyxis would probably never have succeeded in their reverse merger operation without the support of Larry Glassberg at Maxim Securities. Maxim is mid-sized investment banking firm that has not only a base of institutional investors but also a substantial base of retail investors. Glassberg has an exceedingly long experience in the investment bank industry and shipping operations.

Pyxis did not attract sufficient interest for an IPO (initial public offering) because it is a relatively small operation with a fleet of six MR product tankers, two smaller chemical feeder tankers and one MR new order yet to be delivered. Vessel age ranges from three units built in the late 2000’s to a small two-vessel MR NB order of which one unit has been delivered.

The company is certainly on the right side of the market in product tankers, but they face much larger peer companies like Ardmore and Scorpio Tankers. Major established companies like BW Pacific and Hafnia Tankers would like to list publicly, but are themselves constrained to wait for improved market conditions to do an IPO listing. It’s only a matter of stock flotation, but also obtaining favorable valuation with their listed peer tanker companies still trading below or close to NAV despite a surge in profits. This was a basic hurdle that Wilbur Ross was not willing to accept in the case of Diamond S going public.

Vessel values have improved but still remain below what would be expected given current earnings. Part of this may also be due to the restricted bank financing market, where loans are given only to existing customers and preference to larger clients.

The true test here will be if Pyxis can leverage their public listing to raise capital to facilitate growth. That is clearly the motivation of Pyxis for the costs and increased administrative expense of a publicly listed company. With a fleet of eight vessels, they will have to absorb additional administrative expenses of at least US$ 800.000 to 1.000.000 annually. Pyxis as a listed company has an estimated US$ 70 million market cap, of which US$ 66 million will be controlled by its principal, Eddie Valentis. The remaining US$ 4 million of stock has traded less than $100,000 per day. Pyxis remains essentially a private company under total control of its owner. It has no trading volume and will not attract any analyst coverage.

Going into the market to raise capital, the valuation issue becomes critical. Pyxis will likely trade at a discount to NAV [net asset value] and to established companies like Ardmore Shipping or Scorpio Tankers. Should investors put a low valuation, what will be the appetite of the principal shareholder, Eddie Valentis, to dilute his personal share holdings, selling his stock to investors at a discount? Of course, there are other means to raise capital. Pyxis could look to bond issues, for example. Financial expense will be higher than a conventional bank loan, but amortization schedules may be more favorable, providing more free cash flow liquidity that could be reinvested in further expansion. They could also consider convertible bonds or CoCo’s that would get around the share dilution conundrum.

At least, Pyxis is on the right side of the market in the tanker sector. They have a relative young fleet. This listing operation may prove a spring board for future growth, depending on the quality of incremental investment that they take to market for investor support and the prevailing market appetite to invest in the shipping sector.

Saturday, September 19, 2015

Is the Greek dry cargo business model now obsolete?

Of the 700 odd Greek shipping companies listed in Greece, the majority are in the dry cargo sector with small fleets of three to ten units, mainly smaller and older vessels.  Apart from the ubiquitous handy size bulk carriers, Greek shipping is also heavily invested in Panamax bulk carriers. Will these companies survive this current freight market crisis?  Will the crisis result in consolidation?  Is the business model sustainable or will it have to change for the times?

Many of the publically listed dry bulk companies ranging from the smaller ones like Free Seas, Hellenic Carriers and Globus to the larger ones like DryShips and Paragon are suffering from legacy debt problems and weak earnings.  The smaller private companies are at the mercy of the local Greek banking system with its insolvency and capital control issues.  The best off are the cash rich, mature private Greek owners like Eastern Mediterranean or the Angelicoussis Group.

The predominate business model in Greece is vessel provider.  The Greek shipping companies are long in shipping assets, but generally weak in commercial platforms.  The majority of the companies are small and lack scale efficiencies.  This is particularly true for the smaller listed companies with fleets too small to support the high administrative expenses for the public listing. 

This business  model is entirely to be expected for historical and structural reasons.  Greece is a major maritime nation. Greek seamen were the backbone of this system.  The biggest strength and competitive advantage of Greek owners was the link between their offices manned by former mariners and chief engineers and their vessels.  They offered low cost, high quality shipping services to charterers and end users.  Greeks unlike their Scandinavian rivals were never big in cargo operations or freight trading, a particular strength of the Danish shipping industry historically.

The nature of the Greek shipping  business model leads to asset arbitraging as a major means of enhanced earnings.  Freight markets in bulk commodities shipping is highly commoditized with low earnings margins from vessel operations.  This waxes and wanes with the shipping cycles, but historical mean averages have been low.

The dry cargo markets in particular are very fragmented with low entry  barriers.  Shipping companies have no market pricing power.    Vessel values rise exponentially on future earnings expectations in good markets, making vessels sales a highly lucrative business over vessel operations.  It was Greek historical acumen in these skills of sale and purchase profits that has made Greek shipping so enticing to US Capital markets over the last ten or fifteen years. 

Major US institutional groups like Oaktree saw the same US real estate paradigm in the shipping markets.  They were attracted to Greek shipping for a similar sort of play. This led to investor partnerships pioneered by Peter Georgiopoulos and more recently by Petros Pappas both very close to Oaktree Capital.  This also extends to non-Greek groups like Scorpio Bulk, a highly speculative dry cargo asset venture on new building contracts, close to a futures market play.

This sort of play to be effective depends on the right kind of financial and freight market conditions. These conditions were at their prime thirty years ago in the heady days of petrodollars, high inflation and eager banks with abundant credit facilities for shipping companies.  Since the 2008 Global Financial Crisis, with ZIRP (zero interest), QU (quantitative easing) and the end of a globalization super cycle, the environment for asset arbitrating on cyclical freight markets is becoming more and more problematical.

There is a glut of overcapacity globally and a dearth of demand.  Banks has weak balance sheets and limited credit availability.  There is enormous shipyard overcapacity.  The Chinese infrastructure boom is over.  Speculative investment money in shipping has more than often been a godsend to cargo interests, providing ample ship supply to service their transport needs, but it has not been kind lately to investors in the underlying shipping assets. 

With the credit crunch is a limited number of buyers for shipping assets compared to prior years, limiting the potential for mark up in prices.  With the general weakness in commodities prices and ship yard over capacity, shipping assets are exposed to deflationary effects and fall in value over time with lower replacement cost.  Falling scrap prices means lower residual values.

The most successful and resilient business models are the cargo operators of which the Navig8 Group has been an industry leader.  They serve end users customers with chartered vessels.  They are popular with ship owners, hungry for employment in weak markets.  Their business has small margins and depends on  high volume for profits. It is an asset light trading model.

These businesses can go both long and short in shipping assets.  They do not carry long term exposure in shipping assets or bank leverage.  For larger vessels on standardized voyages, they can hedge their positions with freight futures desks.  They can adapt quickly to sudden market changes, adjusting their cargo books and positions in vessels.  These are the flourishing businesses of the times as opposed to the suffering Greek vessel providers.

Institutional investors have been lately turning to partnerships with cargo operators like Navig8 to adopt to the times.  Oaktree and Peter Georgiopoulos incorporated this model in the restructured Genmar from the ashes from Chapter 11 reorganization proceedings, by merging with the Navig8 VLCC venture and renamed their company Gener8.  This ties vessel owning long in assets with a lighter more agile trading model including chartering in vessels.

The question for the Greek dry cargo owners is whether their business model is obsolete and they will have to consider moving into cargo operator business models on a hybrid basis like a Norden or a Pacific Basin with mixed fleets or owned and chartered vessels..  Companies heavy in shipping assets but weak commercially lack economies of scale in the market and are weaker in understanding the freight market risks.  They are overly oriented to asset arbitraging, which in present market and financial conditions is a backwards-oriented business strategy of yesterday, not effective in the present environment.  Chartered vessels would create needed fleet scale for companies with smaller fleets

These Greek companies are facing survival risk and becoming dinosaurs.  They face a double whammy of violent changes both domestically in Greece with the failure of the Greek state as well as external forces in the aftermath of the globalization super cycle of the past century.

Greek Shipping and EU revisited

The third Greek bailout program has now been passed by the Greek parliament and at least the basic tax increases on Greek shipping have become public.  We can now begin to take stock on the damage done to the Greek shipping community by the SYRIZA government and the EU/ Eurogroup bureaucracy.

The tax increases are hardly helpful for a business under a great deal of stress due the very poor dry cargo markets, where the majority of Greek shipping companies in Greece are concentrated.  None of this is positive for the increasing unemployment in the Greek maritime sector. There are 4% tonnage tax increases each year for the next three years.  There is also a continuation of the 'extraordinary' (now becoming permanent) levy on Greek maritime service businesses on the foreign exchange brought in to Greece for covering their office and administrative expenses.  Already tonnage taxes in Greece are much higher than other jurisdictions. 

This makes third party ship management in Greece problematic given that ship managers in major jurisdictions like Cyprus, Dubai, Singapore and Hong Kong do not have this burden.  Ironically, the EU approved the low rates in Cyprus, whilst insisting on rate hikes in Greece.  The other jurisdictions are blessedly outside the Eurozone, without fiscal problems or over indebtedness. There is little prospect of their hunting down their businesses and citizens by repressive taxation as happens in Greece and the  EU as a whole to cover their political mismanagement and losses from repeated  policy failures. 

The only positive thing to be said in terms of advantage for Greek offices is that rents and salaries in Greece are extremely low compared to rival jurisdictions.  The other places are economically healthy, Greece is in a deflationary spiral with massive unemployment and falling real estate prices.  The tax increases are offset by lower personnel and administration costs in Greece as opposed to the other rival jurisdictions.

There are, however, other negatives in Greece beyond these new EU tax measures on the Greek shipping industry.  The two most serious negative factors are the broken local banking system with capital controls and the general uncertainty of the future, including exposure to further tax hikes and erosion of offshore status of Greek shipping in Greece.  All this creates a bad business environment for an industry that is facing a lot of structural problems due changes in world trade and a particularly bad situation in the dry cargo sector, where the majority of offices in Greece are exposed.

The most unpleasant aspect is the situation with Greek banks and capital controls.  The Greek banks are now facing new stress tests and recapitalization issues.  Lending has been at a standstill for months now. The small and medium Greek shipping enterprises dependent on the local Greek banks for the financing of their fleets are suffering the consequences.  The capital controls extend to their US Dollar accounts in complete contrast to the situation prior Greek entry to the Eurozone and the drachma.  In those days, US Dollar accounts were considered freely convertible foreign exchange and there was never any issued about the solvency of the local Greek banks.  Bank finance for vessel purchase to rollover and renew their fleets is now again on hold.

Ship owners like most of the Greek bourgeoisie cling to the Eurozone.  This is becoming more and more problematic as the political and economic situation continues to deteriorate in Greece and the process of the Greece state insolvency takes its course without any debt relief in sight. 

The broader fundamentals internationally are not good.  The EU is unstable with mounting sovereign debt, very poor growth and defective, dysfunctional institutional structure.  The US is entering the last year of a two-term Presidency, where historically there have been major market meltdowns in US equities markets.  The most important of all for shipping, global trade patterns are now changing because the China story is over with falling GDP growth rates and instability in Chinese financial markets, which have caused recently  fall-on turbulence and volatility in US financial markets .  

The China situation has had already a strong effect on dry cargo markets. The tanker markets are still buoyant with the low oil prices.  With the end of the current globalization super cycle, production in the coming years may become more localized and this would have a profound impact on the shipping industry.

Thursday, July 9, 2015

Greek EU Crisis and Greek Shipping Industry: Where are we headed?

The case of Greek ship owners and their embrace of the Euro is but a microcosm of Greek society and the general mindset of many in the Greek middle class. 

Last Friday before the plebiscite, I received a plea originating from Mr. Dimitris Athanasopoulos Group Managing Director of Axia Ventures Group Ltd to vote ‘yes’.   I was amazed at how so many smart, financially literate business people could be so incredibly blind to the mess in Greece and the stark reality starring at them in their faces:
  • They were totally tone deaf to the prevailing public mood in Greece.  
  • I was amazed that these experienced business people would side with EU Creditors and their disastrous ‘pretend and extend’ fudges that have devastated the Greek economy.
  • How could they be totally oblivious to the urgent need for substantial Greek public sector debt restructuring, as now officially attested by the IMF? 
  • Finally, they seemed incredibly na├»ve that this plebiscite would solve any problems, Greek banks could be opened in a few days and things would quickly evolve back to normality given the complexity of the present impasse and depth of the crisis.
How could they be insisting on more of the same failed remedies of the last five years that have created social and economic chaos, led to the disintegration of the Greek political system, put into economic marginalization large swathes of Greek society and left Greece more insolvent and bankrupt than ever?  It seemed to me incredibly foolish and masochistic.
For years the European Union has expressed hostility to Greek Shipping.  The European Union has consistently taken positions at IMO that were against the interests of the shipping industry in new and costly regulations that are only held at bay by opposition from the United States and Japan with the support of their Flag States.  The EU has never seen favorable the offshore status under Law 89 of Greek shipping companies. Lately, Jean Claude Juncker, the EU Commissioner has made a personal campaign to abolish Law 89 and increase taxes on Greek Shipping companies

The ship owning community attempt to deal with this EU hostility by appeasement has failed again and again.  They agreed to equalize tonnage tax to all vessels managed in Greece to the same levels as Greek flag vessels.  Shortly thereafter they barely escaped an extraordinary tax levy on foreign exchange brought into the country that their maritime service industry brethren did not escape and had to pay.  The following year, they tried again appeasement with a new ‘voluntary’ agreement for increased tonnage tax for which the Greek government reneged and passed a law that made the tax increases obligatory and even larger than initially agreed.
Was the Euro needed for the Greek Shipping industry?  Clearly no!  To the contrary, the Euro was a mismatch to the US Dollar, which is the base currency in the shipping industry.  The Euro made office expenses and Greek crewing more expensive.  The shipping industry never had any real capital control restraints with ample reserves in US dollars that allowed unlimited travel abroad.  The Euro decimated their home ship repair industry in Perama.
Did the Eurozone participation ensure political and economic stability in Greece as an intangible benefit to offset the economic costs to the shipping industry?  Clearly no!  Greece has been in turmoil for five years now whereas it had enjoyed a long run of steady growth with the Drachma.  Participation in the Eurozone dramatically reduced these growth rates, decimated local production, caused asset bubbles in real estate and household indebtedness and made the country dangerously import dependent.
Today, Greece is more insolvent than ever with an even more crushing public debt for the size of its GDP.  The country has lost 25% of its GDP in the process and now suffers nearly 30% unemployment and made its youth a lost generation with over 50% unemployment, spurring substantial emigration, especially among younger, educated Greeks.  The same applies to highly-qualified young Greeks in the shipping industry with graduate education and professional certificates in shipping qualifications like chartering, operations, finance and marine insurance.  Foreign shipping operators are flooded with CV’s from young Greeks, sitting idle and unemployed in Greece.
Ship owners talk about moving abroad should Greece revert to a national currency.  First, this seems shamefully unpatriotic and total lack of any love of country.  Second, it would mean the end of any value-added content from Greece or any vestige of competitive advantage over foreign competitors for being Greek shipping.  Greek shipping was competitive and thrived because of the Greek maritime tradition, because of the close relation between the vessel and the office with Greek seaman and finally because of favorable off-shore tax treatment under Law 89.  The Greek business model was vessel provider with a high quality of service to charters. 
This also generated a thriving Greek maritime service industry that would be put in jeopardy with the departure of Greek ship owners.  Domestic Greek banks supported particularly small, medium Greek ship owners, specializing in the financing of older, bulk commodities vessels.  These were invariably US dollar loans on the Eurodollar market.  The Eurozone crisis led to the bankruptcy of the Greek banking system and undermined this access to credit, putting smaller Greek ship owners at risk deprived of credit to roll over and renew their fleets. 
Moving abroad might work for large Greek ship owners, but it will certainly be very difficult for smaller Greek ship owners, who were very reliant on the local Greek banks and service industry for their operation.
I sincerely believe that that best deal for Greece (Greek ship owners and the Greek people) would be GREXIT with very generous public debt restructuring and transition support for balance of payments and other related issues.  Greece to be allowed to remain in EU as regular member like UK and Nordics: Sweden, Denmark or if outside the EU, be given free-trade status that would be an even better and more flexible arrangement to revive and restructure the Greek economy.
The Drachma would facilitate needed structural reforms that will take time to implement and bear results.  It would allow whatever austerity to be offset with increased exports spurred initially by the devaluation: a classic IMF work out program as succeeded in Turkey and other countries.  Sweden achieved this by devaluation without any IMF program.  Sweden as opposed to Greece demurred on Eurozone participation.
The Drachma would be good for Greek shipping.  It would take off any EU pressure to modify Law 89 and offshore status of Greek shipping companies.  It would recreate lost competitive advantage operating in Greece with savings on office and Greek crewing expenses.  It would allow renaissance of Greek ship repair industry, etc.
The Drachma would not create any personal problems for people in the Greek Shipping community.  Credit cards and travel abroad would not face any difficulties with dollar shipping income and ample foreign exchange.
Drachma would mean more employment opportunities in Greece for Greeks.  It would allow surge in investment at properly valued prices as well as prepare ground for export boom.
Hopefully the Drachma will lead to a new revitalized Greek political class that is outward looking and export oriented and rid us of the present discredited political elite that drove the country into the ground by failed EU-bootstrapping built largely on debt and transfer money that funded unproductive, parasitic domestic crony capitalism.  Hopefully, the Drachma will allow important Constitutional revisions that create genuine institutional safeguards on debt levels, public spending and political accountability to ensure the development of a sound national productive base.
Hopefully GREXIT with suitable revitalized Greek political leadership will provide the foundation for Greece to follow the example of Singapore, keep and expand its presence and role as a global maritime centre.


Friday, May 22, 2015

Is asset arbitraging a valid investment theory for the shipping space in today’s economic environment?

Asset arbitraging accounts for at least 90% of all investment in the shipping industry. It is particularly predominant with institutional and private equity investors. Major groups like Oaktree, Apollo and Bayside have taken large positions in various classes of shipping assets. The rationale is cyclical market recovery. This been the bread and butter of many ship owners in the past, but can this work in the current environment of immense shipyard overcapacity, weak global demand and soft commodities prices?

I have never been a warm fan of asset arbitraging as a strategy to build value in the shipping industry. It is another version of the old stock market trading theory of buying low and selling high. The concept is that prevailing shipping assets are somehow mispriced too low. Eventually markets will pick up and the true higher prices will be revealed, when the shipping assets can be resold with a markup.

This viewpoint distorts the nature of the shipping industry, which is a service business to transport cargo. The fundamental driver in this space is cargo volume. The more cargo volume to be transported for the existing fleet available, the better the freight rates. Higher freight rate expectations result in higher vessel valuations in terms of future earning capacity. If you take away the noise from the volatility of the freight markets, long terms returns on shipping assets tend to be moderate and earnings margins restricted.

Costs in shipping are highly dependent on capital and labor. Ships are very capital intensive. They are wasting assets that require considerable maintenance. They have a limited trading life until they are recycled and sold for scrap. Getting in and out of shipping assets depends on class of ship and the liquidity of the resale markets.

I use the term ‘asset arbitraging’ for these shipping asset plays because it reminds us of what this process is and where it leads. Arbitraging eventually evens out market fluctuations. If enough investors see that a class of shipping asset is underpriced and then take speculative positions, then this supplies the market with ample tonnage that provides the end users more than ample vessels for their cargo transport needs and keeps a lid on freight rates. The whole effort is a wash out with no profits.

The dry cargo space illustrates this situation. Several years ago there was an orgy of private and institutional money in dry bulk shipping assets. The purest version of this was Scorpio Bulk (SALT), where they made a massive play in new building orders without even having an existing operating company in dry bulk shipping. All this was predicated on the new building deliveries coming at the time of a market upturn in rates that would lead to significant appreciation in vessel values. Now Scorpio Bulk is trying to lighten up and reduce their position by resales of some of their new building contracts, even possibly some conversions of the orders to tankers.

Unfortunately, the current economic environment does is not supportive of these asset plays:
  • There remains significant shipyard overcapacity.
  • China and emerging markets, which are the main source of cargo volume growth, are slowing down.
  • Advanced economies are still in sluggish recovery and substantial debt overhang.
  • Vessel working life is growing shorter, with both dry cargo and tankers facing age restrictions and trading limitations after reaching 15 years (3rd Special Survey).
Added to these factors is the industry consolidation that is reducing the universe of buyers in the resale markets and the limited credit from the banks available to finance these sales.

So I was not surprised by the recent Tradewinds article on Apollo Global Management putting the 12 Suezmaxes of Principal Maritime onto the market, where some finance sources expressing reservations that it will be easy to find a buyer for an all-cash deal. Also I would not expect the mark up in price to be as much as Apollo was hoping, depending on how much hard cash they can get as opposed to payment in shares from a publicly listed entity.

The other factor is vessel replacement cost. I am not optimistic here. There is an overcapacity of shipyards. Order books are thinning. Steel and scrap prices have been falling. New building prices are more likely to fall in the near future than harden.

Consequently, the best positioned people in these market conditions are freight traders who are asset light business models rather than those heavy in shipping assets. The institutional money in the shipping space has done wonders for end users in providing them more than ample tonnage for their needs to transport cargo, keeping freight rates very low.