Brookfield buys into TeeKay Offshore

TeeKay Offshore Partners (TOO) has been an industry leader in the shuttle tanker and floating storage business. It most direct competitor is Knutsen Offshore, more recently listed but an established operator with Japan’s NYK as partners. Although the offshore business is under stress, shuttle tanker are on long term employment, there are entry barriers to the business and the assets are in limited supply. TOO has recently struck up a new business partnership with Brookfield Business Partners - a new dominate shareholder - that rewrites their balance sheet. This ring fences TOO liabilities for parent TeeKay Corp and makes TOO a formidable player in the marine offshore infrastructure market.

Latest 1st Quarter financial results for TOO showed profits of US$ 15 mio and distributable cash flow double that amount. Both the shuttle tankers and the FPSO floating storage business were profitable. There were no Auditors remarks. These were better result than a year ago 1st quarter 2016, when they had some small losses, most likely from asset impairment charges. Their bank leverage is on the high side (70%) but not yet to the point of breaching LTV covenants.

What destabilized TOO was the generally poor business climate and concerns about possible future difficulties. The catalyst for this was last June when their Lenders sold some US$ 75 mio of the company's secured debt in the secondary market at a discount, reportedly at levels between US$ 0.75 and 0.85 on the dollar.

This precipitated a panic in the share price and spiked over to the parent company TeeKay Corp. It was all about future issues, not  present liquidity issues that risked possible insolvency. There was the matter of future asset values for very specialized assets in a narrow resale market. Oil rig assets in recent distressed sales have lost as much as 60-70% of their value. There was the matter of future contract renewals. In fact, TOO was recently obliged to renew at reduced rate one of its FPSO contracts. Queiroz Galvao Exploracao e Producao. Finally, there was the impact on TeeKay Corp struggling itself in the currently beleaguered tanker market.

The situation was an opportunistic investment for Brookfield Business Partners with a capital injection of US$ 610 million. Brookfield is taking a 60% stake in the company. TeeKay Corp retains a 14% share in the business, injecting a smaller capital amount of US$ 30 mio. Brookfield is also taking a 49% stake in the general partner and providing them an intercompany loan of US$ 200 mio, allowing them to restructure their debt and extend maturities.

They are planning to separate the shuttle tanker business from the offshore floating storage and placing an order for four additional shuttle tankers.

Brookfield is reputedly a low risk investor, seeking 15% long term returns, which is a realistic target in the shipping industry. Given the general situation in Offshore and uncertainties with low oil prices, etc,, it may take a few years until recovery but there is a fair likelihood that the curtailment of new offshore projects the last few years will lead to shortages as older fields like the North Sea are depleted and new projects in the future.

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.

Tail Risk in shipping recovery still very much present!

Lately there is a lot of capital chasing shipping assets, arbitraging on vessel prices.   Oaktree Capital is one of the high profile leaders.  Wilbur Ross was an early forerunner in the Diamond S. venture, doing the Cido deal in 2011.

It has nothing to do with business plans, building value with companies to gain competitive advantage and market share in transport and logistics services. This is pure and crude asset speculation, betting that we are at the bottom of the shipping cycle, vessel values will begin to move up and a quick profit will be made by unloading these assets on the next company, who in turn riding the cycle will hope to gain themselves on the next leg upwards until the last guy in – like a Villy Panayiotides at Excel with the Quintana merger – gets stuck carrying the candle and goes bankrupt with the losses as the market crashes.

My personal view is that Oaktree and others are desperately looking for yield without many options in the present world of ZIRP.  The FED policy under Ben Bernanke’s reflects today's conventional wisdom, trying to push asset inflation to reflate and get out of the current Great Recession aftermath of the 2008 Global financial Crisis.

Shipping assets have caught their radar.  Putting money in risky assets and companies for yield has not always gone very well in past shipping cases.  Berlian Laju, for example, just months after a massive debt restructuring with US$ 200 million in new funds and repeated earlier high cost lease deals ended in debt default just months later, illustrating the risks involved in this strategy.

Whether the present FED policies will ultimately reflate the world economy depends on future real demand for goods and services that generates cargoes for these vessels, pushes freight rates up and then vessel values increase geometrically on the future earning expectations. Until and when this happens, this speculative money is actually generating more over capacity and prolonging any market recovery in the shipping industry.

Meanwhile, we have increasing zombification of many shipping companies like General Maritime now reorganized along with TORM and Eitzen Chemical now renamed Jason, OSG/ BLT are in purgatory with their ultimate fate still in limbo.  Excel Maritime recently moved into a hopefully pre-packed Chapter 11 reorganization.  Genco and others like Eagle are tottering in the brink. The recent Baltic Trading follow on capital raise seems a back door doubling up for Genco - see my recent piece: "Peter Georgiopoulos tries to regain his lost credibility" http://amaliatank.blogspot.gr/2013/06/peter-georgiopoulos-tries-to-regain-his.html.

Their Bankers are desperately trying to keep the dead alive. In turn, speculative capital like Oaktree and others, are buying up distressed debt to keep the banks themselves alive with an increasing number of zombie banks around.  Warehousing of bad assets has become the fashion.  Commerzbank - basically a zombie institution - recently issued a statement that it does expect to sell any shipping assets because they expect the market will bring the prices up...  So why worry about any 'book' losses at current mark to market price levels, capital (in) adequacy, etc.?

Oaktree seems to have a rather chaotic investment approach with different parts putting shipping assets on their books in a rather haphazard way. After all, did it make sense or show good analysis to invest in General Maritime only months from declaring Chapter 11 and needing even more money in a second round?

Normally, investments are supposed to yield value and then second round financing is done to invest in another leg up in the private equity world.  Here Oaktree was doubling down on a bad position, which is not normally good trading practice.  The normal practice would be to lighten up and reduce exposure.  In the current 'pretend and extend' world that we live in, however, everyone is trying hard to avoid cutting losses and many actively practice 'doubling down'. 

Did Genmar ever really have much intrinsic enterprise value as a shipping company beyond its physical assets to warrant the Oaktree "investment" in recapitalization??? I would say no!

Peter Georgiopoulos  never really thought of Genmar as an enterprise - at least in the sense of a logistics transport business serving customers in carriage of cargo.  Peter G. was and is foremost an asset speculator.  He ignored strategic positioning for Genmar to gain market share, improve earnings margins and generate growth through retained earnings. Employment was just a means of holding his assets rather than serving and building a customer base. His biggest sin was ignoring trends in the tanker market and new growth areas. His mindset was on trading assets.  Others like TK Shipping and his nemesis 'Big John" Fredriksen handily outperformed him and provided superior performance to their investors.

In the case of Petros Pappas, the Oaktree approach is to fund Pappas like a bond trader. Pappas has a successful record in asset trading. Oaktree has Pappas like a stock picker in different vessel classes. Pappas trades largely on his own instincts with his own money on a 50-50% basis with Oaktree. His own skin in the game satisfies Oaktree for the moral hazard. Neither Pappas nor Oaktree are looking to build businesses or really have any business plans at all beyond the asset trading.

A recent Tradewinds interview with Lazard’s Head of Shipping, Peter Stokes, sheds a lot of light on this matter. In fact, I am amazed and somewhat gratified to see someone like Stokes, thinking and saying publicly, many of the same things that I have been saying privately and publically when I was recently a keynote speaker at the Hong Kong shipping forum.

Stokes sees two basic scenarios ahead (see "Bungled QE exit could 'burn out' ship values" http://www.tradewindsnews.com/weekly/w2013-06-21/article319083.ece5)):

• Scenario A: - conventional wisdom ‘muddle-through’ recovery in the next few years that is likely to be subpar in quality, partly because of so many trying to ride the coat tails of same scenario.  If everyone is arbitraging, then each is cancelling out the other in any meaningful price action.  Further this self-defeating over time in creating over supply with a new wave of speculative ordering that will grow with any upwards price movement.  There is too much speculative money and too much yard overcapacity.
• Scenario B - complete collapse with another leg down, where investment firms like Oaktree, shipping banks, etc. experience painful and unavoidable losses. The zombie shipping companies finally die. Assets are written down to true values and finally there is a proper shipping recovery based on an industry shake up where only the fit survive: much dreaded Joseph Schumpeter’s ‘creative destruction’. 

A  preview of scenario B is the recent reportage in Tradewinds about an apparently unsuccessful attempt by Wilbur Ross, First Reserve, etc. to float an IPO in the Oslo capital markets for their Diamond S venture that was built on a huge block purchase of product tankers from Cido a few years.  My previous two pieces on the Diamond S venture make interesting reading in retrospect: 

• "Does the CIDO deal mean tanker values are on the upside?" - http://amaliatank.blogspot.gr/2011/08/does-cido-deal-mean-tanker-values-are.html.

• "Diamond S. a new business model for shipping?" - http://amaliatank.blogspot.gr/2011/08/diamond-s-new-business-model-for.html.

Obviously, the latter Scenario B would be a devastating setback for governments (especially the European Union political elite) and many financial institutions.  Such an outcome might ruin their careers and threaten the integrity of their institutions. On the other hand, they are slowly running out of resources for the constant backstopping. “Pretend and extend” credit policies with the massive socialization of losses is far more costly than they are representing to their voters.  So far little of this has proved helpful to an economic recovery. Only the US has had some relative success, but their boost in energy resources may be a more substantive driver in this tepid recovery than FED financial engineering pulling on strings.

The two key elements ahead that may affect shipping asset prices are the US and its tapering to wind down the FED asset purchases and the Chinese restructuring, given that the Chinese marginal rate of investment is unsustainable and the losses are corrupting their banking system. The US and Chinese both realize that this needs to be done and it is unavoidable, unlike their EU counterparts with their “muddle through” theories, eternal dissention and dream-world mentality resembling Mann’s Magic Mountain novel.

Admittedly, I am strongly influenced by my friend Michael Pettis in China. I believe Chinese growth will ultimately disappoint.  The volatility concerned that Pettis expresses about the very large Chinese speculative position in commodities worries me given the potentially negative impact on shipping markets. So I would not be surprised about Stoke’s concern about further drop in shipping asset prices, driven by lower replacement cost in steel, etc. All this shipping investment is predicated on Chinese growth reflating the markets again – lots of very concentrated risk if this does not pan out.

See "Crunch Time: Why low growth is China's new normal" http://www.foreignpolicy.com/articles/2013/06/27/credit_crunch_time_china_low_growth_new_normal

On the other hand, the politicians, particularly the EU elite – our PM Samaras with his never ending Greek success story being the success story of the Eurozone – and Oaktree Capital are really betting the house that the worst is over and there will be happy days again with a robust recovery in just a few months.

Former colleagues of mine like the present Head of National Bank of Greece, Alex Tourkolias, saying that a shipping recovery will lead Greece out of its crisis and John Platsidakis of Intercargo, saying that two years from now the Greek debt crisis will seem like a bad dream gone away are lately exhibiting lots of boosterism.

In Hong Kong, by contrast, the shipping circles were subdued and cautious about a quick recovery in the markets.  Some companies like Pacific Basin have been aggressingly buying newer second-hand units, but these purchases are to renew their fleet and backed against a substantial cargo book, not the kind of overt and open speculation mentioned above by the likes of Oaktree.

So who knows? Stokes and I could be incorrigible pessimists and totally wrong. All I can say is that I still see a lot of tail risk around in shipping and elsewhere.

The Leucadia buyout of Jefferies and departure of Hamish Norton to a job in the Greek shipping industry marks a tsunami of change in the investment banking industry for shipping

There have been profound changes in capital markets for shipping since the Global Financial Crisis of 2008. The market for shipping IPO’s has been severely limited.  Follow-up share issues from solid shipping names can only be placed with discounts to entice investors to enter into the business at levels that they feel comfortable.  A much larger portion of shipping issues now goes to retail investor, giving the large bulge-bracket investment banks with substantial retail capacity considerable competitive edge in placements.  As a result, boutique shipping investment banks like Jefferies and Dahlman Rose have become marginalized in the new market conditions, leading to dramatic changes in both organizations.

After the GFC shock, the shipping industry waxed and waned but never fully recovered from the drop in cargo volume and lower freight rate levels. Initially in 2009 there was a sort of Zarnowitz-style bounce in freight rates that provided a good feeling. Over time, conditions in the bulk shipping markets deteriorated. Cargo demand could no longer keep up with the order book overhang of new tonnage. More recently incremental demand in emerging markets has begun to dry up, leading to significantly bleaker conditions this year for both dry bulk and tankers as well as a new dip in the containership market. Only gas shipping and offshore sectors have healthy demand.

Companies suddenly faced a dramatically different banking climate. The shipping industry, being labor and capital intensive, has relatively low investment returns over time except for cyclical booms. It is has always been dependent on low cost shipping finance to provide necessary leverage for expansion and adequate investment returns. Bank spreads rose to unprecedented levels only sustainable due the very low LIBOR cost of funding.  Even that depended what cost the particular bank could raise its funding. No longer were there banks looking for new customers. Companies become restricted to their existing banks. Credit conditions hardened with far more restrictive loan conditions. Credit generally was hard to find.

Investors lost a great deal of money holding shipping stocks. Many of the new issues in the boom times prior 2008 were startups with little intrinsic enterprise value. They were asset plays on a shipping provider business model. They tried to generate high investor returns with large block vessel acquisition deals that were leveraged with bank finance. As asset values began to shrink and cash flow tightened in weaker freight market conditions, many listed shipping companies began to face covenant violations and required additional capital.

Among the exposed companies was DryShips, who very early in the game recapitalized successfully with repeated ‘at the market’ share offerings to retail investors, which resulted in severe share dilution. This marked a shift from the initial placements with hedge funds and institutional investors taking large blocks of shares. Only a large investment bank of the bulge-bracket nature with a large retail operation could do this kind of placement, raising large amounts of money from feeding day traders and others in small amounts over time.

The IPO window closed with the GFC was briefly opened when General Maritime (GMR) jumped in to raise capital for its Metrostar block tanker acquisition deal. Genmar was not in the greatest health at the time, having bruised itself with a bond issue at higher pricing than anticipated when the bond investors discovered covenant issues with senior secured bank lenders. At the time of the IPO despite a minority of the wary, institutional investors bought the deal and Genmar received a rapid placement without suffering any share discount. Unfortunately, the deal proved poison for investors, who suffered severe losses with the subsequent financial difficulties of the company. Chapter 11 wiped out the unsecured Genmar bond holders in a sizeable cram down.

I believe that the Genmar debacle marked a major change in market perception of the risks in investing in shipping shares. The bond of trust between investors and Peter Georgiopoulos could never be the quite the same again.  This appears to have changed dramatically risk perception. The IPO window closed again. Follow-on issues and rare IPO's were only possible for a select number of shipping companies. For new money - even top shipping names - investors were now demanding substantial discounts for entry prices. Despite very soft rates in the US corporate bond markets, shipping bond issues continue to carry substantial premium.

This new climate proved lethal for Dahlman Rose, leading to major shareholder changes and senior executive departures like David Frischkorn to Global Hunter. Hamish Norton was initially successful in holding on at Jefferies longer than his Dahlman peeor.  Hamish had come to Jefferies prior the GFC from a very timely and prescient move from Bear Stearns shortly before the meltdown there. His assistant Nicky Stillman left Jefferies for Clarksons last year. Market conditions, however, severely restricted potential to build a book of business in the shipping space. Jefferies tried to get restructuring business, but the Omega (ONAV) account was small and precarious with limited options.

Jefferies is now selling itself to Leucadia. Perhaps this influenced Hamish’s decision to leave the firm. Jefferies actually outperformed its larger investment bank peers since the GFC, but wanted bigger capitalization under the umbrella of a larger financial group. Leukadia is their biggest shareholder and its unused tax benefits will shelter Jefferies profits.

Hamish is one of the most capable and conscientious investment bankers in the shipping space with solid rainmaker reputation.  When he leaves banking to go to a private shipping industry position with Petros Pappas in a dry cargo joint venture start up with Oaktree, this is a statement in itself of the dire situation in the investment banking industry regarding shipping issues. Of course, who could ever imagine likewise an established blue chip tanker operator like OSG teetering on Chapter 11 proceedings with shell-shocked CEO and former banker Morten Arntzen at the helm!  Times are difficult indeed in the shipping sector.
   

Shipping is a cyclical industry so there is always hope for a recovery and reversion to boom psychology, but after several years of repeatedly pushing forward market recovery dates because improvement never came, people are less sure of recovery time than before.  No one knows what 2013 will bring.

My personal concern is the increasingly fragile situation in China and emerging market economies, which are the sole source of global incremental demand.  The European Union has been the worst performer with its macabre fascination with debt deflation.  The IMF has signalled repeated EU policy failurs especially in the EU Periphery as high risk to the global economy.  China has a very large and risky speculative position in commodities, having assumed unsustainable double digit forward growth rates that have slowed considerably with negative impact on shipping markets. 

Should commodities prices fall further, this could trigger another leg down in the shipping markets.  Softer iron ore, steel and scrap prices would lead to even lower vessel values.  With dwindling resources have such prolonged weak market conditions, many companies are ill-prepared for a further market leg downwards.  Bankers holding many of these lame duck companies alive fear sizeable losses on their loans.  Understandably, many are hoping for a floor in place from further decline in freight rates and ship values. 

There is the old saying that once you lose virginity, it is impossible to get it back again; but fortunately when good times appear investors tend to have short memories.