Dryships in record US$ 2 bn loan bonanza

Dryships has had an incredible run recently with banks lavishing credit on the group. A consortium led by Nordea Bank and ABN AMRO has coughed up US$ 800 mio to pay for the Ocean Rig Corcovado and Olympia. DVB Bank, Deutsche Bank, National Bank of Greece and Norway’s export credit agency GIEK are also in the deal. Deutsche Bank agreed to restructure a US$ 1.1 bn loan, of which US$ 495 mio has been earmarked to pay for the Ocean Rig Poseidon. The drillship is on hire to Petrobras.

Dryships has taken some hits from the Korean Line bankruptcy on a Capesize bulker and two Panamax vessels, marked down to spot rates from substantially higher time charter levels, deflating some of their 82% contract coverage for this year. Their 4th quarter results disappointed the Street at 20 cents a share by 6 cents below consensus forecast.

On the other hand, their drilling activities as they come on stream have provided a ten-fold increase in fourth quarter profits on the back of increased revenues. Dryships successfully raised US$ 500 mio by private placement for Ocean Rig in their plans discussed now for several years eventually to spin this off as a separate listing.

Added to this is an additional US$ 770 mio deal for tanker new buildings, where there have surfaced again some trust issues between the listed company and Economou's private company Cardiff related to how this order was originated and booked for the listed company. Economou had pledged no more intercompany transactions between Dryships and Cardiff.

Economou recently pulled in US$ 45 mio stock grant from his DryShips business in New York. The stock grants have allowed him to rebuild his share position in the business despite the substantial share dilution from repeated at the market follow-on offerings over the last two years.

Ocean Rig appears to be well capitalized. The financial risks from the tanker foray seem manageable, but it remains a speculative play when there is already a challenging market in the dry cargo sector and the company has suffered recent hits. Again Economou is challenging the 'pure-play' approach as he has done in the past.

Investors seem happy with the company albeit its shares trading currently at US$ 4,80 are far from the heady days of US$ 80-100 per share, but they have improved from previous lows in the US$ 3 range and even briefly traded in the US$ 6 range last December.

DryShips again in the limelight on possible conflict of interest issues

George Economou’s DryShips caused some surprise announcing a US $770 mio order for six suezmax and six aframax tankers. That was nothing compared to the reaction to market speculation when Morgan Stanley analysts Ole Slorer and Fotis Giannakoulis downgraded the stock raising concerns about increasing potential conflicts of interest between the public and private companies of DryShip's chairman George Economou. Economou had previously announced a firewall between Cardiff and DryShips.

Morgan Stanley Research suggests that DryShips may have overpaid by about US$ 50 mio for the six suezmax and six aframax tankers and warns that it expects tanker prices to further decline. This was a very sensitive remark because of previous concerns back in the fall of 2008 concerning the transfer of some Capesize dry bulk orders from Cardiff to the public company in view of subsequent cancelations and accompanying write-offs.

DryShips’s finance chief Ziad Nakhleh vehemently denied these allegations, asserting that not only were the orders done directly between the yard and DryShips but that Cardiff did not have any tankers on order from the yard in question. According to a well-known shipping publication," the denial sparked thinly disguised incredulity on the part of some, since during 2010 Cardiff was widely reported to have built up an orderbook of at least six aframaxes and five capesizes at South Korea’s Samsung Heavy Industries."

Prior the Morgan Stanley hiccup, DrysShip's shares had been rising on increased optimism about their CAPEX offshore funding and announcements of rig employment contracts. There has been speculation for some time about DryShip's spinning off their offshore activities at a premium for its shareholders.

Since then, DryShip's shares have stabilized at US$ 5.25 - not a very exciting level but still considerably better than the July 2010 low of US$ 3.28. DryShips was a star in the bull markets prior the 2008 meltdown with peak share levels close to US$ 130. In 2009, the company entered into a series of ATM offerings that led to massive dilution to deal with bank covenant issues.

Signs of Life in Dryships Shares

Dryships recently sealed a breakthrough drilling contract that caused an 6% bounce in its share price early this week. Its share price was taking a beating this year largely due the employment uncertainty for the deep water drilling rigs on construction, CAPEX gap and the liabilities that dominate its balance sheet.

Dryship's acquisition  of OceanRig, a two-rig drilling company in Norway, back in late 2007 was a major gambit in its future. The company made a major shift into the off-shore drilling sector. As founded, Dryships was one of the most speculative plays in dry bulk. This transformed Dryships into more of a drilling play than shipping company, to which it added an additional two newbuilding deep water drilling rigs negotiated through Cardiff,  George Economou's private shipping company.

Unlike other its other Greek listed peers, Economou started with a much larger controlling share (45.5%) in the business, where he focused on somewhat older, mainly Panamax tonnage initially. His strategy was to build up the fleet in the then rising market by selling off this tonnage at profits and then using the free cash flow from operations and sale profits to buy newer tonnage. Most vessels were traded on the spot market. This strategy quickly made Dryships a market darling where its share price hit the roof with its share price rising from US$ 17.50 as an IPO to over US$ 120 by late 2008 with less than two years of trading.

The OceanRig transaction was done at the top of the market. This loaded the balance sheet with debt and the company put most of its fleet on period time charter for financial posturing. The 2008 financial meltdown hit the company very hard. It found itself very quickly with major loan asset covenant violations and was constrained to enter into a series of at the market supplementary share offering with considerable share dilution in 2009. George Economou's stake in the company plummeted. (Currently it is back to 14.5% after some incentive plan awards in his executive compensation plan.)  Economou held all the key corporate positions. There was rising criticism about transactions between his private company Cardiff and Dryships.

The loan covenant asset-debt coverage violations have taken months of negotiations to resolve. Just recently the company penned a pair of supplemental agreements with HSH on loan covenants laying the groundwork for amendments to its senior and junior loan facilities that carry an outstanding balance of US$ 520.9 mio. Last June, Economou announced that the company would do no further deals with his private company Cardiff.

The company has recently added some depth in its management team with the appointments of Ziad Nakhleh as Chief Financial Officer and Pankaj Khanna as Chief Operating Officer. Nakhleh was formerly CFO at Aegean Marine Petroleum Network Inc and started his career as an auditor at Ernst & Young and Arthur Andersen in Athens.  Khanna was the Chief Strategy Officer for Excel Maritime Carriers Ltd.  Mr. Khanna also previously served as Chief Operating Officer of Alba Maritime Services S.A.  Prior to joining Alba Maritime Services S.A., Mr. Khanna was Vice President of Strategic Development at Teekay Corporation.

The four well contract off West Africa will generate US$ 135 miio in revenue. Dryships still needs financing to cover its CAPEX for two of the four newbuild drillships. It has a US $350 mio ATM offer pending. It still needs contracts on the other three drillships to finish financing remaining payments of US$ 1.1 bn.  Originally Dryships had plans to spin off their drilling company but this has been constantly delayed. It is said that they want to realize at least US$ 400 mio from this transaction.  This may require more progress on the CAPEX financing gap and better contract cover.

Dryships turns to the bond market

After repeated ATM share offerings with massive dilution, Dryships (DRYS) has now turned to the bond market for additional capital with a new US$ 400 mio offering (initially US$ 300 mio). The deal also includes a US$ 150 mio loan in notes to Deutsche Bank, the sole bookrunning manager of the deal. As a feature, the deal appears to offer investors a convertible arbitrage where they can take a short position against the company common share value so they can hedge their investment.

Dryships was badly hit by the financial crisis and precipitous drop in the dry bulk market last year. The company had been outperforming its peers with a more speculative policy of older vessels, shorter term employment, building up the fleet by riding the market up and selling older tonnage to finance and expand into new tonnage. Bank leverage rose accordingly.

George Economou's decision to use Dryships to support his foray into off-shore drilling purchasing OceanRig changed the nature of the company. He privately booked several additional oil rigs and in his usual practice shifted them to Dryships, where there was broader access to capital markets to support the transaction.

An oil rig is a substantially higher capital intensive investment than a ship. The oil rig assets on the company balance sheet quickly overshadowed the shipping operation. Capital needs increased geometrically.

Economou was constrained to posture his fleet with longer term employment to support the burden of ever increasing debt on the company balance sheet under the strain of this new scaling up in another sector. The longer employment profile for the bulk carriers proved a timely move in view of the subsequent financial meltdown in the fall of 2008.

The crash in freight rates and asset values put Dryships into default with its senior lenders that has taken months to renegotiate this year. At the same time, Economou had to restructure the aggressive company capital expenditure program that included both dry cargo vessels and oil rigs. The company was obliged to cancel a large number of new building orders and forfeit deposit money as well as to take substantial asset impairment charges.

To cover the financial hemorrhaging, Dryships embarked upon a series of ATM (at the market) share offerings to increase its capital by massive share dilution. As things have stabilized in the dry cargo market and the oil rigs on order are coming up for delivery, presumably Economou wants to avoid further share dilution by turning to the bond market, hoping to lock in good terms in the face of future increase in interest costs.

The short hedge feature is likely a sweetener for potential hedge fund investors, who are a mainstay investor market for the shipping sector. Most hedge funds have considerable experience in commodities . There is close relation between shipping freight markets and commodities markets. Spot rates are driven by inventory levels and the pricing structure between the derivatives and physical markets.

The higher than expected interest cost of the recent Genmar bond issue, however, would appear to create some clouds on the probable pricing for the Dryships bond issue. With Dryships there is always an ongoing debate on how much new capital is being used to refinance and manage existing debt as opposed to going into fresh investments.

DryShips's two semi-submersible units and four drillships on order for 2011 delivery have recently been valued by analysts at US$ 3.7 bio against the value of its bulker fleet and above-market charters, which is barely half that at US$ 1.9 bio. Most analysts are in agreement that Dryships will have no problems in securing contracts and employment for its oil rigs, but divergence on rate forecasts drives the stock recommendations for the company. Nordea tends to be cautious whilst Lazard is showing some optimism for DRYS.  Both are placing their emphasis on the offshore drilling market and assuming firmer oil prices in 2010.

Is Dryships really an offshore play?

Lazard Capital markets analyst Urs Dur raised his rating on the George Economou-led company to “buy” suggesting coming offshore UDW drilling contracts for new rigs will provide a lift over the next couple of quarters. The deals will mark DryShips’ shift from a dry-bulk company with offshore interests to a deepwater rig company with exposure to the dry-bulk term market.

Considering the weight of the UDW drilling operation on the DRYS balance sheet, I would certainly agree with Lazard. The assets and liabilities of the drilling operation overshadow the bulk carrier operation. DryShips has become a deepwater rig company with exposure to the dry bulk term charter market rather than a spot focused dry-cargo owner with drillship investments.

DryShips still has a US$ 1 billion gap in its debt financing for two drillships, which is staggering compared to its dry cargo liabilities and recent attempts to raise additional capital by share dilution. Contracts attained over the next few quarters will be crucial for the company to finance this gap. At least two of DryShips’ four drillships must have contracts in place by the end of this year. The vessels are set for delivery in 2011.

According to the analyst, the charters should be worth around US$ 500.000 daily, reducing the risk hanging over the company and speeding up a long-awaited offshore spin-off, which would again change the company dynamics if it happens.

The dry-bulk market still faces oversupply issues but most of DRYS's dry-bulk ships are chartered out for much of 2010. Banking on rising oil price in the next year, as is expected by consensus, investors might chose to play DRYS more as a UDW driller in an attractive UDW drilling market.

George Economou vs Jim Kramer

Both George and Jim are iconoclastic personalities. They both have had a mixed performance record with personal ups and downs. Until 2008, DRYS had an exceptionally successful strategy of building up its fleet by retained earning from profitable operations and vessel sale transactions. The company seems often a one-man show with lack of transparency with the Principal appearing to use his private company for business development and passing the transactions to the public company for financing. Stockholders have benefited by this process in results in the past but lately they have been taking some hard hits. The turning point for DRYS was Economou's decision to diversify into the offshore drilling business acquiring OceanRig and ordering additional deep water oil rigs. The financial crisis hit DRYS very hard. Since then, DRYS has been increasing capital with major share dilution. George Economou is not as bad as Kramer says but he has been struggling lately.

The offshore transaction was large for the existing DRYS balance sheet. It absorbed the companies reserves and required a substantial increase in leverage. The company postured itself by reducing spot market exposure on its fleet and moving to longer term employment. The timing was good.

Last fall Economou added some new building contracts generated from his private company that later DRYS was forced to cancel and take losses. This caused some negative comments.

This year, DRYS has been raising capital by issuing new shares and dribbling them out at the market prices. This increase of capital was initially needed in the Groups arduous loan restructuring negotiations for its loan/ asset coverage clauses. In subsequent share issues, DRYS announced a strategy to acquire additional vessels, but there has been some market skepticism about company capacity for additional finance to leverage this new capital.

The China story has enthralled investors in the dry cargo sector for many years now. In the boom years, Far East demand consistently soaked up new tonnage in the market and drove rates to ever higher levels. China now has a great deal of over capacity that it has built largely to service its export markets in the US and EU. These markets have now collapsed.

The US seems to be improving since March this year if one takes Wall Street as a guide but mainly in the financial sector due public monetary policies to bail out lame duck companies and reflate asset prices. The EU has been worsening. It is still an open question how robust the recovery will be so the revival of Chinese export markets is still in question.

China has ample reserves for stimulus and they have probably outperformed the US in putting this money quickly to work. They have renegotiated their commodities contracts and moved to inventory replenishment that has brought a revival in the BDI for dry cargo sector. The Capesize tonnage has had the most benefit with a recent mini-boom. It is not clear whether this is sustainable.

China will most likely need to restructure their export model and this could have a negative impact on future demand projections for dry bulk commodities cargoes in coming years. Meanwhile the dry cargo orderbook is large and China has a significant share of the newbuilding contracts.

DRYS has taken large asset impairment charges for its foray into the offshore sector. It has new rigs on order that need to be financed. It also has had plans to spin off this business to a separate entity.

DRYS is facing large challenges in the present environment. Whatever the outcome, shareholders have gone through significant share dilution this year that will affect future share value. There is the issue of dry market recovery. This year things so far have gone pretty well for the sector. DRYS is completing its first round of debt restructuring. Prolonged market weakness in 2010 could lead to a much more difficult period with its senior lenders but markets may also improve and beat expectations. The main issue in the offshore side of the business is the future of the spinoff plans and its impact on DRYS shareholders. If it goes well, it could boost share value but the company is right now carrying the debt liabilities for this.

Kramer has the ease of being a pundit who can say whatever he likes without much responsibility. George Economou has a lot more weight on his shoulders. I have been critical of George for his excesses in the boom years but I appreciate his struggle in present market conditions. I think that Kramer should show a bit more generosity here. I have outlined the risks for shareholders.

Lucky George...

After successfully raising US$ 500 mio by selling shares over several months at market levels, DryShips is now planning to sell up to US$ 475 mio shares in its second ATM equity offering of 2009. As long as investors continue to purchase the shares at ever higher values above NAV, the more accretive it is for previous shareholders as it aids net asset value.

DRYS management is reserving the widest range of options for the use of the proceeds: to opportunistically acquire additional dry-bulk vessels in the current market environment, and for working capital, existing capital expenditures, repayment of indebtedness, general corporate purposes and, as needed, to continue to enhance our liquidity and to assist in complying with our loan covenants.

The company remains overleveraged. Whilst there has been some improvement in dry cargo rates, the Panamax-size units, which are the core of the fleet, are probably the hardest hit sector in this market. Some forecasters feel that supply-side pressure is likely to cap the Baltic Dry Index in the next two years. In addition, DRYS has taken a sizeable impairment charge on its oil rig acquisition and has more drill rigs on order.

Continued investor enthusiasm to purchase additional shares of this company may prove that positive expectations can be a self-fulfilling means of recovery for this company. The expectations are largely based on steel producers hiking output ahead of the Chinese government's stimulus measures, and fixing iron ore from abroad to meet their anticipated needs.

DRYS after completion of its US$ 500 mio capital raise

DRYS has been in cross currents for some time. It has been suffering from over leverage, losses from newbuilding cancelations, charterer defaults and asset impairment from its acquisition of OceanRig. Now that it has completed increase of capital, its default risk is diminishing and this is likely to have a positive effect on its near term share value.

Increase of capital is dilutive to existing shareholders, especially if done at discount to prevailing share price. DRYS chose to raise additional capital slowly over several months by selling new shares at prevailing market prices. Whether this will add value to the company depends on the use of the funds. Under pressure of senior lenders for default on loan/ asset coverage warranties, these funds are likely to be used to pay down debt. This reduces leverage and default risk.

For this reason, Scott Burke of Oppenheimer recently upgraded the stock to 'outperform'. He also felt that DRYS might have some upside due to firmer freight levels in spring dry bulk markets. I think that he may be overshooting on the freight markets as there has been lately signs of weakness. China seems to be experiencing a hard landing. This does not bode well for an immanent dry bulk market revival.

I continue to feel that a major issue in DRYS that could affect the stock positively would be a successful spin off of its OceanRig offshore drilling business.

Otherwise, it continues to be a battle of attrition and endurance for all shipping companies until there is real improvement in freight market fundamentals.

Bad earnings results and delays in loan restructuring for DRYS

DRYS's latest quarterly earnings report last week showed that the company closed FY 2008 with a massive US$ 361 mio loss. Very troubling was the US$ $700.46 mio non-cash impairment charge charge relating to the Ocean Rig acquisition as the main culprit behind the large net loss.

Despite previous press reports to the contrary, DRYS has not yet secured waivers for its term debt defaults and negotiations with senior debt lenders are still running. Their auditors expressed doubts about the company’s future in its annual report today. So far DRYS has succeeded to raise US$ 380 mio in their ongoing efforts to increase capital by ATM sales. There has been little cheer for DRYS since my last piece on a new contract for one of the oil rigs.

Like most dry bulk companies, DRYS is engulfed in a battle of attrition to deal with the massive debt accumulated in rapid asset expansion in the recent boom years. The Ocean Rig buy-out and addition rig purchases were the straw that broke the camel's back. Despite the healthy profits accumulate from the dry cargo boom years, this foray into off shore drilling overreached their company free cash flow potential and has now led to serious liquidity and loan/ asset coverage problems.

These setbacks raise again the looming possibility of sacrificing the Ocean Rig acquisition for needed cash to save the core company business. DRYS shares at the time of writing this article are down nearly 18%.

Please refer to my previous article on various future scenarios as well moral hazard issues
for this company.

Some light at the end of the tunnel for Dry Ships?

The recent improvement in dry bulk markets has put rates above cash-break even costs and reduced the likelihood of default for Dry Ships and other dry bulk companies. Ocean Rig, - DRYS's big M&A deal last year that changed the shape of the company - secured a three-year exploration drilling deal with Petrobras in the Black Sea, which will allow its semisubmersible Leiv Eiriksson to pick up around US$ 575,000 per day from the charter. Oppenheimer upgraded DRYS since the end of February to 'market perform'.

Ocean Rig is one of the most valuable assets in DRYS. This new contract may assist the group in the eventual spin-off of this company as a separately traded entity. If done at a premium, it will enhance share value for DRYS shareholders.

Meanwhile the company has had protracted negotiations with major lenders and restructured its senior debt obligations.

So long as current dry bulk market conditions do not deteriorate and the off-shore drilling does not tighten, there seems to be some light at the end of the tunnel for this group.

DRYS shares have been lately in a moribund state, but they now are trading sharply higher today.

DRYS: three scenarios in the perils of Pauline

Dryships (DRYS) is struggling to raise US$ 500 mio additional capital at market prices. About half the money has been placed. This is a tactical victory that led one analyst recently to upgrade his recommendation. Some estimate that this new money could keep the company afloat for 2009/2010, but the jury is still out and there is a lot in play. DRYS is undoubtedly one of the most exciting listed shipping companies.

As DRYS writes in its prospectus, further market downside could result in its shares losing 'most or all of [their] value'." What are the major risks in DRYS at present:

1.) How soon and at what prices the remaining half of $500m equity issuance is wrapped up? Right now DRYS is trading below US$ 4 per share. If this trend continues, this equity infusion will have diminishing returns. In any case, the offering is looking very dilutive for existing shareholders.

2.) Whether DRYS's charterers pay on time and in full and the dry bulk market stages an impressive turnaround? Whatever period charters DRYS may have, if the market stays sour, its free cash flow will be impacted negatively by additional charterer defaults, renegotiations, redeliveries and lower rates on renewal.

3.) How much further DRYS's lenders are willing to bend on principal repayment terms? DRYS certainly has plenty of proverbial debtor's leverage but the banks are being pressed for solvency and to clean up their loan portfolios. So far so good, but patience may come to an end.

Ole Slorrer of Morgan Stanley sees three scenarios: Bullish case: US$ 30 based on earnings multiples of 15 and a V-shaped market recovery, base case: US$ 6 based on earnings multiples of 10 and muddling through supported by expectations of an eventual silver lining in the dry bulk market and the oil rig business and worst case: US$ 0 based on further charterer defaults, prolonged weak market, and lenders' decision to foreclose.

One of the most interesting assets in DRYS is the Ocean Rig acquisition. DRYS is planning to spin it off later this year. If successful, it could boost share price. Another possibility is that DRYS sells off the company as a sacrifice sale to raise cash and deleverage for survival. A more pessimistic version is that Economou sells DRYS to a financially stronger competitor.

Nordea who is the principal lender in the Ocean Rig acquisition is a veteran shipping bank. If they determine that DRYS will not be a survivor, they will be very adept in liquidating the company. George Economou is also a veteran in default negotiations with creditors from his bond issue debacle in the late 1990's.

Whatever the outcome of DRYS, it is fairly certain than its CEO will retain his private shipping interests in Cardiff and be a shipping market survivor.

DRYS revisited

Do expectations for DRYS match up with reality? Does the DRYS BoD provide adequate shareholder oversight? Recently there have been several major transactions between DRYS and private companies controlled by the DRYS CEO. In just a few months after entering these transactions, they have resulted in substantial losses for the company.

Despite high expectations and a recent recovery in share price from a low of US$ 3.04 to an early January high in excess of US$ 16 about 10 days ago, DryShips recently issued a press release bracing investors for a net loss of up to US$431.4m in the fourth quarter. The company shares are now trading in the region of US$ 10-11.

Much of this expected loss relates to one-off payments for the cancellation of vessel purchases and disposal of a trio of capesize newbuildings. The decision to axe the purchase of nine capesizes from Economou’s Cardiff Marine could also erode the bottom line.

There is also an unrealized mark-to-market interest rate swap loss of approximately US$177m. Finally there is discussion of a possible write down associated with the Ocean Rig acquisition.

These losses can be classified into two categories: 1.) Risky asset acquisitions from CEO's private company to DRYS and 2.) risky business decisions outside of core business with a major impact on the group as a whole.

Shifting assets between a company that is privately held by the CEO to the publicly listed entity that he manages raises a number of issues. On a positive side, perhaps the CEO is using the private company as a business incubator and the public entity as the financing tool. On the other hand, there are questions about BoD oversight, especially concerning risk management and financial losses so soon thereafter.

The transactions between the public and private entities have been done through stock, debt and cash exchanges. The order cancellations that have led to the losses have been negotiated with cash, stocks and warrants between the respective entities. This makes evaluation difficult and does not assist with transparency.

The offshore diversification into deep water offshore drilling merits some attention. This is an activity that is new and totally outside the purported business of DRYS as a dry bulk cargo transport. It entails huge asset investments in offshore drilling platforms that dwarf the investment in the dry bulk vessels as well as significant increase in debt leveraging of the group. The CEO's private company has been heavily involved in developing this business, too. The results of this operation will have a major impact on the future of the company. Whether this activity can be spun off as a separate listing depends very much on future conditions on Wall Street as well as future expectations for this sector now that oil prices have fallen below US$ 50.

On the market upside DRYS was an outperformer with strategies that outpaced peer companies. So far on the downside, it has been a rough ride.

DryShips: Intercompany transactions, management style and potential moral hazard

US equity analyst Natasha Boyden of Cantor Fitzgerald has called "punitive" Economou's price for allowing Nasdaq-listed DryShips to cancel an order for four panamax bulkers slated for purchase from his Cardiff Maritime. In DryShips, George Economou holds the positions of CEO, CFO as well as Chairman of the BoD. 40% of DryShips is held by insiders and owners. Economou appears to have a predominate role in BoD appointments. SEC rules apparently give DRYS their blessings. Indeed it is frequent practice that major US corporations are run by friendly BoD's with close connections to management in similar fashion. This system reduces diversity in decision-making and limits shareholder rights even for major institutional investors. It appears that there is a high risk of moral hazard in this type of management and BoD structure.

George Economou frequently initiates transactions in Cardiff, his private shipping group, that he passes on to DryShips. This allows him to move quickly to enter into new business. It creates a compensation mechanism between his publicly-listed company and his private group. At a later stage, he obtains DryShips BoD approval and DryShips assumes the financing as well as the ultimate profits and liabilities of the business at a marked-up prices. These are acceptable Wall Street business practices.

In a rising market, this has benefitted greatly DryShips, which has out performed nearly all other conventional listed peer companies in P+L results. Now under present market conditions where there are serious prospects of sizeable losses, these methods open questions should the possible losses fall on investors in the public company from these transactions. Already DRYS has rolled up some substantial real losses in one such transaction and there is risk of loss in another.

Just a month ago, the DRYS BoD approved a controversial deal to acquire nine Capesize units for US$1,17 bio (in cash and shares) and two drill ships from companies reportedly under Economou control.

Now DRYS has forfeited a US$55 mio deposit to cancel the purchase of four bulk-carriers on a previous intercompany deal. DRYS has paid out an additional US$105 mio taking its total outlay on the deal to US$160 mio. All four bulkers appear to be from an Economou order at Shanghai´s Hudong-Zhonghua Shipbuilding.

TradeWinds reports that Economou paid around US$36 mio each for the earlier units and US$50 mio each for the two later ones, at an average cost of around $43m apiece. They maintain that Economou has thus essentially recouped that cost with the US$40 mio per vessel DryShips has paid to date.

Natasha Boyden, an analyst a Cantor Fitzgerald, raises serious questions about the deal, which saw the company pay $105m for purchase options on the vessels, which are reportedly owned by interests associated with Economou. She said: “We believe the terms of the cancelation are punitive and this transaction, in combination with the nine capesize deal in October 2008, raises serious questions in our minds as to the ability of DryShips to finance further transactions.”

The question is how major investment banks will advise their clients on risks in investments like this case.

Comments on DryShips DRYS

If one looks at the current graph of the DRYS at the time this article is posted, it appears a bubble situation. A lot of bubble has already evaporated. Peter Georgiopoulos of Genmar/ Genco recently challenged George Economou, saying that the market has to separate the 'goats from the sheep'. He was angered by the sudden Economou move to the oil rig business contrary to the purported mission of DRYS and rumors about a finder's fee for the bring the business to the company. Against this backdrop, let me comment on DRYS:

• George Economou is a veteran very successful, but maverick ship owner. In the bond boom of the late 1990's, Economou did a controversial bond issue with aging bulk carrier assets that then led to a default on the first payment. He renegotiated and the bondholders took losses. Since then he made a tremendous comeback.
• Economou gives the impression of the traditional private entrepreneur who has unbeatable instinct and does as he pleases, rather than the corporate manager who operates by mutual consent. Right now, he holds most of the officer positions in DRYS – CEO, CFO, etc. The BoD members evidently do not play a strong role. Privately he is seeking to fill these positions and restructure his management team.
• Economou maintains a private company shipping Cardiff as well as being CEO in DRYS. This is a common situation in Greece. The Greek owners often have both a private shipping company, a management company and a publicly-traded company. There are potential conflict of interest issues with both the private shipping company and the management company, which manages the vessels in the public company. Tsakos (TEN), for example, has had for years a similar structure with a private management company and has succeeded to establish a high level of investor confidence.
• DRYS has enjoyed a large profit margins in 2007 for two reasons: there are many units spot enjoying good rates and there have been good at resale profits. The company performance in 2007 is to be commended. Economou succeeded to get the timing right for the bulk carrier boom. Shareholders have benefited, but there is no guarantee of future performance.
• On the other hand, with the company leverage rising, there is increased default risk if the market suddenly turns sour. Finally, it is possible that DRYS is expanding faster than their free cash and this may lead to growing liquidity problems. These last points are from third-party sources and subject to further examination.

As a postscript to this article, DRYS has recently enjoyed a recovery in share price. Latest quarterly results show a doubling of profits, which is excellent for free cash flow and will lower leverage so long as this lasts. One of the benefits of having a large number of units in the spot market is the advantage of higher earnings from the rate volatility.

Economou seems to be making some smart moves, particularly the acquisition of Heidmar for a broader commercial base. With current high oil prices, the oil rig business gambit may eventually pay off .