BLT-Eitzen Merger: too big to fail or too unmanageable to succeed?

The ailing Camillo Eitzen Group recently astounded the market with a merger announcement with the Indonesian-based Berlian Laju Group (BLT) by share exchange to comprise the world’s largest and most modern chemical tanker fleet. Yet neither company is financially strong and both companies suffer from over leverage and aggressive expansion at top of the market prices during the boom times. Fitch promptly revised the rating of the acquiring company BLT as "B" with rating watch negative (RNW) while its US$ 400 million bond issue is "CCC", also with RWN.

Will this merger make a stronger company with a better balance sheet and a good synergy with a shared vision and complimentary product lines that leverage existing infrastructure or vertical integration?

Certainly the joint announcement presents a rosy picture for investors. Total revenues of the combined company for the past 12 months (presumably 30.6.2008 - 30.6.2009) amount to approximately US$ 2.3 billion with an EBITDA of US$ 499 million. Including newbuildings the group will own and/or operate 157 chemical tankers, 14 oil tankers, 42 gas tankers, 50‐60 bulk carriers and 1 FPSO, in addition to services offered through Eitzen Maritime Services (“EMS”). Given that BLT and Eitzen have market shares of 5,3% and 8,2% respectively; the new company would have a 13,5% share roughly the size of Stolt Nielsen!

BLT says that it plans to submit a voluntary exchange offer for all outstanding shares in CECO (Camillo Eitzen Group). CECO shareholders will be offered mandatory exchangeable bonds (MEB) equivalent to NOK 25 per CECO share which will be converted into shares. BLT said the offer represents a premium of 270% on the CECO share price of NOK 6.75 ($1.17) at the close of business on Friday. The deal is subject to a number of conditions including the successful private placement in BLT of a minimum of US$ 200 million in new equity. The offer is expected to be completed by the end of November.

Eitzen has a strained balance sheet. The group has grown rapidly in the chemical tanker sector during the boom years by both vessel acquisitions and mergers. There have been been some integration problems. Their 30-35% contract cover for their fleet is much lower than established chemical operator like Stolt and Odfjell (approx 60-70%) and their dependence on the product markets is relatively high. They were poorly positioned to face the market downturn from the financial crisis. The drop in cargo volume and exposure on the spot market led to a significant drop in their free cash flow whilst they were over leveraged from their aggressive expansion.

Last week CECO and Eitzen Chemical reached agreements with banks to restructure loans of over US$ 800 million. Further they are on the verge of a US$ 100 million equity issue. The merger announcement saw its market value rise 22.17% to NOK 2.81 per share, or NOK 479.86 mio. Eitzen share value had fallen fallen 65.88% from a high of NOK 48.90 each this year following its high-profile financial difficulties.

BLT has also been expanding rapidly in the chemical tanker sector. The group started in the Indonesian cabotage trades first in oil tankers and later products and chemicals with Pertamina employment.. In 2007 it began its global expansion with a US$ 850 million acquisition of US-based chemical-tanker specialist Chembulk. This gave the company access to the US markets, although in 2008 a full 75% of its revenues still came from the Middle East and Asian markets.

American Marine Managers had bought Chembulk earlier in the year as MTM from its founder and main shareholder Doug MacShane and then marked it up and sold it for a premium to BLT at the peak of the market. To finance the $850 million deal, BLT turned mainly to bank debt. The company still has US$ 400 million senior unsecured notes due in 2014 and a US$ 125 million five-year convertible bond due in 2012, issued by BLT Finance BV, a wholly owned subsidiary of BLT. This sent the company's gearing into orbit and it had to resort to drastic measures including sale-and-leaseback deals to bring down its debt load.

BLT appears to have a better contract book than Eitzen, but it is reportedly only 50% so they have considerable spot market exposure and it has been hitting their bottom line. BLT's most recent audited accounts for the first six month period 2009 indicate a fall in gross profits of 32%. BLT closed 30th June 2009 with a US$ 5,98 million net loss as opposed to a net profit of US$ 109 million for the first six months in 2008.

Given the above, it is surprising that BLT has the financial capacity to undertake this merger. The recent Fitch cautionary note on high risks is not unexpected. Of course, the operation is a share exchange and dependent on BTL raising US$ 200 million in new equity with a CCC bond rating subject to downgrade. BLT is merging with a troubled company that needs to be turned around and has severe financial problems. Camillo Eitzen booked a US$ 215 million loss last year as revenue declined 14 percent to US$ 1.32 billion. No one knows whether this deal is a bargain or simply a Trojan Horse. There is a serious risk that this merger - if it goes badly - could cause BLT, which is already in a weak financial position, severe problems.

Statistics indicate that only approximately 50% of all mergers succeed. Both these companies are already pieces of other companies due their recent expansion. Integration and the timing of the market upturn will make or break this deal. Eitzen clearly was not a total success in its merger and expansion deals or it would not be facing its present woes. Putting Eitzen in order is a tall order for anybody.

BLT's main move was its Chembulk acquisition but we do not really know how successful they have been in integrating the Westport-based operation. Off-hand, Indonesians running a US-based outfit with American managers seems a challenge where formible foreign firms like Daimler have met their match and failed in the US. The value of the Chembulk contract book with end-users depends on end-user client satisfaction, which could be potentially eroded by the new ownership or sudden defections by the American management.  It seems that BLT may have let Chembulk run independently and its home office works more like an Asian operation than to try to integrate it.

Axel C. Eitzen will remain actively involved in the further development of the combined group, and will be its second largest shareholder. How will these two groups be integrated successfully to add value to shareholders? How will Eitzen get along with the Indonesians?

* Will the new executive team speak with one voice?
* Will employees of either the buyer or the seller bad-mouth the deal?
* Will the reputation of either company alienate customers?

The merger announcement boilerplate reads:

"The combined entity will create a truly global network capable of serving an international customer base across key markets. In addition to the complementary businesses of the companies, both share a set of common values, and a belief in the value of strong corporate cultures..."

How much of this is really true remains to be seen since there is nothing about this that is prima-facie obvious. It also remains to be seen when chemical market will start to improve. This year 2009 has been miserable.  Both companies are making losses and face challenges with senior lenders.

The only savings grace has been a rise in chemical feedstock imports to China due the cheap prices but this only filled vessels in one direction.  Whilst operators like Stolt with a large contract book benefitted, this offered little comfort to those with spot exposure faced a difficult return voyage with very low rates. Even Stolt and Odfjell have been redelivering chartered vessels, reducing capacity and cutting costs.  Chemicals are tied to consumer economies and the market is not likely to pick up until a return of positive growth in the US and EU. Many commentators, including DnB-NOR bank, are projecting a slow, sluggish recovery for 2010.

If this prevails, it may prove a very trying time for this merger together with the immense challenge of integration and value creation for shareholders.

Odfjell is well positioned in the current shipping crisis

Odfjell is one of the big four traditional parcel chemical tanker operators together with Stolt Nielsen, JO Tankers and Tokyo Marine. Odfjell controls 17.8% of the global core chemical market. They have an integrated logistical system with tank storage, large chemical tanker fleet and sizeable contract book with end users. They are expanding their tank storage business to complement their ME partnership with NCC for Middle East refinery exports to the Far East.

Odfjell is a mature chemical parcel operator with the largest share of the world market of any peer operator. They are well positioned to weather the financial meltdown and current shipping market slowdown. In recent boom years, they expanded moderately their fleet without taking on excessive leverage.  They relied on time-chartered tonnage to fill excess demand. Their large contract book protects them on the downside.

The drop in cargo volume and nominations has caused bottom line damage. EBITDA first half 2009 for their parcel chemical tankers was US$ 49 million, compared to US$ 101 million in the same period 2008. Operating result (EBIT) was a loss of US$ 9 million first half 2009, compared to a gain of US$ 47 million in 2008. Compared to their peers in dry cargo, tankers and container; they are sharing the pain of the downturn, but their situation is comparatively more manageable.

Odfjell is focussing on building up their partnership with their Saudi-Arabian partner National Chemical Carriers (NCC) in the Middle East. In the first quarter the entered into an agreement with NCC to bare-boat charter three 37 000 stainless steel parcel tankers for ten years with purchase options. The three ships are NCC Jubail (1996), NCC Mekka (1995) and NCC Riyad (1995). Furthermore, Odfjell entered into three to six year time charters for three ships that earlier were owned by NCC. These ships are Bow Baha (24 728 dwt/1988), Bow Asir (23 001 dwt/1982) and Bow Arar (23 002 dwt/1982).

In June 2009 Odfjell SE signed a new 50/50 joint venture agreement with NCC to establish a company in Dubai, to be named NCC-Odfjell, to commercially operate our respective fleets of coated (IMO 2/3) chemical tankers of 40 000 dwt and above, in a joint pool for trading in the chemicals, vegetable oils and clean petroleum products markets on a world-wide basis, with emphasis on the growing production and export of the Middle East region. The new company will start operations early next year with 15 vessels and a total dwt capacity of nearly 660.000 tons, which is planned to grow to 31 vessels and total dwt of nearly 1.4 millions tons over the next three years.

Stolt is competing with Odfjell in their partnership with Gulf Navigation where they have ordered a series of Dwt 44.000 coated chemical tankers from Korea, but Gulf is a much weaker partner in providing local commercial business than NCC.  Stolt has recently refused to take delivery of one of these units due late performance.

The Odfjell expansion in its Singapore tank terminals is to facilitate the Far East export business that they expect to develop from the Middle East refinery projects coming on on line. In this context, it is not surprising that senior debt financing for the tank terminal project was easily forthcoming.

Things seem to be looking up for Navios Maritime Partners

The New York-listed company (NMM) announced recently that it would sell 2.8m units to help fund its fleet expansion. The sale of 2.8m units would bring in $34.18m at the offer price. The company has attracted a lot of attention for its opportunistic Capesize purchases of four units in June and two additional units with long term charters in August. Whilst the parent Navios Maritime Holdings reported recently a 56% decline in earnings, Navios Maritime Partners had a 34% increase in revenues.

Navios Maritime Partners (NMM) is a spin-off from Navios Maritime Holdings (NM) after it was acquired by a SPAC set up by Angeliki Frangou and sponsored by Sunrise Securities. It is part of a complicated corporate structure where a general partner company Navios GP L.L.C. owned 100% by Navios Maritime Holdings (NM) has holds a 2% interest in Navios Maritime Partners (NMM). Navios Maritime Holdings (NM) has a 44,7% limited partnership stake in the spinoff company, Navios Maritime Partners (NMM). The remaining share 53,3% limited partnership interest in this spin off company is held by 'common Unitholders', which are publicly traded common units of which 2% is held in a company controlled by Angeliki Frangou. Judging the participation of John Stratakis in the BoD, perhaps Poles, Tublin advised on this structure and played a role in the rationale.

There have recently been some intercompany transactions for vessels, where the spin off company struck a deal to escape a Capesize purchase from parent Navios Maritime Holdings and bought "all rights" to a Panamax with share exchanges. The new Capesize deals with reduced asset value have been channeled to the spin-off company. Already the parent balance sheet lacks transparency and the relations with this new spin-off company further complicate matters. Yet for the time-being in share performance, Angeliki Frangou seems to be managing better than most of her Greek peers in the dry cargo sector.

Whilst Navios Maritime Holding (NM) has made a good recovery from March lows and is outperforming most peer companies, Navios Maritime Partners (NMM) has been out performing its parent company. The parent company is an old established firm with a solid contract customer base providing far more intrinsic value than most publicly traded, Greek controlled dry cargo companies, which are nearly all vessel provider business models dependent on third-party charterers for vessel employment. Further Navios is a mature company, whereas its Greek peers are recent startups, which expanded their fleets rapidly in the boom years with large block acquisitions.

Navios Maritime Partners is more along the lines of its Greek peers. It is a new start up operation, but unlike its peers it is now expanding its fleet in present market conditions with marked down asset prices. It is concentrating on Capesize vessels, which have had the biggest revival this year in the dry bulk sector. The vessels have been conservatively chartered on long term contracts with profit sharing. The company holds options for further vessel acquisitions in 2010, 2012 and 2013 and additional growth through Navios Holding-controlled vessels.

Lately the Capesize market has been waning to lower levels. The tonnage supply on order in this category is substantial but the real question is the sustainability of the Chinese demand for iron ore and coal and the inventory restocking. The domestic stimulus plans have been centered on the construction industry and thus steel intensive, but China has a substantial overcapacity problem in both construction and industry. Export demand continues to be weak.

It is a reasonable play that Navios Maritime Partners (NMM) benefits from lower asset prices with the marked-down Capesize vessel acquisition transactions and better break even levels than most peer companies. The ultimate success of the venture depends on the fate of the dry bulk sector in the coming years and the major driver is Chinese supply chain needs for steel and iron ore.

Grand Union-Aries merger: where is the value?

This reverse merger is one of the strangest shipping deals ever done. Aries (RAMS) is an ailing NASDAQ-listed company with nine product tankers, two container ships and big financial problems. The original IPO had a rough start with a lot of question marks and thereafter there were operating setbacks. Things improved somewhat when Jeff Parry, formerly of Poten, took the helm at CEO. The deal is a barter where Aries (RAMS) acquires three middle-age Capesize bulk carriers in return for a complicated share exchange agreement as well as management and debt restructuring. Whilst the deal may be attractive to major shareholders, it not so clear whether investors are getting much of deal.

Grand Union is Greek shipowning venture launched by Newfront Shipping boss Nick Fistes and Stamford Navigation’s Michael Zolotas. It also by coincidence the name of a well-known US supermarket chain. This is a privately owned, family-controlled shipping company with a fleet of 46 bulkers, tankers and newbuildings. The companies have been around for a number of years, but this is a fairly new venture that has had a very aggressive expansion plan. As a private firm, it difficult to assess its financial condition and how it has been impacted by the financial crisis and bear shipping market environment. Aries (RAMS) is a penny stock and it has had a balance sheet qualification about its future as a going concern.

The vessels that Aries is acquiring are the 135,364-dwt Yiosonas (built 1992), the 151,738-dwt Grand Nike (built 1995) and the 172,972-dwt Grand Mirsinidi (built 1993) in return for transfer a complicated share exchange and debt restructuring. 2,67 million Aries shares are being transferred to Rocket Marine (controlled by Mons Bolin and Gabriel Petrides), giving Rocket 36.8% of the total shares and Grand Union (controlled by Michael Zolotas and Nick Fistes) control of 34.2%. But the voting agreement gives Grand Union control of 71% of Aries. As part of the overall transaction, Investment Bank of Greece is buying $145m in 7% senior unsecured convertible notes, due in 2014, which Aries plans to use for vessel acquisitions and paying down debt, among other potential uses.

The Securities Purchase Agreement is subject to a number of conditions, including but not limited to (1) the entry into definitive agreements for the issuance of the Convertible Notes and the closing of that transaction; (2) the entry into definitive agreements with the Company's existing syndicate of lenders for the refinancing of the Company's existing credit facility; and (3) the absence of any event reasonably likely to have a material adverse effect on the Company or the three Capesize drybulk carriers.

The deal will see Fistes become chairman of Aries, while Zolotas will become executive director and president, as the board swells to seven members. It is difficult to evaluate the financial impact of this complex transaction on Aries. The management and BoD changes are significant.

Financially no party appears to be putting cash in the deal. The 'equity' appears to be in the vessel transfer. Further there appears to be some additional debt and refinancing from a bond issue with the Investment Bank of Greece, not a run of the mill shipping finance entity. It is not clear whether this increases Aries leverage. Some cash in the deal would have provided more transparency and plain vanilla comfort for investors.

The weakest point is the lack of commercial synergy. The biggest value in Aries is its nine product carriers (their container business is a dead letter, but the product sector is also in deep recession), but Grand Union brings no expertise or contract base to service these units. A merger with a group like Scorpio (of Monte Carlo) would have offered a better synergy, adding more value here. Aries (RAMS) is clearly betting all their strained resources on the Capesize unit additions in the dry bulk sector. This follows the Top Ships example of opportunistic fleet diversification to get out of their hole at the time, but at much lower asset price entry levels and ready financial structuring that purports to improve the balance sheet.

It would be helpful if Aries (RAMS) prepared an investor presentation to make sense of this complicated transaction. Perhaps something will be soon available so we can make further comments.

Eagle/ Kelso partnership: constraints and options

Eagle is presently limited at best in its ability to acquire new vessels, even at distressed levels with constraints to pay half of any future equity raises to reduce debt. By the Kelso partnership, Eagle CEO Zoullas will work with Kelso to pursue vessel purchases on a private basis but will pay commercial and technical management fees to the public company for any bulk carriers acquired. Eagle will have right of first refusal on any bulker the private venture wants to buy.

Eagle has fared relatively well in the crisis so far but not without some setbacks. The block expansion deal with Alba Shipping at the top of the market prices put them into this crisis with the pain of overvalued vessels, some charterer defaults, some order cancellations and over-leverage putting them in violation of their senior debt covenants.

Management did its housekeeping to put things in order. It raised last month US$ 100 mio cash by share sales, which represents a modest share dilution compared to some other peers. It amended its credit facility with lender Royal Bank of Scotland (RBS). The non-amortizing facility has been reduced to US$ 1.2 bn from US$ 1.35 bn, with Eagle also shouldering a higher margin of 250 basis points over Libor, plus the above-mentioned obligation to pay half of any future equity raises to reduce debt.

The Kelso agreement appears fairly structured in terms of interest conflicts. Eagle has right of first refusal on any bulker the private venture - called Delphin Shipping - wants to buy. It also gets a "first look" at any bulkers Delphin acquires and decides to place on charter. Whilst probably a good thing for Kelso and Zoullas, it is neutral for Eagle.

The China Conundrum

A great debate rages over whether China's economic model is sustainable. Western economists often express fawning admiration of the success of this state capitalist model, some of the most virulent critics are Chinese. There are issues of asset bubbles in real estate, massive export production overcapacity, missallocation of resources and a banking system riddled with non-performing loans.

The Western conventional wisdom is that Chinese stimulus has been more effective because it is state-directed and financed by trade surpluses rather than debt. There is a general confidence that rising domestic consumer demand will save the day in the end.

Back in 1994, Paul Krugman wrote an article: "The Myth of Asia's Miracle", where he compared rosy Western projections of Asian growth with cold war projections of Soviet growth rates. Krugman maintained that the rapid growth in output could be fully explained by rapid growth in inputs: expansion of employment, increases in education levels, and, above all, massive investment in physical capital. He pointed to two basic implications:

• The willingness to save, to sacrifice current consumption for the sake of future production.
• Future limits to their industrial expansion - in other words, economic growth based on expansion of inputs, rather than on growth in output per unit of input, is inevitably subject to diminishing returns.

We know that the Soviet system fooled most Western intellectuals and eventually imploded. Are today's China watchers any smarter?

Sceptics like Andy Xie and Martin Hutchinson argue that most statistics out of China are misleading and false. China remains a repressive, closed society with little transparency and lots of corruption. The state corporate sector is still gigantic and supported by state-owned banks. Savers are not permitted to take money out of China, and their huge savings prop up an overvalued stock market and a bond market that is comparable in size to the freely flowing international bond market. Private sector companies are either youthful fly-by-night operations or dubiously privatized state behemoths. Prices are still largely administered, and investment flows mostly to the politically connected rather than the economically attractive. Education is relatively poor outside the main population centers, and land ownership is still restricted.

Even though China has had three decades of high growth, few companies are globally competitive. While China is experiencing weak exports now, the weak dollar allows China to release the liquidity saved up during the boom worrying about currency depreciation.

Xie stresses that there is tremendous over capacity in the construction industry. The pricing structure is highly distorted. State-owned enterprises borrow from state owned banks and give the money to local governments at land auctions, so everything turns around the big Government pocket. Further the rapid urbanization and one-child birth policy will have a very adverse effect on demographics that will create a train-wreck situation. "China’s wealth inequality is already very high. A sizable or even the majority of China’s population may not have meaningful wealth even after China’s urbanization is complete."

Xie argues that the party in China will be over when the US dollar starts to appreciate again. The risks are that prevailing FED easy money and massive increase in US sovereign debt will lead to higher inflation, obliging the FED to raise interests rates as they did in the 1970's.

Of course, there are two divergent aspects in this argument. Easy money and massive FED liquidity are already putting some renewed pressure on the US dollar. Higher interest rates, however, are only foreseeable when and if inflation rises in the US. Right now that is unlikely with only the slope of GDP decline improving, but the massive overleveraging and debt overhang in the US opens the temptations to debt monetization down the line. Already treasury yields are starting to harden. Should the FED be obliged to raise interest rates as they did under Paul Volcker, then Asia could be in deep trouble.

In any case, with the US consumer shopped out, overleveraged and coming prospects of higher tax load, it is certainly not evident that there will be a quick revival of consumer export markets. The EU is also likely to recover slowly. This is likely to lead to a permanent structural rebalancing of Chinese export surpluses. It is not obvious that Chinese domestic demand could absorb the production overcapacity, especially considering what was said above. The stimulus is not workable for an indefinite time period.

Shipping markets are highly dependent on China as the main demand driver against a massive order book built up in recent boom times. The construction industry accounts for approximately 50% of Chinese steel demand so it is closely related to coal and iron ore imports in the dry bulk sector. Massive container ordering was predicated on unlimited export market potential to the West. There have been substantial refinery projects in the ME for export to the Far East as well as huge refineries built in China for the tanker business.

The China story still excites Wall Street investors and already this year, China has again brought a revival in the dry cargo market. Should reality further down the line not meet these expectations, then truly hard times could fall on this industry.

Will there be any distress deals in shipping?

Since the fall 2008, public policy response to the financial crisis has to reinflate asset prices by flooding the markets with massive central bank liquidity. Banks have not been aggressive in covenant breaches. Some major shipping players feel that asset prices are artificially high. ATM share offerings have enabled public companies to bail themselves out. All eyes are presently on the quality of the future recovery in 2010 and beyond.

Last fall shipping markets plunged with the outbreak of the financial crisis. Shipping had enjoyed unprecedented boom times, riding globalization, outsourcing and the rise of China as an economic superpower, following the footsteps of Japan in the 1950's and 60's.

This year's notable recovery of the BDI - mainly in the Capesize sector - is due to a new surge in Chinese inventory building in coal and iron ore after several months of market penury with rates below breakeven levels. Chinse importers were renegotiating supply contracts down to the lowest possible prices and drawing down stock. There is a great deal of debate whether this is the beginning of a new bull market for dry cargo or it is simply temporary inventory hoarding for speculative purposes and concerns of more US dollar weakness ahead.

After a period of relative out performance, the tanker markets took a nose dive. Early in 2009 there was big demand for storage due the extreme premiums in forward oil futures over prevailing spot prices. The rise in oil prices changed this situation. Clean petroleum markets have been hit the hardest. Chemicals are somewhat better off with a surge in Chinese feedstock imports, but most other routes are slack with significant drop in cargo volume. Containers continue very weak, often below operating costs, except some feeder trades.

Despite substantial fall in asset prices and high senior debt leverage levels of many publicly listed companies from the popular fleet block vessel acquisition/ merger deals at the top of the market, few companies have gone into serious default, leading to liquidation. In the relatively few cases of foreclosures, banks have tried to transfer assets to new entities, hoping to position themselves for recovery.

The financially weaker companies have been aggressively issuing new shares, mostly sold slowly in small lots over the market. George Economou has pioneered in this technique raising nearly US1 billion for DRYS. Initially there was brisk investor enthusiasm until the market started to perceive the massive increase in share count. Lately even some of the worst performers like TOPS with a bad record in share value and continuing restructuring negotiations with senior lenders have found ready new money from a standby facility that Yorkville - a New Jersey-based financial firm - offered them with open arms.

For these reasons, Peter Georgiopoulos argues that "While that's [sic governments have supported the banks and banks essentially have returned the favor by supporting clients] good in some ways, it has kept the market artificially high".

So far, this downturn in the shipping markets has been different from some of the historic collapses. Meanwhile the war of attrition continues and the issue ahead will be the quality of the recovery as well as the sustainability of the Far East growth model (see my accompanying article: "The China Conundrum").