Is Chinese demand for dry cargo as sustainable as industry analysts claim?

Despite the global financial crisis, this year has seen some revival in dry cargo rates, especially for Panamax and Capesize vessels. This has led to some renewed investor interest in the sector, notably by Peter Georgiopoulos. The investment thesis rests on Chinese growth potential. Chinese analysts tend to be more reserved. They see significant barriers to expansion in the hinterland and have mounting concerns over misinvestment and asset bubbles, jeopardizing future financial stability.

Western frenzy over China and its prospects tends to resemble the dot.com enthusiasm of the late 1990's with glowing forecasts of everlasting, insatiable demand. It is true that China is a resource-scarce economy with increasing import needs but there are serious issues of longer-term sustainability.

Whilst China entered the crisis with the highest investment rate in history, there is also very high investment misallocation. The primary source of China's high savings rate is their state owned enterprises (SOE's) that are sustained by energy and land subsidies, cheap credit, low wage costs and lax environmental standards. Without subsidized and controlled interest rates, even ignoring the other subsidies, the most important of which maybe the currency undervaluation, Chinese SOE profits in the aggregate would be negative. There is no guarantee that the current environment of low interest rates and cheap money is indefinitely sustainable.

Most of the cargo demand for larger bulk carriers depends on the steel industry, where iron ore is a major factor. The iron ore market has been brutal for China, partly due to China's own inefficient system. China imports more ore than Europe and Japan combined. Skyrocketing prices have cost China dearly.

For four decades before 2003, fine iron ore prices fluctuated between US$ 20 and US$ 30 a ton. As ore was plentiful, prices were driven by production costs. After 2003, Chinese demand drove prices out of this range. Contract prices quadrupled to nearly US$ 100 per ton, and the spot price reached nearly US$ 200 a ton in 2008.  The gradual concentration of major iron ore mines by the world's three largest suppliers was a major reason for this price increase. The nature of Chinese demand was another major reason. China's steel production capacity has skyrocketed, even though capacity is fragmented.

China's local governments have been obsessed with promoting steel industry growth, which is the reason for fragmentation. Huge demand and numerous small players are a perfect setup for price increases by the Big Three miners, which often cite high spot prices as the reason for jagging up contract prices. But the spot market is relatively small, and mines can easily manipulate spot prices by reducing supply. On the other hand, numerous Chinese steel mills simultaneously want to buy ore to sustain production so their governments can report higher GDP rates, even if higher GDP is money-losing. China's steel industry is structured to hurt China's best interests.

The Chinese government is very much wedded to it’s 8% growth target and will do whatever it takes to come close to that target – including flooding the domestic banks with a wall of cheap money to lend as economic stimulus. However, preventing a downturn with easy money is a dangerous way to reflate the economy.

As profitability for the businesses that serve the real economy remain weak, there has been of shift of investment in the first half of 2009 disproportionately into property, stock and commodity markets rather than private sector capital formation. This shift in the medium term threatens to undermine China’s financial stability. Thus, China is experiencing a relatively weak real economy and red hot asset markets.

The Chinese imports that revived the bulk carrier market this year were mostly for speculative inventories. Bank loans were so cheap and easy to get that many commodity distributors used financing for speculation. The first wave of purchases was to arbitrage the difference between spot and futures prices. That was smart. But now that price curves have flattened for most commodities, these imports are based on speculation that prices will increase. Demand from China's army of speculators is driving up prices, making their expectations self-fulfilling in the short term.

Even more foreboding is a looming real estate bubble. The real estate sector in China is especially critical to the bulk carrier market because approximately 50% of Chinese demand for steel is generated by the construction industry. Most Western shipping forecasts are based on unlimited future need in China for new construction. The reality is quite different. China’s urban living space is 28 square meters per person, quite high by international standard. China’s urbanization is about 50%. It could rise to 70-75%. Afterwards the rural population would decline on its own due to its high average age.

So China’s urban population may rise by another 300 million people. If we assume they all can afford property (a laughable notion at today’s price), Chinese cities may need an additional 8.4 billion square meters. China’s work-in-progress is over 2 billion square meters. There is enough land out there for another 2. The construction industry has production capacity of about 1.5 billion square meters per annum. Absolute oversupply, i.e., there are not enough people for all the buildings, could happen quite soon.

The most basic approach in studying bubbles is to look at valuation. For property the most important measures are price to income ratio and rental yield. China’s average price per square meter nationwide is quite close to the average in the US. Yet the US’s per capita income is seven times China’s urban per capita income. The nationwide average price is about three months of salary per square meter, probably the highest in the world! Consequently, a lot of properties cannot be rented out at all. Those that can bring in 3% yield, barely compensating for depreciation. The average rental yield, if one including those that can’t be rented out, is probably negligible. China’s property price does not make sense from affordability or yield perspective.

Some argue that China’s property is always like this: appreciation is the return. This is not true. The property market dropped dramatically from 1995-2001 during a strong dollar period.  Property prices could drop like Japan has experienced in the past two decades, which would destroy the banking system.

In summary, the market frenzy now will not last long. The correction may happen in the fourth quarter. There could be another wave of frenzy next year as China can still release more liquidity. The biggest risk is the global economy cruising toward mild stagflation with a 2 percent growth rate and 4 percent inflation rate. With rising inflation expectations, the US Fed will be compelled to raise interest rates in an effort of soak up the excess liquidity created by its vastly expanded balance sheet. A stronger dollar and a weak US economy would almost surely send China’s asset markets and the economy into a hard landing like during the Asian Financial Crisis.

All this underlines the risks in overly optimist forecasts for China in the dry bulk sector and we have not even mentioned the huge order book overhang and new deliveries of tonnage in the coming years.

Rising risks of an asset bubble in China threatened by US stagflation

China and the US are dealing with their imbalances by exacerbating the very things that caused them in the first place. China entered the crisis with one of the highest rates of misallocation of investment in recent times. With its enormous liquidity released for stimulus, China with waning export markets has become a giant Ponzi scheme, with money pouring into asset speculation. US expansionary monetary policies are leading to a stagflationary environment that will pop this bubble.

Rising productivity from the build-up in infrastructure and manufacturing outsourcing, together with a policy of keeping its currency undervalued, led to massive export growth in China. The resulting dollar earnings pumped up China’s monetary system. Thanks to energy and land subsidies, cheap credit, low wage costs and lax environmental standards, Chinese state-owned enterprises (SOE's) are the primary source of their high savings rate that is financing US deficits and public debt. China has been keeping its currency undervalued to boost SOE exports by purchasing US dollars and placing the surpluses in US treasuries in a symbiotic relationship.

The SOE's surpluses in China are simply part of the transfer from household income to the state sector. The state sector ramps up investment more for policy, not profit, concerns. In the past, they ploughed this money into construction and factory investment projects that may well be already non-viable, but now they are significantly making matters worse letting the stimulus money go into massive asset speculation.

While China is experiencing weak exports now, the weak dollar allows China to release the liquidity saved up during the boom in the past five year without worrying about currency depreciation. As profitability for the businesses that serve the real economy remain weak, there has been of shift of investment into property, stock and commodity markets rather than private sector capital formation. Thus, China is experiencing a relatively weak real economy and red hot asset markets. This shift in the medium term threatens to undermine China’s financial stability.

China's corporate sector increasingly looks like a shadow banking system. It raises funds from banks, through commercial bills or the corporate bond market, and then channels the funds into the land market. The resulting land inflation underwrites corporate profitability and improves their creditworthiness in the short term. As land sales and taxes from property sales account for a big portion of local government revenues, there are powerful incentives to pump up the property market. Land sales are often carefully managed to spike up expectation through SOE's. When SOE's borrow from state owned band and give the money to local governments at land auctions, why should the prices be meaningful? The money circulates within the big government pocket. Tomorrow’s non-performing loans, if land prices collapse, are just today’s fiscal revenues. If private developers follow the SOEs to chase the skyrocketing land market, they could be committing suicide.

China's imports this year have been mostly for speculative inventories. Bank loans were so cheap and easy to get that many commodity distributors used financing for speculation. The first wave of purchases was to arbitrage the difference between spot and futures prices. That was smart. But now that price curves have flattened for most commodities, these imports are based on speculation that prices will increase. Demand from China's army of speculators is driving up prices, making their expectations self-fulfilling in the short term.

The US is trying to reflate by massive government bail outs and stimulus plans that are financed by high deficits and rising public debt levels. The FED has embarked on an aggressive expansionary monetary policy, keeping interest rates low by purchasing agency debt in order to reflate the economy and drive asset prices up. Whilst these policies are prima-facie inflationary and there will be a huge unwinding problem in the future, the low monetary velocity and slack economic conditions counter balance any immediate risk. There is, however, a growing carry trade borrowing in US dollars at ZIRP and leveraging this wall of liquidity into more risky assets such as stocks and commodities.

Monetary stimulus is considered an effective tool to soften the economic cycle. It works by inflating asset markets. By inflating risk asset valuation, it leads to more demand for debt that turns into demand growth. In other words, monetary policy works by creating asset bubbles.  In this crisis, household and business sectors in the US have not been increasing indebtedness; falling property and stock prices have diminished their equity capital for supporting debt. The public sector has rapidly ramped up debt to support failing financial institutions and increase government spending to cushion the economic downturn.

US households cannot continue leveraging up to absorb the excess production that Chinese companies  have invested in additional capacity to export. The recent rise in US personal consumption was accompanied by a 3.4% decline in household disposable income. If US household income declines, and this is likely to continue as unemployment rises even further, it is hard to imagine that US households are really going to splurge on new consumption. So in spite of temporarily good consumption numbers, there probably has been no sustainable increase in US consumption, just in government financed spending.

Regardless what central banks say and do, the world will be awash in a lot more money after the crisis than before -- money that will lead to inflation. Even though all central banks talk about being tough on inflation now, they are unlikely to act tough.

The global economy is cruising toward mild stagflation with a 2 percent growth rate and 4 percent inflation rate. This scenario is the best that the central banks can hope to achieve; it combines an acceptable combination of financial stability, growth and inflation. This equilibrium is balanced on a pinhead, requiring central banks constantly to manage expectations. The world could easily fall into hyperinflation or deflation if one major central bank makes a significant mistake.

With rising inflation expectations, should the US Fed be compelled to raise significantly interest rates in an effort of soak up the excess liquidity created by its vastly expanded balance sheet: this would be the worst possible situation: a strong dollar and a weak US economy. China’s asset markets and the economy would almost surely go into a hard landing. It would reverse the US - China symbiosis.

The Chinese would face a serious financial crisis where their overinvestment and misallocation of resources comes finally to roost with a rash of non-performing loans that would threaten their banking system with permanent loss of capital. The US would risk being caught in a conundrum with sky-rocketing interest expense on its high level of public debt resulting in ever larger fiscal deficits and there would be a drying up of Chinese surpluses to finance the deficits.

Berlian Laju taking its distance from Eitzen Chemical in the CECO Merger

Berlian Laju (BLT) plans to leave Eitzen Chemical as a separate entity and retain the previous management to run it. They will transfer Eitzen Chemical debt from the CECO holding company back to the subsidiary. As a deal prerequisite, CECO lenders must agree to waive all principal payments and loan covenants for a three-year period. Of the US$ 200 mio cash that BLT is required to inject in CECO, only US$ 50 mio will go to Eitzen Chemical. BLT will invest US$ 130 mio of these funds in Indonesian projects.

It is clear that BLT does not have the management resources to run Eitzen Chemical and prefers to rely on its existing management to deal with its problems rather than to be involved directly themselves. They make it a condition that the senior lenders grant forebearance for three years as a condition to their participation in the merger deal.

BLT is sheltering itself from Eitzen by removing all the Eitzen Chemical debt liabilities from Camillo Eitzen and Company (CECO) and putting them back on Eitzen Chemical. BLT's share in Eitzen Chemical through CECO will be just under 50% and their role will be as shareholders with any transactions with the company taking place on a third-party basis.

There are no plans to fold CECO or its operations into BLT. There appear no major changes in the way CECO does its business. Of the US$ 200 mio cash that BLT is raising by a bond issue for this transaction, only US$ 70 mio will go to CECO and of these funds, US$ 50 mio will go to Eitzen Chemical.

Needless to say previous reference to cost savings and synergy in the merger deal was mostly window dressing for retail investors, since BLT has confirmed that will be no integration or rationalization. On the chemical side, BLT is three different companies operating independently:

• BLT's Indonesian operation trading cabotage in Indonesia and internationally in southeast Asia, which is their home market and core business.
• Chembulk operating from Connecticut with stainless vessels mainly Dwt 20.000-30.000 with fairly large tanks in long haul trades.
• Eitzen Chemical (subject the merger), which also has a Connecticut office that they acquired from the Songa merger in 2007. Their fleet is mainly smaller vessels of which the largest concentration is their City class units: stainless Dwt 12.000-13.000. They also have some coated units.

Compared to larger, traditional chemical parcel operators like Stolt or Odfjell, this new BLT/ Eitzen Group has little resemblance. Stolt and Odfjell are fully integrated operations. Their vessels have many small tanks suitable for higher-paying specialty chemicals carried in smaller lots. They have a worldwide presence in both regional and long haul markets together with a complimentary tank storage business in key areas like Houston, Rotterdam and Singapore. They are heavily contracted with end-users up to 70%. Both companies have positioned themselves in the Middle East with local partners for the commodity chemical business envisaged from the new refinery projects. Financially, they have been outperforming BLT and Eitzen in bottom line results.

BLT/ Eitzen by contrast have vessels on the smaller end of the scale. The larger Chembulk units have fewer and larger cargo tanks than the Stolt or Odfjell vessels and more suitable for product-oriented and commodity chemical trades. BLT/ Eitzen have no tank terminal business. Their contract base is much thinner. Eitzen is only 30% and BLT is 50%.

To a large degree, Eitzen Chemical will have to stand on its own. BLT is using US$ 130 mio of the new money raised for this merger deal in its own operations in Indonesia. Their cash risk in the CECO merger is US$ 80 mio of which US$ 50 mio is in ailing Eitzen Chemical, but their leveraging the merger deal to put new capital in their own domestic operations.

The fact that BLT is looking to put most of the new capital (US$ 130 mio) in their domestic activities is not a good sign of support for Eitzen Chemical. It shows where they view their priorities. It is also a graphic example of the value they are bringing to the table for CECO/ Eitzen Chemical in this transaction. BLT is doing what they know best: Indonesian cabotage business and taking its distances from Eitzen Chemical. They get the benefit of the profitable CECO dry cargo operation and the offshore business. It is an attractive share exchange deal where they put minimal cash in CECO and get additional cash for their own business.

Frankly, I would have expected the Eitzen senior creditors to be a lot more demanding to grant CECO a three-year moratorium on principal payments and loan covenants and especially to dilute their security by accepting the risks in transferring the Eitzen Chemical debt from the CECO holding company. In effect, all they are getting from BLT in comfort is an additional US$ 30 mio in CECO and US$ 50 mio in Eitzen Chemical. There is no new management, no revised business plan or attractive commercial synergies, except in promises for the future. There is also no extended financial involvement, but rather an attempt to limit their future liabilities.

Georgiopoulos gives thumbs up to dry bulk in an opportunistic play

Peter Georgiopoulos is aiming for an opportunistic asset acquisition play thorough Genco's (GNK) new Baltic Trading, which could seek US$ 230 mio in its initial public offering (IPO) with a plan to purchase five to seven vessels by the end of 2010. He is betting on recovery in this sector, carefully sheltering his existing dry cargo company Genco and he is demanding top dollar for his participation and management in the new venture.

Georgiopoulos's concept is to set up a new company "Baltic Trading" with a symbol BDI as a speculative play in the dry cargo sector using equity capital to purchase vessels, avoiding senior debt and operating the vessels in the spot market at least initially. His NYSE-listed Genco (GNK, an owner of 34 bulkers, plans to contribute US$ 75 mio to the company in exchange for Class B stock, giving the parent 50% of the voting power.

It will be a full-payout company, paying dividends that amount to all net income minus cash expenses. The fleet will likely be made up of Capesize, Panamax and Supramax bulkers through timely and selective acquisitions. Baltic pledges to grow through follow-on equity issues that require little debt financing but says it may use a revolving credit line for bridge loans.

This will be the first initial public offering (IPO) in New York since the ill-fated Britannia Bulk in June 2008. Morgan Stanley and Dahlman Rose, who both have strong connections with hedge funds, will be the underwriters.

Genco chairman and founder Peter Georgiopoulos will also serve as chairman of Baltic Trading. Genco finance chief John Wobensmith will play the same role at the new outfit. Genco board member Basil Mavroleon will also hold a Baltic seat, but there will also be a significant number of independent directors.

Genco also is to receive management fees of up to 1.25% of gross charter revenues for commercial services, US$ 750 per vessel per day for technical management and up to 1% of gross purchase price in sale-and-purchase (S&P) transactions. Genco farms out technical management to Wallem and Anglo Eastern. Charter-oriented Genco is to have first rights to charter opportunities, while spot-focused Baltic gets first look at voyage deals.

Georgiopoulos is making heavy use of investor equity capital in this venture, yet he retains considerable control over the operation though Class B voting power. Further Genco will benefit in fees and commissions both on vessel sale and purchase and chartering. Peter Georgiopoulos has a strong track record with investors and he is demanding his price for involvement and participation.  He is taking a conservative position in sheltering his existing dry cargo business and limiting his risks.

Innovative use of capital markets for Navios Maritime

Angeliki Frangou has been outperforming her Greek peers in innovative finance for her opportunistic expansion and aggressively picking up distressed assets in the dry cargo market. Her use of "mandatory convertible preferred shares" in the recent purchases of Capesize newbuildings lessens the leverage risks for Navios and avoids dilution. She succeeded in raising US$ 374 mio new equity for NMM at a minimum discount. Her US$ 375 bond issue to cover new buildings and debt is smart finance.

Frangou's strategy to buy a mature dry bulk company with a cargo system was quite different from her Greek peers, who started up with block vessel purchases on a vessel-provider model and scaled up on the same basis, using bank debt and raising new equity at discount. Scaling up at the top of the market prices led to sizeable losses for many listed companies with asset impairment charges and protracted negotiations with senior debt lenders for asset coverage covenant violations. Several companies were compelled to raise additional capital by massive 'at the market share issues' (ATM) that were highly dilutive. Jumping the gun in scaling up, many are now quite limited to expand their fleets at today's lower asset prices.

Initially there were issues about what direction the new Greek management under Frangou would lead Navios; but this year Frangou has been outperforming all her Greek peers in share price recovery. Whilst Navios (NM) peaked in early June, Navios Partners (NMM) surged in August when her Capesize deals attracted a lot of attention and NMM has continued to outperform NM, albeit NM has also been holding its own.

The use of convertible shares allowed Navios effectively to do the Capesize acquisitions at a discount to the nominal value. Navios funded US$ 47.9 mio of the purchase price in convertible shares. Two-thirds of the convertibles went to the previous owner and one-third to the shipyard.

Navios shares were trading at US$ 4.45 per unit at the time the deal was announced. When it comes time for the paper to be converted into Navios common shares, they will do so at no less than US$ 10 each. And they could fetch as much as US$ 14 under better circumstances. In either case, Navios gets more buying power than it would have at its current share price. Putting it another way, instead of paying about US$ 71 mio each for the Capesizes, Navios would pay only US$ 57.8 mio each if the shares convert at US$ 10. If Navios's common share does better in the meantime, however, and conversion comes at $14 each, Navios would pay only US$ 54.6 mio for each ship.

The structure also lessens the level of dilution that would occur if Navios just sold shares today to pay for the purchase. Under most circumstances, the preferred shares do not become common units for at least three years and that is in the more favorable US$ 14 scenario. Under the base-case US$ 10 conversion, they become common units five years (30%) and then 10 years from now (70%).

Navios AA rating and good track record allow them to tap the high yield market in a period of tight bank finance conditions and low interest rates. Whilst the equity buyers for recent ATM issues by weaker peer companies have been largely individual or "retail" investors, high-yield investors tend to be large institutions more fussy about where they place their money.  The offering will provide extra funds to pay for the purchase of two new vessels set for delivery in late 2009 and early 2010. It will also help cover debt on existing loans.

Navios is concentrating heavily on Capesize tonnage and expanding very aggressively. This carries risks if dry bulk recovery in the coming years is less robust than expected, but Frangou has been very prudent in fixing the new acquisitions with good charter cover and posturing her fleet with secured income. The use of use of convertible notes and bond finance is good financial posturing.

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.

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.