The following is a guest post by George Schultze, founder of Schultze Asset Management LLC, an alternative investments firm founded in 1998 that manages approximately $225 million in assets and specializes in event-driven and distressed securities investing. Mr. Schultze is author of The Art of Vulture Investing: Adventures in Distressed Securities Management (Wiley Finance, 2012).
Anyone who’s taken a look at the global shipping industry recently probably knows that there’s a boatload of distress in the waters.
In fact, we’ve recently witnessed a number of shipping firm restructurings including Excel Maritime Carriers, Overseas Shipholding Group, STX Pan Ocean, General Maritime, B&H Ocean Carriers, Genco Shipping & Trading, ZIM Integrated Shipping Services, Nautilus Holdings, and Ermis Martiime Shipping, to name a few. These names represent just some of the many potential shipwrecks in this challenged industry.
Why do we see all this distress in shipping? The answer is two-fold. First, shipping companies borrowed far too much money during the peak shipping commodity cycle a few years ago. Second, this industry is extremely competitive and is subject to unpredictable crests and troughs. As a result, charter rates have dropped precipitously, such that many overleveraged shipping companies became insolvent.
To be sure, there are small pockets of smooth sailing in the shipping industry. For example, U.S. Jones Act fleet operators, which carry goods between U.S. ports, are benefiting from higher domestic demand due to rapidly-growing domestic energy production. Even so, this commodity industry can be extremely difficult to navigate. The best strategy necessarily mandates a flexible capital structure which won’t get waterlogged in rough seas.
Two recent shipping restructurings, Genco Shipping and Overseas Shipholding, show how the traditional rules of bankruptcy operate in this unique industry. As many of us no doubt know, most U.S. companies that go bankrupt provide little to no recovery whatsoever for pre-petition shareholders. That truism has helped create numerous opportunities for trading stocks of shipping companies.
By way of background, Overseas was founded in 1948, generated over $1.0 billion in revenues and $235 million in EBITDA during 2013, and owns over 90 major shipping vessels. Meantime, Genco generated about $228 million in revenue and $83 million in EBITDA in 2013, and owns over 50 shipping vessels.
In fact, just last week a federal bankruptcy judge ruled that Genco Shipping (an ocean transporter of drybulk cargo) was insolvent and that its old stockholders therefore couldn’t hold up the reorganization any longer. Old Genco shareholders, including some well-known hedge funds, had spent significant time and money litigating Genco’s bankruptcy. Although they won the battle by getting an official committee of equity holders appointed in the Bankruptcy Court, they lost the war by failing to get anything more than the out-of-the-money warrants originally proposed in the debtor’s plan.
In the company’s plan, former equity holders are now due to receive 7-year warrants, exercisable to purchase up to 6% of the company’s newly-issued stock, at a valuation of nearly $1.3 billion. The debtor’s financial advisor estimated that the value of these warrants was only $30 million which works out to about $0.49 per share for old shareholders. Fortunately, normal bankruptcy law principles applied in Genco’s case – even though equity holders received something (a “gift,” to quote the judge), the company’s insurmountable debt will not simply be reinstated. As a result, pre-petition stockholders of Genco (ticker: GNKOQ) now stand to see their share significantly diluted within the next few weeks.
In fact, this is the usual course of business for bankrupt companies, with equity security holders (stockholders, preferred stock holders, etc.) usually losing their entire investment. Depending on valuation, often junior lenders also see their investments evaporate in bankruptcy. The good news about this messy process is that what comes out on the other side is often a newly-recapitalized company with a new lease on life. In fact, the best restructurings that I’ve seen over my nearly 20 years in this business are those where as much debt as possible is wiped out during bankruptcy.
An interesting contrast within the shipping industry can be seen in the Overseas Shipholding (ticker: OSGIQ”) case. Like Genco, the Overseas case was also hotly-contested – with out-of-the-money equity holders mounting a seemingly never-ending legal battle. As with Genco, Overseas shareholders succeeded in getting an official equity committee appointed in the Bankruptcy Court. However, Overseas equity holders achieved a little more. In fact, they were able to sponsor a plan that gives pre-petition stockholders 6% of the value of the newly-reorganized company (not just out-of-the-money warrants) and also reinstates, or pays off, most pre-petition debt.
The unfortunate catch with Overseas’s plan is that the soon-to-emerge new company will remain highly-leveraged. In fact, based on management’s projected financials for 2015, new Overseas will have post-reorganization leverage of about 5.2x EBITDA. As a result, it might face future problems if it doesn’t hit is financial projections.
Going forward, investors should expect to see more shipping industry restructurings. Genco Shipping and Overseas Shipholding have set interesting precedents for this industry. As usual, the most important thing that matters in bankruptcy is a firm’s valuation. However, normal bankruptcy principles of absolute-priority, wherein the waterfall of value flows down through senior and then junior creditor classes, are still critical. In the unusual case where value flows down to stockholders, investors should exercise caution unless the new balance sheet has sufficient flexibility to weather the next storm. In a competitive, commodity cycle driven industry like shipping, there will always be storm clouds on the horizon.
