Thursday, 29 September 2016
Last updated 16 min ago
Jul 31 2014 | 7:31am ET
By George J. Schultze
Managing Member, Schultze Asset Management
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 most overleveraged shipping companies are now hopelessly 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 short selling the stocks of insolvent shipping companies.
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 by 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 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 capitalistic 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 in this case.
As a result, pre-petition stockholders of Genco (ticker: GNKOQ) now stand to lose nearly their entire investment in the shares within the next few weeks. As of this writing, the stock is still trading at $0.90 per share – perhaps because of undue speculation that something positive may yet happen before the case winds up and the old stock is ultimately cancelled. But in my experience, that type of thing hardly ever happens this far along in a bankruptcy case like Genco’s.
In fact, this is the usual course of business for bankrupt companies, with equity security holders (stockholders, preferred stock holders, etc.) 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 took their “success” a little further. In fact, they were able to push through 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 still be 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, if the company misses projections, it could be facing a “chapter 22” situation – a second trip through chapter 11 bankruptcy after not sufficiently bailing out the balance sheet the first time around.
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 be cautious to not invest long 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.
George Schultze is the 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 also the author of The Art of Vulture Investing: Adventures in Distressed Securities Management (Wiley Finance, 2012).