The entire shipping industry has been in a depression for many years and is marked by multiple bankruptcies. The cause of this was the overbuilding before the 2008 downturn. The shipping companies believed that the China miracle would continue and thus provide an increase in demand for ships. We now know this was the absolute wrong decision.
Financing for new ships post 2008 has dried up and there have been minimal new orders in the last few years. However, the glut of ships will persist until the end of 2013 because the orders placed in 2007-2008 are now being delivered. Many shippers are trying to delay or even cancel orders but this is not easy and thus the oversupply. Supply/Demand should start to look favorable near the end of 2013 or early 2014. The key is that you have to survive 2013 to benefit from any upturn in day rates.
DryShips (NASDAQ:DRYS) has a significant stake (78 million shares) in Ocean Rig (NASDAQ:ORIG) and this is the key to Dryship's survival. Recently, DRYS sold some ORIG stock and used it as collateral to avoid bankruptcy. ORIG stock has been hurt by this potential overhang from DRYS selling its ORIG stock. The solution to this problem is for ORIG to convert to an MLP. Many companies have converted to MLPs recently and their share prices have jumped significantly (CVI and SDRL).
An MLP structure will allow DRYS to get its hands on significant cash flow through the distributions. Not only will ORIG see significant appreciation converting to an MLP, but it will also alleviate the issue of DRYS being a seller of ORIG. The MLP distributions will allow DRYS to survive 2013 and beyond. The NAV for ORIG is $18.65 and rigs tend to trade at 1.1x NAV. Therefore, a value of $20.50 seems reasonable (35-40% upside).
The current price of DRYS represents a 10-15% discount to NAV (see below). This valuation is assuming a liquidation of the ships and the ORIG stake to pay back creditors with the remaining going to shareholders. There is some debate about how hard it is to sell ships in this market but Wilbur Ross smells opportunity and has set up a fund to buy ships from distressed sellers. The NAV is $805.4 million and the shares outstanding are 380 million. Therefore, NAV/Share = $2.12 which implies DRYS is trading at a ~15% discount.
|FMV of Assets (in $ million)|
|Ocean Rig Shares (2)||1,174.5|
|Fleet Market Value||1,001.0|
|Liabilities (in $ million)|
|Shipping Bank Debt||932.3|
|MtM Liability on IRS||71.3|
(1)Proforma for net sale proceeds of $123.2 million as a result of secondary sale of 7.5 million ORIG shares in February 2013
(2)ORIG common shares held by DRYS of 78.3 (proforma for the ORIG shares sale) at share price of $15.00.
Source -- DryShips website.
Conclusion - If ORIG converts to an MLP, it will not only increase the value of DRYS's stake but it will also allow DRYS to access some of ORIG's cash flow through distributions. DRYS will also not have to sell any more shares to survive. The upside in ORIG is significant if this were to occur. ORIG's share price could increase to $20.50 (1.1x NAV). Additionally, the risk of DRYS going bankrupt would be alleviated which should also provide upside. Assuming ORIG jumps 35%, the value accrued to DRYS equity holders would be $1.11.
Also, if DRYS's ~15% discount to NAV is removed, this would add another $0.25 to DRYS. If both of these events happen, the price of DRYS could increase to $3.25 from its current $1.83 price (70%+ upside). And, as the shipping cycle turns, the value of the ships should rise and provide even more upside. I like to think of DRYS as a very long dated option on the eventual upturn in the shipping cycle. Survival to 2014 is key and the MLP conversion will allow DRYS to be a survivor.