Seeking Alpha
Long/short equity, value, debt, base metals
Profile| Send Message|
( followers)  

Introduction

After writing an earlier article about Safe Bulkers (NYSE:SB), I was put off by the exorbitantly high "management fees" the company pays to a company associated with its CEO, and I didn't see any reason to invest in the common shares of Safe Bulkers.

However, the company has recently issued preferred shares, and the fact that the CEO is investing $20M of his personal money in this issue has triggered my attention, and I decided to give these preferred shares a closer look to see if they might be interesting for the common man like you and me as well.

I'll be very brief about the Q1 results and the balance sheet, as I covered those issues in my earlier article. In this article, I'll mainly focus on the IPO prospectus of the $40M preferred share issue.

The Q1 Results and the balance sheet

Safe Bulkers announced an adjusted net profit of $16.1M, or $0.21/share, which is down 30% from the adjusted earnings of Q1 last year. Fleet utilization was also a bit lower at 98.5% vs. last year's 99.8% utilization rate, and on top of that, the time charter equivalent rate also dropped by 25% to just $18,000/day.

Looking at the balance sheet as of March 31st of 2013, the company had a working capital of $44M and a healthy current ratio of 2.23 (everything above 1 indicates the company has sufficient current assets to cover the current liabilities).

Shareholders' equity increased to $438M, which translates into $5.71/share.

For a more extensive look at the Q1 results and the company's balance sheet, please read my previous article on Safe Bulkers, as I don't think it's useful I copy paste all the data here.

The preferred share issue

Back in June this year, the company closed the sale of $40M worth of (unrated) preferred shares B, which have an annual cumulative coupon of 8% and are callable from July 30 2016 on. The SB-B issue ranks junior to all indebtness but senior to the common shares, so should the company go bankrupt, preferred shareholders will rank higher than the holders of the common shares.

The annual coupon will be increased by a factor of 1.25 every time there is a covenant default, a cross default (a default under any of their credit facilities), a dividend payment default or a failure to redeem.

The triggers to an increased preferred dividend

The breach of a certain covenant

In case one of the covenants will be breached for a consecutive 120 days, this will trigger a covenant default event, after which the previous coupon will be increased by a factor of 1.25. In the prospectus, the company outlines one important covenant which cannot be breached, namely the "limitation on net worth" covenant.

If the net worth of the company (defined as Total Assets minus Intangible Assets minus Total Borrowings) drops below a certain level, this will be seen as a breach of covenant. In this case, the Net Worth vs Preferred Stock ratio cannot drop below 2, meaning that the net worth of the company should always be twice as high as the value of the preferred shares. As the total amount of issued preferred shares is $40M, the net worth of the company cannot drop below $80M for more than 120 consecutive days. If the covenant remains breached for 120+ days, the dividend increases by a factor of 1.25.

The only problem is that the majority of the holders of the preferred shares can elect to waive compliance with the covenants, and as a management company controlled by Safe Bulkers' CEO owns exactly 50% of the preferred shares, it's not unlikely this compliance duty can and will be waived.

2. A cross default

If the company fails to make an interest payment or a repayment of the principal amount to the lender under any form of credit facility, another dividend hike will be triggered.

3. Dividend Payment Default

If the company fails to make a dividend payment for four consecutive quarters, a dividend payment default will be triggered.

4. Failure to redeem the preferred shares

If the company fails to redeem the preferred shares by July 30, 2018, the redemption failure default will be triggered, which will cause a hike in the preferred dividend rate with a factor of 1.25 as well.

It's interesting to note that once a default has been triggered, "on each subsequent Dividend Payment Date, the Base Dividend Rate payable in respect of the succeeding quarterly dividend period shall increase to a number that is 1.25 times the Base Dividend Rate payable on the Series B Preferred Shares as in effect as of the close of business on the day immediately preceding such Dividend Payment Date, until no Covenant Default, Cross Default or Dividend Payment Default exists or, in the case of a Failure to Redeem, until all the Series B Preferred Shares are no longer outstanding."

This is a very interesting part of the prospectus, meaning that even if the company is in good standing with its lenders, the company has to redeem the preferred shares by 2018, otherwise a dividend hike will be triggered with a factor of 1.25 per quarter. This is where the real force of compounding comes in. The next table shows that after just 6 quarters of any default, the preferred dividend reaches its maximum of 30% (but of course, if that happens, it'd be a sign the company is in severe distress).

Amount of quarters in default

Dividend Rate

1

10

2

12.5

3

15.63

4

19.53

5

24.41

6

30

Conclusion

Whilst the numerous penalties included in the prospectus offer some kind of safeguard against a potentially deteriorating financial situation of the company, it's interesting to note the CEO can block a dividend increase caused by a breach of the Net Worth vs Preferred Stock ratio, but after scanning the entire IPO document, it looks like this is the only default where the SB-B holders can waive the compliance. There is however one clause in the IPO document stating. "In some circumstances, if any and all events of default under the indenture, other than the non-payment of the principal of the securities that has become due as a result of an acceleration, have been cured, waived or otherwise remedied, then the holders of a majority in aggregate principal amount of all series of outstanding debt securities affected, voting as one class, may annul past declarations of acceleration or waive past defaults of the debt securities."

As a conclusion, because of the fact the CEO has coughed up $20M of his personal money to invest in this issue of preferred shares, one can be quite certain the company will do whatever it takes to fulfill its obligations under the terms of this issue. On the other hand, exactly because the CEO owns 50% of the issue, he can easily single-handedly waive certain defaults meaning he can effectively block any increase in the preferred dividend caused by a default.

I'm willing to dip my toes into the Safe Bulkers water and will very likely take a small position in its preferred shares B. I'll see how it plays out, but I hope my preferred stock will be called by July 30, 2018.

Source: A Closer Look At Safe Bulkers' Preferred Shares