Global Ship Lease: Heads I Win, Tails I Don't Lose Much

Global Ship Lease (GSL) is a containership lessor that signs long-term lease contracts based on fixed lease rates. GSL was spun-out by CMA CGM, the third largest liner shipping company, in late 2008. GSL has 16 ships that it owns and leases out to CMA on long-term contracts. The lease rates to be received are fixed, so GSL gets a steady cash flow. Also GSL is not impacted by the drop in lease prices, due to the long-term nature of their contracts. CMA owns a 40% stake in GSL, so there is an incentive for CMA to ensure that GSL doesn't go into bankrupcy, more on this below.

Current Results

GSL's fixed long-term contracts ensures the company gets a steady flow of cash. The company makes about 15M of FCF per quarter. In the worst quarters the global economy faced and extremely tough quarters for the shipping industry, GSL grew its CF.

Quarter - NI - CF
3Q 08 - (.3)M - 12M
4Q 08 - (43)M - 13M
1Q 09 - 11M - 15M
2Q 09 - 22M - 14.8M

So basically in some of the worst quarters in decades, the company increased cash flow (net income is impacted by hedges for interest rate). So operationally the company can pay the current interest expense and still generates plenty of cash.

The company takes the FCF and gives it out as dividend to shareholders. In the last 2 quarter of '08 and first quarter of '09 the company gave out $.23 per quarter. For CMA, taxwise this works out nicely.

GSL has quite a bit of debt. It has about 550M of debt. The company can easily cover its interest expense on the debt and still has tons of cash flowing in. Although the company's debt has a covenant about debt-to-ship value. If the debt-to-ship value goes over 100% the bank can cause default. Although given that the company can pay the interest expense and generates plenty of cash, the bank is highly unlikely to force bankrupcy. The current situation has caused the company to stop making dividend payout since Feb '09. Since Feb, the company's debt-to-ship value ratio is over 100%, although the bank has still not forced default. (The stop on dividend has forced investors who were holding the stocks for the dividends to sell out and has created an incredibly compelling investment opportunity.)

The company has been working w/ the bank to amend its agreement. The contracts are still in discussion but it is highly likely an amendment will be worked out and the company will start paying out dividend.

The Bank's Perspective

From the bank perspective, it doesn't make sense to force the company into default. First, the company can pay the interest expense (about 4.5M per quarter). Second, by forcing default the banks will be stuck w/ ships in a market where the value of the ships is extremely low. So the banks would take a loss by selling the ship at these depressed values. Third, GSL has a steady stream of cash coming. With the long-term rates, GSL is not exposed to current market rate fluctuations. So I know what this company can make and whether it can keep making the interest payments. Finally, GSL makes plenty of FCF each quarter. So if I'm the banker, I'm thinking how do I force the company to pay me more. If I'm the banker, I work with this company to either increase the interest rate or force the company to make additional principal payments. In either case, it would be a mistake on the banks part to force default. Also since the bank hasn't forced default since Feb, that is clear indication the bank is not interested in bankruptcy.

To understand the bank's perspective, all you need to do is look at what's happening in the commercial real estate market. The big REITs are on the brink on bankruptcy because of the drop in occupancy and asset value. Although the banks have been working w/ the REITs to extend maturity on the loans or forcing the companies to raise equity. In either case, the REITs are surviving and the banks are not stuck w/ having to sell assets in a distressed market or writing down the assets on its balance sheet. In GSL's case, 'occupancy rate' does not drop due to long-term contracts. The asset values also don't drop, since the company is not really looking to sell its assets until after the contracts are over. I think GSL doesn't really need to raise equity, since it is not struggling operationally to meet its operational or interest expense.

CMA CMG Risk

I think GSL's biggest risk comes from what CMA is doing. As long as CMA can keep paying the monthly charter rates, per agreement, GSL will make its steady cash flow. CMA is a private company, so getting data on it is hard. The main concern regarding CMA is that it has tons of CapEx that it has signed agreements for. With the bad credit crisis and already having a ton of debt, people have concerns over CMA's ability to survive. Although CMA can get out of those CapEx agreements by paying a penalty and cutting back on other expenditures. Also, CMA roughly gets a huge dividend from GSL, so CMA would look to cancel lease agreements with other lessors first. CMA is getting the dividends, tax benefit, and has an equity stake in GSL. So CMA cancelling its contracts with GSL would be the last scenario that CMA would consider.

The shares of GSL have dropped substantially for mainly two reasons: the CMA concern (whether GSL's agreements will be honored by CMA) and the temporary hold on dividends payout has dropped the shares dramatically. The CMA concern is valid, although CMA has options to cut or control its CapEx. Also CMA has been buying back its debt in the open market at huge discounts, so management is taking the right steps. As for the hold on dividends, I think this is only temporary. The management definitely wants to pay out those dividends and CMA wants the dividends. Once the bank issues are fixed, I think the dividends will be reinstituted. Also there has been huge selling in GSL shares recently, I think this is because a major holder started unloading once the dividends were put on hold.

Current Valuation

The shares currently trade at $1.40, a market cap of 98M. Remember the company was paying dividends of $.23 per quarter, so you are getting a 70%+ dividend yield if the old dividends are reinstated. Most likely dividends will be cut. It is not clear what type of dividend payout will happen in the future, but you basically get a company making 60M in FCF for less than 100M. Plus the assets don't need to be sold in this distressed market, so GSL can wait until the market recovers to get a fair value on its assets. GSL doesn't have a single contract expiring until 2012, plenty of time for the market to recover and place historical values on the assets.

Comments

[PlanMaestro:]

Pakiya, thanks for giving visibility to GSL. A couple of clarifications:
- The CMA CGM counterparty risk is even lower than you think. CMA CGM has the flexibility of not renewing more than 150 leases this year, flexibility that its competitors do not have. At this moment it has 99% of its fleet occupied.
- The cash dividends are being retained so at this moment the company has $0.5+/share in cash. Not bad for a company generating close to $1/share in FCF and a $1.5/share valuation

For investors interested in this idea, I recommend checking the Yahoo board where there is plenty of information on GSL and CMA CGM. A good place to start is
messages.finance.yahoo...

Aug 11 05:50 PM

[Pakiya:]

i agree with both your points. i wanted to be conservative on my outlook for the stock and CMA's situation. i agree, CMA's investment in GSL and the dividends CMA gets further lower the counterparty risk. also, CMA has room to maneuver its CapEx obligations.

Aug 11 07:50 PM

[Dalrymple:]

CMA stopped working with the rating agencies at the beginning of summer after its credit got downgraded. They decided not to "supply information" to them anymore. I am sure that makes the bankers nervous about the GSL's stability of contracts. CMA allegedly has a very low level of cash reserves.
internationalshippingn...

Aug 12 06:19 AM

[stktrde:]

The market is, and always has been, a crap shoot.

Give me better than average odds, and that's my bet.

GSL has long term contracts, a young fleet, and more than adequate cash to service debt and dividends. Worst case scenario is that banks require dividends go to principal reduction, thereby making for a stronger balance sheet.

That scenario is already in the share price, so anything better than that moves shares up dramatically. If debt reduction is ordered, this simply becomes a longer term play, and more gilt edged. I'm buying with both hands on dips.

Aug 12 10:53 AM

[Michael Dem...:]

CMA CGM had over $1B in cash at the end of Q1. Financials are posted on Bloomberg.


On Aug 12 06:19 AM Dalrymple wrote:

> CMA stopped working with the rating agencies at the beginning of
> summer after its credit got downgraded. They decided not to "supply
> information" to them anymore. I am sure that makes the bankers nervous
> about the GSL's stability of contracts. CMA allegedly has a very
> low level of cash reserves.
> internationalshippingn...

Aug 12 12:03 PM

[Dalrymple:]

www.joc.com/node/411692
Guess some change in the cash balance over the quarter...


On Aug 12 12:03 PM Michael Demaray wrote:

> CMA CGM had over $1B in cash at the end of Q1. Financials are posted
> on Bloomberg.

Aug 12 01:06 PM

[PlanMaestro:]

Dalrymple, CMA CGM has more than 1B in cash, has port operations that could be sold, and it is easily outperforming its rivals. It has burned far less cash and it has 98%+ of its fleet ocupied.


On Aug 12 06:19 AM Dalrymple wrote:

> CMA stopped working with the rating agencies at the beginning of
> summer after its credit got downgraded. They decided not to "supply
> information" to them anymore. I am sure that makes the bankers nervous
> about the GSL's stability of contracts. CMA allegedly has a very
> low level of cash reserves.
> internationalshippingn...

Aug 12 01:50 PM

[PlanMaestro:]

Well that article is probably wrong because CMA CGM burned just 300M Q1 and it had more than 1B in cash

Aug 12 01:55 PM

[Pakiya:]

if only one thing is learned from the credit crisis, let it be that bond rankings really don't mean anything. if AAA rating can go bankrupt and you have rating companies questioning Berkshire's ratings, i would rather go without these ratings.

CMA does have many issues, both operational and debt. Although they have plenty of options to fix these issues. Also, if CMA goes bankrupt, who ends up with the ships and ports they own? The banks would rather work things out with CMA then be forced to sell in a depressed market. Just look at what is happening in the CMBS markets and with General Growth Properties.

The current GSL stock price offers a huge reward for little risk. If the company doesn't pay dividend for another 12 months, the company's cash position will be 100M. with 550M in debt, they can easily pay off the principal and get closer, or under, the 100% LTV limit. There are some risks with CMA bankruptcy, but the current price offers too good of an odd for a multi-bagger.

Aug 13 12:24 AM

[Ellito:]

well, just bought lots of GSL.
wish me luck.
Thanks.

Aug 13 07:16 PM

[Jan B:]

Pakyia,

Great piece BUT,

You write as if the free cash flow generated can all be paid out but from what I gather that is not really the case as the financing struture looks like a bullet structure and you then have to repay the entire principal at the end. This will roughly equal the entire free cash flow (8.5*60). Do you see it differently?

So effectively the market value of the company becomes the discounted value of 15 year old container ships which is a lot less atractive than 60 MUSD annual dividends.

Jan

Aug 14 04:16 PM

[Snitzer:]

Although there will always be some amount of global container freight volume, the main question is if/when the Asian/American markets reopen, and that's looking a bit dim for the foreseeable future. They widened the Panama Canal, built up East Coast ports so as to run the ever larger container ships from China to the American East Coast direct, thereby eliminating rail/truck costs between coasts. Problem is, they're all dressed up but the parties been canceled, or at least postponed, and while yes, there will be some super good deals in the sector, the time is not yet right to pluck.

Aug 14 10:45 PM

[Glen Bradford:]

$GSL I regret that I didn't find this sooner, I was invested in SBLK, FREE, DAC. My investment mentality is the heads I win, tails I don't lose much and then ample diversification to ensure that I don't lose.

Aug 15 12:51 PM

[Pakiya:]

it is still not late to get into GSL. i think once the debt issue is resolved, the shares should trade in high-single to low double-digits.


On Aug 15 12:51 PM Glen Bradford wrote:

> $GSL I regret that I didn't find this sooner, I was invested in SBLK,
> FREE, DAC. My investment mentality is the heads I win, tails I don't
> lose much and then ample diversification to ensure that I don't lose.

Aug 16 04:55 PM

[Pakiya:]

GSL is not really a play on the shipping industry. it is rather a bet on whether the debt issue gets resolved. once the debt issue gets resolved, the shares can give you a multiple-bagger from current prices.


On Aug 14 10:45 PM Snitzer wrote:

> Although there will always be some amount of global container freight
> volume, the main question is if/when the Asian/American markets reopen,
> and that's looking a bit dim for the foreseeable future. They widened
> the Panama Canal, built up East Coast ports so as to run the ever
> larger container ships from China to the American East Coast direct,
> thereby eliminating rail/truck costs between coasts. Problem is,
> they're all dressed up but the parties been canceled, or at least
> postponed, and while yes, there will be some super good deals in
> the sector, the time is not yet right to pluck.

Aug 16 04:56 PM

[Jeffrey Wal...:]

Hello, I'm a bit delayed in adding to this Q&A dialogue -- Pakiya, thanks for the write-up -- what do you make, if anything, of the selling by Millennium Management ("Integrated Core Strategies") during 1H09?
finance.yahoo.com/q/it...

To be fair, they still own 8.3% of the company as of 8/3/09:
www.sec.gov/Archives/e...

Perhaps simply reducing exposure in face of challenged fundamentals and credit concerns.

Thanks,
Jeff

Sep 17 02:28 PM

[Pakiya:]

look at the recent purchases by George Soros and Marathon. looks like they are buying up a big chunk of the shares.

Nov 25 04:46 PM