Global Ship Lease: A Fairly Valued Stock

Some of the recent post on Global Ship Lease (GSL) have caught my attention and I almost got so excited I bought shares in GSL while on vacation without analyzing it carefully. Now I'm back and have done my homework and the results are, to be honest, not particularly interesting.

Given the nature of the company being a leasing company (or charter owner as it is called in shipping language), the only sensible way to evaluate its market value is by warming up Excel and to start discounting the cash flows from now to the end of 2025 when the last ship's charter is terminated. This is relatively easy because all that is needed is assumptions on:

Charter income

Made up entirely of fixed charter income, and only a small percentage needs to be deducted for off hired days. I have put this to 1.35%.

Operational and General&Administration cost development

I have put this at a fixed ratio to income plus an annual increase of 3% to account for labour price inflation.

Note: This is not completely exact as operational costs will be lower in the years after 2018 as only the bigger ships are left which have lower operational costs per income USD. On the other hand the general and administration costs will probably be a higher percentage of income when less ships are managed.

Interest expenses

While GSL attempts to swap floating to fixed on its main borrowing facility, this does not lead me to believe that they will deviate significantly from long term interest rates which are currently at 4%. To this I add 3.5% which is the current margin on top of LIBOR on their facility.

Balance sheet items

On the asset side, only cash items have value while on the liabilities side all liabilities have to be repaid.

Second hand value/scrap value at the end of each ship's lease

This is by far the hardest part to evaluate. I have tried to get in touch with members of the ship brokering market to put values on the ships if they were to be sold today with the age they will have when the charters are over (between 12 and 18 years excect for two 7/8 years).

Discount rate

I don't feel any particular rate is right so I'll show you outcomes with different ones.

Conclusion

As it should be lease calculations once the contracts are signed the most important input for the value of the lease arrangement is the residual value of the asset in question.

Company market value as per discounted cash flows using above assumptions.

Residual ship value	Discount rate 5%	7.5%	10%	12.5%
Current prices	114M	77M	53M	37M
-50%	12M	8M	6M	4M
+100%	317M	215M	147M	102M

The current value is $85 M which is not so different from the above calculation with a discount rate of 7.5% and unchanged residual ship value. So as written in the beginning, the not too exciting conclusion is that GSL seems to be priced correctly.

I have, for the fun of it, tried to understand how it could once have traded at $8 per share and a market cap of $430 M. If i use a residual values that are 3.5 times higher I come to $420 M. This ties in well with the changes in ship prices and the Baltic Index in the meantime and gives me conviction in my discounted cash flow model.

Trading advice

Trade this stock as a slightly leveraged proxy for second hand container ship prices and nothing else. They could very well go up as they are at very low levels. if they do and the stock does move that will the time to enter.

I don't expect GSL to sign up new contracts any time soon as financing is scarce, container lines are reluctant to sell and lease back as it crystalizes their balance sheet losses on the their ships, and finally there isn't much demand for long term charters - on the contrary.

With regards to CMA CGM's (main charterer) credit risk, I suggest you to read some of the recent posts on GSL that cover this topic well.

Disclosure: I don't have a position in GSL.

Comments

[Michael Dem...:]

Are you using a Free Cash Flow to Firm model with a WACC and backing out residual debt, or are you using a Free Cash Flow to Equity model and using an equity discount rate? If using a FCFE model, are you assuming GSL's intrinsic value is based solely on the current credit facility amendment recently agreed upon, or do you have an upside scenario factored in where the company refinances in the interim (one year, two years, three years from now) and the FCFE shifts?

Sounds like your version is a run-off model and in such a scenario I would not disagree with your conclusions, but if financing markets re-open there is a scenario where GSL starts diverting cash to shareholders much quicker which would significantly change the value of GSL. The run-off scenario which you describe is the second-worst outcome, in my opinion, next to a CMA CGM bankruptcy. A static run-off, however, is not a high-probability scenario as financing markets will certainly re-open, shipping volumes will recover and vessel values will rise. The clincher of course is the timing. I think your conclusions demonstrate that GSL is fairly valued today if it simply lets its current book of business wind-down over time.

Sep 04 11:51 AM

[J. Bruun:]

Hi Michael,

You are right it is indeed a run off model. If you where to assume that the spread moves back to 2.5% in 2011 then it adds about 13 MUSD to the market value on 7.5% discount rate and unchanged residual values.

At unchanged residual values there wont be much if any free cash to pay as dividends unless the value of ship to loan covenant is waived/cancelled. But mind you this just subtracts from the final run off value.

I don't add much upside for credit markets opening or container lines being more interested in chartering as the deals are made so that they are rather neutral for both parties as they are so easy to calculate. So at any given time the value of new charters will change with the residual value and interest rates but starting a neutral net value.

I do agree that container ship second hand value can increase but at the current prices it is fairly valued. They can also fall further. The ship yards have full order books and there is already over supply. Think of the situation of the 1970's for the VLCC's (large Tankers). It took almost 30 years for that market to recover.

So the conclusion remains. GSL is a leveraged bet on second hand container ship values with a CMA CGM credit risk.

Sep 04 12:59 PM

[Michael Dem...:]

"At unchanged residual values there wont be much if any free cash to pay as dividends unless the value of ship to loan covenant is waived/cancelled. But mind you this just subtracts from the final run off value."

The nature of the industry is such that as vessel values rise, credit terms will loosen thereby enabling a refinancing, which in turn will allow cash flows to be diverted to the equity holders. The impact on residual values is not the important part. So why is this important? Because if GSL is able to refinance under less restrictive terms than the current credit amendment -- its cash flow to equity (which is currently ~50% of the equity market value of the firm) can be diverted to shareholders via dividends/share buybacks etc. As you point out, paying out cash today subtracts from residual equity realized in the future. But this can't be so quickly dismissed. Time value of money is the crux of value for GSL as a dollar next year is worth substantially more than a dollar 15 years from now. In an extreme example, even if GSL holders have to pony up $580MM 15 years from now to pay off the outstanding loan balance when the ships are disposed of, they would make a fine return by receiving $50MM operating cash flows annually in the interim. This extremely crude example yields an NPV of a $232MM market cap at a 12.5% discount rate. This is meant to be illustrative, not accurate -- the timing of cash flows matters.

Assigning no probability to a refinancing scenario where shareholders can participate in the cash flow to equity materially sooner than disposal of the asset, in my mind ignores what is to my mind a more likely outcome than a continuation of the current situation.

I appreciate your analysis.

Sep 04 02:49 PM

[J. Bruun:]

Do remember that you start out in above by assuming that second hand ship values increase. If this happens you are right but again you are making a bet that ship prices will go up from where they are now and that is exactly what I'm writing - GSL is a bet on second ship values.

To be fair we also have to attach likelihood to ship values declining further and in this scenario a CMA CGM default is increasingly likely. If this where to happen GSL will not be able to re-charter out the ships at nearly as high prices and it is doubtful how much they would get as an ordinary creditor in CMA CGM. This I expect would lead to bankruptcy for GSL too.

Sep 05 04:15 AM

[Ellito:]

Mr. Bruun;
In your first paragraph, you said: "I almost got so excited I bought shares in GSL while on vacation withou analyzing it carefully."
This sentence is kind of confusing. So, had you bought any shares of GSL ? Or, almost bought some shares of GSL ?
If you bought some shares, you regretted it, right ?
If you had not bought any, now you are telling people to dump GSL, right ?
Sounds like you have an agenda to write this article.

Sep 08 03:43 AM

[J. Bruun:]

Hi Ellito,

I don't have any particular agenda with this article. I almost bought shares because GSL seemed so attractive on the surface. When digging deeper I came to the conclusion that the market is approximately right in my opinion. That is what I'm sharing with you and secondly that giving it is a leasing company the most important variable is variation in the residual value i.e. second hand ship prices.

I have never had a position in GSL.


On Sep 08 03:43 AM Ellito wrote:

> Mr. Bruun;
> In your first paragraph, you said: "I almost got so excited I bought
> shares in GSL while on vacation withou analyzing it carefully."<br/>...
> sentence is kind of confusing. So, had you bought any shares of
> GSL ? Or, almost bought some shares of GSL ?
> If you bought some shares, you regretted it, right ?
> If you had not bought any, now you are telling people to dump GSL,
> right ?
> Sounds like you have an agenda to write this article.

Sep 14 05:44 PM

[Mghaynes:]

If I am not mistaken, ship prices are a function of shipping rates. Shipping rates are near all time lows. So, assuming rates return to normalcy by the time GSLs first leases are due to expire in 2012, then is it not likely their $300M equity can be monetized to the tune of $6.5 or so per share? In the meantime they are cashflowing about $15M/quarter. Granted, that is going to pay down debt right now as opposed to dividends, but it is still adding equity value to the company. I'm no expert, but when they start paying dividends again, let's say starting in 2011 at a rate of $.70/year, I bet the stock trades north of $5. So, is a 2x bagger in 2 years fairly valued?

Oct 20 12:12 PM

[horsetackinc:]

It sounds like sour apples to me. Either your writing is VERY poor (your college professor would cringe) or you DID buy the stock and lost money. My bet is you have an ax to grind.

There is a risk/reward factor here. There is a lot more upside than risk. The only hurdle that I can see from this going a lot higher is CMA CGM coming to terms with it's debt. Recent articles have indicated that there will be a positive announcement in November in regard to this issue.

My advise is to either stop crying about your bad investments or take a writing class so you can correctly express your opinions.


On Sep 14 05:44 PM J. Bruun wrote:

> Hi Ellito,
>
> I don't have any particular agenda with this article. I almost bought
> shares because GSL seemed so attractive on the surface. When digging
> deeper I came to the conclusion that the market is approximately
> right in my opinion. That is what I'm sharing with you and secondly
> that giving it is a leasing company the most important variable is
> variation in the residual value i.e. second hand ship prices. <br/>
>
> I have never had a position in GSL.

Oct 25 07:56 AM

[J. Bruun:]

Looks like we missed a great trading opportunity. This article is from September 29 but GSL only started tumbling late October:

joc.com/node/413663

It is worth keeping track on what will happen in the next two weeks as CMA CGM intends to reach an agreement with their lenders by mid November:

www.bloomberg.com/apps...

For your information container ship chartering rates are marginally down since the writing of this article.

Jan

Nov 02 04:03 PM

[frogmatic:]

There is still a fantastic trading opportunity in the stock today, but it's the opposite of the one you're thinking of. If GSL was "A Fairly Valued Stock" at $1.69 (the price at the time you wrote this article) what does that say about the stock at $1.12?

On Nov 02 04:03 PM J. Bruun wrote:

> Looks like we missed a great trading opportunity. This article is
> from September 29 but GSL only started tumbling late October:
>

Nov 13 03:51 PM