- Eagle Bulk Shipping is working under waivers for violation of debt covenants to avoid default, which require agreement to terms of a Restructuring by April 15.
- The company's March 31 10-K is clear that unless they agree to restructuring terms by April 15 they have "substantial doubt about our ability to continue as a going concern."
- The company states: "it is expected that any Restructuring transaction would be substantially dilutive to the Company’s current shareholders, driving down price per outstanding share substantially."
Eagle Bulk Shipping's (NASDAQ:EGLE) latest annual report and 8-K filings contain new disclosures that warn investors of an impending restructuring, to be agreed to by April 15, 2014, which is expected to substantially dilute existing shareholders and lower EGLE's share price significantly. Management also warns of substantial doubt in their ability to continue as a going concern if they cannot agree to restructuring terms with lenders. Investors bear significant risk holding EGLE going into this event and could suffer significant losses.
The latest 8-K and 10-K (Annual Report Overview section paragraphs 3-5) SEC filings state that on March 19, 2014 Eagle received certain waivers from their lenders to avoid default. Eagle violated the maximum leverage ratio covenant December 31, 2013 and expected to violate that covenant again as well as the minimum interest coverage ratio at March 31, 2014, which is expected to continue through each measurement date in 2014 (see F-8 Note 1 in the annual report). In order to avoid default under their credit agreement and on more than $1 billion in debt, Eagle must agree to a restructuring with their lenders by April 15, 2014. Eagle management states in the annual report in the top Overview section:
If the Company cannot comply with such terms and reach an agreement with the Majority Lenders in the time frames provided, our lenders could accelerate our indebtedness and foreclose their liens on our vessels, which causes us to conclude that there is substantial doubt about our ability to continue as a going concern.
Bankruptcy is the worst case scenario. Management's best case scenario, also from the annual report March 31, couldn't be more clear. In discussing the April 15, 2014 restructuring requirement:
...it is expected that any Restructuring transaction would be substantially dilutive to the Company's current shareholders, driving down price per outstanding share substantially.
We have an event date and we have management's expectations of the impact of that event on the share price. Rarely do we get such a clear communication from a management team on the future share price of their stock.
Who Are Shareholders Up Against?
The lenders that Eagle is negotiating with are private investment firms who bought a majority of Eagle's debt (roughly $800 million of $1.2 billion total debt) from Royal Bank of Scotland in late 2013 as described in this Wall Street Journal article. RBS wanted out due to the risk they held as a creditor to Eagle and the potential for lack of payments on their loan. Their only tools as a bank were to extend the debt obligations while Eagle continued to burn their cash or take over the assets at horrible market resale rates. The private investment firms have more tools at their disposal to make money on the distressed loans, including taking equity from shareholders (i.e., dilution).
It is interesting to note in the above WSJ article that the private investment firms are said to have bought the debt at 90 cents on the dollar, which was considered attractive to RBS and high for distressed debt. This price would provide a maximum total upside of 11% on the private investment firms' investment if they collect 100% of the debt, plus a low annual interest rate (average 3.87% in 2013 from page 74 of the annual report) if they were able to exact payments on the debt over a number of years (5-10). Over those years to repay the debt the annual return would be far lower, likely 5-6% annually, which is far too low given the default risk they are taking.
Based on the investment return expectations of these firms and Eagle's own statements, I believe that it is both the private investment firms' and Eagle management's intent to take substantial equity in the company from shareholders and give it to Eagle's lenders (i.e., dilution) in order to extend Eagle's debt obligations and avoid bankruptcy. The alternative for shareholders is default and potential bankruptcy, a complete loss.
How Much Dilution?
How much will management be required to dilute existing shareholders to satisfy the lenders? I don't want to speculate on what the private investment firms expect from this investment. But we know they allocated $800 million in a distressed debt situation with the intent to make a good return given the high risk. 5-6% annually with the risk of default and the current balance sheet is not enough. 10-20% annually is a better range, or 5-15% annually above the full debt repayment and interest return.
On $800 million invested, 5-15% will require $40 - $120 million annually in returns on top of the debt returns, or $200 - $600 million over 5 years.
We are 6 years into the global recession and still plodding along at unprofitable shipping rates. With Eagle's current market capitalization of $70 million, the private investment firms will need to take a major portion of that equity from shareholders and still hope for a rapid recovery to have a decent upside given their risks.
I question why they bought this debt at these prices. The above WSJ article points out that there are currently few opportunities in distressed debt, which usually goes for pennies to 75 cents on the dollar vs. 90 cents. The investment firms almost have to force the company into bankruptcy and pilfer most all shareholder equity in order to have a chance at a reasonable return. It will be difficult for the investment firms to turn a significant profit.
I expect a major dilution to current shareholders, with the likelihood for the lenders to receive preferred shares with higher priority claim to future assets and earnings. This is consistent with the company's own statements: "substantially dilutive" and "driving down price per outstanding share substantially."
I cannot make a case for current shareholders to come out on top of this dilution even with a wildly aggressive recovery timeline and a long-term hold of 5-10 years.
What Tools Does Management Have?
Also from the latest annual report (Liquidity and Capital Resources section page 77) when discussing credit agreements:
Under the new shelf registration statement, the Company may issue up to an aggregate of $500,000,000 of securities, including common shares, preferred shares, debt securities (which may be guaranteed by certain of the Company's subsidiaries), warrants, purchase contracts, rights and units comprised of any of the aforementioned securities.
This registration renewal was filed in August 2012, I expect so that management could prepare for the possibility they recognized at the time which is now happening. Management has the tools they need to dilute shareholders and they are ready to use them to avoid the worst case scenario. The current $70 million market cap is small compared to management's ability to issue up to $500 million in new preferred shares at further distressed prices, justifying the extreme dilution raised above and again validating management's own words of 'substantially dilutive' effects from any restructuring. The only leverage management has is the threat of bankruptcy to their creditors. Not exactly a strong platform for shareholders.
Given These Clear Risks, What Does the Balance Sheet Look Like?
PricewaterhouseCoopers, the company's auditor, states on page F-2 of the 2013 annual report that:
The accompanying financial statements have been prepared assuming that the Company will continue as a going concern.
After repeating the restructuring and going concern points, they then finish this paragraph with:
The financial statements do not include any adjustments that might result from the outcome of this uncertainty.
The following balance sheet is from page F-3 in the 2013 annual report. We'll call this the 'operating balance sheet' since it assumes, per the auditor's own statements, that the company is operating its business normally. The bold italics show where major downward adjustments would occur to the balance sheet in the event that the company were to stop normal operations:
EAGLE BULK SHIPPING INC.
CONSOLIDATED BALANCE SHEETS
December 31, 2013
December 31, 2012
Cash and cash equivalents
Accounts receivable, net
Other assets and Fair value above contract value of time charters acquired
Total current assets
Vessels and vessel improvements, at cost, net of accumulated depreciation of $389,545,066 and $314,700,681, respectively
Other fixed assets, net of accumulated amortization of $484,169 and $324,691, respectively
Deferred drydock costs
Deferred financing costs
Fair value above contract value of time charters acquired
Total noncurrent assets
LIABILITIES & STOCKHOLDERS' EQUITY
Other accrued liabilities
Deferred revenue and fair value below contract value of time charters acquired
Unearned charter hire revenue
Total current liabilities
Deferred revenue and fair value below contract value of time charters acquired
Fair value of derivative instruments
Total noncurrent liabilities
Commitment and contingencies
Preferred stock, $.01 par value, 25,000,000 shares authorized, none issued
Common stock, $.01 par value, 100,000,000 shares authorized, 16,638,092 and 16,638,092 shares issued and outstanding, respectively
Additional paid-in capital
Retained earnings (net of accumulated dividends declared of $262,118,388 as of December 31, 2013 and December 31, 2012, respectively)
Accumulated other comprehensive loss
Total stockholders' equity
Total liabilities and stockholders' equity
While $1.7 billion of assets and $531 million in stockholder's equity may look attractive for a company with a $70 million market cap, we must recognize how the company's current debt status and ability to continue to operate affects these numbers. As stated, the auditor did not take these events into account when computing these numbers.
In a liquidation type event, Prepaid expenses, Deferred drydock Costs and Deferred financing costs would be zero, because there is no future revenue to offset these prior costs. More importantly, $1.6 billion in Vessel assets would be substantially reduced, and subsequently $531 million in Stockholder's equity would be substantially reduced, potentially to zero if the external market value of the vessels and other assets do not cover the $1.2 billion in debt obligations.
I won't try to value those assets myself in a non-operating company scenario. But Eagle has already provided a relative indication of the external market value of those assets by choosing not to sell any vessels in the past year and not repeating the potential to sell vessels now in the face of debt default.
Management stated in the 2012 annual report (Liquidity and Capital Resources section, pages 73-74) that they were:
evaluating asset sales, equity and debt financing alternatives that could raise incremental cash.
They would have sold vessels in the interest of shareholders and the future of the company if it was attractive to do so. We have an objective measure that the current market resale value of the vessels would be far lower than the operating balance sheet shows and would not help their debt or stockholder's equity situation in the interest of the company or shareholders.
Surely It's Already Built Into The Share Price
Some astute investors may argue that when the above filings were made in late March the share price did not drop significantly, so the prospects of bankruptcy and dilution were already built into the share price. We know that management disagrees with that assumption based on their March 31 statement that any Restructuring will result in 'driving down price per outstanding share substantially.'
But for sake of argument let's assume that the share price accurately reflects all knowledge and is at a fair level given the risks and opportunities. If those astute investors read last year's 2012 annual report in hindsight, when the company's market cap was lower than it is now, the company stated then (2012 annual report Liquidity and Capital Resources section again, pages 73-74) that their financial resources were sufficient to carry them to Q1 2014 (a positive then) and again that at that time they were "evaluating asset sales, equity and debt financing alternatives that could raise incremental cash."
At that time, one year ago, the company had 12 months' financial runway and the potential to sell assets to reduce debt. This was a positive statement for a dry bulk shipper at the time. There was hope for EGLE to weather the then 5-year global downturn in shipping for at least another year and longer if they sold assets. If it did recover, its then $40-$60 million market cap could skyrocket to $1 billion or more based on assets and future growth and revenues. Investors had hope and could shoot for the moon.
Even with all of the positives (relative to other shipping companies), plenty of time to recover, and options the company had at that time, the share price remained significantly lower than it is now.
A year ago Eagle reported 45 operating vessels. Today they report 45 operating vessels. No asset sales. No incremental cash to fend off lenders. It has been and still is a horrible time to sell dry bulk shipping assets. It was so poor that management chose not to sell any ships but rather face the current prospect of dilution or bankruptcy, which they clearly and accurately understood, as documented in the 2012 annual report.
In the past year Eagle has lost $70 million in net income. Their main lender sold its loan at a loss. The new lender has more aggressive tools and strategies to make a profit at shareholders' expense (not really, since bankruptcy would be worse for shareholders). Management is warning of an immediate impending event to dilute shareholders or default on debt. And it is too late to sell assets in a continued dismal shipping market.
The prospects were far more hopeful and positive a year ago than they are now. Eagle has fewer options now than they did a year ago, when the market cap and share price were lower. A year ago EGLE traded at $1.80 to $3.80, or 10-60% lower than its current price. The fact is that things have gotten far worse for Eagle and now the negative event is imminent.
Any argument that says the share price has current knowledge fully baked in would have a hard time justifying a higher price now than a year ago. Using this logic makes a strong case for a much lower share price now compared to last year. The downside risk is far greater now than it was then. The main difference is that now we have a firm date for the event and it is in a few days.
What is Keeping the Price Up?
Note that some investors still believe there is potential for a big recovery, which is supporting the price now in the face of significant likely downside. Some investors have been lulled by the long time that Eagle has not had to take action on their debt. Surely if Eagle made it this long they will get through unscathed. I must state that anyone who is short EGLE is at risk if any of those assumptions are true. The following should reassure them.
EGLE is a distressed micro-cap with a $70 million capitalization trading under $5. It is below many professional and institutional investors' price and capitalization requirements for investment. 74% of shares are owned by retail investors, many of whom don't take the time to read SEC filings. And since the latest annual report March 31 there have been few to no shares available to short, thereby allowing the shares to trade above fair market value in light of the impending negative event. That will change April 15.
Do You Trust Management? I Do.
In summary, I have to give Eagle management an 'A' grade. They cannot control the global economy nor dry bulk shipping rates. They managed their debt better than many other shipping companies and avoided share dilution and bankruptcy longer than others. They set themselves up to weather the worst case scenario by allowing for major dilution of shareholders if required. Their predictions in early 2013 of debt covenant violations at the end of 2013 and in Q1 2014 if the global economy did not improve were correct, to the day! How often does a management team hit their projections that exactly? This is a management team you can trust. And their current honest communication of restructuring, share dilution, share price reduction and the potential for bankruptcy could not be more clear.
Investors are warned.
Disclosure: I am short EGLE. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I welcome comment and counter-arguments to this article that are well informed and based on facts. I have searched for anything positive for current shareholders here but all I can find is the prospect of avoiding bankruptcy.
Editor's Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.