Perhaps more than any other investment sector, shipping carries with it an aura of deceitful practices and financial imprudence. There is a mysticism to it, an impression of executive indulgence at the expense of shareholder suffering. It often feels inescapable. Critics of the sector, some having fairly come to their conclusions and others simply projecting erroneously, tend to make grandiose general accusations which encompass universal condemnation. This is, in a word, unfair. While every shipping company must operate within the confines of the sector, that does not mean that all companies in the sector operate the same. On individual merits, each company is as much an autonomous entity as it is part of a larger industry.
At times, the criticism is downright inappropriate. Some denunciations take on ethnic or racial tones and manifest themselves in wildly unsuitable comments. Some antagonistic commenters have gone as far as to say "you can't trust the Greeks" or have expressed skepticism by saying that "Greek shipping executives don't care about shareholders." Regardless of one's stance on the sector, or one's prior investment experiences in shipping stocks, there is never a reason to allow singular experiences to generalize the entirety of a people. Not wanting to perpetuate this problem, or to glorify the ignorance of such commenters, links to specific criticisms will not be provided herein. Nonetheless, the point here is clear. Legitimate criticisms and/or inquiries are worthy of response, whereas baseless generalizations which are culturally insensitive are not even worthy of the seconds it took to share them.
With that premise in mind, this article will serve as a follow up to a previous publication. In December of 2013 I wrote an article making a bullish case for Paragon Shipping (PRGN). I stand by that article with conviction, and remain an unwavering advocate of the long term opportunity which exists there; especially from current levels. However, it suffices to say that not all members of the Seeking Alpha community agreed with my perspective. Fortunately though, for all readers and prospective investors, the vast majority of criticisms, inquiries, and contestations which appeared in the comments section of that article were contributed by even-handed and knowledgeable members of the community. Furthermore, the recent comments from an earlier article of mine, which spoke to the sector as a whole and also included Paragon as a component of that piece, have also posed fair and reasonable questions worthy of response. Out of respect for the knowledge of those inquisitors, and in appreciation of their professional tactfulness, I have once again reached out to Paragon CEO Michael Bodouroglou in an effort to procure responses to some of the most popular inquiries. This article will include those answers provided.
A Brief Recap
For those of you who did not read the earlier articles referenced and linked herein, it seems only fair to offer a summation of those pieces as a context for the details provided in this article.
In October of 2013 I wrote an article regarding the forward looking prospects of the dry bulk shipping sector as a whole. I cited the fact that the sector had just endured a half decade of misery which was arguably the worst crisis in the modern era of maritime commerce. A massive disparity in supply and demand ratios, coupled with widespread financial misconduct, low freight rates, and deteriorating asset values, had embarrassingly decimated the sector amidst one of the worst global economic downturns in recent history. It was my contention that an improving global economy, increased stability in the trajectory of dry good prices, improving charter rates, and a slowing of new build orders, would all contribute to sustainable growth over the next half decade. Included in that article was a mention that Paragon Shipping could well be one of the companies best poised to benefit from the ongoing recovery.
Then, in December I wrote a piece specifically on Paragon. That article had focused largely on an extensive interview with Paragon CEO Michael Bodouroglou; however it also cited the role of global urbanization in the dry bulk recovery, the considerations of multiple analyst upgrades, the importance of the sectors cyclical nature, and my personally high opinion of Mr. Bodouroglou as both a business leader and a man. I believed then, as I do now, that Mr. Bodouroglou is a highly capable leader who is financially responsible, progressively humble, shareholder focused, industrially astute, and growth oriented. Needless to say, a considerable number of readers offered differing opinions. They posed questions, and I procured answers, at least to the most popular and oft repeated inquiries.
Following Up With Michael Bodouroglou
On June 23, 2014 I inquired with Mr. Bodouroglou as to his availability to answer a brief number of questions which derived from my previous articles. Always willing to address criticisms, and always cognizant of shareholder value, he immediately complied. Therefore, the brief interview seen directly below took place that same day.
The questions being asked will appear in bold text, whereas the answers will appear in italicized text. The interview transcript begins immediately;
Mr. Bodouroglou, thank you once again for taking the time to speak with me and to answer additional questions pertaining to Paragon Shipping. Since we last spoke in December, price action at Paragon has been erratic. After peaking above eight dollars in March, the price has returned to the five dollar range. While this price volatility has been felt around the sector, and is not exclusive to Paragon, could you share your perspective as to what you believe has contributed to this instability, outside of "peak season" ending, both as it pertains to the dry bulk sector, and to Paragon specifically?
We believe the volatility has been driven solely by the market this time around. The dry bulk market, particularly in our size segments, has been under considerable pressure due to several issues, including the delayed grain season out of South America, some defaults on grain cargoes from China, the Indonesian ban on exports, and the accelerated deliveries of vessels in the first quarter of the year, which will normalize for the remainder of the year. While year over year, on average, the market is better than in 2013, everyone including us expected the market to be much better than it has been, which has caused the pressure on our share price. Given our market cap, we tend to be a bit more volatile than our peers, which has caused our shares to take larger swings, but that is one reason we have started a share buyback program, because given these swings, we believe our company is a very attractive investment.
Secondly sir, while I am, personally and professionally, a believer in the long term prospects at Paragon, it suffices to say that not everyone shares my bullish perspective. After all, the market is built on conflicting opinions.
Following my previous article on Paragon at the end of 2013, there were varied responses. Many people shared my optimism, whereas others voiced their often venomous opposition. One such point of contention focuses on the relationship between Allseas, Paragon, Loretto Finance, and Box Ships. Many investors believe that Paragon shareholders have been erroneously saddled with debts for the construction of the container ships, as well as payments to Allseas for the oversight of said construction. Moreover, it has been alleged that the decision to loan money to Box Ships from Paragon was a principal cause of Paragon falling into temporary breach of loan covenants. These allegations, mistaken or otherwise, also accompany the belief that Loretto Finance earned 2% of all dilution at no cost. If you would, please respond to these questions and denunciations so that the investment community can be provided with a more accurate picture of these professional relationships and decisions.
Thanks for the opportunity to answer this question.
Let me start by saying that all related party arrangements and any related party transactions are fully disclosed and we are very transparent in what these relationships are. All such arrangements and transactions are subject to approval by a special committee at each company consisting of independent directors. Having said that I think that your question is two-fold; one concerning the fact that Allseas is not part of Paragon, structurally, and the second refers to the particular investment in containers and various transactions with Allseas and Box Ships.
So, with respect to the first part, having the management company outside the listed entity is very common among shipping companies. Probably the majority of publicly listed shipping companies have a similar structure. This is because it is more cost efficient, more flexible, and provides greater legal and liability protection. There are several cases where general and administrative costs, and/or operating expenses, are higher in companies that perform the day-to-day management of their vessels in house. That is why we adopted this structure from the beginning at our IPO 7 years ago.
That being said, I appreciate though that a certain number of investors would prefer Allseas to be part of Paragon entirely, and I respect that.
Nonetheless, our operating expenses remain one of the lowest in the industry, and we are very competitive on costs when looking at the total costs per vessel per day; all this despite the fact that we have a relatively smaller fleet than many of our peers. On this basis, we are very competitive, so while people criticize the fees that we pay to Allseas, they miss the fact that on an all in basis, we have a competitive cost structure and a favorable organizational paradigm.
As to the 2% anti-dilution clause for Loretto, which is a subsidiary of Allseas, that was part of our management agreement that was implemented to incentivize Allseas. Incentive plans such as these align the interests of Allseas executives to where we need them, and drive the performance of the staff. They also ensure the operational results that I referred to above, and are therefore of considerable benefit to Paragon's shareholders.
Now moving to the specific issue of the containers and the dealings between Paragon and Box Ships;
Our investment into containers in 2010, and the subsequent spin off of Box Ships in 2011, was intended to benefit the shareholders of Paragon. We had expected an improved containership market going forward with better valuations for both companies as investors value pure play companies. Hence, all decisions at that time should be seen in this context. Unfortunately, the market did not develop the way we expected and I believe that this is the reason why some people voice criticism. I gladly accept criticism and responsibility for the merits of investment decisions that did not go well; after all, I happen to be, personally, very much invested myself, and aligned with shareholder interests.
Regarding losses on the containerships, the reality is that Paragon never ordered any vessels for Box Ships. In 2010, Paragon placed an order for 3 kamsarmaxes for itself. A while later, given the weakness in the dry bulk sector, values eroded and new eco designs appeared. We believed at the time that these orders would turn out to be challenging for the company. As a result, Allseas negotiated with the yard and successfully managed to convert these orders into Eco Type wide-beam containerships by transferring the deposit of $23 million already paid by Paragon for the Kamsarmaxes to the container contracts without any penalty to Paragon. This was a significant success, and it was perceived as such by the market at the time.
The reason why the containerships did not end up in Box Ships was because of timing, as we were already well into launching the offering for Box Ships when the agreement with the shipyard to convert those three kamsarmaxes into the two containerships was being negotiated. It was also a matter of strategy, as Box Ships was a dividend paying vehicle, and buying newbuilds prior to delivery with no revenues would not be beneficial to that goal.
It was also impossible to sell the vessels to Box Ships after the IPO since the latter could not afford to acquire them and fund the construction cost, as it would have had a significant impact on its ability to pay dividends.
Paragon gave Box Ships a right of first refusal on the sale of these ships. Paragon never gave any upside potential away associated with these vessels, while it also protected its own investment in Box Ships in which it was the largest shareholder. This was crucial.
The fact that Paragon lost money in these contracts is unfortunate, but it was due to market developments. It had absolutely nothing to do with Box Ships.
Lastly, the complaint about Paragon breaching loan covenants because of its loan to Box Ships is totally incorrect. The loan that Paragon gave to Box Ships was necessary as part of spinning Box Ships into a public company. It was also done at terms and conditions that were favorable to Paragon. The loan earned 5% interest above Libor at a time when we did not need the cash and our bank deposits were paying us less than 0.1%. This was a performing loan all the way until it was repaid in full by Box Ships. The issues we had with our loans were purely based on the steep decline of vessel values through the crisis, and the reduced EBITDA due to the weak market. So it is an utterly false statement to say the loan to Box Ships was in any way related to any issues we had with our lenders.
I am quite appreciative of such a comprehensive answer, but in adding to the previous question, just in order to ensure clarity, I must make one more challenging inquiry. Shareholders who are, or once were, investors in both Paragon and Box Ships, have overwhelmed my previous article with one primary question broken into two parts. First, why is that Box Ships shareholders didn't take over the debts for the new builds following the spin-off, and secondly, after having allegedly stated that Box Ships would buy the containership, and that Paragon would not take a loss on the deal, why did Paragon end up absorbing a portion of the expenses and costs associated with that transaction?
This question is another example of how easy it is for people to be disoriented if they do not follow up the story from beginning to end.
I hope that I explained clearly in your previous question the facts behind the order of the containerships and the reasons why Paragon remained the sole stakeholder of these newbuilds as opposed to Box Ships.
If the containership market had taken a different turn, and Box Ships shares today were valued higher than the IPO price, all of Paragon's shareholders would have applauded the investment in Box Ships. It has been market circumstances which complicated matters, not corporate negligence, which is what most people are missing regarding cause and outcome.
What is remarkable, and what is often disregarded or misunderstood, is what Allseas has done during this time to mitigate the losses as a result of the investment in the containership newbuilds. It's been extraordinary.
Let me try and explain.
The contract price of each of the containers was $57.5 million and Paragon's deposit was $11.5 million each. Since the market price of each vessel had dropped to $40-$41 million by delivery, this meant that Paragon was $16-$17 million out of the money for each vessel, a $32-$34 million loss in total including the $23 million deposit. Paragon's exposure to the yard was for a contract of $115 million with a deposit of $23 million; thus, $92 million.
At the end of 2013, Allseas was able to negotiate with the yard for the cancellation of one of the vessels and reduce the contract price of the second to $55 million - down from the original of $57.5 million and the retention of the full $23 million deposit without any penalty to Paragon.
In other words, Paragon's exposure to the yard had been reduced to one vessel at a price of $55 million with a deposit of $23 million!! So, $32 million from $92 million!
Furthermore, just before delivery, Allseas was able to obtain a further discount of $770,000 on the contract price, as well as find a third party who bought the vessel for $41.2 net, which according to all reports was a firmer price than many believed was the market at the time.
The result of the above actions, which were undertaken by Allseas, was that on delivery, $10 million of the equity invested in the newbuild was returned as cash into the company!!!!
This restructuring, and disposition, of an investment that could have had serious repercussions for the company, may appear very simple on paper but it does not happen overnight. People cannot imagine the enormous amount of effort, resourcefulness, persistence, planning, and hard work that the company's management, and Allseas, provided to have such a favorable outcome. If fully understood, shareholders and spectators would acknowledge how extraordinarily these circumstances were managed!
Sir, thank you for providing answers to those questions. I know that when investors and critics challenge the decisions and activities of executives it is often an uneasy experience. Therefore, on behalf of the investment community, thank you for your continued transparency, and your willingness to answer difficult questions which sometimes come across as accusatory and provoking. It is a tremendous testament to your character that you are always willing to respond to critics in a professional and thorough capacity.
Moving on now, I have two more comparatively easier questions. First, in having endured the financial crisis, and in now having the opportunity to look ahead, what do you see coming for the industry in the next three to five years? Do you believe the BDI will ever return to its astronomical heights seen between 2007 and 2008?
It is very difficult to look ahead three to five years, as the biggest issue for the dry bulk market today is supply, and we only have a picture of supply for the next two to three years. That being said, we expect that the market will continue to improve, but also remain volatile for the next two years. The question for now is what happens with newbuild orders. If new orders pick up again, we may very well see an oversupply of vessels again in 2016 or 2017, but at least for 2014 and 2015 the shipyard capacity is full and the view on supply is clear. We do not expect the BDI to return to astronomical levels, but we do believe that it can easily get back to historical averages, excluding the peak years, which is around $18,000 a day for Panamaxes, and $16,000 a day for Supramaxes. We were already very close to these levels in the fourth quarter of last year, and believe we will get back to those levels accordingly.
So then, in piggybacking on the previous question, what do you see coming for Paragon in the next few years? Why do you believe, as you have expressed to me previously, that Paragon is so well positioned to capitalize on market expectations over the next half decade? Moreover, why should shareholders, both existing and prospective, be excited to be a part of Paragon for the medium and long term horizons, especially in light of the fact that expectations are currently aligned only with historical averages?
We have a very detailed plan at Paragon, which is focused on reducing our cash flow break even so that we can sustain market fluctuations, and can get back to paying a dividend to our shareholders as the markets improve. All of our 14 vessels operate in the spot market, and we have built in growth with our 7 newbuilds that are expected to be delivered between the third quarter of this year and the fourth quarter of next year. This gives tremendous upside potential to our earnings if the market improves; as we expect it eventually will. We are also trading well below our net asset value, which most analysts calculate to be over $10 per share, and our goal is to remove this discount entirely. We are undervalued, growth oriented, and shareholder focused. I can say that not only as the CEO, but also as a large shareholder myself.
This conversation with Mr. Bodouroglou was, by comparison of my previous discussions with him, a bit more difficult. Nobody likes to have their integrity questioned, whether it is business oriented or of a personal nature. As people we are innately defensive, intrinsically suspicious, and fundamentally self-protective. The second and third questions, as seen above, specifically challenged Mr. Bodouroglou's own instincts. He was responding to criticisms and doubts which cast accusatory implications upon himself and his companies; which, to most CEO's, are really one in the same. He is an executive, he is a leader, he is a shareholder, but he is also just a man. He is as human you or I, and he is therefore prone to emotional outbursts and inevitable frustrations. However, despite the challenges in those questions, his composure was never lost. His professionalism never abandoned him. His devotion shined through.
Some CEO's are as defensive of their companies as a mother is of her children. They defend it blindly even when they know they are wrong. They are handicapped by emotional delusion and restricted by unconditional love. Their reality is often distorted. At Paragon Shipping however there is no such phenomenon. Mr. Bodouroglou offered real, tangible, empirically based responses to moderately difficult questions. He admitted that, in hindsight, the company's market expectations failed to come to pass regarding the containerships, and that those flawed outlooks resulted in noteworthy challenges. He addressed the relationships between his entities, and he pointed out the missteps and the achievements equally. He presented realistic market analysis, and forecasted the future conservatively. Perhaps most importantly though, he offered insight, both as a reminder to some and as an introduction to others, as to the complications of corporate structure in the shipping world, and as to the relentless efforts required to mitigate poor decisions.
Lastly, Mr. Bodouroglou presented palpable reasons for investor support and considerations. The company continues to trade at a discount to net asset value, has growth oriented ambitions expected to result in increased earnings, and is determined to return to paying dividends to shareholders. All of these principles are further predicated on the fact that the company intends to carry this plan out amid tepid expectations; a return to historical averages (excluding peak years). To call these forward looking prospects fair and reasonable would be an understatement. It is clear that Mr. Bodouroglou's feet are firmly grounded in reality.
As stated at the beginning of this article, this is a follow up piece. I "followed-up" because I am an ardent advocate of the Seeking Alpha platform. I am a believer in crowd sourced research. I believe that there is value not only in the articles published by contributors, but also in the comments shared by readers. I believe that shareholders are entitled to having their questions answered, and I believe that if those questions are presented in a respectable and courteous nature, then it is my responsibility to procure the answers to those questions. I know that some readers will continue to challenge the answers provided, and that to others there will never be an answer which meets their expectations. Some people will simply always believe there is "more to it than that", but there are limits to information. In a world of supply and demand ratios, the demand (questions) will always be greater than the supply (answers). That is simply the world we live in. Inquisition is infinite, data is finite.
The dry bulk recovery is real. It may not happen tomorrow, as I have stated numerous times previously, but the trajectory is upward. It's true, the sector may never return to the awe inspiring levels of May 2008, but that doesn't mean there isn't value in certain companies from current levels. Paragon Shipping is currently trading for $5.70 per. That is a significant discount to net asset value, and forward looking expectations are indicative of both growth and income (share appreciation and future dividends). I believe this continues to be a strong entry point for new investors with a long term investment horizon, and as I have stated previously, I believe the downside to be limited. There are many questions which can be asked of Michael Bodouroglou and Paragon Shipping, but the most important one is this; is there value in the company today from current levels? The answer is undoubtedly yes. If prospective investors can focus on the successful navigation of challenges in recent years, as opposed to the challenges themselves, then they will see that an investment into Paragon Shipping is well worthy of consideration.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.