On July 2nd, a federal court issued its ruling on the Genco Shipping (GNKOQ) bankruptcy case. As I predicted in a previous SA article, the company was deemed insolvent despite the equity committee's objections. Large hedge funds had bought Genco stock at nearly $2 a share thinking they might be able to convince the judge that there was enough value in the company to provide a meaningful recovery for shareholders. However, the judge dismissed these optimistic projections as pure fantasy. The law is clear: under the absolute priority rule, if bondholders are impaired, shareholders don't deserve a dime.
Genco is what Eagle will look like in 3-6 months
The parallels between Eagle (NASDAQ:EGLE) and Genco are obvious. Both operate in an industry decimated by historically low shipping rates. These companies expanded their fleet at precisely the wrong time, just before demand plummeted in 2008. By one estimate, since 2008, industry capacity outgrew demand by a whopping 53% (source). Genco's ship-count now stands at 53; Eagle's at 45. Unfortunately, rates have never fully recovered and the companies have been spilling red ink ever since.
In the Genco case, the judge summed up nicely the difficult economic reality for shipping companies: "The industry is competitive, highly fragmented, and has low barriers to entry. There is little brand loyalty or other features to distinguish competitors. Because of this, the shipping industry is vulnerable to weak profits. When rates are attractive, investors can enter the market with relative ease, leading to increased supply that in turn forces chartering rates down. Thus, ship owners and operators struggle to consistently produce returns in excess of the cost of capital." I'm not saying these companies can't ever turn a profit, just not with the amount of the debt they currently have on the books.
The tough road ahead for Eagle
Both Genco and Eagle are over-levered companies that have defaulted on their unsustainable loan obligations. Luckily, both companies were blessed by patient lenders who afforded them time, by waiving covenants repeatedly and providing comically long extensions on interest payments. Eagle has now gotten its six or seventh stay of execution (it's hard to keep track). Just recently, Eagle essentially gave away 20% of the company in exchange for a short-term delay on their interest payments. Management is willing to print as many shares as they need in a desperate attempt to stave off bankruptcy. While Genco was able to reach an agreement with creditors over a prepackaged bankruptcy filing, Eagle is still holding out hope for some sort of distressed exchange.
Yet in all fairness, Eagle management isn't as delusional as Eagle shareholders (85% or so of the float is made up of retail investors). The company has repeatedly warned that their current shares are essentially worthlessness. From its 10-K: "it is expected that any Restructuring transaction would be substantially dilutive to the Company's current shareholders, driving down price per outstanding share substantially." Why shareholders don't listen is deeply perplexing to me! (A point echoed by Michael Cutlers in a recent SA article).
Is Eagle headed for bankruptcy court like Genco? Frankly, it doesn't matter. Whether it's a debt-for-equity agreement, a prepack bankruptcy or a Chapter 7 filing…the money isn't there. Some naive investors may think they are getting a $142 stock for the bargain price of $3. Well, news flash: the glory days of 2008 are long over. Doesn't matter how long you wait for a recovery, EGLE is headed for $0. Weak players like Excel Maritime Shipping (OTCPK:EXMCQ), Genco and Eagle - which all took on way more debt that they could handle - will leave shareholders with nothing. In fact, in Genco's case, management will end up with a bigger share of new equity than current shareholders. I fully expect the same thing to happen in Eagle's case.
Eagle is insolvent just like Genco
In its last quarterly filling, Genco listed assets of $2.9B. Turns out the bankruptcy court ruled their NAV was only $1.4B, well shy of the nearly $1.6B in debt it owed. Outcome: Genco shareholders are entitled to no recovery whatsoever. Now with Eagle, their balance sheet lists $1.7B in assets. Since the company has $1.2B in debt, it would appear on the surface that there's plenty of money left over for shareholders. Well, that's obviously not the case! Remember in the case of Genco, the judge agreed with the $1.4B valuation of the company, which is about 50 cents on the dollar. Using a similar ratio for Eagle gets you at a valuation of $0.8B or so. So shareholders are about $500M away from seeing a single penny!
Bankruptcy law favors bondholders
The law stipulates that in situation like Genco or Eagle, a wealth transfer must occur from shareholders to creditors, until every liability has been paid out in full. The creditors are first in line, and by the time the shareholders step up to get paid, there's going to be nothing left. The judge summed it up nicely: "the Court's conclusion [is] that Genco is insolvent and, therefore, the equity holders are not entitled to any recovery." Why Eagle shareholders expect a vastly more favorable outcome is a mystery.
The court even ruled that the Genco prepack bankruptcy plan was in fact overly generous, considering lenders were projected to only get between 80% and 90% on the dollar. Genco gave existing shareholders far-out-of-the-money warrants so they can eventually buy-back a potential 6% stake in the new company. The judge characterized those Genco warrants as a "gift from senior creditors". Of course, Eagle lenders may also feel bad for the poor stockholders and share some of their equity out of a sense of altruistic generosity! I guess that's what Eagle shareholders are clinging to.
The absurdity of the Genco equity committee
The judge cautioned about trusting the rosy pictures painted by stock analysts, "whom have an incentive to be unduly bullish because they are trying to sell securities in the shipping industry". The sad truth is that in the shipping industry, it's only the total resale value of your ships that matters. Some shareholders will argue that you should use cash flow valuation, or comparative multiples like EBITDA, or even book value, to estimate what the company is worth. Not so fast! Genco shareholders tried that in court and the judge dismissed the idea outright: "the DCF analysis is not an appropriate method of valuation, largely due to the highly speculative nature of rate projections for the dry bulk shipping industry".
The equity committee hired an unknown analyst to testify that Genco might be worth as much as $467M to shareholders. The "expert" witness talked about a long-expected recovery in shipping rates that would lavish bulk shippers in additional revenue. (I use 'expert' in quotation marks because the 3 hedge funds on the equity committee had hired Morten Arntzen, of CMG. The judge had a field day with him: "CMG was formed just a few weeks prior to the hearing [and] Mr. Arntzen has never previously been paid for his rate forecasts. […] It is not clear from Mr. Arntzen's testimony exactly the nature of CMG's services. Thus, Mr. Arntzen's actual analysis doe s not provide much more information than a court could itself discern". Evidently, Mr. Arntzen is the best witness the hedge funds could come up with!)
Are Eagle shareholders willing to put their money where their mouth is?
The equity committee tried to convince the judge that Genco was worth way more than its liabilities; which would entitle shareholders to a piece of the pie (i.e. creditors aren't legally entitled to more than a 100% recovery - any leftovers must return to shareholders). So the judge said 'fine', if you really think Genco is worth that much, would you be willing to buy it right now at that price? At that moment, all the big hedge funds in the room pretended to have left their wallets at home. The judge harped repeatedly on that fact:
- "The Court finds it telling that no equity holder, including large hedge funds on the Equity Committee, has expressed any interest in investing its own money in a transaction involving the Debtors."
- "It was meaningful that no members of the Equity Committee were prepared to invest their own money into the Debtors at prices within the valuation range advanced."
- "There has been no inquiry or expression of interest by any other party about buying Genco, including from any of the equity holders."
- "Difficult to establish credibility in [a] valuation fight if [the equity holders are] unwilling to 'buy into' [the] capital structure at a higher valuation post-emergence."
- "Thus, although equity holders are not required to put up any money, the Debtors' views on value are supported by the lack of interest in the Debtors' assets by equity holders and the market."
Why Eagle's stock is still overpriced
Not convinced? In the Genco decision, the court quoted estimates from the website VesselsValue.com. Luckily VesselsValue.com also offers such an estimate for Eagle. The fleet is worth less than $1B ($951M to be precise - source:). Since the company has $1.3B in debt, it's still not enough to justify any type of distribution to EGLE shareholders. Case closed.
Disclosure: The author is short EGLE, GNKOQ. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has no business relationship with any company whose stock is mentioned in this article. The author is long SEA.
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