Company and Capital Structure Overview
Eagle Bulk Shipping, Inc. (NASDAQ:EGLE) is an owner of 45 dry bulk vessels with a focus on the Handymax (35k-60k dwt) sector in the dry bulk industry, with particular emphasis on Supramax (50k-60k dwt) vessels. The company was formed in 2005 by the Chairman and CEO, Sophocles Zoullas, and Kelso & Co. In 2007, the company began a significant expansion and newbuilding program and contracted for the construction of 35 vessels. The newbuild program concluded in 2012 with the majority of the funding coming from the company's credit facility. On average, the company's vessels are 6.9 years old.
The company's capital structure is very simple and includes a senior secured term loan with a $1,129 million cash-pay tranche and $52 million tranche that represents accumulated PIK-interest. The loan is priced at L+350 with an additional 250bps of PIK interest. The financial covenants include an interest coverage covenant, a maximum leverage covenant and a minimum liquidity covenant. The company was in violation of the covenants as of Dec. 31, 2013, and March 31, 2014, and is unlikely to be in compliance with the covenants throughout 2014.
Additionally, Eagle skipped an interest payment at the end of June. Eagle has been operating under a waiver and forbearance agreement since March and will likely file for Chapter 11 bankruptcy protection in the Southern District of New York in the next few weeks in order to restructure its balance sheet. The first version of the waiver and forbearance agreement required that the company execute a binding restructuring support agreement (RSA) with its lenders by April 15, 2014; however, that date has been extended several times in order to observe the outcome of the Genco Shipping and Trading Ltd. (GNKOQ) bankruptcy.
The current date to finalize the agreement is July 15, 2014. Total leverage is approximately 124% on a loan-to-value basis and 17.4x LTM EBITDA. Based on the signature blocks to the waiver and forbearance agreement, the majority of the loans are held by distressed hedge funds, including: Oaktree Capital Management, Davidson Kempner, Canyon Capital, Brigade Capital Management, Onex Credit Partners, Panning Capital Management and the Merrill Lynch and Goldman Sachs distressed debt desks.
Potential Restructuring Transaction
Although other outcomes are possible, Eagle seems to be headed for a Chapter 11 bankruptcy restructuring in the near-term. The company missed an interest payment, is in violation of its loan covenants, its loans are held by distressed debt investors that traditionally buy distressed debt in order to take control of companies and according to press reports, the company and the lenders hired bankruptcy and restructuring professionals several months ago. A transaction that does not involve a restructuring would require substantial new equity capital from investors or an improbable act of kindness from the lenders to the shareholders. Therefore, the best way to value the company is based on the Genco bankruptcy precedent.
Genco Valuation and Court Ruling
The main economic dispute in the Genco bankruptcy was the proper methodology to value a dry bulk shipping company that is primarily a tonnage provider and not an integrated operator. The company and its advisor, Blackstone, stated in the Coleman Declaration that the best methodology to value a dry bulk shipping company would be to calculate the net asset value (NAV), which is the appraised value of the fleet combined with cash, net working capital and the value of equity investments. Blackstone also stated that it used other methodologies (e.g., comparable public company, DCF, precedent transactions) to confirm the NAV valuation, but did not find any of the analyses to be reliable independently. Under the NAV methodology, the equity was approximately $87 million out-of-the-money -- or approximately 7% of the fleet value component of NAV.
The equity committee advisor, Rothschild, argued in the Augustine Declaration that the valuation should be based on all of the valuation methodologies rather than just the NAV valuation. Using these methodologies, the equity committee argued that the equity was worth $282 million or approximately $6.40 per share. In order to come to this conclusion, the equity committee used unusual weightings of the different methodologies and created its own set of projections that were more optimistic than the debtors' projections.
On July 2, 2014, Judge Lane ruled against the equity committee in his Memorandum Opinion on Confirmation Issues. The Court ruled that the NAV is a reasonable analysis and that the comparable company analysis was equally useful. He said that the precedent transaction analysis had limited utility and that the DCF analysis is not an appropriate method of valuation for shipping companies. In regard to the comparable company analysis, the Judge ruled that some adjustment for vessel age is appropriate.
The Genco shareholders are due to receive warrants that represent 6% ownership in the restructured company. Blackstone valued the warrants at approximately $33 million, or $0.75 per share. The warrant value and current share price are substantially less than the share price at filing and the value that the equity committee argued for.
Using the Judge's framework from the Genco ruling does not yield positive results for Eagle's shareholders. Based on Vesselsvalue.com, the value of the Eagle fleet is approximately $953 million. The valuation in the most recent 10-K was $981 million. Vesselsvalue.com is normally conservative, so we can assume the value of the Eagle fleet is between $950 million and $1,050 million. This range of fleet valuation yields a distributable value of $977 to $1,077 million. In order for the equity to be in-the-money, the value of the fleet would need to be approximately 15% higher than the midpoint ($1,000 million) or $1,155 million. A valuation that equates to $1.00 or $2.00 per share is significantly higher than the fleet value.
Using a comparable company analysis (includes Baltic Trading, Diana Shipping, Paragon Shipping, Safe Bulkers and Star Bulk Carriers), an appropriate range of multiples on 2015E EBITDA is between 6.0x and 8.0x before adjusting for vessel age, vessel type mix, above market charters and newbuild commitments. Enterprise value to Fleet Value would range from 0.92x-1.49x based on Vesselsvalue.com valuations. Using these multiples to Eagle's 2015E EBITDA of $146 million (source: CapitalIQ) and fleet value of $953 million, the equity would still be out-of-the-money, although it would be a much closer call than the NAV analysis.
Conclusion and Trading Opportunity
Based on the valuation analyses, it is safe to say that the only recovery Eagle shareholders will receive will be a gift from the lenders. A small gift would likely make the bankruptcy case more efficient and build goodwill with the board, management team and Judge, especially since the Genco shareholders received a recovery. Given that Genco equity was closer to in-the-money based on the NAV analysis, the most shareholders should expect would be comparable to the Genco shareholder recovery of $33 million. $33 million would represent $2.00 per share.
Although it is possible, Eagle shareholders do not receive a recovery (and are unlikely to be entitled to a recovery), I would expect a recovery between $1.00 and $2.00 per share in the form of a warrant. Optimism for an equity committee and a better outcome than Genco is misplaced. Unless vessel values or freight rates begin to rise substantially in the near term, no institutional investor or reputable bankruptcy professional is likely to join/represent an equity committee in a valuation fight or contested confirmation.
Based on current option pricing, an investor could write September calls and purchase August (or July if you want to be more aggressive on timing) puts that provide a substantial payoff if the stock trades down to the recovery value after the RSA is announced. The spreads could be designed for no initial cash outlay or a small credit or debit balance. Different combinations may be attractive to different investors. Shorting the stock could prove profitable also; however, the borrow is likely expensive. The company is required to come to an agreement with the lenders on an RSA by July 15, 2014. The RSA will include information about the equity recovery, if any.
Disclosure: The author is short EGLE. 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.
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