TOP Ships: A Deep Out of the Money Call Option of Debatable Duration

| About: TOP Ships (TOPS)

The bulk and tanker market is depressed and eventually it will be a good time to snap up cheap operators.

TOP Ships (NASDAQ:TOPS) is a deep out of the money call option on the product tanker market and bulk panamax market. If offers tremendous upside due to its high market exposure per USD share investment and the downside is naturally limited to zero. The problem is - the duration is questionable.

NAV model and conclusions

I have calculated TOPS' current NAV by taking the market value of the ships + value of long term bareboat charters + other assets - debt - other liabilities. The amount is roughly in line with the current market cap of 27 mln USD. There is significant uncertainty to this number as it is the difference between large numbers being ship values of about 378 and debt of 350. So a 10% variance in the ship value leads to a +100% change in the NAV.

This also means the Value to Loan is about 108%.

The obvious conclusion is that TOPS is priced correctly. However, the return picture is completely asymmetric. If long term charter rates return to their historic average of 22000 USD for product tankers and there are similar changes in the bulk market over a 2-3 year period, you will be looking at a return of at least 500%. If rates fall further you are limited to your investment. This gives the debt a certain value to the equity holders.

If this was it I would be ready to take risk and sit back and see how things turned out. It is not as I will show in the cash flow model below.

Cash flow model and conclusions

I have tried to built a 2010 - 2018 cash flow model for TOPS to understand how the company will fare under various changes to the key input variables:

  • Tanker spot and forward rates (product tankers to be specific)
  • Bulker spot and forward rates (panamax, handymax and supramax)

They are all important factors but TOPS will in 2011 have a cash flow of about 29.4 mln USD ex debt repayment. It, however, needs to repay 37.88 mln USD as per the loan repayment schedules. As it has no cash this is impossible. Only very extremely unlikely changes to spot rates and LIBOR can alter this.

With forward rates as they are now TOPS will not be able to reach its repayment schedule in each of the 9 years.

So what happens now with regards to financing?

The company already is in covenant breach on all its loan agreements and has been for a long time. It works with 5 lenders and this is how they are acting and how I think they will act:

RBS (RBS.L) - It seems like RBS forced TOPS to sell Dauntless. Perhaps this is the most aggressive of the 5.

HSH and DVB (DVB.F) - they appear cooperative but I'm not sure this will last. They may not have the willingness to take the ships on their books through a forced liquidation of TOPS.

Alpha and Emporiki - I am rather confident they prefer to extent and pretend as I speculate they have stretched loan books.

The potential outcome from this:

A: If the banks force a bankruptcy onto TOPS and they get the ships on their books. This may turn out alright for them but the risk is that it will already be too late before they are actually in a position to sell them and that this will force them to record losses.

B: They somehow keep TOPS going by amending the repayment schedule while enjoying the fat margins put in place after the covenant breaches. The problem with this solution is that should shipping markets recover it will still give the banks an opportunity to force a bankruptcy on TOPS on the way up where they actually can sell the ships for more than the outstanding principal

C: Variations to above; changes to the margin on the loans.

All of this of cause depends on the specific loan agreements that I haven't seen.

We haven't seen that many of scenario A take place but B may still happen. It would be a sign of confidence from the banks if it was to pass.

Supply / demand

The current analysis of supply and demand makes for depressing reading. It is easy to focus on the large order books. They are very specific as you can count and calculate percentages per year and ship type. It is very convincing.

The demand side is much harder to quantify. Future GDP growth and its translation to shipping demand, changes in trade routes, congestion, unrest on key shipping routes, changes in floating storage. You can make calculation based on assumptions but it is not convincing in an environment when most of us are still fearful even though we rationally still reason that world GDP and trade will be much larger in say, 2015 or 2020, than it is now.

I can't claim to know when it will turn but I think it is worth keeping in mind that it is much easier to make the bearish arguments.


I think the tank and bulk market will eventually come back to a normal level where there is balance between new building prices and earnings. After all demand is still growing and as ships age they are scrapped. Timing is, however, very hard as above analysis shows so a prudent approach would be to allocate very small amounts, say every 6 months, and if TOPS goes bankrupt then look for a similar leveraged player.

A short term timing opportunity may be to wait for TOPS to do a reverse split to go above the 1 USD listing requirement, which usually leads to a fall in the share price relative to the pre slit price and then get in.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in TOPS over the next 72 hours.