Euroseas: Value With Pittas Family Insider Dealing?

Jul. 2.12 | About: Euroseas Ltd. (ESEA)

I wrote a quick analysis of Euroseas (NASDAQ:ESEA) back in April with an argument that ESEA was worth approximately $3.56/share in market-adjusted book value, backed by a strong current ratio of 1.9 and operating cash flows of approximately $15M. I pointed out two huge pitfalls for the stock- a shelf registration for up to $400M of equity and massive sales (in relation to daily volume) by an insider.

Although no additional equity was needed, in late May, ESEA pursued a rights offering to sell up to 13.85M shares at $1.10- at 31% of market-adjusted book! The details of the rights offering can be viewed in a Euroseas Webcast.

Rights Offering Results

The results were posted on June 19th; the offering was reportedly over-subscribed and $14.9M in cash was raised. The Pittas Family "Friends Investment Company" fully subscribed in advance to the Rights Offering and they also over-subscribed to take shares that were not utilized by other shareholders. (Page 8 of this presentation announces full intent to subscribe and take oversubscription allotment)

According to a June 28 SEC filing, Friends increased their share of ESEA approximately 20.3M shares of a new 45M float - to 45%. Friends Investment Company is now very close to full control over Euroseas!

Implications:

Many Greek shipping companies have had issues with insider dealings, most notably Dryships (NASDAQ:DRYS) through sales and purchases with related parties to include last year's Ocean Freight (NASDAQ:OCNF) takeover. Other companies such as Paragon Shipping (PRGN) use related parties to process ship management, often throwing a 5% commission 'bonus' to insiders.

These insider maneuvers are easiest when the controlling parties own a large portion of the shares. Euroseas has long used Eurobulk Ltd. to manage the fleet. Eurobulk is a shell company owned by the Pittas Family and other partners and earns 10% of Euroseas revenue. With Pittas et al back in control, I expect these transactions to continue.

With Euroseas still trading, even after massive dilution, below 50% of its adjusted market value, I would not be surprised to see these Rights Offerings continue.

Balance Sheet:

  • $54.4M in cash and other liquid assets vs. $18.7M in current liabilities: current ratio of 2.91.

  • $58.1M in total cash and liquid assets to cover $18.7 in current liabilities and $60.7M long-term liabilities -- $21.3M in net debt covered by book valued vessels of $219.8M and $16.5M invested in Euromar.

Fleet Valuation:

  • Panamax (4 @ 12, 15, 19, & 24 yrs): 15.4 + 12.3 + 8.2 + 5.6 = 41.5M

  • Handymax (1 @ 14 yrs): 11.6M

  • Handysize Container (4 @ 18y avg + 3 @ 21y avg): 34.2M

  • Intermediate Container (3 @ 16y avg): 27M

  • Core Fleet Valuation: $114.3M vs. book carrying value of 219.8M (52% of actual book)

Equity Discount:

With a market-valued fleet of $114.3M and $16.5M Euromar investment to cover net debt of $21.3M, Euroseas has an adjusted equity valuation of $109.5M (compared to book equity of $216M) or approximately $2.43 per share. If ESEA traded at market value, even after massive dilution, there is still 127% of upside.

Cash Flow:

In 2011, Euroseas produced operating cash flows of $17M, offset by $13.47M in loan repayments and $8.44M in dividends paid.

In Q1-2012, Euroseas produced approximately $4M of OCF, and I predict approximately $14.5M for 2012.

Investment Approach

I have recommended Euroseas as a buy for several months. This recent Rights Offering has shaken my confidence in the fairness of the management. Obviously, through publicly available ownership information, the Pittas Family believes in the value of Euroseas, and I do as well. However, will ESEA deliver before the value is siphoned off through "management fees" and other insider-type transactions?

I believe that ESEA is worth purchasing for anywhere under $2, but only combined with a portfolio of shipping stocks. There are too many unknowns for this to be a major staple of any portfolio. If you are looking for a solid shipping investment and can only choose one stock, Diana Shipping (NYSE:DSX) is the best bet in my opinion.

Disclosure: I am long ESEA, DRYS, PRGN, DSX.