Setting the Record Straight on Eagle Bulk Shipping
Many people were surprised when Eagle Bulk Shipping (NASDAQ:EGLE) announced on June 20 that it had managed to restructure its debt, as the company seemed headed towards bankruptcy. Still, the market hasn't reacted positively to the news; the company's share price still hovers around the $3 range it traded in before the announcement. In this article, I will take a closer look at Eagle's restructured debt and will explain why there is little to no value left in this stock. I have two main points to get across: first, the company's debt burden is likely to absorb the entirety of the fleet's future earnings, leaving nothing remaining for shareholders. Secondly, should the company ever manage to make a profit, it is unlikely that shareholders will ever see any of it, since management has a history of acting aggressively for their own interests instead of the interests of the stockholders they are supposed to represent.
Interpreting the New Debt Structure
The terms of the deal are somewhat complicated, so let's go through them one at a time.
$1,129,478,742 presently outstanding under the existing revolver will convert into a term loan, with a maturity set to December 31, 2015. Subject to certain conditions, the amendment provides an option to the Company to extend the maturity date an additional 18 months to June 30, 2017.
Comment: Before this deal, the company had been on the brink of bankruptcy. Eagle's liabilities exceeded the value of its fleet ($966m, by my estimates), and it was barely able to pay the interest on its debt, much less pay down principal. Under normal circumstances, the company probably would have been pushed into bankruptcy and had its ships sold off, but this is an exceptional market. At today's vessel prices, the lenders won't recoup their investment by selling the fleet, and they are reluctant to take a write-down to their balance sheet. So instead of forcing Eagle into bankruptcy, they have allowed it to continue operating and taken control of the company and its earnings. This includes taking 20% of the common stock.
Eagle Bulk will receive a new liquidity facility in the aggregate amount of $20,000,000. The amendment requires no fixed repayments of principal until maturity, and is subject to a quarterly sweep of cash in excess of $20,000,000.
Comment: Why would a bank give them more cash when they're already losing money? Note that the bank has claimed all of the company's earnings for the next couple of years. This isn't a life raft but life-support, intended to keep the patient's body alive until its organs can be harvested.
All amounts presently outstanding under the existing credit agreement will bear interest at LIBOR plus a cash margin of 3.50% and a payment-in-kind ("PIK") margin of 2.50%. This aggregate margin can be reduced if Company leverage is lowered.
Comment: This is where the loan gets a little bit complicated, but we'll work through it. In a PIK loan, interest isn't paid immediately but is tacked on at the end. In other words, the company is going to pay 6% interest over LIBOR (1-yr LIBOR is currently at 1.05%). So the company has to pay 2.5% interest every year, and an additional 3.5% which will accumulate until the end of 2015/2017.
Now 7.05% interest on $1,129m means $80m a year in interest payments, which greatly exceeds Eagle's operating income of $47.16m for the trailing twelve months. In all likelihood, the company isn't going to be able to pay this rate of interest, so the bank has given them the option to convert this interest into interest-bearing preferred shares-in other words, the company can convert its interest into further debt. If this debt can't be paid off by 2020, the company can pay the bank by converting its preferred shares into more common stock. Long story short, there are 0 odds that this company will be profitable. This is all window dressing. The bank doesn't want to take a write down on the company, so it is piling on interest and taking stock, firming up their control over a corpse.
Is there any chance, even remote, that the company will ever generate a profit? Let's consider your usual shipping scenario. Typically, a vessel will generate handsome earnings for about 25 years, but most of those years of earnings don't belong to the ship's operators but to the lenders who financed the cost of purchasing the ship. The ship's operators only receive their share of the profit in the final golden years of a ship's operating life once its earnings have finally paid for its original operating cost.
So how many golden years can we expect will remain for Eagle's fleet? Its ships are already six years old on average, and yet the company has made little progress towards paying back their acquisition cost. The next three to five years, too, will be consumed by high interest payments, which will leave it with only about 15 years left. Even that small window can't be counted on: vessel values will have to dramatically improve before the end of 2017 if Eagle is going to escape its bondage to its lenders. So even in this optimistic scenario, Eagle will never generate more than a pittance for its owners.
Who Really Owns the Company?
I mentioned in my previous article that Eagle's management has a terrible reputation, and that a shareholder suit had been filed against them, alleging that the company has been operating for the benefit of management instead of shareholders. The directors have paid themselves tens of millions of dollars, even as the company has defaulted on its debt payments; there has been a suspicious arrangement where Delphin Shipping, the CEO's private company, has utilized Eagle's logistics services at low cost; and the company has suspiciously switched auditors last year. But now the situation has gotten much worse: on June 28, the company reported to the SEC that the company had awarded CEO Sophocles Zoullas 1,000,000 shares, and had awarded 400,000 shares to his brother Alexis Zoullas. Included in the report was a note stating that these awards will be the first of four annual installments. That's right, the CEO is granting himself and his son 5.6m shares, equal to 36% of the company.
How is this possible? On Nov. 17, 2011, shareholders approved an equity incentive plan that allowed management to be awarded up to 5.6m shares over a four-year period. Hidden deep within the 50-page plan was a clause stating that this amount of 5.6 million isn't to be adjusted in the event of a reverse stock split, such as the 4:1 split that occurred on May 23. We can only assume that shareholders were unaware that they were handing over the company when they signed off on the plan.
This company has nothing left for shareholders. The debt refinancing plan wasn't a magnanimous gesture by the banks, but a way for them to keep the company alive so they don't have to take a write-down on their balance sheet. This situation benefits management and the banks, but it does nothing for the common stockholder. Unless a dramatic market recovery occurs, Eagle will probably never escape this situation; if it does escape, it will probably never generate a profit; and any profit it makes will probably be siphoned off by management. With the company's poor balance sheet and reputation, it is unlikely to ever secure the funds necessary for future growth. It should come as no surprise that the CEO has been selling shares, and that the CFO stepped down a few weeks ago. The carrion are gathering around this company; if you're looking to buy a battered-down shipping stock, there are many others to choose from.
8/9/2012 update: On this morning's conference call, management stated that the stock options will be granted on a split-adjusted basis, despite the provision in the equity incentive plan. This will bring management compensation to 1.6m shares, not 5.6m.
Disclosure: I am short EGLE.