Navios Maritime Holdings, Inc. (NYSE:NM) is a financially troubled microcap that is extremely risky as an investment or trade. It is the parent company of Navios Maritime Partners (NMM), Navios Maritime Acquisition (NNA), Navios Maritime Containers LP (NMCI) and Navios South American Logistics (NSAL), a privately held company. Prior articles analyzing NM are available here and are a must-read primer to understand the following analysis. Navios has an outstanding Tender Offer for its Series G (NM.PG) and H (NM.PH) Preferred Stocks. The Tender Offer is analyzed in detail here.
NM announced on February 4th that it was increasing the TO prices on the Series G and H Preferred and extending the Tender Period to February 15th. The increase was necessitated by the tepid response to the initial TO of 29.61% and 23.26% for the Series G and H, respectively. The article referenced above should be reviewed to understand the terms of the original offer, particularly the implications of a successful Consent Solicitation that would strip the remaining Preferred of their protective covenants and render them worthless.
For shares of Series G ADS surrendered, the Company is offering:
- $7.25 in cash and/or
- $8.28 principal amount of the Notes
- The revised consideration represents an increase of (1) $2.42 per share in cash and (2) $2.76 per share in Notes.
For shares of Series H ADS surrendered, the Company is offering:
- $7.16 in cash and/or
- $8.19 principal amount of the Notes
- The revised consideration represents an increase of (1) $2.39 per share in cash and (2) $2.73 per share in Notes.
As presented in the table below, the estimated fair value of the modified offer, assuming the Minimum tender amount is received and the Solicitation is successful, is less than $4 for both the Series G and H in comparison with the $6 closing prices on February 8th for both series. To review the conclusions of the prior article regarding the first TO:
- A successful Solicitation renders the 1/3 of the outstanding shares worthless.
- The Cash portion of the TO is only available for 50% of the shares.
- NM is likely to default prior to the maturity of the 2024 Notes offered as compensation for 16.67% of the shares tendered. The valuation therefore only includes the Present Value of a partial coupon payment on April 15th, 2019, and five semiannual payments prior to the January 15th, 2022, Maturity of the Ship Mortgage Notes. The PV of the interest payments is calculated using a discount rate of 20% since the Senior Secured Notes, which would be senior to the 2024 Notes, are currently trading at a cash interest yield of over 16%.
Based on the projection of Ending Cash Balance for Q1 2019 provided below, the assumption of more than the first partial interest payment on April 15th being received may be generous.
|Maximum||Cash Cap||Cash Tender||Total||Shares Paid||Note Tender||Total|
|Shares Tendered||Share Limit||Price||Cash Tender||W/ Notes||Price||Note Tender|
|Series G||Series H|
|2024 Notes||$364,770||2024 Notes||$727,699|
|Remaining Preferred||$-||Remaining Preferred||0|
|Total Value||$5,509,207||Total Value||$10,970,537|
|Current Shares O/S||$1,419,155||Current Shares O/S||2,861,128|
|Value per Share||$3.88||Value per Share||$3.83|
The valuation in the table above is predicated on the assumption that all 100% of the Series G and H is tendered. This, of course, is a highly unlikely event. The actual participation will fall well below that level. If 50% or less of both the Series G and H is tendered, the tendered shares would receive 100% cash, or $7.25 and $7.16, respectively, for Series G and H, assuming that NM would close the TO despite the Solicitation not succeeding. At any tender rate over 50%, a combination of cash and notes would be received, and at any tender rate over 66 2/3%, the tendered shares accepted for repurchase would be prorated. The financial benefit for tendering shares, therefore, steadily decreases as the participation rate rises above 50%.
Ship Note Pricing Is a Warning Flag
On February 8, the 7 3/8% Ship Mortgage Notes Due January 15, 2022, traded as low as 54.274% of Par. The cash yield on the Ship Notes is therefore 13.61%, and the Yield to Maturity is 32.85%. The calculation of the YTM assumes that the face value of the debt is repaid at maturity, and this is likely a flawed assumption.
The Ship Notes hit a 52-week high of approximately 85% of Par during August 2018, when dry bulk rates were at their yearly highs. The Ship Notes declined steadily until the release of Q3 earnings in November 2018. From the release of Q3 earnings to February 8th, 2019, the Ship Notes plunged in almost a straight line from approximately 75% of Par to a low of 52.27% of Par. The selloff mirrored the steady decline in the Baltic Dry Index, but it was also triggered by the market's realization that Q3 dry bulk rates, which were reasonably good, were going to be insufficient to prevent an eventual default on the Ship Notes at maturity.
The precipitous decline in the market value of the notes is a reflection of the dramatic increase in the perception of default risk by the bondholders. The decline has been exacerbated by the dramatic decline in dry bulk rates YTD 2019 (discussed further below). Given NM's parlous financial condition, a sustained decline in dry bulk rates during Q1 2019 would push NM close to the edge of default, with the coupon payments on the Ship Notes and Senior Secured Notes due early in Q3 looking like an insurmountable hurdle barring a continued liquidation of vessels.
Baltic Dry Bulk Rates Collapse
The following table compares current Baltic Dry Bulk rates with year-ago levels. There is a tendency to dismiss the current decline as seasonal due to the celebration of the Lunar New Year in Asia, China specifically. Lunar New Year was February 5th this year compared with February 16th during 2018. There is a small divergence in the timing of Lunar New Year on a year-over-year basis, but this likely does not account for the dramatic difference in year-over-year dry bulk rates.
Perhaps there has been a negative impact on Capesize rates due to the tragic tailings dam collapse at a Vale mine and the subsequent curtailment of production at other Vale mines. In many of the articles I have published beginning December 2018, I expressed concerns about the economy during Q1 2019. There is something more than seasonal fluctuations and mine curtailment impacting dry bulk rates. If the economy is slowing and the decline in bulk rates turns out to be more than a 7 or 8 week blip, this will be an existential threat to NM.
|Baltic Dry Bulk Indices Comparison|
In "Fleet and SOTP Valuation Makes for Grim Holiday Reading", I provided the following projection of Cash Available for Principal Payments and CapEx (DD/SS).
|OpEx + G&A||$48.91|
|Cash Interest Expense||$88.82|
|NMM Cash Dist||$2.73|
|Less: Environmental Fine||$(2.00)|
|Cash Available for Principal Pmt, CapEx||$37.68|
The projections were based on the following estimates of TCEs for the various vessel classes owned by NM. A comparison with current TC Average rates at February 1st from a research piece by Banchero is provided.
|2/1/19 TC Avg.||Estimates|
To put these numbers in context, the quarterly cash flow available for principal payments and CapEx would equal approximately $9.4 million. Quarterly principal payments are projected at approximately $4 million. Disregarding Dry Dock/Special Survey costs, CapEx below $500k per quarter is unsustainable. That implies that Free Cash Flow after principal payments and CapEx would be less than $5 million. With 35 vessels in the fleet, if average TCs are $2,000 per vessel below model estimates, cash flow would decline by approximately $6 million per quarter and push NM into quarterly negative cash flow. Q1 to date, average TCs have been well below the model assumption. If this is sustained through the end of the quarter, NM's negative cash flow could easily exceed $10 million. Even assuming a reasonable bounce back in dry bulk rates post Lunar New Year, the range of negative cash flow during Q1 is likely to be $5 to $10 million.
NM's Liquidity Crisis
Assuming the Minimum tender threshold of 66 2/3% is achieved, the revision in the TO discussed above raises the cash portion of the compensation to $15.387 million. This is an issue because NM will run out of cash by the end of Q1 2019, particularly if dry bulk rates stay at levels more than $2,000 per day below the rates assumed for the NM 2019 projections discussed above, barring the continued liquidation of assets.
In "Analysis of Q3 Earnings", I provided an estimated range of Q4 ending Unrestricted Cash of $52 to $58 million prior to changes in Working Capital. This estimate is for the Dry Bulk Operations, i.e. NSAL is unconsolidated from the NM Balance Sheet. Given the web of intercompany accounts, NM could delay payments to affiliates or accelerate payments from affiliates to bump this number higher. For the following analysis, Q4 Unrestricted Cash is assumed at $60 million (to provide a bit of an analytical buffer.)
|Q1 Ending Cash Balance Projection|
|Projected Cash @ Q4 2018||$60.0|
|Ship Note & Senior Secured Coupon Pmts During Q1||$40.0|
|Tender Offer Cash Payment - 66 2/3% Series G and H tendered||$15.4|
|Credit Facility Prin Pmts||$4.0|
|CFFO before WC Changes Q1||$-|
|Projected Cash @ Q1 2019||$(1.9)|
Please note that CFFO before WC Changes of $0 is a very generous assumption based on the quarter to date dry bulk rates. Barring a meaningful recovery in rates, CFFO before WC Changes is more likely to range between a negative $5 and $10 million. Please also note that proceeds from the sale of vessels would need to mostly be used to repay the debt associated with the vessel prior to any remaining proceeds being available for general corporate purposes, such as buying back Preferred. Finally, the Credit Facilities require the maintenance of a Minimum Liquidity level of $30 million for the Dry Bulk Operations (reminder, this is after NSAL has been unconsolidated). As detailed in the table, NM is going to fail the Minimum Liquidity covenant test during Q1 2019.
Series G and H Preferred Repurchase Will Fail Restricted Payment Requirements
A repurchase of the Series G and H Preferred meets the definition of a Restricted Payment under Section 4.11 of the Indenture for the Ship Notes. The following are the excerpts that directly pertain to the contemplated Preferred Stock repurchase and the limitations on exercising such a repurchase.
(a) The Company shall not, and shall not permit any of its Restricted Subsidiaries to, directly or indirectly:
(ii) purchase, redeem or otherwise acquire or retire for value (including, without limitation, in connection with any merger or consolidation) any Equity Interests of the Company or any direct or indirect parent of the Company;
(all such payments and other actions set forth in clauses (i) through (iv) above being collectively referred to as "Restricted Payments"), unless, at the time of and after giving effect to such Restricted Payment:
(1) no Default or Event of Default shall have occurred and be continuing or would occur as a consequence of such Restricted Payment;
The Definition of Default is contained in Section 1.01 of the Indenture:
"Default" means any event that is, or with the passage of time or the giving of notice or both would be, an Event of Default.
The language on Events of Default is contained in Section 6.01, and a default under the Financial Covenants of the Credit Facility that would remain uncured would result in the acceleration of the debt and qualify as an Event of Default. NM has been in default under its Credit Facilities for the 5 quarters ending December 31, 2018, but obtained a waiver from the creditors to cure the default. This disclosure language was included in the Q3 Financial Statements:
Certain covenants in our senior secured credit facilities have been amended for a specific period of time up to a maximum of one quarter (from the current balance sheet date) to increase the covenant levels for the applicable net total debt divided by total assets maintenance covenants, as defined in each senior secured credit facility, to a maximum of 85% to 90%.
The waiver under the Credit Facilities expired on December 31st, 2018. At that balance sheet date, NM would need to pass the net total debt divided by total assets ratio of 75% under a Credit Facility to avoid a continued default. This would be measured using the Equity Method of accounting for NSAL, which is consolidated for GAAP accounting purposes in the Financial Statements. For the Nine Months Ended Q3 2018, NM had incurred losses of $74.1 million for the Dry Bulk Operations (NSAL is unconsolidated and recorded using the Equity Method to calculate Dry Bulk Operations earnings), so NM is unlikely to have cured the Net Liabilities to Net Asset covenant test failure.
In addition, as detailed in the table above, NM would fail the Minimum Liquidity covenant test during Q1 2019 with or without the TO closing, barring significant asset sales or an injection of capital. I consider it highly unlikely that the CF creditors will provide NM with another waiver that would allow NM to execute the TO for the Series G and H Preferred, particularly given the existential crisis that NM will suffer due to a prolonged decline in dry bulk rates.
Please note that the majority of the cash on NM's Consolidated Balance Sheet is at the NSAL level. NSAL has its own Restricted Payments language in Section 4.11 of its Debt Indentures that severely limits its ability to pay a dividend to its shareholders. I have a draft of an article that details this limitation that will be published prior to NM's release of earnings.
In summary, it is highly questionable whether NM can execute the TO without pulling a very big rabbit out of a very big stovepipe hat. I remain puzzled why NM continues to pursue this gambit and Preferred investors need to recognize the risk that the TO may not be executed or, if it is, that they will be exposed to a clawback if NM files for Bankruptcy.
Bankruptcy Clawback Period and Its Impact on the TO
The Ship Mortgage Notes were issued by a subsidiary incorporated in Delaware, so an NM bankruptcy would be adjudicated in a US Bankruptcy court under Federal Bankruptcy Law. Payments to creditors prior to a bankruptcy are subject to a 90-day clawback period, i.e. the creditors that received the payment would need to reimburse the payment of the bankruptcy estate so that the money could be properly distributed to all creditors on the basis of seniority and on a pro rata basis. There are similar constraints regarding payments to equity investors, including the repurchase of equity prior to a bankruptcy.
The clawback period for equity investors, preferred or common, who received dividends or had their equity securities repurchased by the bankrupt entity could be up to 2 years if the repurchase leaves the company without adequate capital or the securities exchanged for the cash are considered to be of little or no value, and the transaction is treated as a fraudulent conveyance (this is a bankruptcy term of art and not a violation of a criminal statute).
This may seem esoteric, but it is a real risk, given the demonstrable shortfall in the value of NM's assets to its current outstanding debt. This is examined in detail in "Fleet and SOTP Valuation Makes for Grim Holiday Reading". NM's liabilities are estimated to be over $300 million in excess of assets. This would meet the definition of inadequate capital. In a bankruptcy process, NM would not be able to dictate an estimate of the market value of its assets. The creditors would present their own estimate, and it would likely be difficult for NM to win this argument based on current facts.
As discussed above, the payment of approximately $15.4 million of cash in the instance of 50% of the Series G and H Preferred being tendered would plunge NM into a clearly identifiable liquidity crisis. It would also support a creditor argument that NM was inadequately capitalized at the time of the TO. Please also note that the need for a waiver for failure of financial covenant tests for a period of 5 quarters (and perhaps longer) under the Credit Facilities provides further evidence of NM's capital inadequacy.
Any holder of Series G and H who chooses to tender, therefore, runs the risk that the transaction will be unwound at a later date if NM files for bankruptcy within 2 years of the completion of the TO. On the other hand, selling to another party in the open market at a price exceeding $6 for either the Series G or H would 1) be at a level well above the estimated cash value of the TO assuming an 80% tender participation rate (see Valuation section) and 2) not subject to a future clawback. If an investor is thinking of tendering, the investor should try to take advantage of the limited liquidity in the Series G and H Preferred and sell in the open market during the week of February 11th.
The recent collapse in dry bulk rates will rapidly push NM to the edge of the default precipice if it persists through the end of the quarter. It is a very real existential crisis for NM, and this is reflected in the Ship Notes trading at 54.27% of par. Serious financial and legal impediments exist to the completion of the TO. Preferred investors should take advantage of the current market prices of the Series G and H and sell as many shares as the limited trading liquidity allows.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.