Genco Shipping and Trading (GNK) is a highly leveraged company in the brutally competitive dry bulk shipping industry. GNK’s long-term debt has recently been recategorized as a current liability, since it is in violation of its debt covenants and has had to plead for lender forbearance. Its debt covenants have been waived, but only until Dec. 31, 2013. Furthermore, lenders have agreed to suspend debt service payments, but only until March 31, 2014 and GNK has already said it cannot make payments if BDI rates stay at current levels. GNK’s debt is junk and is trading at $42. It has already issued dilutive equity and has very limited capacity to issue additional equity. Its total liabilities equal $1.8 billion against a market capitalization of just $117 million.
Furthermore, there is a history of mismanagement (capital misallocation, including the mystifying and unexplained partial spin-off of Baltic Trading Ltd. and poor risk control) and what could be regarded as questionable ethics of the chairman in particular. For example, there are a large number of related-party transaction disclosures with respect to companies owned or controlled by the chairman and/or family members of the chairman. There is a history of exorbitant compensation directed to the chairman despite miserable company performance.
It is, in summary, a poorly managed company in a terrible industry, deep in a long cycle downdraft, facing the end of forbearance by its creditors and in default of its covenants.
Genco Shipping and Trading (GNK) is in the dry bulk shipping industry as a charter operator. Its current fleet includes nine Capesize vessels, eight Panamax, 17 Supramax, six Handymax and 13 Handysize totaling 3.8 dwt. It owns a 25% economic interest (and an 83% voting interest) in Baltic Trading Ltd., a company it spun off a couple of years ago. GNK’s chairman is Peter Georgiopoulous, who is also chairman of Baltic. While nominally a charter operator, it is essentially operating on the spot market as explained below.
Dry bulkers in general have been on a multi-year free fall due to a rather extreme oversupply of vessels ordered in previous years and continuing to come to market. This oversupply has driven down the Baltic Dry Index (BDI) and thus also driven down the rates GNK can charge it clients to well below its all-in cost. Despite being nominally a charter-operator, GNK is effectively operating as on the spot market since all of its long-term charter contracts have terminated and have been replaced by very short-term (i.e. close to spot) contracts.
This BDI dynamic persists to today (see chart). Critically, the oversupply of vessels shows no sign of abating as new builds continue to add to the worldwide fleet. In its annual report, the company acknowledges this fact but attempts to spin it by saying that the rate of increase in vessels worldwide has slowed while the rate of scrappage (removal of ships for resale as scrap metal) has increased. Despite this spin, the fact is that the worldwide fleet is expanding and is going to continue to expand for some time, until the orders made in previous “good” years have all been delivered. Examples abound of dry bulkers receiving deliveries of new vessels, particularly on the large-sized (Capesize) end of the vessel size range.
There is a history of mismanagement and what could be regarded as questionable ethics of the Chairman in particular. On the capital misallocation front, the company continued to enter into purchase agreements to buy existing vessels and new builds even as the BDI continued to decline and the global oversupply dynamics became apparent. There was also the mystifying and unexplained partial spinoff of Baltic Trading Ltd. to function as a separate spot-market operator (as mentioned above, GNK continues to control the spinoff and has a 25% economic interest). Debt has been piled upon debt for these acquisitions and the company had to do a dilutive equity issuance recently.
Perhaps more troubling, there are a large number of related-party transaction disclosures with respect to companies owned or controlled by the Chairman and/or family members of the Chairman. (Rather than enumerate them here, I will just direct the reader to page 54 of the 2012 annual report which lists many disclosures.) Furthermore, there is a history of exorbitant compensation directed to the chairman despite miserable company performance. For example, in 2010, which was a poor year for the company, the chairman was compensated to the tune of $10 million by GNK and another $6 million by BALT, while he also presumably indirectly benefited from the related-party transactions. The real kicker was the $2.6 million in compensation he received from GNK in 2012 while essentially “running the ship into the reefs,” so to speak.
The company currently has liabilities totaling $1.8 billion against a market capitalization of $117 million. While it has a book value of more than $900 million, that value is overstated as the company has not properly marked down is assets (i.e. the vessels operating at a loss). On page 23 of the 2012 annual report, the company explains two rather alarming facts:
1. That it will be unable to make required payments on its credit facilities starting March 2014 (note that it had previously received relief from the lenders and forbearance).
2. That it is may not be in compliance with its maximum leverage ratio and its minimum permitted consolidated interest ratio covenants, for which it has secured a waiver until Dec. 31, 2013.
GNK’s debt has been recategorized as a current liability as of sometime in second quarter 2013 because it was determined it was not in compliance with the covenants and therefore total payment was due December 31, 2013, unless the waiver was extended.
This dire state is coupled with the fact that the company is operating its vessels well below its all-in cost (i.e. including both vessel operations as well as interest cost). It has been generating negative cash flow as of the most recent quarter. Despite a hopeful uptick in BDI seeming to come to the rescue, it has since tumbled significantly (see chart) to about $1,500 from a recent peak of more than $2,000. However, $1,500 is not the bottom, as rates hovered around $1,000 for the 12 months ending Sept. 2013.
The most obvious catalyst is if the company fails to secure an extension on the covenant waivers that expire on Dec. 31, 2013. GNK would be forced to raise cash, meaning it would have to sell assets (vessels) into an extremely depressed market. Granted, calling the covenants in is what Marty Whitman likens to the “right to commit suicide.” But, it may require GNK to further dilute equity holders, pay penalties or make other concessions. The lenders, seeing the obvious end to all of this, may decide to just pull the trigger now.
The next most obvious catalyst is failure to pay debt service as of March 2014 (and, of course, failure to get the lenders to extend forbearance). That is subject to the same issues as the debt covenant waivers, above.
A third, less obvious catalyst would be a significant slowdown, particularly in China, which would further suppress BDI and therefore GNK revenue.
Finally, there is a significant customer concentration risk, as over 30% of GNK’s revenues come from Cargill. Granted, Cargill is not likely to default, but it could blow a hole in GNK’s operations by making even a modest change in its vendor selection.
Note that short interest is 19.54%, down 10% from previous rates as per Morningstar.
Risks and Counterarguments
There are several risks and counter-arguments of concern:
· By far the biggest, in my mind, is that Oaktree (Howard Marks) has a position in the company. It is quite a small position, but I feel like a moron for getting on the other side of a transaction from Marks. Likewise, Royce has a position (also quite small).
· The company’s P/B is a shocking 0.1. As mentioned above, the “B” part of the equation is probably significantly overstated, but even 0.3 or 0.5 would be a potential red flag for a short. This might induce a buyout or some other “resource conversion” (Whitman nomenclature) event.
· Lenders might kick the can down the road and the BDI may recover. While the first is possible, the second is quite unlikely because of the continuous growth in global vessel counts. For this to happen, global GDP growth would have to skyrocket and China would have to restart its building boom.
· At 42, the debt might be a “loan-to-own” situation for a distressed-debt investor. (Note that Oaktree has an equity position, not a debt position in the company.)
I am not an experienced short-seller and probably do not know what I do not know. With that said, this situation seems to tick a lot of the boxes. Hopefully, someone will read this before the situation works out (so they can also profit) or so they can warn before it turns against me. Right now, I have a nice position using put options (a very small position), a good portion of which have moved into the money over the past week as I was finalizing my short case.
Author’s Note: This is the first time I have published a short theses. Much appreciation in advance for any feedback and suggestions on how to enhance the analysis. I would also love to see someone write the long thesis.