The DryShips Inc. (DRYS, Financial) saga is probably one of the most outstanding examples of corporate greed and shareholder suffering on a developed market exchange ever. The case is so bad, I would not be surprised if it ends up being taught in business schools as a cautionary tale to both managers and investors alike.
What is interesting about this debacle is the fact management has continued to milk shareholders for cash rather than choosing the more honorable route of declaring bankruptcy -- it would have had the same impact of wiping out shareholders.
While a lot of the blame can be placed on management for its poor handling of the company's predicament, investors should have been able to see DryShips' problems emerging for years, especially since dry bulk freight rates collapsed following the financial crisis.
Sailing into the storm
The company's initial problems were a reflection of wider industry trends. In the run-up to the financial crisis, shipping companies loaded up on debt and placed hundreds of orders for new vessels, anticipating a steady increase in demand for many years. This increase in demand never materialized. Instead, the market was flooded with dry bulk vessels, depressing rates. Oversupply sparked a race to the bottom for operators who went out to sign contracts at any cost to minimize losses.
DryShips' problems started with the market collapse and have only gotten worse since then due to mismanagement. There are several lessons to learn from this saga, which is an excellent example of how not to invest.
First, DryShips is a good example of the problems associated with investing in cyclical businesses. Even the largest businesses in cyclical sectors suffer from slowdowns, and if they do not have a strong balance sheet to weather the downturn, there will be problems. If the company cannot raise funds from the debt markets, then shareholders will have to foot the bill, which is a warning in itself. If banks and other lenders are unwilling to provide financing to the business, shareholders should think twice about throwing more good money after bad. The key lesson here is to be wary of investing in cyclical companies or companies that have a high dependence on capital markets.
Second, CEO George Economou owns less than 0.1% of the business, but controls the company via preferred stock with 100,000 votes per share. Additionally, Dryships deals with private entities associated with Economou, which manages its ships and profits from these transactions.
As a result of the opaque operating structure and conflicts of interest, Economou has managed to draw as much money from investors as possible without exposing himself financially. Instead, he has presided over a massive transfer of wealth from shareholders to the entities he controls (Economou controls 90% of the company’s debt, which is almost entirely safe thanks to the generosity of long-suffering shareholders). If Economou had a significant equity interest in the company, would he be treating shareholders with the same level of disregard? It is unlikely. The lesson here is it is difficult to trust managers without skin in the game. If management owns a significant percentage of the outstanding equity, they are incentivized to achieve the best returns for all shareholders and stakeholders alike, not just themselves.
A value trap
DryShips is a case study value trap. The company has a weak balance sheet, lack of pricing power, reliant on capital markets to keep the lights on, has weak leadership and the management is not aligned with shareholders. Even though the company has traded at an enormous discount to book value for the past 10 years, this discount has not been enough to make up for management's disastrous capital allocation decisions.
Benjamin Graham said, “there are no bad assets, just bad prices." I would argue DryShips is a rare example of a "bad" asset. The company’s downfall should serve as a warning to investors that no matter how cheap an asset is, without pricing power and a competent, independent (no conflicts of interest) management team that has skin in the game, it is unlikely to ever be a sensible investment.
Disclosure: The author owns no stocks mentioned.
