DryShips Inc (NASDAQ:DRYS) issued its Q1 2017 Earnings Release on May 10th (“Earnings Release”) after the close and prior to the effectiveness of its previously announced 1:7 reverse stock split. It issued a follow-on press release on May 12th that presented per share financial information reflecting the reverse stock split. At March 31st, DRYS had 17 vessel acquisitions pending that would more than double its dry bulk tonnage and diversify the Company into tankers and VLGCs. In addition, DRYS had issued a torrent of common stock to fund these acquisitions during and subsequent to Q1. The financial information disclosed regarding the first quarter was therefore of limited value and the important disclosures centered on the issuance of common stock, the status of any prospective debt financing, additional acquisitions, and future earnings projections.
Debt Issuance Update
DRYS exercised purchase options to acquire four VLGCs from Cardiff Marine, George Economou’s closely held investment vehicle. The VLGCs are currently under construction in Chinese shipyards and due for delivery beginning in June and ending in December 2017. The construction of the vessels is being funded by the equity payments made by Cardiff/DRYS (roughly equal to the $21.9 million purchase option price paid by DRYS to Cardiff) and most likely a Chinese export bank. The Chinese government has provided below market export financing to domestic shipyards during the last few years in an attempt to stanch the flow of shipyard bankruptcies due to the severe downturn in construction orders.
The Earnings Release provided the following update:
Earlier this month, the Company received a firm commitment from a major European bank and an Asian export credit agency for a secured term loan facility of up to $200 million to partly finance the delivery of its four Very Large Gas Carriers (VLGCs). The commitment remains subject to documentation and successful syndication.
DRYS’ purchase price per vessel is $83.5 million, $334 million for all four. The $200 million debt financing would represent approximately 60% of the purchase price, a reasonable Loan To Purchase Price ratio considering the above market 5 year Time Charters with investment grade credits on the vessels. There was likely a term-out provision (i.e. the vessel purchaser could opt to roll the construction financing into a term facility at delivery if alternative financing was not available) in the construction loan from the Chinese export bank, so the export bank is incented to help DRYS complete the new term debt facility.
A new term debt facility would allow the export bank to lay-off a portion (perhaps even the majority depending on the terms) of the principal outstanding under the construction facility to a syndicate of other banks at closing and secure a market interest rate (or higher given the DRYS taint). It would likely selloff the remainder of its exposure under the new term debt facility at a later date as the loan seasons. DRYS has a lousy reputation in the credit markets, but the underlying TC credits and the structured finance entities that will hold the vessels will ameliorate those concerns, at a price of course!
Since the first VLGC is scheduled for delivery in June, the first $50 million tranche of the financing will likely be drawn down during the next six weeks. As indicated in the Sources and Uses table below, the $200 million financing for the four VLGCs would reduce DRYS’ acquisition funding shortfall to approximately $32 million, assuming that it does not obtain additional debt financing secured by its remaining vessels.
DRYS equity market value was $48.6 million at the May 12th close. This value assumes that it will never obtain debt financing. That is looking like an increasingly dangerous bet. The market, however, did not believe the debt financing update included in the Earnings Release judging by the price action. Volume during May 11th and 12th equaled almost 108% of DRYS’ outstanding shares so the selloff triggered by the reverse split and Earnings Release will likely run out of steam next week.
Sources and Uses Table
The following Sources and Uses Table is updated for the vessels delivered prior to May 10th, cash available at May 10th, the prospective $200 million financing for the VLGCs, and the announced acquisition of a Suezmax tanker for $64 million. Beyond the option exercise payments to Cardiff Marine on the VLGCs, it is difficult to know if the cash balance and the vessel book value as of May 10th reflect milestone payments on other vessels. If so, it would reduce the funding gap. Please note that I am in the process of updating my Cash Flow model to reflect the Suezmax acquisition and the timing of the VLGC financing. The numbers may change a bit but I do not expect the change to be material.
| DryShips | ||
| Sources/Uses | ||
| May 10th | ||
| Announced Acquisitions | ||
| VLGCs | $334,000 | |
| VLCC | $60,000 | |
| Suezmax | $64,000 | |
| Newcastlemax | $93,000 | |
| Aframax 2012 | $29,000 | |
| Kamsarmax Newbuild | $26,500 | |
| Kamsarmax 2x 2014 | $45,500 | |
| Kamsarmax Acquisition April 27th | $24,000 | |
| Subtotal | $676,000 | |
| VLGC OptionExercisePmts | $87,600 | |
| RemainingPayments | $588,400 | |
| Cash Available May 10th | $340,700 | |
| Debt Financing VLGCs | $200,000 | |
| Cash Flow | Q2 | $(2,766) |
| Q3 | $8,982 | |
| Q4 | $9,315 | |
| Funding Shortfall | $32,169 | |
EBITDA Projections
DRYS is estimating that post acquisition EBITDA will be approximately $77 million based on the following rate assumptions:
On an annual basis, assuming all the vessels we have agreed to acquire have been delivered, that vessels are fully utilized and earn $16,000 per day for Newcastlemaxes, $12,000 per day for Kamsarmaxes, $10,000 per day for Panamaxes, $18,000 per day for Aframaxes, $25,000 per day for Suezmaxes and $30,000 per day for very large crude carriers (“VLCCs”), and the rest of the vessels in the Company’s fleet that are employed under time charters will earn their respective fixed rates, the Company estimates for indicative purposes that its active fleet (i.e. excluding laid up vessels in our offshore support fleet) will generate EBITDA(1) of approximately $77.0 million.
Five of DRYS’ six offshore support vessels are currently laid-up or idle. The TC for the sixth vessel will be terminated this month due to its well above market rate and it will join its brethren in lay-up. I still expect DRYS to dispose of this business during 2017.
Dry Bulk rates for Panamaxes and Capesizes have declined about 30% from recent highs due to a seasonal decline in activity. Dry Bulk rates are still significantly higher than last year and I believe the rates being forecasted by DRYS for its Dry Bulkers will prove to be low as rates begin to rise again from August through yearend.
Assuming the VLGC term loan of $200 million with an interest rate of 8.5% (probably high) and $200 million of Sifnos debt with a 6.5% interest rate, total interest expense would be $30 million. Adjusting DRYS’ EBITDA forecast for this cash interest expense amount would yield cash earnings of $47 million. A reminder, March 12th closing equity market value was $48.6 million. DRYS is therefore trading for a bit more than 1x projected cash earnings.
Stock Issuance
Stock issuance between April 28th and May 10th was approximately 263k post split shares (or 2.7% of the May 10th shares outstanding). I would not read anything into this decline in issuance since the period included the run up to earnings and the reverse stock split.
Conclusion
George Economou made the following statement in the Earnings Release:
With this rapid expansion phase behind us we look forward to taking delivery of the vessels we have acquired in the last few months at historically low asset values and starting to generate revenue that will improve our bottom line and demonstrate the earnings capacity of our fleet over the next few quarters.
Do you believe him? Do you believe that the expansion phase has ended and that DRYS will not acquire additional vessels for a few quarters? Do you believe they will complete the VLGC financing? If you answered yes to either of those questions, you do not want to be short this stock.
Disclosure: I am/we are long DRYS.
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.
Additional disclosure: Please note that I have traded DRYS on a regular basis, sometimes intraday round trips, for the last several weeks on the long side. I do not short stocks. I will likely aggressively trade DRYS over the next several days, increasing and decreasing my position based on the stocks performance. I expect DRYS to be volatile over the next several weeks and I view trading DRYS as extremely risky.
Editor’s Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.
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