Ezra and Bagehot… the denouement is nigh.

News that Ezra had delayed its annual meeting didn’t come as a huge surprise to me. I think, and I have no special insight or contacts here, that Ezra has a solvency problem, not a liquidity problem. By that I mean I believe the value of its assets do not secure, or can in anyway pay, for the liabilities incurred in building up the business. I think the reason the AGM has been delayed is because Ezra management and Directors are struggling to get the auditors to sign the statement of going concern. I don’t see how it can be done without the banks agreeing to roll over their loans from short-term to long-term, and as this would jeopardise their security interests,  I don’t think they will. There are cross default clauses in loan and charter agreements etc, its not as easy as calling people up and demanding a rate cut here.

The language from Ezra/ EMAS Chiyoda is all about temporary suspension of payment. They are implying they have a liquidity crisis, and despite people arguing to the contrary, its a crisis when you are a public company and you come out and ask for a respite from creditors and then can’t produce your accounts.

In the 19th century Britain had a series of credit crunches and banking crises that led to panics and investor (depositor) losses, and each seemingly became worse than the last. Walter Bagehot, wrote a book Lombard Street: A Description of the Money Market, and famously enunciated the idea that if a bank had good quality collateral, but a problem with accessing it, the central bank should lend against this. The distinction between illiquid and insolvent was born and central banking was changed forever; as Bagehot wrote:

If it is known that the Bank of England is freely advancing on what in ordinary times is reckoned a good security—on what is then commonly pledged and easily convertible—the alarm of the solvent merchants and bankers will be stayed…

The point about the value of the collateral in ordinary times is as crucial as the insolvency versus illiquidity. In 1907, prior to the US having a Federal Reserve, a banking panic broke out in New York; a private sector solution was found when J.P. Morgan called the large banks into his office and locked them in until they found an answer (issuing clearing certificates) because all realised the problem was one of liquidity. In 1931 Hoover tried to get Thomas Lamont (the senior J.P.Morgan partner) to organise a private rescue of the Chicago banks, it failed because the banks knew the asset base of the other banks did not match their commitments: it was a solvency problem.

Ezra needs funds, it is only the type of securities and the amount that are in question.  EMAS Chiyoda  has insufficient project work to cover its charter obligations to Ezra and therefore compromises the ability of Ezra to pay its creditors. A private sector solution could be found here, the Singaporean government could call up Temasek and Clifford Capital ask them, on an arms length basis, what the cost of a term sheet would be for a start-up  deep water offshore contractor, with limited backlog and some very expensive ships. Investment analysts love comparable company analysis, the government caller could point out the last company that went long on deep water pipelay without infrastructure, CEONA… “…Hello, is anyone there?…. Where are you? Strange the line has gone dead….”

I can’t speak for the Japanese but I would be having a sense of humour failure about this. They thought they were buying a controlling stake in a smaller Saipem or Technip, whereas Ezra appear to have thought they were selling a working capital facility. The investment bankers did a cracking job here. The due diligence report must have been a novel of intense fiction…

One of the first lessons in investment theory is sunk cost: don’t invest/speculate on prior investments: judge each new capital outlay on its merits. And on this basis I just have to have some semblance of belief that a group of rational financial investors will put no more money in based on the current capital structure. The investment proposition, stripped to its basics is this: new money will go in to fund a deep water pipelay contractor, in one of the worst markets ever, to take market share off Technip, Heerema, McDermott and Subsea 7? Really? This would be a multiyear investment in the hundreds of millions (given the vessel OPEX) to have any chance of success. And for what payoff? Stranger things have happened… but not many…

Ezra and EMAS Chiyoda don’t need another loan here they need plain vanilla equity. Pure risk capital, that realises and prices the size of the task management would have to rebuild the company in a down market, and compete against some of the most skilled offshore engineering houses in the world, and do this on an asset base acquired at the top of the market when everyone else did theirs more slowly (i.e.lower average cost) over years. I suspect the price of that is too high given the possible upside without a huge reduction in liabilities.

And the asset side is a problem. Regardless of the fact that Norwegians just like building ships (and they are very good at it), the economic logic for owning ships as a contracting company is the risk reduction from controlling the asset where the majority of the execution risk takes place. DSVs and pipelay vessels are the perfect example of Coase theorem, of internalising costs to insure against externalities (risks) you can’t control. The problem here is many  Ezra vessels are just commodities that can be acquired for less than half what they are paying and the company has burned through its equity, and the market hasn’t turned, and they cannot be chartered to anyone else.

The fact of the matter, following the Bagehot dictum, is the collateral will not be good in normal times. The Lewek Constellation, a beautiful ship, is unsellable at anything like an “economic/book” price because anyone who needs one has one. The asset illiquidity is too high and banks did not demand enough equity in the vessel to reflect the volatility in price. The same is true for the Lewek Centurion. ABB have built a competitor to the Lewek Connector … I could go on. This isn’t short term illiquidity these are assets that will never recover close to book value.

And right now all Ezra/EMAS Chiyoda suppliers will start demanding payment upfront so working capital will go through the roof, companies will be reluctant to make upfront payments as they will become unsecured creditors, bankers will be reluctant to make payments because they will lose more…It is very hard for a company to recover from this, as Bagehot realised the only real solution here is a flood of liquidity, but there is nothing here that would warrant it from a private or public sector investor.

As I have said before any Board that sanctions a major field development with a company in this financial position could well be accused of negligence, but without these contracts the company has no future. I am not ruling out some Lazarus like resurrection from the dead here because I don’t think the Singaporean government and DBS want to admit the scale of the mess yet. But loans won’t solve this. If Ezra is to emerge as anything like a credible company there needs to be a major change in the capital structure, a massive debt for equity swap, and a decent amount of plain vanilla equity. Anything less will not save this.

I could be wrong, but we are going to find out very soon; because either a decent amount of cash will go in and suppliers, banks, and charters will start getting paid or its terminal. I’d like not be right here as this will affect a lot of people, so I’ll happily be wrong. We will all know really soon.

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