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.

One E(nor)MAS Chiyoda mess…


I hope the agreement Forland Shipping reached with EMAS Chiyoda was that if they didn’t get cash up front they were going to take their ship, with all the project equipment on board, and sail away. Let the lawyers fight out preferential creditor treatment once you have the money. Unlike Ocean Yield (“OY”) Forland are on a time charter and as a small operator they simply cannot afford to take the hit here because the more I look at this the more convinced I am that we are heading for an administration scenario here.

I read the EZRA and EMAS financial information this morning so you don’t have to… As a general rule when accounts are so byzantine I treat them with increasing scepticism… and with my Minsky debt hat on this morning I see why…

Before I bore you with some numbers, and therefore those who aren’t interested can switch off, just look at this from the ‘big picture’ scenario: EMAS Chiyoda charters the majority of its assets off either EZRA/EMAS and its associates or bareboat charters from OY or time charters from Forland. They have a cash problem and want the shareholders to participate in a fundraising while also seeking a creditor solution. What the EZRA/EMAS side want in effect, given their asset concentration through charters on the Lewek Constellation, the barges etc, is Chiyoda and NYK to fund 60% of these charters as well as providing a credible financing path to winning long-term projects. Fool me once it’s your fault, fool me twice it’s mine…

Chioyda paid USD 180m in April for a 50% stake to EZRA (USD 360m equity value) and of the consideration USD 30m was given as working capital to the company. Later EZRA sold a 10% stake to NYK for USD 36m (in order to keep the valuation constant I assume). For c. USD 186m the Japanese investors have ended up with a 60% share in a company with no work and some very expensive vessel charters to the seller of their “investment”… (imagine the hangover… pass the sake please it’s a bad morning…?)

Apart from that it’s all going swimmingly well… Or is it? I understand the work for BHP in Caribbean (Angostura) was a disaster financially. Having taken lump sum construction risk the weather and currents worked against them (read: poor tendering and the need to buy work) and BHP didn’t accept any variation orders. If correct this was surely part of the issue in the quick onset of these financial issues and will make fundraising even harder.

You can imagine the Japanese joint criteria for any further investment: they aren’t going to put more money in now until the sellers (and probably OY and Forland as well) take substantial reductions in the fixed cost base i.e. the vessels. But EZRA/EMAS can’t do that because they have their own financial problems. EZRA has provided guarantees for many of EMAS’s charters and EMAS, 75% owned by EZRA, is insolvent effectively if the assets were to be liquidated in the current market.  EMAS has announced it has reached a term sheet deal with its lenders, and given the PSV and AHTS exposure this is no surprise, but the equity in this business has in effect gone.  One of the minor highlights of interest from the most recent accounts is the split of EZRA/ EMAS originally generated goodwill of USD 154m via the transaction but EMAS has just written its equity down to USD 90m. On an asset base that big in an illiquid market like this that is within the margin of error and the line between insolvency and illiquidity becomes akin to taking a measuring stick to Lilliput. All that is solid melts into air

So in reality that leaves EZRA as the owner of Triyards and a minority shareholder in a bankrupt contractor which is the largest customer of its asset base.  On 31 August 2016 EZRA had debts due within 12 months of USD 1.1bn which mean they are long-term debts that have fallen current and the senior lenders understand how serious this is and EZRA states that if agreement cannot be reached with them it has a going concern issue (Net Debt to Equity having risen from 0.77 to 3.05 in one year). EZRA have negligible cash in relation to this and their biggest asset, the Lewek Constellation, wouldn’t be worth half of what they paid for it if it could be sold at all. And therein lies the problem in financing anything because even if you believed EMAS Chiyoda could be competitive in deepwater installation the shareholders are not going to inject capital at historic asset levels in today’s market given the risks, but without fresh capital into EMAS Chiyoda, EZRA cannot support its debt on the assets. The amount of money now required to make EMAS Chioyda a viable proposition in deepwater construction, where tens of millions are handed over in procurement and engineering prior to offshore execution, is I believe prohibitive to any rational investor. At the moment the CFO of any major project where EMAS Chiyoda has bid is calling up the tendering guys and telling them to throw that bid in the trash no matter how good the terms. This will takes weeks of financial stability to turn around not 60 days and will involve some serious write downs from the banks… so park that in the unlikely space.

If L&T ride to the rescue to protect the single Saudi contract it will be an assets only deal. In distress M&A you may be able to find a credible white knight to alleviate this concern but this isn’t likely here given the inter-relationships and the size of the debt obligations that need to be met. Either that or the Japanese have been the smartest guys in the room and they are just going to call the EZRA banks and offer to take the assets they want at pennies in the dollar and then inject some real equity into the “JV” and dilute EZRA out?

This brings us nicely to the problems of debt and as always therefore to Hyman Minsky. Minsky would have termed EZRA/EMAS a firm financed by Ponzi finance, not indicating criminality, but a firm that had to constantly keep borrowing to meet its debt obligations. Forland would have been categorised as a speculative firm, in that it had difficulty meeting payment obligation in the short term (although in such pro-cyclical asset industry the line between solvency and liquidity is very thin); most firms in offshore would fall into this category. OY however, even with re-delivered tonnage, would only be a hedge firm, able to meet cash expenses from income, the redelivery will hurt the dividend but isn’t fatal (and highlights again the quality of the management at OY).

Both EZRA/EMAS and Forland in their own way were able to grow on the back of a massive investment bubble. EZRA constantly grew by borrowing and creating little industrial value; the decision of lenders to allow it to build the Constellation, a vessel so outside its known technical parameters as a company and in relation to its balance sheet, was a sign of how far the market had peaked. It’s an amazing vessel but it takes more than offshore crew to make it work, the balance sheet and in-house competencies to generate regular work at the margin levels to pay for that vessel were never there. Much like a bank EMAS became an asymmetric payoff model except there will be no lender of last resort here (although whether OCBC and DBS are allowed to use a proportion of their exposure for liquidity purposes at MAS is a whole different story).

Forland was typical of the smaller end of the bubble where a small Norwegian ship owner was able to take on extreme leverage based on a counter party with very little equity and on a charter substantially less than the economic life of the asset. Provided everyone kept paying there was no problem. But as Minsky always stated it was the cash flows, the hard financing constraint, that started the reflexive cycle to asset prices…

Unless there was some pre-funding commitment as part of the original sale to the Japanese (which surely would have been invoked now) this refinancing just looks too hard. Too many players, too many different tranches of securities and agendas, and simply not enough time if there are cash flow problems now. And unlike Italian banks I can’t see three rounds of rights issues, each one ever more dilutive than the last, being a viable strategy here.

The Singaporean judicial management process just isn’t developed enough for this either being relatively new so this is going to be a mess which means that OY are getting the Lewek Connector back without a shadow of doubt and Forland will get the Lewek Inspector back as well.

As a wise New Zealand philosopher once remarked: if something is impossible it isn’t likely to happen…

Offshore contractors face ‘bank run’ scenarios


I was struck by how much EMAS (and other offshore contractors with poor balance sheet strength) need to be viewed as facing a ‘bank run’ like scenario after reading this BIS article on the collapse of Continental Illinois. The key question is can a ‘funding run’ be stopped for both contractors (and banks). The Lewek Constellation (above) is an amazing operational asset, but it needs a vast flow of future profitable project work to keep it going (and proper deepwater construction work not infield), and the question at the  moment when looking at the financial strength of EZRA/EMAS/ EMAS Chiyoda is who would award them a complex multi-year construction project?

The only thing that keeps these vessels (and others in the fleet like the currently in default Lewek Connector) is large lump sum jobs with a strong blended cost of high value, low capital intensity, project management fees to balance out OPEX of the vessels. At the moment large companies are all doing this at relatively low margins; where is the incentive to get an even cheaper price from EMAS Chiyoda and find mid project there has been a credit event? The offshore phase is the capstone of all the earlier custom engineering work that has been paid in stages along the way. No one ever got fired for buying IBM was an ad used with great effectiveness to convince mid-level procurement managers to go for the brand. In the current environment no one is going to get fired for buying Technip, Subsea7 and McDermott; but risking a multi-million dollar field development on EMAS Chiyoda is whole different story. Should a credit event occur all pre-funded engineering and procurement spent would in reality make the purchaser an unsecured creditor (and a lot of it would be vessel specific so no use anyway); not to mention performance bonds etc. There have been no significant news of awards for the Lewek Constellation recently and in reality there are unlikely to be.

Offshore contractors are in a pro cyclical industry and take long positions in assets with long funding and economic lives that are in a downturn illiquid to the point of having no saleable value (like now). These assets are funded with some equity but also a significant quantity of debt, with a funding profile less than economic life of the asset, from senior banks and more recently by increasing amounts of (often “issuer rated”) high-yield bonds, or off balance sheet financing from vessel charters. In operational terms an offshore contractors asset base has been funded by a series of offshore CAPEX projects significantly smaller in length and value than the underlying asset base. In banking this is called maturity transformation: banks lend long and borrow short; in offshore the contractor goes long on illiquid assets and funds them in the short-term project market. There is a clear analogy here with contractors serving the E&P companies by going long on highly specific illiquid assets and funding this with a series of short-run projects. Clearly the capital structure of the industry in a macro sense has not reflected this reality well as increasing margins led to ever increasing amounts of debt and rising asset values substituting for real equity (and Swiber and EZRA/EMAS were two of the best exponents at this form of financing). Minsky would have seen this coming a mile off

Net fee income is important for banks as the money they make on the asset base often only covers the funding costs with a small margin. This is true for offshore contractors as well, as discussed above, when that “fee income’ for engineering and project management dries up in poor market conditions the operational offshore asset base cannot even come close to covering its funding costs.

The Continental Illinois demonstrated how hard a bank run is to stop, as even with a Government guarantee, financially rational investors choose to leave in droves ensuring institutional failure. Just like a bank loan portfolio an asset like the Lewek Constellation will be worth nothing like its book value in the current market; it  may actually be “worth” close to zero given the high running costs and the lack of other uses. The same will apply to EMAS Chiyoda as a whole (and other offshore contractors): a run in confidence on their ability to be in business in 12 months time will become a self-fulfilling prophecy in all but the most exceptional cases because the financial gain from any price reduction that could be offered cannot compensate the risk of a large offshore project not being completed.

The pro cyclicality of operational offshore and financial assets  leads to huge volatility and as the Cerrado deal showed the OPEX costs may actually induce steeper depressions than problem loans from financial institutions. One thing is clear: at the moment many assets in an offshore construction/support vessel fleet are almost unsellable at any price and there is no Bagehot inspired institution willing to lend freely on any quality asset to stop a liquidity crisis becoming a solvency one. In fact as the current wave of restructuring among contractors at the moment indicates these are  solvency and liquidity issues combined. Like a banking crisis the offshore industry is awash in leverage and this will in all likelihood prolong the downturn and make a recovery harder.

What really needs to happen for EZRA/EMAS/EMAS Chiyoda is for all the creditors together  to undertake a massive debt-for-equity swap (if you have faith in the assets be the Bagehot: effectively lend freely on collateral that would be good in “ordinary” times – of course there isn’t much because the vessels are chartered); to try and get over the current downturn (if you believe it is just that or DCF some future recovery value anyway) and try and recover value in an orderly fashion accepting that the asset base may simply not be  worth what it was a couple of years ago. Like Continental Illinois though what is likely to happen is that regardless of extra support and measures that management can negotiate to slow the process everyone (funders in the broadest sense) just decide this is a situation they need to get out of as soon as possible.

It’s a bank run… there is no incentive for anyway to stay in and game theory suggests getting out first may be best individually even if staying in collectively would be better. For the offshore industry as a whole this is probably a good thing as EMAS Chiyoda doesn’t really solve any customer problems and was always (in hindsight) a symbol of an investment bubble. But this is going to hurt… I’d love to read the due diligence report Chiyoda and NYK got for this… the only possible solution is that they double down and fund this for a couple years but it would be bold move given current conditions.