You can’t stop time…

“In 1936 I suddenly saw that my previous work in different branches of economics had a common root. This insight was that the price system was really an instrument which enabled millions of people to adjust their effort to events of which they had no concrete knowledge.”

Friedrich Hayek

“They say I’m old-fashioned, and live in the past, but sometimes I think progress progresses too fast!”

Dr Seuss

In Singapore both EOL and Pacific Radiance are trying to freeze time to their advantage. I can’t see it working. Both parties seem to be using a judicial process to try and slow the reality of weak market conditions, and yet the longer this keeps on the worse the offers to finance these businesses seem to get.

EOL signed a “binding” term sheet with new investors in September 17… Then BTI/Point Hope came back and said they wanted new terms, and then again… and again. The only possible explanations were A) EMAS is performing even more poorly than was estimated last September when they first agreed a “binding” term sheet, or perhaps than in December 17 when they agreed a revised “binding” term sheet; or, B) the market hasn’t recovered so the new investors don’t want to put cash in. The parties were looking to sign another (“binding” I presume?) term sheet so asked the court for a moratoria that will allow them to keep operating while they tried to sort out a $50m investment. But then today BT accepted reality walked away. It bodes ill for Pacific Radiance.

At some point the creditor groups led  by DBS and OCBC must be forced to either recognise the market value of the assets or just accept what is needed in terms of the size of the write down, which is going to be very large if they liquidate the EMAS fleet now, or new working capital required and what it will be priced at. It is very hard to see anything viable coming out of EMAS whatever the price.

Pacific Radiance can’t even get the binding part of a term sheet: they just have a group of investors so keen to move forward they can only agree preliminary terms. News reports suggest that these are investors from outside the industry looking for a bargain. Good luck with that. The only operational plan appears to be for the company to carry on as before and spend a ton of new money on OpEx while waiting for the market to turn (and enter the nascent Asian wind market). That’s fine if you could actually get the money signed up to do this, but of course that hasn’t happened yet…

The Pacific Radiance restructuring involves USD 120m cash going in and the banks writing off $100m but getting $100m cash out immediately. Getting effectively .5 in the dollar on some aging offshore support vessels is a great deal in this market (see above)… almost too good to be true… The remaining USD 120m gets paid back over three years starting on January 1 2021. This is the ultimate bet on a market recovery in the most margin sensitive OSV market in  the world. Pacific Radiance generated a cash loss from operations of $4m in Q1 2018, so should the market not come back then you have a small amount of cash sitting behind USD 120m of fully secured bank debt. Given current OSV rates if investors are putting money into this project they are betting that this company can generate at least $40m per annum to pay the banks back before they have any prospect of their equity having any value in only 3 years time.

I will be really will be surprised if the Pacific Radiance deal goes ahead in this form. At this stage of the cycle if you are providing working capital finance to help the banks recover their asset value you should have some prospect of getting your money back first. A three year repayment profile just doesn’t reflect the economic realities of these vessels or the likely market moving forward no matter how much the banks behind this may choose to believe something else.

People keep telling me that DBS and OCBC have have taken large internal write-offs with their investments in these companies. I struggle to believe this as if this were really the case the banks would surely just equitise their investment fully, bring the new money in, and sell the shares when they started trading again, which in simplistic terms is what happened to the creditors in the Tidewater and Gulfmark. Both banks, as with all banks with lending to the sector, should be maximising their own position, but in doing so they are ensuring collectively the poor financial performance of the entire fleet they longer they keep the extensions up.

There is a fine line in these situations between judging when the market is being excessively negative in the short-term, and therefore put new money in, or just liquidate. I know the bankers are loo king at Pacific Radiance going how can USD 600m be worth so little? But the answer is the assets have a very high holding cost and breakeven point and they lent in the middle of a credit boom. Given current market prices it looks like the banks are holding out not just for the unlikely now but the impossible. In economic terms these banks own nothing more than a claim to some future value on a vessel if the market recovers, and for a load of reasons (some related to accounting regulations), they want others to front this cost. But the economic substance of their claim remains the same.

Both Pacific Radiance and EMAS are  locked in a problem of mutually assured destruction if they both get temporary funding for another season. The market is structurally smaller than it was five years ago and ergo the vessels are not worth as much, and at the moment cannot generate enough cash to cover more than OpEx (not even including dry docking). The market hasn’t come back and shows no sign of doing so in any substantial way. If both of these firms secure further cash to blow on operating at cash break even for another season or two they will simply ensure overcapacity remains and no one in the industry can make money and therefore no rational investor should put money into the industry until capacity is reduced.

This Tidewater presentation shows quite how oversupplied the market is: from 4.5 vessels per rig to 8 on a significantly lower rig base down 40% from the peak in 2014.

Tidewater Market Equilibrium.png

The other point to note is that turnover for Pacific Radiance dropped 16% on last year for Q1 2018. Price deflation in an asset industry, particularly one with debt, is the nuclear bomb of finance as debt remains constant in nominal dollars while real earnings to service it decline. I doubt Pacific Radiance lost market share so I think that is indicative of pricing pressure that customers are pushing on them. What is clearly not happening, as in every other sector of offshore, is that E&P companies are asking vessel owners to scrap older tonnage so they can pay a premium for newer kit. In fact they are just demanding, as they always have but particularly in Asia, the cheapest kit that meets a minimum acceptable standard. The “aging scrapping” myth will have to wait a while longer before becoming reality. Pacific Radiance might be right and the nadir of the market has arrived, but there is precious little sign of an upward trajectory from here, and plenty of signs from contracted day rates that market expectations are for at least another season of rates at this level.

To be fair the graph is contrasted with this:

Supply is tight.png

But “adjusted supply” is a forecast and a nebulous concept at best. And with a 16%% drop in revenue over last year even if the increased utilisation figure is true it just means productivity is dropping. There is no good news at the moment on the supply side.

If prolonged these constant judicial delays to economic reality risk doing further harm to the sector as they will actually discourage private sector investment. MMA raised private money on market terms to manage the downturn, yet it’s returns are being forced lower because it is effectively competing against firms being kept on life support by a seemingly never ending stream of judicial moratoria from its competitors. The more this happens the less other private investors will become to get involved because a never ending overcapacity situation becomes effectively a court annoited market.

There is a moral hazard problem here where these indefinite moratorium agreements encouragement management, and in some cases creditors, to negotiate in bad faith while the costs of this are paid for by private sector investors who have put new money into competitor companies. The BT/ EMAS position shows the folly of allowing parties unlimited time to negotiate as it worsens the economic pain for firms that have proactively sought solutions. At some point these parties need to be given a “hard stop” date at which time the courts will not allow moratoria to be rolled over.

Eventually the restructuring in Asia will begin in earnest because there are simply not enough chairs now the music has stopped (with apologies to Chuck Prince). EMAS surely looks likely to kick this off.

Popiah Radiance apparently?

If this story in The Business Times is true, and I have no reason to believe that it isn’t, then the Pacific Radiance restructuring is not going well.

As a general rule bringing an Ultra-High Net Worth individual in on this deal means the fundraising banks have exhausted all the institutional money they can find to inject some equity in here. The investment banks have been around the fund managers who have had as much fun as they can handle in offshore, and looked at situations like this (disclosure I am an ex-Director of Bukit Timah AS):

Singapore’s Kim Heng Offshore and Marine Holdings Limited has purchased three anchor handling tug supply (AHTS) vessels for USD9.6 million, securing them at a fraction of a previous valuation…

Kim Heng said that the vessels were previously valued at approximately USD33 million each, but it was able to acquire them “at extremely low valuations” due to the downturn in the oil and gas industry…

So now the banks are forced to widen the circle to people who may know nothing about offshore, but have a lot of money and can be sold on the “new” rebound story. Let’s wait and see if this deal actually executes like as outlined. The only attraction for an UHNW investor coming in would be an extreme price discount and unbelievable terms and conditions, and the Pacific Restructuring term sheet doesn’t indicate that?

I mean even the bankers here can’t really believe this plan will work? Surely? They must be in it for the fees and targeting an UHNW who is the client of another bank? You wouldn’t sell this deal to your own clients would you?

There is an excellent article here in OSJ that again just emphasises how bad things are in the offshore support market. Especially in Asia. What could go wrong? Ignoring the fact someone very wealthy, and therefore potentially credibly litigious, is your cornerstone investor when no credible market reports suggest an upturn.

Pacific Radiance’s last accounts show bank debt and loan notes of USD 526m. The term sheet indicates that the secured banks are writing off $100m, getting $100m immediately, and end up with a reprofiled $120m and everyone else (unsecured) gets shares (I am assuming having read it quickly). So quite how much cash in the bank you get from putting in $120m is unclear but it clearly isn’t a massive number.

The gap between the actual transacted values and the book values of offshore support vessels is still just so extreme that if there is a trading problem equity holders are guaranteed to get nothing. At some point simply saying the loans don’t have to be paid back for three years must still be realised as unrealistic. This is the deal from the term sheet:

The remaining re-profiled Bank Loans of approximately US$120 million will be repaid over 3 years from 1 January 2021 to 31 December 2023.

50% of the contractual interest margin payable under the re-profiled Bank Loans shall be deferred for a period of 3 years from 1 January 2018 to 31 December 2020 and the deferred interests shall be paid by 31 December 2023.

So before this new equity would have a claim of value the current Pacific Radiance fleet would have to generate enough cash to pay the banks back $40m per annum starting in 2021? Oh and make good the interest. Really? And if they don’t? The new shareholders will be wiped out in another refinancing or sale? And what sort of upside is the spreadsheet showing? Which is just the situtation SolstadFarstad has arrived at earlier… It’s just not real unless the term sheet isn’t showing some protections on offer to the equity investors.

 

I’ll be interested to see if a canny self-made man really puts money in under those conditions. It smacks of desperation on the capital raising side in that all the institutions, who have the time and resources to undertake due diligence, get that this is simply keeping the banks going here without any industrial solution at all.

All you are getting for that money is a future claim on a declining asset base which you must compete with on price to get utilisation. That is the only deal on the table here and this is not a high quality fleet in terms of residual value. The US supply firms have got real: any claims to these vessels are equity in economic reality if not legal status. Everyone should just convert their claims and then it would be easier, but if they can really find people who go for this then well done. But it is a short-term solution and nothing more. #denial

Watching with interest.

 

Debt is the problem…

Pacific Radiance announced it was restructuring last week and Harvey Gulf this week. I have talked about the Pacific Radiance situation before and this latest deal just reveals how desperate the banks are to keep some option value alive here. They basically write off $100m and get $120m of new money as working capital… I guess in their situation it’s logical… but it just locks in another cycle of burning newly raised money in Opex and ensures that day rates in Asia will remain depressed.

Eventually, as it is starting to happen in the ROV game, this will end. A good slide here from Tidewater this week highlights the efficiency of US capital markets and the state of denial that exists in Europe and Asia at the lending banks:

OSV net debt.png

The US firms all firmly on the left (well when Hornbeck Chap 11’s anyway) and the Europeans stuck firmly to the right. There is a very limited number of ways this will play out. SolstadFarstad is coming back in early June with it’s DeepSea solution (the photo above was at Karmoy this week, Solstad’s home port) when another excruciating round of write-downs and negotiations will be presented. But nothing sums up the sheer impossibility of SolstadFarstad being a world leading OSV company that than the slide above, and the Herculean financial challenges all the leading European companies face. It is simply not sustainable.

The Nemean lion of debt in offshore supply…

The slaying Nemean lion was the first of the twelve labours of Heracles. The lion had an indestructible skin and it’s claws were sharper than mortals swords. I sometimes feel that the first task in getting some normality into the offshore supply market is to find a Heracles who can begin to slay the debt mountain built up in good times…

In Singapore Otto Marine and Pacific Radiance appear all but certain to enter some sort of administrative process as their debt burden divorces from the economic reality of their asset base. The best guide to what they need to achieve, and the enormity of the task, come from the recent MMA Australia capital raising. I think MMA is a company that understood the scale of this downturn, and reacted accordingly, but they still have a tough path to follow, but at least they have an achievable plan.

The MMA plan involved raising AUD 97m new equity (AUD $92 cash after AUD$ 5m in fees, which is steep for a secondary issue and shows that this wasn’t easy) compared to bank borrowings of AUD $ 295m i.e. 33% of the debt of the company, or over 100% of the equity value (at AUD 88m) was raised in new capital in one transaction in November 17. In order to do this the lending banks involved had to agree to make no significant dent in the debt profile before 2021, reduce the interest rate, and extend the repayments. “Extend and pretend” as it is known in the jargon. All this for a company that in the six months ending 31 Dec 2017 saw a revenue decline of 22% over the same time last year (AUD $119m to AUD $92m) and generated an EBITDA of only $7.6m (which excluding newly raised cash would give a Debt/EBITDA of 14.3x when 7x is considered high).  I’d also argue the institutions agreed to put the money in when the consensus view (not mine) was that 2018 would be a better year, raising money now looks harder. (Investment bankers can sometimes come in for some stick but this, in my opinion,  was a really good deal for the company and the banks earned their money here).

The fact that MMA’s Australian banks have far less exposure to offshore supply than the Singaporean banks made them more pragmatic (while still unrealistic), but this shows what needs to be achieved to bring in new, institutional quantities, of money to back a plan. As a portfolio move from large investors, making a small bet on a recovery in oil prices leading to linear increase in offshore demand, I guess that is sensible. I don’t think it will work for the reason this slide that Tidewater recently presented shows:

TDW OSV S&D.png

There is too much latent capacity in an industry where the assets, particularly the MMA ones, are international in operational scope. By the time the banks need to start being repaid these 20-25 years assets will be 3 years older, 7 since the downturn, yet expected to bear an unmarked down principal repayment schedule. It’s just not realistic and requires everyone else but you to scrap their assets. It maybe worth a punt as an institutional shareholder… but I doubt that few really understand the economics of aging supply vessels.

This contrasts with Pacific Radiance where this week the bondholders refused to agree to accept a management driven voluntary debt restructuring and management seem to be relying on the industry reaching an “inflection point”. As soon as you hear that you know there is a terrible plan in offing that relies on the mythical demand fairy (friends with the Nemean lion I understand) to save them.

I would have voted against the resolutions this week as well had I been a bondholder, but mainly because of the absurdity of agreeing to a plan without the banks being involved or new money lined up. The bond was for SGD 100m… have a look at the debt below on the latest Pacific Radiance balance sheet (Q3 2017)… can anyone see a problem?

PR Balance Sheet Q3.png

Pacific Radiance has USD 630m in debts. Even writing off the bond would mean you are in a discussion with the banks here. I have no wish to take people through the math involved in what the bonds are worth becasue in reality all anyone owns here is an option on some future value, and if you are not the bank you don’t even have that. In order to bring the plan into line with MMA, Pacific Radiance would be looking at presenting an agreed plan with the banks, and ~USD 220m capital raise, an amount that is real money for a company that is still losing money at an operating level.

No one believes the vessels and the company are worth USD 710m. If the banks really thought they could get even .80c in the dollar here by selling to a hedge fund they would be out tomorrow. A large number of the Pacific Radiance vessels are well below the quality of the MMA vessels and in the real world it would seem reasonable for the banks to have to write down their debt significantly to attract new money. If vessels are sold independently of a company transaction, like MMA, then they go for .10c – .20c of book value, so it would make sense for the banks to be sensible here. However, I fear that so many have told shareholders they are over the oil and gas exposure that major losses here will be resisted despite economic reality. I suspect the write-off number here would need to be at ~50-60% of book value to make Pacific Radiance viable and get such a large quantity of new money, an amount that will have risk officers at some Singaporean banks terrified.

As I keep saying here the real problem is that if everyone keeps raising new money for operational expenditure, on ever lower capital value numbers, then the whole industry suffers as E&P companies continue to enjoy massive overcapacity on the supply side. Eventually without a major increase in demand a large number of vessels are going to have to leave the industry and this will happen when the  banks have no other options, and we are starting to get close to that point.

In reality the Pacific Radiance stakeholders need to sit around the table, have a nice cup of tea, and accept the scale of their losses. Then all the stakeholders can come up with a sensible business plan and the new money for operational expenditure can be found. But the banks here will be desperate to be like the MMA banks and get the new money in without suffering a serious writedown while trying and push the principal repayments out until a later date. I don’t see that happening here and the bondholders may as well sit around with all parties rather than be picked off indepdently. A major restructuring would appear the only realistic outcome here and if Pacific Radiance is to continue in anything like it’s present form there will be some very unhappy bankers.

Illiquid or insolvent? Bagehot and lenders of last resort to the offshore industry…

Thus over-investment and over-speculation are often important; but they would have far less serious results were they not conducted with borrowed money. That is, over-indebtedness may lend importance to over-investment or to over-speculation.

The same is true as to over-confidence. I fancy that over-confidence seldom does any great harm except when, as, and if, it beguiles its victims into debt.

Irving Fisher

SINGAPORE – Offshore marine services firm Pacific Radiance has been granted S$85 million in loans under two Government-backed financing schemes.

I’d suggest the Singaporean Government brush-up on the difference between a shift in the demand curve and a shift along the demand curve To non-economists the difference may look semantic but to every stage 1 student it is drilled into them that a shift along the demand curve occurs when price changes and then the quantity demanded responds, a shift in the demand curve means a fundamental change in demand. It is the difference between a change in the quantity demanded versus a change in demand, which are self-evidently two completely different things.

I would argue, and have on this blog consistently, that we are seeing a complete reconfiguration of the offshore supply chain, think Woodside moving to electronic Dutch Auctions for commodity supply vessels, rather than a short-term fluctuation in demand as the result of temporarily low oil prices.

Quite why the Singaporean Government feels it knows better than the market is beyond me here? I should note at this point I am not an unadulterated free-marketeer, my favourite paper at University in NZ at the height of Rogernomics and its successors in a supply-side revolution, was “State-Led Development in South-East Asian Tiger Nations: Singapore, Hong Kong, Taiwan, and South Korea”. In the debate between the World Bank and the activists I took my lead from Robert Wade (also from NZ) and others who saw active government involvement in the economies as an essential part of the process that drove these economies to outperform and pull their people out of poverty. I was a believer, I agree still to a certain extent, with Alice Amsden who argued the governments’ of the region actively set out to “get the market price wrong”.

But I also grew up in New Zealand, which terrified of rising oil prices in the 1970’s had launched Think Big, and by the time the Motonui synthetic “gas-to-gasoline” plant was finished the tax payer footed the bill for every single litre manufactured. It was in short an economic disaster. Trusting a Government ministry to out-judge the energy market is a dangerously expensive passtime.

I should also note that Stanley Fischer, in an unbiased review of South East Asian development policies following the East Asian Crisis noted:

As to Asian industrial policy… some degree of government involvement can in principle be successful, and that it was successful in practice, too, in some Asian economies by allowing new industries to overcome coordination failures and exploit economies of scale. I also believe the potential for such interventions to go wrong is very high, both because the government may make the wrong decisions, and also because they are conducive to corruption. In most cases the best approach is for a country to create a supportive business environment, including policies and institutions that encourage innovation, investment and exports in general, and to leave allocative investment decisions to the private sector.

So when I read that Pacific Radiance has secured loans from two entities affiliated with the Singaporean Government I have to question what is going on?

Firstly, there is a moral hazard element here as the shareholders and the banks appear to benefit from an overly generous dose of leverage on average assets. The Straits Times notes:

The Government will take on 70 per cent of the risk share for both the IFS and BL loans, which were rolled out last November to help local offshore and marine companies weather the current prolonged industry downturn by gaining access to working capital and financing.

These are loans largely owned by DBS and UOB. I don’t undertand how if this is an economic transaction these banks need this level of support? This is an assymetric payoff where the Government takes most of the risk and the banks pick up most of the upside.

Secondly, the sanity: this money is going on OpEx:

The loans … will help support the group’s working capital needs over the medium term, said Pacific Radiance in a statement on Thursday.

Really? Does the Government of Singapore believe that a short-term market dislocation has occured that will see USD 5-10k per day per vessel of OpEx recovered when the market comes back? Pacific Radiance has USD 605m of liabilities over a fleet of 60 vessels and JVs with a further 60 in Indonesia. Like Deepsea Supply, and a host of others pretending the vessels are worth anything like this is a fantasy. But another problem isn’t just the size of the debt, and the quality of the assets underpinning it, but the income being generated to service it:

PAC RAD Sales Q1 2017

Sales are dropping like a stone, and as a general rule depreciating assets that earn less than you thought are worth less. The loan doesn’t solve the fundamental problem: Pacific Radiance have borrowed too much money relative to the revenue these assets can now earn and are likely to in the forseeable future. As you can see over the same period comparison as above Pacific Radiance is consuming cash at an alarming rate:

PAC RAD Cash Flow Q1 2017

Most worrying is the amounts due from related companies which would have to be seen as doubtful, but the business is also using large amounts of cash in operations and this loan is simply going to go in and then go out on that operational expenditure. Loan covenants on fixed assets were simply not designed to cope with turnover dropping 24% quarter-on-quarter: there was too much leverage in the offshore sector to support this. The banks need to come to the party here for this to be a viable firm.

Third, this seems completely contrary to what other major players in the market, like Bourbon are saying (and they are surviving without government assistance):

Mr Pang noted that the longer-term outlook for the industry has improved, as Opec and certain non-Opec producers have sustained oil production cuts until June this year and have also agreed to extend these cuts by another nine months. “This concerted effort by oil producers should enable supply and demand to balance in the medium term.”

The Singaporean Government is essentially making a bet on a private company that seems to have no other plan than simply hanging around waiting for the market to improve. To be honest that doesn’t strike me as a great plan, and if enough investors agreed with Mr Pang surely getting an equity rights issue away should be easy for the company to raise the money and wait for this miraculous occurrence? In fact of course with the Swiber AHTS going for 10% of book value the loan already looks doubtful.

The government of Singapore has now become the Lender of Last Resort to the offshore sector and therefore the Bagehot dictum applies “lend freely at a penal interest rate against collateral that would be good quality in normal times” (I have discussed this before) . The formula is help the illiquid but not the insolvent. Bagehot outlined this formula in 1873 after repeated shutdowns in the London money market put sound financial institutions at risk. The Bank of England had followed this dictum in 1866 when London had its own Lehman moment and the Bank of England allowed Overund, Gurney and Co., one of the largest institutions, to fail.

I haven’t done a full valuation of the Pacific Radiance fleet but a quick overview of the assets on the website makes it clear this is pure commodity tonnage and some of it very low end. Quite why anyone thinks this is going to recover to previous levels needs to be outlined explicitly I would have thought given the scale of the commitment that is in the process of being made. I don’t think in the current market this would qualify as high quality collateral in normal times. There also appears nothing penal in the loan at all.

Worringly for Singaporean tax payers, looking at Ezion and others, Bagehot also wrote:

‘either shut the Bank at once […] or lend freely, boldly, and so that the public will feel you mean to go on lending. To lend a great deal, and not give the public confidence that you will lend sufficiently and effectually, is the worst of all policies’

I think Pacific Radiance had a solvency problem not just a liquidity issue, but the systemic problem is now the longer Singapore props up companies like this the longer the industry will take to recover. If Singaporean taxpayers decide to support Ezion and a host of others they need to be prepared to write some very big checks, and the US companies fresh from Chap 11, with clean balance sheets, will be in a far better place to compete.

During the last Global Financial Crisis Paul Tucker of the Bank of England stated the Bagehot dictum as ‘to avert panic, central banks should lend early and freely (ie without limit), to solvent firms, against good collateral, and at ‘high rates.’ These loans do nothing of the sort by backing poor quality collateral and providing uneconomic liquidity to a company with an unsolvable problem. People are not paying less for these vessels because there is a panic they are paying less because E&P companies are using them less and they cost a lot to run! These loans will only delay the pain and hinder other struggling firms. The banks should have been forced to realise the assets at current market values as the penal rates both Bagehot and Tucker outlined and the shareholders should have been completely wiped out.

As a comparison I do not think MMA will be so lucky. I have experienced Australian banks first hand and I suspect the “Big Four” will be ruthless and simply shut the company down soon having given the company temporary respite to see if this was just a short-term dislocation. Unfortunately from an economic perspective this type of capacity reduction is exactly what is needed to rebalance the industry.