Investors are a forgiving lot.
Over the past year, they have learned to take lavish fleets of corporate jets and outlandish executive bonuses more or less in stride, all while remaining engaged with an extremely challenging equity market. As the credit crisis has worn on, many investors have even looked past potential debt covenant defaults and painful asset sales in hopes of waiting out this crisis and participating in an eventual recovery.
Now, a new wave of share dilution is being offered up as compensation for that patience, as companies from Bank of America (NYSE: BAC ) to Anadarko Petroleum (NYSE: APC ) try to rally enthused investors to raise capital through equity offerings. Of all the injuries investors have sustained at the hands of corporate excess, however, the triple play of share dilution at DryShips (Nasdaq: DRYS ) may finally mark the limit of Fools' patience with controversial CEO George Economou.
Returning to the well until the well runs dry
Jefferies & Co. analyst Douglas Mavrinac exclaimed: "Enough is enough," joining at least three other analysts in downgrading DryShips shares. Diluting existing shareholders' equity by 25% with a $475 million at-the-market offering, Economou has again turned to investors to save his heavily indebted company from the ravages of a perfect storm.
With this third dilutive offer, DryShips will have more than quadrupled the share count since last November. Fools love multibaggers, but prefer them to occur in share price rather than number of shares.
After responding positively to covenant waivers and a $630 million drill ship contract with Petrobras (NYSE: PBR ) , the 30% whipping that shares have incurred since the offering announcement writes another chapter in the relentless volatility of DryShips' stock.
The next subprime crisis
While economists watch things like commercial real estate and credit card defaults, Diana Shipping (NYSE: DSX ) President Anastassis Margaronis recently issued a dire warning that a "disaster for the shipping markets" and a "wave of destruction for banks to rival the subprime crisis" could be touched off by shippers' insistence on proceeding with orders for new vessels.
The decision to tap the equity markets at this juncture has this Fool wondering whether Economou agrees. If Economou shares his competitor's concerns that $600 billion in shipping industry debt could enter crisis mode once weakened demand collides with a growing oversupply of vessels, then an equity offering could be seen as acknowledgement thereof.
As the worldwide order book stands, new vessel building in 2009 will yield more than a 10% dry bulk fleet expansion, net of scrapped vessels. Given the relatively small number of banks specializing in financing shipping ventures (many located in Germany or the United Kingdom) and the very large sums involved, the impacts of failed ventures could indeed send an unwelcome domino effect rippling through banks, shipping companies, and even the shipyards.
Already, lenders have been stressed by plummeting vessel asset values and breaches of debt covenants, but if weakened commodity demand persists for long enough that distressed vessel sales become more commonplace, then shippers as a whole will have a very hard time repaying debt.
Morgan Stanley is counting on it, and is creating an investment fund that will specifically seek distressed valuations for discounts of up to 60% on shipping debt. Investing as much as $400 million, Morgan Stanley hopes to acquire interest in about 40 dry bulk and container vessels.
Shame on you, Mr. Economou
If Economou enjoyed a clean track record of defending shareholder value or maintaining healthy separation between DryShips and related family interests, like DryShips' hired fleet operator Cardiff Marine (70% owned by Economou), then perhaps patient Fools could forgive this latest dilutive transgression. But he does not have a clean track record.
Economou raised $175 million in junk bonds for his Alpha Shipping venture years ago, only to end in bankruptcy in 1999. Capital raised in the DryShips IPO was used to purchase vessels from his sister, who also owns a chunk of Cardiff Marine. Genco Shipping (NYSE: GNK ) Chairman Peter Georgiopoulos once suggested that Economou is "play[ing] games with their shareholders' money."
Hanging shippers out to dry
For DryShips, the latest equity offering would raise much-needed liquidity to cover short-term debt requirements, but at least one analyst believes the proceeds will instead go toward the company's two drill ships presently on order.
For the sector at large, the move corroborates emerging industry expectations of a potential crisis among shipping lenders. From vessels for sale at 60% off, to a likelihood of some major bankruptcies, I believe we have caught a glimpse of the sector's weak medium-term outlook. Shipping will remain within an epic battle for survival, but Diana Shipping, Genco Shipping, and Navios Maritime Holdings (NYSE: NM ) continue to look more stable relative to their peers.