Global Ship Lease

GSL was spun-out by CMA CGM, the third largest liner shipping company. GSL has 17 ships that it owns and leases out to CMA on long-term contracts. The lease rates to be received are fixed, so GSL gets a steady cash flow. Also GSL is not impacted by the drop in lease prices, due to the long-term nature of their contracts. CMA owns a 40% stake in GSL, so there is an incentive for CMA to ensure that GSL doesn’t go into bankrupcy.

GSL has substantial loan for the 17 ships. It has over 550M of debt. The loan covenants require that GSL maintain at least a 90% of debt-to-ship value ratio. The ship value ratio is determined by taking the market value of ships in the second hand market. If the company has 90-100%, GSL can’t paid dividends. For example, in last quarter of 2008 the company’s ratio was well below 90%, GSL paid out $.23 dividend for the quarter. A debt-to-ship value ratio over 100% allows the banks to force default.

GSL is not directly impacted by the market condition. Let’s look at the Net Income and Cash Flow for the 3 most recent quarters:

–   NI         –  CF
3Q       (.3)M    –  12M
4Q      (43)M    –   13M
1Q      11M      –   15M

So basically in some of the worst quarters in decades, the company increased cash flow (net income is impacted by hedges for interest rate). So operationally the company can pay the current interest expense and still generates plenty of cash.

Currently GSL has a debt-to-ship value of over 100%. GSL has been in this situation since early ’09. GSL got the banks to give the company extra time to come up with the fair value of the ships. Basically the market was putting ridiculous low valuation on ships, so GSL was getting an extremely low value. Also, GSL makes about 13M of FCF, so why would the banks force a company that can pay its interest expense and has plenty of additional cash (to support a higher interest rate or pay down principal). Since Feb ’09 the company has gotten the bank to extend the agreement. The company is working with the bank to amend the agreement so the company can start paying dividends again.

From the bank perspective, it doesn’t make sense to force the company into default. First, the company can pay the interest expense (about 4.5M per quarter). Second, by forcing default the banks will be stuck w/ ships in a market where the value of the ships is extremely low. So the banks would take a loss by selling the ship at these depressed values. Third, GSL has a steady stream of cash coming. With the long-term rates, GSL is not exposed to current market rate fluctuations. So I know what this company can make and whether it can keep making the interest payments. Finally, GSL makes plenty of FCF each quarter. So if I’m the banker, I’m thinking how do I force the company to pay me more. If I’m the banker, I work with this company to either increase the interest rate or force the company to make additional principal payments.

GSL’s biggest risk comes from what CMA is doing. As long as CMA can keep paying the monthly charter rates, per agreement, GSL will make its steady cash flow. CMA is a private company, so getting data on it is hard. The main concern regarding CMA is that it has tons of CapEx that it has signed agreements for. With the bad credit crisis and already having a ton of debt, people have concerns over CMA’s ability to survive. Although CMA can get out of those CapEx agreements by paying a penalty and cut back on other expenditures. Also, CMA roughly gets 40M in dividends from GSL, so CMA would look to cancel lease agreements with other lessors first.

The shares of GSL has dropped substantially for mainly two reasons: the CMA concern (whether GSL’s agreements will be honored by CMA) and the temporary hold on dividends payout has dropped the shares dramatically. The CMA concern are valid, although CMA has options to cut or control its CapEx. Also CMA has been buying back its debt in the open market at huge discounts, so management is taking the right steps. As for the hold on dividends, I think this is only temporary. The management definitely wants to pay out those dividends and CMA wants the dividends. Once the bank issues are fixed, I think the dividends will be reinstituted. Also there has been huge selling in GSL shares recently, I think this is because a major holder started unloading once the dividends were put on hold.

The shares currently trade at $1.40, a market cap of 98M. Remember the company was paying dividends of $.23 per quarter, so you are getting a 70%+ dividend yield if the old dividends are reinstated. Most likely dividends will be cut. Even if they only pay 10% of the old dividends, $.02 per quarter, you get about 6% yield. I think the company’s dividends won’t be $.23 per quarter, but at the current prices you will most likely get a high double-digit yield. Also, you have a company still making 50M of FCF. Even if the banks increase the interest rate, you still are getting a company for an extremely low FCF multiple. No matter what happens, once the debt-to-ship issue is resolved, the shares should give you a multi-bagger return from the current prices.

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