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Global Ship Lease: Heads I Win, Tails I Don't Lose Much.
by: Pakiya August 11, 2009

Global Ship Lease (GSL) is a containership lessor that signs long-term lease contracts based on fixed lease rates. GSL was spun-out by CMA CGM, the third largest liner shipping company, in late 2008. GSL has 16 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, more on this below.

Current Results

GSL's fixed long-term contracts ensures the company gets a steady flow of cash. The company makes about 15M of FCF per quarter. In the worst quarters the global economy faced and extremely tough quarters for the shipping industry, GSL grew its CF.

Quarter - NI - CF
3Q 08 - (.3)M - 12M
4Q 08 - (43)M - 13M
1Q 09 - 11M - 15M
2Q 09 - 22M - 14.8M

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.

The company takes the FCF and gives it out as dividend to shareholders. In the last 2 quarter of '08 and first quarter of '09 the company gave out $.23 per quarter. For CMA, taxwise this works out nicely.

GSL has quite a bit of debt. It has about 550M of debt. The company can easily cover its interest expense on the debt and still has tons of cash flowing in. Although the company's debt has a covenant about debt-to-ship value. If the debt-to-ship value goes over 100% the bank can cause default. Although given that the company can pay the interest expense and generates plenty of cash, the bank is highly unlikely to force bankrupcy. The current situation has caused the company to stop making dividend payout since Feb '09. Since Feb, the company's debt-to-ship value ratio is over 100%, although the bank has still not forced default. (The stop on dividend has forced investors who were holding the stocks for the dividends to sell out and has created an incredibly compelling investment opportunity.)

The company has been working w/ the bank to amend its agreement. The contracts are still in discussion but it is highly likely an amendment will be worked out and the company will start paying out dividend.

The Bank's Perspective

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. In either case, it would be a mistake on the banks part to force default. Also since the bank hasn't forced default since Feb, that is clear indication the bank is not interested in bankruptcy.

To understand the bank's perspective, all you need to do is look at whats happening in the commercial real estate market. The big REITs are on the brink on bankruptcy because of the drop in occupancy and asset value. Although the banks have been working w/ the REITs to extend maturity on the loans or forcing the companies to raise equity. In either case, the REITs are surviving and the banks are not stuck w/ having to sell assets in a distressed market or writing down the assets on its balance sheet. In GSL's case, 'occupancy rate' does not drop due to long-term contracts. The asset values also don't drop, since the company is not really looking to sell its assets until after the contracts are over. I think GSL doesn't really need to raise equity, since it is not struggling operationally to meet its operational or interest expense.

CMA CMG Risk

I think 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 cutting back on other expenditures. Also, CMA roughly gets a huge dividend from GSL, so CMA would look to cancel lease agreements with other lessors first. CMA is getting the dividends, tax benefit, and has an equity stake in GSL. So CMA cancelling its contracts with GSL would be the last scenario that CMA would consider.

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.

Current Valuation

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. It is not clear what type of dividend payout will happen in the future, but you basically get a company making 60M in FCF for less than 100M. Plus the assets don't need to be sold in this distressed market, so GSL can wait until the market recovers to get a fair value on its assets. GSL doesn't have a single contract expiring until 2012, plenty of time for the market to recover and place historical values on the assets.

Source: http://seekingalpha.com/article/155490-global-ship-lease-heads-i-win-tails-i-don-t-lose-much?