The Tale of Britannia Bulk

Posted on 03/08/2010

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While I am unaware of the record shortest time from initial public offering to bankruptcy, Britannia Bulk must certainly be in contention for this not-so-prestigious honour. The company raised $116m to float on the NYSE on 18th June 2008, but by 31st October 2008 had filed for administration in the UK courts.

Britannia Bulk was a dry-shipping company with a fleet of 22 vessels, including 13 drybulk vessels, five ice-class, five ocean-going ice-class barges, and four ice-class tugs. They also had on order an additional six Panamax ice-class drybulk vessels, which were scheduled to be delivered between June 2009 and September 2010. These additional six ships would have increased the company’s available tonnage by 72%. The company earned a net profit in 2007 of $46m on revenue of $567m and reported shareholders equity of $72m at year-end. The IPO prospectus (produced by Goldman Sachs and Bank of America, among others) noted such strengths as:

“Leading Shipping Provider in the Baltic Market; Favorable Industry Dynamics for Drybulk Shipping; Attractive Business Model Providing Flexibility to Respond to Market Conditions; Strong Relationships with High Quality Repeat Customers; Track Record of Strong, Profitable Growth; and Experienced Senior Management and In-House Technical Team.”

Britannia Bulk also received a BUY recommendation from veteran US stock market commentator Jim Cramer, who in his show “Mad Money” broadcast on CNBC on Friday 27th June noted:

“The Baltic Dry Index took a hit after China reduced its iron ore orders, a move which sent Dry Bulk shippers down. Cramer would pick up recent IPO Britannia Bulk Holdings from the rubble, because the move dropped its price from $15 a share to $12.80. Cramer expects demand to return to normal, and likes the stock’s 8.8% dividend. In addition, DWT is adding six more ships to its fleet, and unlike other shippers, can cut through ice and sail efficiently in inclement weather. Cramer urged investors to use limit orders, buy in increments, and not to pay over $13 for the stock.” (Quotation via http://www.seekingalpha.com (http://seekingalpha.com/article/83191-britannia-bulk-rules-the-waves-cramer-s-mad-money-6-27-08)

Could investors have done anything to avoid losses on this company? Well, those reading the IPO prospectus would have noticed the following disclosures:

High financial leverage. Britannia Bulk’s expected pro-forma indebtedness at the close of the transaction was expected to be $170m. This compares to average per annum EBITDA (from 2004-07) of $34m, a ratio of 5x. On the other hand, those investors with a more short-term focus would have noted that gross debt was only 1.3x LTM EBITDA. However, given the extent of the boom in the shipping industry, it would have highly speculative to measure credit statistics based on a highly profitable last twelve months rather than more normalised conditions in the industry. Therefore the company’s management team was taking a bet that conditions in the shipping industry, and the profitability of Britannia Bulk, would not return to the lower levels seen in the earlier part of the company’s history.

Subject to restrictive financial covenants. While it is not uncommon to find companies with restrictive financial covenants in their borrowing agreements, it is a sign that the company’s bankers view its financial position as relatively high risk in nature. Remember that a breach of financial covenants has the same effect as a payment default, giving the banks the option of accelerating on their loan and taking control of any security, potentially leaving equity holders with nothing. Britannia Bulk had agreed to the following covenants in its loan facility agreement:

“The Facility documentation will include (i) covenants regarding compliance with regulations, management, inspection, employment and charter of the Vessels and (ii) restrictions on:
the Subsidiary Guarantors’ ability to engage in any other business;
the Subsidiary Guarantors’ ability to incur debt and other liabilities;
the creation of security over the Subsidiary Guarantors’ assets;
amalgamation, merger or reorganization of the obligors; and
certain transactions with affiliates.
The Facility documentation will also require that we maintain certain financial ratios, including:
the fair market value of the vessels Navigator II, Endeavour II, Endurance II, Ice Trader II and Ice Power II must be at least 140% of the outstanding facility amount;
liquidity (defined as the sum of our free and available cash and readily marketable securities) of not less than the greater of $20.0 million or 6.25% of net interest bearing debt of our consolidated group;
a ratio of EBITDA to net interest expense of not less than 2.5 to 1.0; and
a stockholders’ equity to total asset ratio of not less than 30%.”

Britannia Bulk’s loan agreement also requires the facility to repaid in full in the event of a change of control occurring. This effectively gave the company’s banks a veto on any possible takeover or merger.

High historical capex relative to cash generation. During the period 2004-07 Britannia Bulk generated average per annum cash from operations of $20.6m, though spent an average of $68.9m on capex, a ratio of 3.3x. This financing requirement was met almost entirely via regular rounds of additional debt financing. While many small and growing companies have large capex requirements, this ratio of cash-out to cash-in is quite unusual, particularly as it was sustained over four years. Also, the use of cash flow is a management decision and recent spending patterns can often be indicative of likely spending in the near future.

High committed capex relative to cash generation. Further disclosures in the IPO prospectus include the cost of the six additional ships that Britannia Bulk had on order. The company had committed to pay a total of $356.4m for the ships, which were due for delivery in 2009 and 2010. After deducting a $71.3m deposit which had already been paid, this meant a minimum capex spend of $142.6m in each of the next two years. By means of comparison, Britannia Bulk generated $52.1m cash from operations in 2007.  Again, this is a rather explicit bet from management that they believe the shipping industry would continue to prosper in the coming years.

Additional financing would required to support future capex. As might be expected from the quantum of the company’s historical capital expenditures relative to operational cash flow generation, and the size of the company’s planned to future vessel acquisitions, there was a reasonable probability that Britannia Bulk would not be able to afford to meet these commitments. In this disclosure, management explicitly acknowledge that they will need to return to the financial markets to raise additional capital, and also mention the likely serious consequences if they were to fail in this respect. I would describe it as highly imprudent for any company to make multi-million-dollar capital commitments without first having equivalent financial commitments in place from lenders or shareholders.

“We anticipate financing the remaining outstanding $285.1 million aggregate purchase price of these vessels through cash available from operations and additional debt or equity financings [emphasis added]. We may be unable to secure such financing on satisfactory terms and our inability to complete the acquisition of these vessels could harm our business, results of operations and financial condition.”

A reliance on short-term freight rates. Although the company had sold a portion of its capacity on medium-term contracts, Britannia Bulk was still reliant on short-term freight rates for a significant portion of its income. Management noted in the prospectus that:

“We depend on spot market charters for a significant portion of our revenues. In the three months ended March 31, 2008 and in 2007, 2006 and 2005, we derived approximately 39%, 52%, 36% and 33%, respectively, of our revenues in the spot market. Although chartering a significant portion of our vessels on the spot market affords us greater opportunity to increase income from operations when rates rise, dependence on the spot market could result in earnings volatility. A significant decrease in our spot market rates could adversely affect our profits or result in cash losses.”

Therefore the IPO prospectus for Britannia Bulk (which was produced by respected Wall Street investment institutions such as Goldman Sachs and Banc of America Securities) gave potential investors plenty of reasons to steer clear of the transaction. However, while a more cautious investor would not have been surprised by the failure of Britannia Bulk, the speed and manner of the company’s demise would prove to be quite shocking. So what happened?

The key factor to contribute to the downfall of Britannia Bulk was a downturn in shipping industry conditions, though the company’s capital structure and poor decisions taken by management in the months following the IPO meant that the company was faced by a liquidity squeeze in 3Q08 as shipping rates declined, allowing the company’s bankers the opportunity to take control.

The chart below shows how shipping rates declined by over 90% from their peak in June 2008 to a trough in November the same year. Given that Britannia had disclosed that typically 30-50% of revenue is dependent upon short-term freight rates, this meant that revenue would decline by a similar amount. With operating costs largely fixed for a shipping company, this would have a geared impact on profits. Revenue in 1Q08 was $300m and operating profits were $37m; therefore a revenue decline of 30-50% with no offset from lower costs (admittedly a worst-case scenario) would leave Britannia Bulk facing losses. With reserves of liquidity or via access to capital markets, companies are able to weather periods with losses; however, with little cash on hand (approx $20m at completion of the IPO) and large existing borrowings, Britannia Bulk did not have the balance sheet to handle such market dislocations.

The volatility in the shipping market was then exacerbated by poor decisions taken in the months following the IPO. On 28th October, the company put out a statement to the equity markets to notify them of the situation. The key quotations are as follows:

“While the Company has not yet concluded the review of its financial results for the three months ended September 30, 2008, the Company expects to announce a significant net loss for the period compared to the net income achieved during the second quarter of 2008. The Company believes that the expected loss will have resulted from the substantial decreases in dry bulk charter rates that occurred during the period, exacerbated by the Company’s increase in chartered-in capacity during the same period and its entry into the forward freight agreements (“FFAs”) and a bunker fuel hedge.”

“Since July 2008, the Company bought FFAs that appear not to have been purchased to hedge identifiable ship or cargo positions. This resulted in the Company being more exposed to the falling charter rates and reduced overall demand for dry bulk shipping services than it would have been if its historic practice of using FFAs as economic hedges had been followed. In marking these FFAs to market, the Company expects to recognize a significant realized loss for the three months ended September 30, 2008.”

“In the three months ended September 30, 2008, the Company entered into a bunker fuel hedge which is currently uncompetitive because it is hedged to prices which are significantly above the current market price of bunker fuel. As a result, the Company currently estimates that its aggregate bunker fuel hedging losses for the three months ended September 30, 2008 will be significant.”

“The Company has engaged AlixPartners, a leading corporate advisory firm, to assist the Company in discussions and negotiations with the Company’s lenders and trade counterparties and to address the Company’s current financial and liquidity issues. Representatives of AlixPartners are working to immediately implement measures to conserve cash and reduce costs. AlixPartners is expected to have an integral role in helping the Company address key issues with its lenders and trade counterparties.”

“The Company is not currently in violation of its financial covenants. Although no such violations currently exist, severe adverse market conditions and the severe financial difficulties currently being experienced by the Company (as well as a revaluation of its fleet) have resulted in a very high risk of a future violation of one or more financial covenants in the near term. If such violations occur and the Company is unable to cure such violations or obtain waivers within the applicable cure periods to the extent available, such violations will constitute an event of default under the Facility. The Company is in discussions with the lenders under the Facility regarding its current severe financial difficulties and the possibility that events of default may occur under the Facility. There can be no assurance that a resolution of the issues surrounding the Facility will be reached. The Company is considering its alternatives if it is unable to reach an accommodation with the lenders, including liquidation, administration or protection under applicable bankruptcy or insolvency laws. In either case (an accommodation with the lenders or a liquidation, administration or bankruptcy) it is unlikely that the Company’s shareholders would realize much, if any, value.”

We can see from these disclosures that Britannia Bulk was impacted by the decline in dry bulk charter rates, but also that these declines were exacerbated by losses on FFAs. Given that losses were made on FFAs during a period in which freight rates declined, this suggests that Britannia Bulk had increased its long position on the shipping market, essentially speculating that freight rates would continue to increase. It would have been expected for Britannia Bulk to take out short positions in FFAs – effectively hedging their revenues against declines in freight rates – so this kind of position is highly unusual and has multiplied the effect of falling freight rates on Britannia Bulk. Secondly, we can see that while Britannia Bulk was increasing the gearing of the company’s revenue line to the shipping market using FFAs, it was also fixing its future cost base via bunker fuel hedges, increasing the level of operational gearing in the income statement. Again, this would act to magnify the effects of the declining freight rates upon Britannia Bulk’s profitability. The consequences are immediately apparent, despite the appointment of restructuring advisers Alix Partners. The high indebtedness and restrictive financial covenants means that the future of the company is in the hands of the bankers, and the company acknowledges that default and administration are a possible outcome, leaving shareholders with zero value. Just three days later, the company announces:

“Britannia Bulk Holdings Inc (the “Company”)(NYSE:DWT) hereby announces that its indirect wholly owned subsidiary, Britannia Bulk Plc, has been placed into administration under United Kingdom insolvency laws.

Britannia Bulk Plc is the borrower (the “Borrower”) under a US$170 million term loan facility with Lloyds TSB Bank Plc and Nordea Bank Denmark A/S (the “Facility”), which Facility is secured by twenty two vessels in the Borrower’s owned fleet. The Company guaranteed the Facility. As set forth in the Company’s press release of October 29, 2008, the lenders under the Facility provided notice to the Borrower of the acceleration of all of its obligations under the Facility and set off the Borrower’s cash accounts on deposit with one of the lenders.

The discussions that ensued with the lenders under the Facility regarding a sale of certain of the Borrower’s assets were ultimately unsuccessful. Accordingly, the board of directors of the Borrower resolved to place the Borrower into administration under the UK insolvency regime and, by filing a notice of appointment of administrators at the High Court in London earlier this afternoon, appointed partners of BDO Stoy Hayward in London to be the administrators of the Borrower.

With the Borrower in administration, the Company will not have access to cash to pay any obligations and expects that its common shares will have no value.”

Therefore, in a matter of only 135 days, investors in the Britannia Bulk IPO had managed to lose 100% of their investment.

Although shareholders would later attempt to recover their investment through the US courts, alleging securities fraud against the directors and IPO underwriters, the judge eventually threw out the case, noting that all the material facts had been disclosed in the original prospectus.

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Posted in: Failed Companies