Last week, DnB Nor Markets, Enskilda and Fearnley Fonds executed a rather challenging deal very smoothing. The transaction resulted in a $125 million private placement for Aker American Shipping ASA (AKAS).  Sources in Oslo tell us the deal was priced at the high point of the range and was 5x oversubscribed.  It is important to point out the equity execution development that was seen in Oslo, which demonstrates that Norwegian bankers have developed a clever way to control deal risk in today’s choppy market. As we saw with the recent B+H placement, issuers are now hiring underwriters to sell shares on a private placement basis, with the agreement that these shares will later acquire a public listing.

Profits generated by the AKAS offering will be used to fund the construction and ownership of 10 U.S. flag product tankers, which will be delivered at the Kvaerner Philadelphia Shipyard from 2006 to 2010 and bareboat chartered to OSG. In addition to the offering, Aker will be listed on the Oslo Stock Exchange next week. Our calculations tell us that AKAS sold roughly 45% of its shares in the recent equity offering for $125 million.

There are two aspects of the AKAS deal that got investors excited.  First, investors in AKAS will also own the Kvaerner Philadelphia Shipyard, which is positioning itself as the most efficient builder of vessels to replacing the aging U.S. Jones Act Fleet.  Second, Norwegian and international investors and OSG are excited about the “simple math” involved in the supply and demand outlook for U.S. flag product tankers.

According to the structure of the deal, AKAS will bareboat the ships to OSG, who will then timecharter them to an OSG subsidiary called OSG PT, which was formed for the purpose of the transaction and will then time charter them to U.S. oil majors. Under the terms of the bareboat, OSG will take the first five vessels for seven years and the next five vessels for five years. Also, OSG negotiated an unlimited number of charter extension options of three or five years plus one year.

While the exact details of the deal have not been revealed, market sources say AKAS is planning to deliver the vessels at an average of $86.4 million. AKAS will initially fund the equity portion of the deal with funds raised through the recent offering and later with free operating cashflow once the vessels have been delivered and can be financed. As for the economic aspect, we understand that OSG will take the vessels from AKAS on bareboat charter rates in the mid $20,000 range.

There are definite risks that this deal carries for everyone involved.  For OSG, the risk takes the form of the time charters. From a return on equity standpoint, however, OSG has little to lose.  They have no money in the deal, so any money OSG makes will essentially equate to an enormous return on investment. For shareholders in AKAS, the major risk comes earlier than for OSG. It is absolutely critical that the Kvaerner Philadelphia Shipyard deliver these vessels on time and on budget, which shipyards in the U.S. are not known to do.  If AKAS cannot produce the ships at or under budget there will be little or no return to the shareholders.  While OSG will pay a floor rate that will keep the deal current with its lenders, the upside from this equity will be limited by charter rates and what new business the shipyard is able to generate.  For both AKAS and DnB, there is the outstanding value exposure to the shareholders of AKAS.  Each vessel will produce $7.3 million EBITDA, ($20,000 bareboat per day for 365 days), meaning that vessels are valued at 11.7x initial EBITDA.

In sum, we feel this was a well-done deal.  While of course there are still risks involved, close management of the construction process and smart commercial management will ensure success for all parties involved. And afterall, doing good shipping deals always require the assumption of risk.

Is Hawaii the Next Puerto Rico?

As we have seen in the Puerto Rico market since the demise and withdrawal of Navieras, a little bit of extra capacity in a captive market can really pollute rates and destroy capital. Competition in the Hawaii market will be further exacerbated by the coming arrival a new Pasha-owned ro/ro working on the trade lane between Los Angeles and Hawaii. If there is a bright spot here, it is that the Hawaiian economy has been strengthening and might even be able to handle the added capacity.

Using Equity to Finance a Debt Deal

The debt financing of these vessels will be another interesting facet of the OceanBlue deal. We highly doubt that Caterpillar will be involved in ships that will compete against those in which they have already taken a considerable amount of risk. Moreover, with the vessels essentially operating in a “start up” business and with book values that make them totally uncompetitive in the international market should the startup not work, we think bank debt will be low. Therefore we would expect to see this deal financing with at least 50% equity and quite possibly more. This would give the lenders the ability to get out whole should they need to remarket the vessels on the international market.

Ocean Blue and the Need to Beef Up

One challenge associated with raising equity for OceanBlue will be the fact that the exit strategy is unclear unless DnB and Jefferies are able to make investors comfortable with the idea that OceanBlue will be able to beef up its business through newbuildings or acquisitions and then go public at a multiple of its book value. But where will they look to expand? With the supply demand balance of Jones Act markets extraordinarily tight, it will be both difficult and expensive to find good assets. If they are able to sell this story, though, then the IPO of Horizon Lines will come at a very good time by creating a comparable valuation that will get potential OceanBlue investors excited. The challenge therefore, is that OceanBlue is really a debt deal that needs equity – but at the end of the day, we have little doubt that the new Kvaerner ships will end up being consolidated into Matson or Horizon. There have been rumors that Alexander and Baldwin has been thinking of selling off Matson Navigation, though Horizon is the more logical choice in light of the age of their fleet and the fact that they are raising fresh equity. After all, Horizon Lines will need the ships at some point, and the economics of these ships is actually pretty reasonable. Moreover, Kvaerner might well shut down after the obligation to deliver these final vessels is fulfilled, which would make it very difficult for Horizon to find large ships at a comparable price.

As we have seen in the Puerto Rico market since the demise and withdrawal of Navieras, a little bit of extra capacity in a captive market can really pollute rates and destroy capital. Competition in the Hawaii market will be further exacerbated by the coming arrival a new Pasha-owned ro/ro working on the trade lane between Los Angeles and Hawaii. If there is a bright spot here, it is that the Hawaiian economy has been strengthening and might even be able to handle the added capacity.

The debt financing of these vessels will be another interesting facet of the OceanBlue deal. We highly doubt that Caterpillar will be involved in ships that will compete against those in which they have already taken a considerable amount of risk. Moreover, with the vessels essentially operating in a “start up” business and with book values that make them totally uncompetitive in the international market should the startup not work, we think bank debt will be low. Therefore we would expect to see this deal financing with at least 50% equity and quite possibly more. This would give the lenders the ability to get out whole should they need to remarket the vessels on the international market.

One challenge associated with raising equity for OceanBlue will be the fact that the exit strategy is unclear unless DnB and Jefferies are able to make investors comfortable with the idea that OceanBlue will be able to beef up its business through newbuildings or acquisitions and then go public at a multiple of its book value. But where will they look to expand? With the supply demand balance of Jones Act markets extraordinarily tight, it will be both difficult and expensive to find good assets. If they are able to sell this story, though, then the IPO of Horizon Lines will come at a very good time by creating a comparable valuation that will get potential OceanBlue investors excited. The challenge therefore, is that OceanBlue is really a debt deal that needs equity – but at the end of the day, we have little doubt that the new Kvaerner ships will end up being consolidated into Matson or Horizon. There have been rumors that Alexander and Baldwin has been thinking of selling off Matson Navigation, though Horizon is the more logical choice in light of the age of their fleet and the fact that they are raising fresh equity. After all, Horizon Lines will need the ships at some point, and the economics of these ships is actually pretty reasonable. Moreover, Kvaerner might well shut down after the obligation to deliver these final vessels is fulfilled, which would make it very difficult for Horizon to find large ships at a comparable price.