May 22, 2011 - 6:10pm EST by
2011 2012
Price: 11.40 EPS $0.00 $0.00
Shares Out. (in M): 81 P/E 0.0x 0.0x
Market Cap (in $M): 923 P/FCF 0.0x 0.0x
Net Debt (in $M): 139 EBIT 0 0
TEV (in $M): 1,062 TEV/EBIT 0.0x 0.0x

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I am recommending another arbitrage trade between two shipping companies. The essence of the trade is that I can buy a fleet of ships for $637mil and then sell that exact same fleet for $1 376mil leaving me with a profit of $739mil.
The trade in a nutshell is as follows:
Diana Shipping (DSX) consists of 10 capesize and 16 panamax drybulk ships. It has an enterprise value of $1 062mil. 
Navios Maritine Partners (NMM) consists of 6 capesizes and 10 panamaxes. It has an enterprise value of $1 376mil.
If I went long 60% of DSX and short 100% of NMM I would effectively be
  • long 6 capesizes and short 6 capesizes
  • long 10 panamaxes and short 10 panamaxes
I would have to hand over $637mil for 60% of DSX, but, will receive proceeds of $1 376mil from shorting NMM leaving me with $739mil in my pocket.
More accurately the calculation is as follows: 
EV =$1062mil = $923mil (MrktCap) + $139mil(Net Debt).
(see calculation below)
EV =$1 376mil = $1 086mil (MrktCap) + $290mil(Net Debt).
(see calculation below)
So 60% of DSX minus NMM
EV =$739mil = $532mil(MrktCap) + $207mil(Net Debt)
To summarize
- Long $554mil DSX stock, Short $1 086mil NMM stock leaving you with net proceeds of $532mil in your pocket.
- The $207mil results from the different mix of debt and equity used to fund the assets. One way of neutralize the difference in the funding decision is to add debt to DSX(60%) balance sheet. An effective way of achieving this is to short $207mil of 5year* bonds. The proceeds from the bond short will put an additional $207mil in your pocket and you will effectively be long $290mil and short $290mil of 5 year debt.
*I chose 5 yr bonds as this matches the duration of NMM's debt.



I have adjusted the traditional EV calculation to take into account the purchase of a 2007 panamax costing $30mil to be delivered in June 2011 as well as two 2012 capesizes costing $59mil each to be delivered in Q2/Q3 2012. The reason I have made these adjustments in this analysis is because I have added the income streams of these additional ships to the earnings power of the fleet.
Stock Price                        $11.40
No Shares                         81mil
MrktCap                           $923mil
Net Debt                          $ 26mil
EV(Traditional)               $949mil
Debt(Panamax)                $ 30mil
Debt(2 Capesizes)           $ 83mil (2 @$59mil each less $35mil advance)
EV(Adjusted)                  $1 062mil


Similarly, I have adjusted NMM's EV for the acquisition of a 2004 panamax and a 2010 capesize announced in May 2011. The purchase price for both ships is $130mil and they will be delivered in June 2011. The ships will be paid for with cash $85mil, debt of $35mil and issuing 507k shares to the vendor.
I have also adjusted the March 2011 EV for the public issue of 4.6mil shares in April 2011 raising $90mil.
Stock Price                       $19.23
No Shares                        56.5mil (51.4mil + 4.6mil + 0.5mil
MrktCap                          $1 086mil
Net Debt                          $   260mil
Debt(Panam+Cape)         $     35mil
Cash(Panam+Cape)        $     85mil
Cash(Issue 4.6mil)          $    -90mil
EV(Adjusted)                 $1 376mil


I cheated three times in the above analysis.
Firstly. I fiddled slightly with NMM's fleet. After adding the two new ships NMM actually own 6 capesizes, 9 panamaxes and 1 ultra-handymax. Because the ultra-handymax (52 000dwt) is similar in size to the panamaxes(70 000dwt) I added the handymax to the panamax fleet to give 10 panamaxes. The reclassification is not that material as the second hand prices are fairly close. A 10yr old panamax currently goes for $27mil versus $20mil for the handymax.
Secondly, in addition to NMM's owned fleet they have two ships which they lease-in for $13 700 a day and charter out for $24 000 and $28 000 respectively. These back-to-back leases run for another 2 years. As the NPV of these income streams is only $15mil I have excluded these ships from the analysis.
The third cheat is more material. This write-up would end here if ships in the two fleets were of the same age and had similar charter profiles.
Unfortunately the age and employment profiles differ and so one has to adjust the $739mil arbitrage profit for these differences. The best way to get a feel for these adjustments and the risks of this trade is to play with different scenarios using a sensitivity analysis.


Do you remember that first finance class where you were told that an investment is a discounted cash flow. I am not sure the sell side made that class as they seem to think that a shipping company can be valued by guessing the eps and then using an arbitrary rating to get to the value!!! Maybe they are just mucking with my blood pressure but I sure do wish I could force them to use their bonus to buy a ship in the real world using this approach.
I think it is obvious that the only way to value a shipping company is to do a DCF for each ship. The easy assumptions required for this analysis are listed below
  • The useful age of a ship is 25 years. Scrap value = $10mil 
  • Cash operating and administration costs are $6000 per day per ship.
Modeling the revenue streams is a little more complicated. Ships can be chartered out on fixed periods at fixed rates. For instance, NMM have chartered a capesize out at $41 325 a day until November 2019.
The above time charter revenue streams are obviously easy to model. However, if the ships are chartered out on the spot market these ships earn the market rate which I am sure everybody knows is extremely volatile and notoriously unpredictable.
DSX and NMM provide very good disclosure of their fleet with the employment profiles for each ship in their earnings releases and on their websites. A comparison of these employment profiles show fairly large differences and it is therefore essential that the robustness of the arbitrage profit needs to be tested using various scenarios in the DCF models.
Because the arbitrage profit is so wide only three scenarios need to be examined to confirm that the arbitrage profit is secure.

Scenario 1

Assuming both capesize and panamax rates fall to the cash operating costs of $6000 a day then the DCF value of NMM should equal $490mil. Assuming debt remains at $290mil then the market cap of NMM should equal $200mil. The profit on the NMM short will be $886mil ($1086mil-$200mil).
The DCF of DSX equals $323mil. Assuming debt remains at $139mil then the market cap of DSX should be $184mil. The loss on the DSX(60%) long will be $443mil. (60%*$184mil - $554mil)
Under this scenario the net profit will be $443mil.

Scenario 2
Assume the current rates for capesizes and panamaxes of $18 000 and $16 000 a day respectively prevail.
The DCF value of NMM equals $709mil. Assuming debt remains at $290mil then the market cap of NMM should equal $419mil. The profit on the NMM
short will be $667mil ($1086mil-$419mil).
The DCF of DSX equals $937mil. Assuming debt remains at $139mil then the market cap of DSX should be $798mil. The loss on the DSX(60%) will be $75mil. (60%*$798mil - $554mil)
Under this scenario the net profit will be $592mil.

Scenario 3

Assuming long term maintainable rates of $30 000 and $24 000 a day for capesizes and panamaxes respectively.
The DCF value of NMM equals $906mil. Assuming debt remains at $290mil then the market cap of NMM should equal $616mil. The profit on the NMM short will be $470mil ($1086mil-$616mil).
The DCF of DSX equals $1 479mil. Assuming debt remains at $139mil then the market cap of DSX should be $1 340mil. The profit on the DSX(60%) long will be $250mil. (60%*$1 340mil - $554mil)
Under this scenario the net profit will be $720mil.


The scenarios above show that even if shipping rates fall to their cash operating costs then there is still an arbitrage profit of $443mil. This profit rises as rates rise. For fun I plugged in rates of $100 000 per day and calculated the arbitrage profit to be over $1 500mil.


As can be seen from scenario 2 which uses current shipping rates NMM is trading well above it's DCF value while DSX is trading close to it's DCF value.
As far as I am concerned the main reason for this is that NMM are paying out a dividend of 43c per quarter which equates to an annualized dividend of 9%. On the other hand, DSX have suspended their dividend because they want to retain cash to opportunistically grow their fleet.
Despite the fact that NMM have been retaining very little cash it has doubled its fleet over the last two years mainly through public offerings. Maintaining the attractive dividend has been a very clever startegy as it has ensured access to cheap equity which can be used to acquire ships.  
The dividend is costing $22mil per quarter which means NMM only retains $10mil per quarter. Instead of retaining earnings for acquisitions NMM have funded their aquisitions with four public offerings over the last 18months issuing 19.6mil shares and raising $355mil. It is startling to note how soon the public offerings follow the dividend announcement. For instance, a dividend was declared on Jan,26 2010 followed by a public offer on Feb,2 2010. Again a dividend on April 26, 2010 followed by a public offer on May, 5 2010 etc etc. Give the investors a dividend and then ask for it back the next day!!
While I believe that their is more than enough margin of safety in this arbitrage there is a risk that the profitability of the NMM short leg could be hurt if the market continues to allow NMM to issue "overvalued" equity to grow their fleet, eps and dividend.


NMM have bought 7 ships over the last 2 years all from Navios Holdings (NM) which owns 27% of NMM. Given the current market conditions I think they have overpaid for these ships, but, because the acquisitions enhance eps and support the attractive dividend the crucial return on investment metric has been ignored by the market.
I want to illustrate this point using the acquisition of a 2010 capesize for $98mil in November 2010. The capesize had a charter attached of $50 588 per day for 5 years, $18.4mil per annum ($16mil after costs). At the time of the transaction capesize rates were $30 000 a day which meant that capesize was "over rented" by $20 000 a day or $7mil per annum. Over 5 years this amounts to $35mil. At the time similar capesizes were trading at $56mil. Adding the $35mil to the $56mil gives $91mil. This is $8mil less than the $98mil paid.
Because it is hard to prove the $8mil overpayment I will ignore it. My problem is that today 5 year old capesizes are selling for $46mil. The IRR on the $98mil investment is only 7% assuming the ship is sold for $46mil when the charter ($16mil * 5yrs) ends. This is a terrible return given the risk of the asset, but, because NMM only had to issue 5.5mil shares to fund the acquisition the transaction was earnings enhancing and locks in further dividends which is all that matters to some investors.
NMM is playing a fantastic game, but, in my experience these reflexsive strategies described in the Alchemy of Finance are great while the music is playing, but, tend to unravel at some stage or another especially if the growth in assets slows. I am happy to be long DSX while I wait for this catalyst.
While waiting for the "music to stop" is the major catalyst two smaller catalysts are also worth mentioning
1. The profitability of this trade will be enhanced if shipping rates rise (see scenarios)
2. The Navios Appolon chartered out at $23 700 per day or $700k per month experienced engine trouble in March. I have been monitoring the ship using www.marinetraffic.com and it is still held up in a port in Taiwan. (http://www.marinetraffic.com/ais/default.aspx?oldmmsi=372221000&zoom=10&olddate=5/22/2011 4:24:53 PM). The lost revenue for this quarter so far is close to $1.4mil which is substantial considering that quarterly net income is only $16mil. There is also a chance that a big repair bill hits the income statement.


Current capesize rates are $18 000 a day. The DCF models show that to justify NMM's current stock price the capesize rate will need to rise to $50 000 a day. On the other hand the models shows that DSX's stock price reflects current depressed shipping rates. Given the similarity in fleets and the substantial margin of safety I expect this arbitarge trade to be very profitable.
Also, because this trade becomes more profitable as shipping rates rise I think this is a great risk adjusted bet for those who are bullish on shipping rates.


- Cyclical change to the currently successful funding model.
- Shipping rates rise.
- Navios Appolon engine trouble.
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