Questions for Shipping Investment Case Study

You are required to analyse the case study. Specifically, you must complete the following, for each of the three parties involved in the case study separately:
1. Is the project acceptable?
2. Which items will be subject to further negotiation?
3. What options are embedded in the project?
4. What key factors affect the values of those real options?

The following information provides a synopsis of the main parts of the case study, in order to be used in the analysis.

Parties

1. The Bank (UK) collaborates with all parties
2. Shipowner Investor (Japan) – INV (30 vessels under 1 – 10y T/Cs)
3. Industrial Group (Netherlands) – IG (coal, iron ore, steel cargos under spot or 3y T/Cs)

There are three principal parties: the Bank, the Investor (“INV”) and the Industrial Group (“IG”).

Before the subject transaction, INV and IG are both clients of the Bank. INV and IG are not known to each other, although they know of each other’s good reputation in the marketplace. The Bank is a multinational, AA-rated financial institution, with its head office in the UK. It has branches all over the world and provides a complete range of banking products.

IG is a substantial, publicly listed industrial group based in the Netherlands. It is a client of the commodity finance division of the Bank’s Rotterdam Branch. IG has huge shipping requirements for its cargoes, which include commodities such as coal, iron ore and steel products. The chartering division handles the shipping requirements by chartering in ships on either voyage or short time-charter basis. IG has never owned any vessels itself, mainly due to the lack of ship owning expertise and the fact that ship owning is capital intensive, which could affect the ratios on its balance sheet. Also, it has never time-chartered (T/C) in any vessels for longer than a three-year period.

INV is a private, family-owned shipowner based in Japan with a fleet of 30 vessels before the subject transaction. The fleet consists of Handymax (all of 40,000 dwt), Panamax and Capesize bulk carriers as well as two tankers. It is a client of the Bank’s shipping finance division based in Tokyo. INV is very liquid and is a pure ship owning entity in the sense that it has good ship owning expertise but does not control any cargoes. All 30 vessels of its existing fleet are time- chartered out on medium (1 – 3 years) or long-term (5 – 10 years) basis to reputable charterers in the same league as IG.

March 2000: IG entered cargo contracts (FOB) for 15y and needs 10 Handymax vessels.

April 2000: Bank suggests that IG team up with INV for 5 NB Handymax vessels (as IG do not want to buy them but just to employ them and be able to benefit from capital gains from raising vessel values).

Current Market Data

● During the last 5y: the 3y-T/C rate has been between $6,500 – $12,500
● the 5y-T/C rate is between $9,000 – $9,500 (expected to increase)
● the NB cost is between $18,5M – $25M (average $20M)
● IRR is 15% p.a. to 10% p.a. (realistic and depends on the debt/equity ratio)

Loan Terms

1. Number of vessels = 5 NB Handymax vessels (delivered in 3 month intervals from mid 2002)
2. Total value amount = $20,000,000 / vessel (= $100,000,000 / 5 vessels)
3. T/C period = 10 years
4. T/C rate = 10,000/day (at a premium over $9,500/day)
5. Profit sharing = INV 50%, IG 40%, Bank 10% (after repayment of loan & equity)
6. Total cost = $20,000,000 (on turnkey basis) = $18,800,000 (contract price) + $400,000 (predelivery interests) + $100,000 (supervision fees) + $100,000 (upfront finance costs) + $300,000 (pre-delivery expenses) + $300,000 (initial working capital)
7. Loan amount = $17,000,000 (85%) (post-delivery tranche) ($5,640,000 pre-delivery tranche)
8. Equity amount = $3,000,000 (15%) by INV (from preference shares with 5% p.a. coupons)
9. Profit distribution = (a) towards outstanding interests and principal of loan, (b) towards outstanding interests and principal of preference shares, (c) towards dividends to partners on the 50/40/10 ratio
10. Loan amortization = Straight-line for 15 years + $5,500,000 balloon payment after 10 years
11. Loan tenor = 10 years with no penalty for prepayment (in 40 equal quarterly payments) $287,500 (= $11,500,000 [= $17,000,000 – $5,500,000 balloon] / 40 installments)
12. Loan Securities = shipping securities plus a limited guarantee from INV
13. Loan Pricing = LIBOR (7%) + Spread (1%)
14. INV trigger options = Ceiling Option Trigger (sale of vessel for capital gain profits when vessel’s net sale proceeds reach certain option price) and Floor Option Trigger (sale of vessel to cut losses when values decrease)
15. Bank introduction fee = $1,000,000 (= 0.5% x $100,000,000 x 2 parties) and “first right of refusal”
16. INV supervision fee = $100,000/vessel for the NB
17. If vessel is sold after 10 years at $10,750,000 then IRR = 10% p.a. This gives INV a protection (floor) against the downside risk. He must then concentrate on the upside from his option right
18. Bank suggests a ceiling price of $22,500,000 for the first year after delivery with a reduction of
$1,000,000 p.a. thereafter
19. IG must decide whether the T/C premium can be justified by the 40% profit sharing. IG wants a wide ceiling/floor collar, while INV wants a narrow collar
20. INV guarantees OPEX over-run for 10 years (or pro rata if vessel sold before then) within $3,000/vessel + 2% p.a. escalating thereafter

May – June 2000: Negotiations start (issues to be discussed: timing, counterparty risk, exit strategies, IRR)

August 2000: MOU is drafted