13-03-2017

DryShips Inc.’s Buying Binge: Making It Great Again or Diworsification?

Dryships

The shipping company has already acquired four vessels since the start of the year and is on the hunt for more deals.

DryShips (NASDAQ:DRYS) spent the bulk of the past year working to shore up its balance sheet. The culmination of those efforts was the mid-December agreement for a comprehensive refinancing, de-leveraging, and strategic repositioning with an entity controlled by its founder. That agreement not only provided the company with funding to operate but “to evaluate the possible acquisition of assets at distressed values.”

While the initial plan was to go bargain hunting, in reality, it has gone on a buying binge, signing deals to acquire up to six vessels. Because of the rapid speed, it seems like the company is in a rush to purchase ships just because it can. That’s a concern given the apparent lack of direction and the company’s history.
Fully loaded liquid natural gas tanker departing a harbor.

On a rebuilding mission

One of the casualties of DryShips’ efforts to shore up its balance sheet was its fleet. The company had no choice but to sell off vessels over the past year to pay down debt. As a result, it had just 13 dry bulk vessels remaining along with six offshore supply vessels as of the end of last year, which is down from a fleet of 39 dry bulk vessels, 10 tankers, and 13 offshore drilling units that it had in early 2015.

However, with newly minted liquidity in hand, DryShips started 2017 on a mission to rebuild its fleet. CFO Anthony Kandylidis said at the time “that given where we are in the cycle in both the tanker and dry bulk markets, we are faced with a unique entry point to acquire vessels in these sectors at historic low prices.” Because of that, it was on a mission to “make DryShips great again.”
First, a little detour

While the company initially said that it would target the tanker and dry bulk markets to rebuild its fleet, DryShips broadened its horizons a bit when it announced the closing of a new credit facility in early January. CEO George Economou stated at that time that because the company had “completed the restoration of our balance sheet” that it was “now ready to begin looking at acquisition opportunities in all of the shipping sectors including dry bulk vessels, tankers, and gas carriers, as the opportunities arise.”

The addition of gas carriers to its opportunity set was by design. That’s obvious because just two days later DryShips announced that it signed an option agreement with companies controlled by Economou to acquire up to four Very Large Gas Carriers for up to $334 million. These vessels are quite different from those the company had owned in the past because they came with previously signed long-term time charters, meaning that they are not subject to volatile spot market prices. Because of this, DryShips will be able to rely on the relatively steady cash flow that these ships provide. In fact, when including option years, these vessels have a $390 million backlog.
Back in the tanker game

The company followed up that deal with the announcement of its strategic reentry into the tanker market, agreeing to buy two vessels for a total of $102.5 million. However, unlike the gas carriers, these tankers will be employed in the spot market, which means the company’s cash flow from these vessels will ebb and flow with volatile market prices.

Those market prices can move dramatically in a short amount of time. Just ask leading tanker company Nordic American Tankers (NYSE:NAT), which has experienced that volatility firsthand. Over the past three quarters, for example, tanker rates have bounced from $16,700 per day in last year’s third quarter to $25,000 per day in early 2017. However, this volatility goes both ways. As the below chart shows, Nordic American Tankers’ cash flow from operations has been anything but stable, even dipping into the red in recent years:

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NAT Cash from Operations (Quarterly) data by YCharts.

Diversifying at its worst

One way Nordic American Tankers handles this volatility is by focusing on one vessel type, which reduces its cash operating costs. In fact, the company has a cash breakeven rate of $11,000 per day because of this laser focus. DryShips, on the other hand, now owns a menagerie of ships, many of which have nothing in common other than they all float.

Investing legend Peter Lynch coined a term for companies that operate like that: diworsification. In his view, companies that diversify too wildly can ruin their original business because they focus on too many things at once. That appears to be the path DryShips is taking with its diversification strategy because there is no rhyme or reason to it other than the company believes it is getting a good deal on the vessels.

However, the strategy of buying simply to buy has failed DryShips in the past. For example, just two years ago, the company unloaded its entire tanker fleet because it had to increase its liquidity to reduce the selling pressure on its stock after it got in over its head in debt by expanding too aggressively. It’s a mistake it appears poised to repeat if it continues to buy ships just because it can instead of buying to fit within its strategy, which at the moment remains undefined.

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