DryShips (DRYS) has had problems with its credit lately. It has refused to take delivery of Capesize vessels (and has cancelled many future deliveries). DRYS has had to pay a stiff price for all of this. It has cancelled its dividend. It has, however, been able to renegotiate its credit with Bank of Piraeus (BPIRF.PK) to restructure two loan facilities totaling $220 million, with $164.9 million currently outstanding. Under the terms of the deal, outstanding repayments will be reduced by roughly 47% in 2009 and by 21% in 2010. The deal also includes a covenant waiver through Jan. 1, 2011. DRYS has made a shelf registration to sell $500M worth of its shares purportedly to help shore up its credit situation. This will no doubt cause share value dilution. I have talked to investor relations at DRYS. They say there is no set timeline on the sale of these shares. They will inform shareholders when the shares are sold. The shares have fallen as a result from the recent $13-$15 range to their current price of approximately $6. They were as low as the high $4 range at one point. This begs the question, why buy now? The answer is twofold. First, nothing has dramatically changed in the DRYS shipping business. It is still a great value. The ship deliveries that were cancelled were cancelled to cut back on CAPEX for the near future. This is something nearly every company is doing in these hard times. The money raised from the share sale will likely be used to retire debt (or make further acquisitions). The money from these shares is going to be used to make the company more financially stable. The BDI has been going up steadily on increased demand from China, due to its infrastructure heavy stimulus package (and a possible second infrastructure package). The imminent approval of the US stimulus package is likely exerting an indirect effect also. The BDI stands at 1642 with the capesize spot price at $30,001. It has risen consistently for the past two months. Second, DRYS has announced that it is planning to spin off its Ocean Rig holdings as a new company by issuing shares as a dividend to its shareholders. The regular dividend has been cancelled. However, I have not heard that this dividend has been cancelled. The proposed spin off was supposed to occur in Q1 of 2009. However, I have confirmed with DRYS’ Investor Relations that the spin off has now been delayed until 2H 2009. Its format is best described by the DRYS announcement, After we file all appropriate documents with the SEC, and once approved, we will spin-off the entity to our shareholders as a dividend. We hope to do so in the fourth quarter of 2008 or in the first quarter of 2009. This is not an IPO, as we will not raise any new equity. Simply, each shareholder in DryShips, as of the record date, will end up owning a share in DryShips and a share in the new spun-off entity, which they can then keep or sell on a U.S stock exchange, and the market will then determine the ultimate value of those shares. At the time of the spin off announcement, DRYS made the following estimate about the likely value of the new entity’s stock. Using several methodologies, it was estimated that the total equity value of Primelead would be between $2.55 billion and $2.80 billion, which if correct, and taking into account the 100% owned by DryShips and divided by the 63 million shares should result in a common stock price of $30 to $31 for the spun-off entity. As we showed in our recent presentation, if you assume a daily rate in excess of $675,000 per drillship, you get an EBITDA level which after applying a multiple of 5, which is the current market, you get an Enterprise Value of $900 million per drillship, or $5.4 billion for all six units. Taking out the net debt of this entity you get an equity value of about 2.7 billion. 75% of this value ($30-$31 per share) goes to the 63 million shares owned by DryShips shareholders post closing and post spin off. DRYS itself will retain a 25% interest in Ocean Rig (according to Investor Relations at DRYS). Note that RIG trades at a 1.15 book multiple. DO trades at a price to book ratio of 2.67. NE trades at a P/B of 1.39. The Ocean Rig entity’s Price/Book ratio is likely to be higher than the average of the lower two values above. This is a perhaps overly optimistic view of the Ocean Rig entity’s worth in the current market situation. Still, even if you cut that estimate to $10/share, DRYS would still be a great bargain. You would get the DRYS dry bulk business, which seems to be nearly the entire valuation basis for the stock at the moment ($6). Plus, you would get the Ocean Rig business entity ($10+). This is another case where the break up value of the stock is worth more than the company as one entity. The total would give you in excess of $16. Since the stock is now trading at $6, you will have made money. If oil recovers in the second half of 2009, this will make the Ocean Rig spin off entity far more valuable. If dry bulk shipping continues to improve going into the summer, the price of the DRYS dry bulk business will go up dramatically. At this point I see tremendous upside, with much less downside. DRYS may not have gotten the new capesize ships. They may have paid off to not take them. This will likely eventually hurt growth. However, it has essentially ensured that DRYS will remain profitable in the hard times of the next year or two. Again you raise the question, why buy now??? The answer is simply that you can rely on Mr. Economou. You can rely on Mr. Economou to be self-serving. You can rely on him to be the smart man that he is. He owns a lot of shares himself. Other interests of his also own significant shares of DRYS. How does this help you? Simply, there is no specific date on the shelf registration sale of the DRYS shares. For Mr. Economou to get the most out of his shares, he will sell as few shares of DRYS between now and the spin off date as he can. That way he will get a higher proportion of the Ocean Rig company when it is spun off. No doubt DRYS itself will retain shares in the Ocean Rig company. However, it will not issue new shares in the Ocean Rig company for any future DRYS shares it sells. Buy now!!! Have faith in Mr. Economou!!! Have faith that he will do what is in his best interest!!! If you are waiting to see how badly the current shares get diluted by the $500M stock sale, you are likely letting a good opportunity slip by. You are going to miss out on the Ocean Rig spin off. When you buy after the stock goes up - on the spin off due to the stock in the spin off DRYS retains itself (25% according to Investor Relations at DRYS), you will have missed getting the spin off yourself. Then you will likely get hammered by further sales of DRYS shares from the $500M shelf registration. It seems likely Mr. Economou will pick that time – the time when the DRYS shares are higher priced – to sell off some of DRYS to retire some debt. Play the game with Mr. Economou. It seems much more likely to be profitable than to try to play against him. Other shippers simply do not have this coming spin off. It is a great value opportunity. NOTE: Many worry that the day rates on these rigs have gone down recently. This is probably true. However, they are likely to go back up. There is still demand. RIG just contracted long term for 3 of its UDW rigs at $495,000/day to $537,000/day with Reliance of India. The cost to operate these rigs is only about $150,000/day. I think you can see where the profit is. The two of the UDW drill rigs DRYS has on order are costing it $800M each (I am unsure the exact cost of the other two). Even at this cost they will quickly pay for themselves at current day rates. Is DRYS carrying a lot of debt because of this? Yes, they are. Is this likely to pay off for DRYS? Yes, it is. Keep in mind that PBR has made huge discoveries in deep water off the coast of Brazil. The next frontier in the Gulf of Mexico is very deep water drilling. These, along with other deep water drilling opportunities (Indonesia, the China Sea, the North Sea, etc.), should keep the demand high for the UDW rigs. If we are not at the bottom of the recession, we are close. The deep sea oil drilling business should start to pick up toward the end of 2009. Related Articles * Wright Express Corp. Q4 2008 Earnings Call Transcript Feb 11, 2009 * ATC Technology Q4 2008 Earnings Call Transcript Feb 11, 2009 * Commercial Vehicle Group Inc. Q4 2008 Earnings Call Transcript Feb 11, 2009 * Genesee & Wyoming Q4 2008 Earnings Call Transcript Feb 11, 2009 * SkyWest Inc. Q4 2008 Earnings Call Transcript Feb 11, 2009 Related Stocks: * DRYS Investing Ideas Get a daily email of Long Ideas, Short Ideas, Cramer's Picks and more. We don't spam Print this article with comments This article has 65 comments: Register or Login to rate comments » * o David White o 668 Comments o DRYS announced a preliminary agreement with Nordea Bank today for a covenant waiver on its $800M Primelead Facility. Assuming this goes through as proposed, this effectively puts at least a temporary end to DRYS's loan covenant breach problems. DRYS reached agreement with Piraeus last week. The BDI is up strongly again today to 1815. The capesize spot price is now at $34,101. The BCI is at 3344. DRYS stock is up in pre-market trading. The technicals indicate the first strong support is at about $3.60. The first strong resistance is at $9. The stock is currently trading at approx. $7. It seems much more likely that the stock will move up to find new support at $9, especially given that the financial problems seem to have been resolved at least temporarily. Further investors should take into account that the consistent rise in the BDI lately will likely mean that the market prices of old ships will be going up also. DRYS has one of the best price to book ratios in the industry. If the used ship prices go up, DRYS should soon have no problems with covenant violation, as these problems have largely arisen due to mark-to-market accounting rules. Feb 09 09:12 AM |Report abuse | Link | Reply +8 -5 * o User 344315 o 4 Comments o other shipping stocks to consider with growth and sales valuation: ESEA - Euroseas, Ltd. KEX - Kirby Corp. SBLK - Star Bulk Carriers Corp. TBSI - TBSI Intl. Ltd. TOO - Teekay Offshore Partners L.P. for more shipping stocks with bullish technical indicators click here: www.synergeticstocks.c... Feb 09 09:25 AM |Report abuse | Link | Reply +2 0 * o Jake Berzon o 170 Comments o Website "Have faith" are the key words here. To buy DryShips now would mean to take a leap of faith believing that the company will be able to survive this recession without filing for bankruptcy and wiping out current equity holders. If they can do that - good things will likely happen. If not - you will get wiped out and the current stock price reflects this risk. Feb 09 09:53 AM |Report abuse | Link | Reply +12 -1 * o dawase o 49 Comments o Website You presume he won't be issuing shares to himself, no? Feb 09 10:19 AM |Report abuse | Link | Reply 0 0 * o David White o 668 Comments o dawase: You have to go by their press releases. They can be sued if they are demostrably misleading. According to those, 75% of the Ocean Rig value will go in stock shares to the owners of DRYS shares at the ex-dividend date. As I tried to point out, Mr. Economou owns some DRYS shares himself. Plus he has interests in companies that have DRYS shares. It is in his interest to make the dividend distribution of Ocean Rig (i.e. give shares in Ocean Rig to owners of DRYS shares) before he allows the DRYS shares to be diluted very much. The new agreements with the two banks DRYS was in default to should allow him to do this. Once the distribution takes place, selling DRYS shares (from the shelf registration) will not depreciate his new holdings in Ocean Rig. Therefore Mr. Economou will sell very few DRYS shares (or as few as possible) until after the dividend distribution. I also tried to point out that the dividend distribution would likely make the DRYS share value go up because DRYS is retaining 25% of the Ocean Rig stock. That stock will then have a defined value that will likely be much higher than the value Ocean Rig currently consitutes on DRYS books. Plus with the BDI going up consistently, dry bulk shipping stocks should go up generally in lock step. Feb 09 11:25 AM |Report abuse | Link | Reply +5 -3 * o David White o 668 Comments o Jake Berzon: what you say can be said of many great companies. To allay your fears somewhat, Morgan Stanley just upgraded the Commodity Shipping Sector from "Cautious" to "In-Line". The BDI continues to rise dramatically. Plus China (the biggest dry bulk customer) is likely to announce yet another stimulus package soon. This should help Dry Bulk immensely. Feb 09 11:28 AM |Report abuse | Link | Reply +4 -2 * o guliamo o 74 Comments o Website This is great analysis, but could we be missing the Forrest for all the trees here? For me, to go long - I need a better reason than re-figuring balance sheets. DRYS have done a terrible job managing their business and the macro truth remains - demand for shipping and products is down down down.. will they survive? maybe. But beaten down companies with better macro prospect are a dime a dozen these days.. Nevertheless, great piece, thanks. Feb 09 11:37 AM |Report abuse | Link | Reply +3 -2 * o Mai o 6 Comments o Hi David: DRYS would have gone up $2-3 at such a news, but shorts are not covering. Do you know why? Thanks! Feb 09 11:45 AM |Report abuse | Link | Reply 0 0 * o David White o 668 Comments o Jake Berzon: I should also point out that DRYS is actually in a much "safer" financial position after this latest spate of bad news. It has cancelled a lot of its new capesize deliveries. This will mean that there will be a much higher proportion of DRYS' ship that will be operating on long term contracts. DRYS now seems much more able to meet it financial obligations. It along with EXM and GNK may have to greatest debt problems. However, DRYS and EXM have the lowest price to book ratios. They both represent huge potential profits to the upside. There is risk in every stock purchase. The smart investor balances risk with reward. The potential rewards on DRYS are great!!! No doubt analysts have crucified it for the recent loan fiasco. However, that just makes it a better buy for the average investor. Analysts will likely re-assess DRYS based on the even more recent information soon. You do not have to wait for them. DRYS should do well as long as the Chinese don't head into a dramatically worse economic situation. The proposed new China stimulus package should help in that regard. The US stimulus package should also help China as they export to the US. This all makes one think that dry bulk shipping should be looking up. Apparently Morgan Stanley and the Baltic Dry Index agree with my assessment, at least so far. The situation can always change. You can always use sell stops on your stock to prevent big losses. For now, this seems like an excellent opportunity. A week or two ago DRYS one year price target was approx. $35. Today on Yahoo it is approx. $10. In my mind DRYS is in much better financial condition today than 2-3 weeks ago. DRYS has eliminated a lot of its CAPEX for 2009. It looks much stronger financially going forward. With a good number of long term contracts, it should be able to weather the recession reasonably well. Plus the Ocean Rig distribution as a dividend is likely to net each DRYS shareholder at least $10/share. Add the likelihood that DRYS stock will go up considerably from its current position to say $20 to $40 by year end. Then you have a real opportunity to see your DRYS shares rise from about $7 now to say $40 (inlcuding the Ocean Rig distribution money). That is more than a 5-fold rise. If you only get the $10 from the Ocean Rig distribution, you still made a trade that netted you more than 100% on the year. If you use stops, you can limit your downside. I believe DRYS should be able to soon establish a support level at $9 (i.e. be consistently above $9 soon). If you then put your stops at $8, you could have made a sure profit without much risk. You could put your temporary stops at $5.50 for the moment. Then you are risking at most $1.33 to possibly gain $10 to $33 over the next year. Most people would consider this a good risk. Once DRYS goes creditably above $9, you could move your stops up to ensure that you make a profit no matter what. If you don't believe the thesis of this article, you obviously do nto want to invest in DRYS. I do. I am invested.