SUNK BY JUNK
Stepping into the bond market can be a disaster if the issuer doesn't understand the business Fred Cheng explains
By Fred Cheng

Golden Ocean, a London-based ship owner, was a good company with good ships, good charters, good financing relationships and an excellent track record of timing market cycles and repaying all financiers. The collapse and bankruptcy of Golden Ocean in 1998 was a prime example of where and how financial structures can go wrong.

Sadly, the US$300 million Golden Ocean high-yield bond deal - which led to the company's collapse - was doomed to fail primarily because of a lack of understanding between the company, its investment bankers and its bondholders. With hindsight, we should have achieved a better rating and raised money with secured bonds. Secured bonds on first-class cashflow streams would have shielded the bonds from the volatility of the short-term freight market. In other words, we should (and could) have refinanced our existing fleet of long-term chartered ships. So why didn't we do secured bonds?

At the time, it was a matter of having an offer proposed to me that seemed too good to refuse. An unsecured loan at 12 percent? Unfortunately, I did not understand the high-yield bond market well enough to question it - and that was the beginning of the mistakes we made.

The Ratings Game

Our trouble worsened when we received a CCC rating from one of the rating agencies who didn't know or understand the shipping market. As a result, the interest rate increased from 12 percent to near 20 percent at the last minute - after all the expenses for the roadshow had been incurred. Then, our US investment banks, Sutra & Co and Libra Investments, said that the bondholders required an option to have the company issue another US$100 million at the same pricing in six months' time - allowing for the fact that there was a clause restricting us from ordering more ships.

They told us it would be fairly easy to obtain a waiver on the restriction from ordering more ships so that we could afford the extra money on the back of more orders. When the time came, they forced the money on us but would not give a waiver on realistic terms.

With no choice, we asked legal counsel what to do and they came back with the idea of purchasing options on more new buildings, which according to them would be "bulletproof" within the bond indenture.

Of course, our legal counsel did not tell us beforehand what the bondholders' reaction would be - and that's when the trouble really started. When the Asia markets collapsed, it exacerbated a relationship already strained by misunderstanding.

Rough Seas

There was misunderstanding on the part of the bondholders who did not - and had no interest in - understanding the shipping business, and misunderstanding on our part on the whole principle of high-yield bonds. And there was misunderstanding of the real motives of the investors who purchased them.

Next, the bondholders used the newbuilding purchase option transactions recommended by our solicitors to drag Golden Ocean, which was still performing, into restructuring - in an effort to gain control of the equity in Golden Ocean. Unlike working with experienced banks/shipping financiers, who are gentle when a company is struggling, the high-yield investors were rough - investors changed every day, they thrived on misinformation, and they worked in small groups trying to cut side deals. Lawyers who thrive on protracted restructurings became involved in the process.

At this time, many of the new bond-holders specialized in buying bonds of companies below NAV and liquidating them for an immediate profit.

Distressing News

What Golden Ocean needed were the kind of investors who buy bonds and hold them. Instead our bonds were packaged and sold by a group of ex-Drexel Burnham people who made their living off of distressed companies. Ironically, while all of this self-created financial drama was occurring in New York, the company was running as usual. We took delivery of ships, chartered ships, financed ships, and did it all in a very difficult market.

In the end, I resigned from Golden Ocean and a new management took over. Again, even though the company was performing, the bondholders instructed the new management to auction the company through the Chapter 11 process. So why did I resign from a company that was my life's work? This brings me to one of the most significant and painful lessons of all. If you are the owner of a company you have to maintain daily involvement and absolute control - especially when it is under siege by this sort of creditor. I didn't, and by the time I realized what had happened, it was too late.

One of the most important lessons for me personally is that non-secured high-yield bonds are not about meeting financial obligations; they are about understanding the bond markets.

When the bonds were first issued, I thought of them as just another debt to be repaid. But unlike loans from traditional shipping financiers, these bonds are traded all the time. Although I knew this, I never thought through the consequences when the bonds were issued. More importantly, I never thought about the possibility of buying back the bonds at a discount myself.

The mistake was made on day one when I put all my eggs in one basket and put all my life's work into the same company that issued the bonds - leaving no significant assets to repurchase bonds.

Thereafter, a further mistake was to put additional shareholder loans into the company instead of buying bonds at a discount. The irony is that bondholders are actually happy when you are there to buy bonds back, even at a huge discount from the day they were issued.

They teach that the bond market, like any other market, goes through its own cycles when money is given away and when money needs to be retrieved. Therefore, theoretically one could take one's least attractive shipping assets in a good bond market (not necessarily a good shipping market) and issue bonds which one then buys back at 10 or 20 cents to the dollar, thereby getting "free" money to the tune of 80 or 90 cents. The irony is that not only is this allowed but bondholders are actually happy to be bought out when either they are tired of the business or when they need liquidity when their own markets turn south.

The most valuable question is this: could the US capital markets have been used successfully by Golden Ocean? And if the answer is yes. How?

In retrospect, a more appropriate structure would have led to a better rating. A better rating would have led to more reasonable pricing. More reasonable pricing would have appealed to investors with a longer view.

Fred Cheng is now chairman of shipping company Shinyo International based in Tokyo.