Harry Campbell

General Maritime, a publicly traded tanker shipping company, is finding out that when you play with the big boys, you sometimes get hurt.

The company recently received a $200 million loan from Oaktree Capital Management, one of the largest hedge fund managers in the world. General Maritime thought the loan would solve its financing problems, but instead it has created only more trouble. General Maritime’s story highlights the potential hazards when public companies borrow from hedge funds.

The tanker shipping business is cyclical, and the cycle has been down since the financial crisis. There is a glut of tankers these days, as well as a volatile economy. These forces have pushed General Maritime into survival mode. The company’s stock price has declined to 60 cents from more than $40 a share before the financial crisis. This year, the company faced having to obtain or refinance almost $700 million in debt. About $550 million came from senior lenders, but the company still needed another $200 million.

Deal Professor

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Here is where things get murky. An independent committee of General Maritime’s board was formed to explore financing options and two investment banks were hired, Jefferies and Allen Company. General Maritime has declined to disclose how many institutions it approached for financing. But in March, the company announced that it would borrow $200 million in a secured loan from Oaktree Capital. As part of the loan, General Maritime would provide Oaktree the right to acquire 19.9 percent of the company for a penny a share.

Hedge fund lending is increasingly common. Hedge funds still have large amounts of uncommitted capital that they are looking to put to work. Some companies, especially middle-market ones, are finding fewer avenues for loans. Hedge funds are filling this void.

Hedge fund lending is unlike traditional bank lending. Hedge funds are sophisticated entities prone to using creative lending structures, and they are not afraid of taking risk. Hedge funds are willing to lend when other aren’t — a valuable service, to be sure. But hedge funds expect higher returns. The desire to take risk and earn higher returns has led to complaints that hedge funds take advantage of companies and charge exorbitant interest rates. Hedge funds may also create complex financial structures, which may turn out to haunt the borrower.

This all happened in the case of General Maritime.

First, Oaktree dictated hard terms. The loan terms look very much like those only a company on the verge of bankruptcy, and therefore with few negotiating options, would agree to. Oaktree is getting a right to 19.9 percent of the company. The interest rate that Oaktree is charging fluctuates, but in June it was at 12 percent a year.

This is far from your typical subordinated debt deal, where a lender simply lends money at a rate of interest. General Maritime was in distress, but it also had assets like tankers that it could sell and did not appear to near insolvency. It also had at least another year before it needed to secure this financing.

Second, Oaktree has provided Peter C. Georgiopoulos, General Maritime’s chairman and owner of about 6 percent of its stock, 4.9 percent of the profit from the loan. It does not appear that Mr. Georgiopoulos paid for this interest.

Instead, it appears to be a reward bestowed by Oaktree — but a reward for what? This is the worst sort of conflict. The chairman is making money off his company’s distress. Because of the conflict, the company’s independent directors needed to approve the loan, which they did, but this is still poor optics at best.

(General Maritime declined to comment for this column, saying that because a shareholder vote was looming, Securities and Exchange Commission rules prevented it from speaking. Oaktree also declined to comment.)

Third, the General Maritime board is failing miserably in agreeing to this complex financial deal, taking steps which actually make the company’s situation worse. After agreeing to the loan, General Maritime entered into an arrangement with Jefferies to sell $50 million more in stock on the open market.

The problem? General Maritime shareholders must approve compensating Oaktree for the dilution in share price that resulted from the stock sale. If shareholders approve, Oaktree will be issued more stock valued at about $10 million. If shareholders reject this transaction, then the interest rate on the Oaktree loan rises to 18 percent, possibly costing General Maritime more than $100 million.

This is not a choice. It is a gun to shareholders’ heads. General Maritime could have easily avoided this dilemma by holding the shareholder vote before it sold these shares.

General Maritime chose not to follow this route for unknown reasons. Nor is it clear why General Maritime needs this extra $50 million or why it didn’t raise the money at the time of the Oaktree loan.

It all smells. On the one hand, you have Oaktree pushing aggressively for terms that include an equity stake and having no qualms about allowing an open conflict with Mr. Georgiopoulos’s profit participation.

On the other hand, you have General Maritime. Along with its bankers, the company appears to be forcing this transaction down shareholders’ throats and failing to provide evidence that this is the best deal available. This only makes people more suspicious.

Institutional Shareholder Services, the proxy advisory firm, said on July 27 that the entire transaction, not just the most recent proposal, was “thin gruel served cold — a clear and striking failure of governance by the entire board, not simply its chairman.”

(On Tuesday, in the face of this nonchoice, General Maritime’s shareholders approved the transaction).

The General Maritime story is a cautionary tale for companies searching for capital in hedge fund land. The terms and structures are simply not typical of what commercial banks offer. Hedge fund lending is a more sophisticated game. Part of this is because the companies in need of the loans are riskier because of their smaller size or distress.

It is also because hedge funds are willing to push the edge in terms and structure. Could you imagine JPMorgan Chase giving a profit participation to General Maritime’s chairman in these circumstances? Hedge funds appear prepared to push for both the most aggressive terms and to be the actual one making the deal. They appear ready to risk public condemnation to do it.

Smaller and distressed companies may simply lack the experience and wherewithal to deal effectively with hedge funds. They also may be too stricken to bargain effectively or capably. For them I have a warning: Be careful or you will end up like General Maritime.

Article source: http://feeds.nytimes.com/click.phdo?i=69515b813413993b127ed345938a1e29