Danaos Corp.: Eagle Bulk Investment Raises Concerns, Inspires Activist Roadmap To $130

Danaos Corp. Overview

Danaos Corporation (NYSE:DAC) is a containership owner focused on operating vessels with medium- and long-term fixed contracts. The firm survived a decade of downturn in the 2010s and emerged as one of the biggest victors in the recent supercycle. DAC also benefitted significantly from their large equity stake in ZIM Integrated Shipping (ZIM), which they fully divested for enormous gains. Danaos currently has approximately 20M shares outstanding for a market cap of around $1.33B. The current dividend policy is a fixed $0.75/qtr payout, offering investors a yield of 4.5%

This public update reflects on recent performance and capital allocation decisions and reiterates our previous 'fair value estimate' of $95/sh.

Biggest Risk at DAC is the Massive Cash Pile

Danaos has performed incredibly well throughout the recent containership cycle, and as of Q1-23 results, DAC has amassed a cash pile of $360M with total available liquidity of $731M. This compares to negligible remaining debt attached to the legacy fleet, which means Danaos is flush with free cash to allocate. The biggest risk at Danaos is not related to operations or overall financials, but rather that management might allocate their newfound profits in inferior ways.

Danaos has $2.3B in contracted revenue through 2028, most of which is high-margin, heavily front-loaded, and backed by top-tier counterparties. However, the entire enterprise value (market cap + net debt) of the company is barely $1.4B. This otherwise horrendously low valuation reflects the market's view that management cannot be trusted as stewards of this capital. I personally am long Danaos Corp. and our current 'fair value estimate' at Value Investor's Edge is $95.00/sh, so clearly I do expect somewhat reasonable allocations. However, our estimates of the current value (NPV12 model) of contracted EBITDA + residual fleet valuations (demolition of everything 20-years or older and midcycle values for the modern tonnage) are closer to $120/sh, so even our relatively bullish value assessments include a sizeable "management discount" of roughly 20%.

Generally speaking, as long as management doesn't do something completely stupid or nefarious with its cash flow, DAC should be valued much closer to $120/sh. The bigger the discount to $120, the larger the implied 'management discount'. The market's latest quote is $66/sh, which basically means the market is saying management is only worth 55-cents on the dollar, or to put it another way: the market expects Danaos Corp. management to destroy 45-cents of every dollar of current value through a mixture of incompetence and conflicts of interest. To be fair, DAC is not alone: several peers, including Costamare (CMRE), Euroseas (ESEA), and Global Ship Lease (GSL) also trade at fairly large discounts.

Latest Actions and Performance Ratings

Containership Business, Firing on All Cylinders: A-

Danaos Corp. recently announced attractive charters for all six of their initial newbuild vessels, which are scheduled for delivery in 2024. They also added two additional 6k TEU newbuilds, scheduled for delivery in Q4-24 and Q1-25. Finally, DAC has reportedly been the recipient of several incredibly lucrative forward charter fixtures on some of its legacy fleet, extending charters from 2024-2027 at massive rates of $50kpd, far higher than what we had modeled. It is clear that the core containership business is meeting or exceeding all reasonable expectations!

The only reason DAC receives an "A-" instead of an "A+" is because they ordered two additional newbuilds earlier this year.

Lackluster Shareholder Returns: C

Although the core business is performing incredibly well, investors in DAC might not know it. Shares are down almost 40% from their peaks and shares are down 15% from August 2022 levels even though market performance has been stellar. The primary reason for these losses is a disappointingly small level of shareholder returns, namely the failure to raise the common dividend payout and the reluctance to engage in meaningful share repurchases, even when trading at insane discounts of 50%+ to adj. NAV or cash flow models.

DAC could have easily raised the common dividend from $0.75/qtr to $1.00/qtr earlier this year to send a signal of strength to long-term investors, but instead they kept the payout flat and have shared less than 10% of the recent market profits with their investors. Although DAC repurchased 40.5k shares in Q1 and 176k shares subsequent to quarter-end, this is far too little and far too slow. If management won't buy their own stock hand-over-fist at 55-cents on the dollar, why should anybody else trust them?!

I give Danaos a "C" grade, because they have conducted some repurchases, they limit stock-based compensation to reasonable levels, and I am hopeful they will soon decide to lift their dividend to at least $1.00/qtr.

Investment into Eagle Bulk (EGLE): C-

Danaos Corp.'s recent investment into Eagle Bulk makes great sense in total isolation if one is also moderately bullish on midsized dry bulk. EGLE owns and operates a world class fleet of midsize dry bulk vessels and has a current net asset valuation ("NAV") in the mid to upper-$60s. DAC seems to have acquired most of their stake between $39 and $45/sh, which suggests an average purchase price of roughly 65-70% NAV. Since EGLE previously had super lower leverage, this is akin to buying a fleet of midsize dry bulk vessels, complete with a solid operating platform, at just 65-70 cents on the dollar. Bravo!

However, the problem here is that investors in Danaos Corp. did not sign up to participate in some sort of 'maritime hedge fund.' No. Investors in DAC are either attracted by the long-term containership business and platform, or they have bought shares because they saw $120+ of value trading at just $55-$65/sh. As I mentioned earlier, the market currently expects management to destroy 45-cents of every dollar of value via either incompetent or nefarious actions. To be clear, this deal is not a bad buy; it is an excellent value. This deal is also not nefarious in any fashion. However, this deal is significantly inferior to the following choices:

Alt-1: Repurchase DAC at an even larger discounts

DAC shares currently trade at 55% of reasonable value, whereas EGLE was trading at 65-70% of reasonable value. Not only are DAC shares a better relative value, but this also keeps the core focus on the containership business which investors have signed up for. If investors are bullish in midsized dry bulk, they can go out and buy EGLE shares for themselves. We don't need or want John's help to do so with the funds of our company.

Alternative Rating: A+

I rate this alternative action an "A+" because of the massive value accretion offered to all Danaos Corp. shareholders while also keeping the business equity fully intact. It also rewards the most loyal and most long-term DAC investors.

Alt-2: Pay a large special dividend, let us all buy EGLE

If John Coustas is personally bullish on midsized dry bulk, and if he found EGLE stock attractive at a 30-35% discount to NAV, then I would conclude that John is a very reasonable and intelligent investor. However, if John wants to buy a massive stake in EGLE, he should do so with his own personal funds. Moreover, he should distribute cash to all of us co-owners of the Danaos business so that we can also decide whether or not we wish to invest in EGLE stock, or perhaps invest more funds back into DAC stock.

Alternative Rating: A-

I rate this alternative action an "A-" because it respects shareholders' diverse views on the market and allows everyone to make their own choice with their funds. This action receives a slightly lower rating than the repurchase because it does leak significant funds out of the company and does not accretive value in the same exponential fashion as a repurchase. A repurchase is buying $1.00 for $0.55 (82% overnight gain on investment), a special dividend is just paying $1.00 for $1.00.

Worse Move: Buying More Containerships: "D"

While buying EGLE stock was not a favorable move compared to the other two wildly superior choices for capital allocation, it is significantly better than DAC deciding to plow more money into the containership sector directly. Containerships face a challenging market with still-massive orderbooks, bloated asset valuations, and cash-rich peers.

To be clear, buying more containerships at $1.00 on the $1.00 is doubly inferior when DAC could instead buy their own stock at $0.55 on the $1.00.

Worst Move: Buying Dry Bulk Vessels Directly: "F"

While buying EGLE stock was not a favorable move compared to the other two wildly superior choices for capital allocation, it is significantly better than DAC deciding to venture into another segment entirely with direct vessel ownership. Peer Costamare (CMRE) has attempted this route, and their questionable diworsification has led to CMRE recently trading at the lowest valuation in company history. Buying dry bulk vessels directly would betray shareholders' trust and would also reflect a massively subpar allocation by paying $1.00 on the $1.00 for singular dry bulk assets instead of paying $0.65 on the $1.00 for EGLE stock, which also comes with an excellent operating platform.

Bottom Line: Buying EGLE the 'Least Bad' Move

When asked my views on this transaction over the past week around Marine Money in New York City, I generally concluded:

The Danaos Corp (DAC) decision to buy a huge stake in Eagle Bulk (EGLE) is the 'least bad' option of all subpar capital allocation decisions. CEO John Coustas and CFO Evangelos Chatzis decided to ignore the two best capital allocation decisions: 1) massively ramp up repurchases or tender offers 2) pay a massive special dividend and instead decided to open up the wide menu of "Bad Capital Allocation." From this 'menu of bad choices', John and Evangelos have selected the least bad option. "It could have been worse" is hardly cause for celebration...

The market continues to value DAC at just 55-cents on the dollar. We value DAC at 80-cents on the dollar. This sort of transaction confirms that 55-cents is too low, suggests that 80-cents is probably reasonable, and unfortunately confirms that DAC is still not worthy of 100%.

Activist Roadmap: Path to Penance & $130/sh

I want to be very clear, in case this update might have sounded overly harsh: I have tremendous respect for CEO John Coustas and CFO Evangelos Chatzis. They have done a very impressive job of managing Danaos Corp. and I have nothing but good things to say about the operational competence and financial results from the core containership business.

I also suspect that they will be reading this update in short order. Again, I want to reiterate that as a long-term investor in Danaos Corp., I want nothing but the best for the value of the business and my entire alignment is on driving the maximum total return for ALL shareholders.

Therefore, if one might ask: "How can Danaos Corp. rectify this decision and return to the straight-and-narrow path of doing right for 100% of shareholders? What sort of actions can DAC take which will fully regain trust in management and lead to significantly higher valuations in the market?"

Thankfully, the proper path forward is extremely clear and simple:

1. Immediately Distribute All EGLE Shares as a Dividend

Now that EGLE has taken some defensive allocation moves of their own, Danaos will clearly never be able to own much more than 15-16% of the company unless they come forward with a bid at close to 100% of NAV. This would be a terrible choice due to logic already thoroughly argued above.

However, DAC has profited by purchasing shares at $39-$44, which now trade at $48. DAC can rectify this entire situation and allow EGLE to withdraw their recent poison pill by simply distributing all EGLE shares as a dividend to DAC shareholders. This will represent a significant return of capital to investors and it will also allow John Coustas himself to emerge with a roughly 7-8% direct stake in EGLE due to his large DAC ownership with zero personal cash outlay.

2. Launch a Tender Offer for DAC Shares

Danaos Corp is insanely undervalued. This is only due to one reason: the market does not trust management to properly allocate capital. Repurchases are very accretive, but they can take time. A massive tender offer for 3-4M shares at $70/sh would drive significant value for all long-term investors.

If DAC repurchased 4M shares at $70/sh, this would drive value from $120/sh to $132.50 in one fell swoop.

• $2.4B Current Value / 20M Shares Out = $120/Sh Current Value
• $2.4B - $280M cash (4M x $70/sh) = $2.12B Pro Forma Value
• $2.12B / 16M Shares Out (20M - 4M Tender) = $132.50/Sh Fwd Value

The same transaction will increase the ownership percentage of loyal and committed shareholders while allowing weaker hands and skeptics to exit. This transaction will also allow John Coustas to increase his stake from roughly 45% to roughly 57% for zero personal cash outlay.

3. Raise Regular Dividend to $1.00/Qtr

Danaos Corp. has tremendous free cash flow projected to 2026 and beyond. Moreover, DAC has fixed all six of its initial newbuilds on lucrative charters and they have secured forward fixtures on many of their crucial reopenings during 2024. The $1.00/qtr dividend costs exceptionally little and the current payout represents less than 10% of their free cash flow gains from the ongoing cycle.

The cost to raise the dividend from $0.75 to $1.00 would be roughly $20M with the current shareholder or just $16M after the proposed scenario. This is less than the amount of free cash flow that DAC generates in about 10 days.

If DAC Follows Through: Value of $120-$130/sh

If Danaos Corp. management and their Board of Directors signs off on the three approaches above, then DAC could achieve a reasonable valuation of $120-$130/sh by the end of 2023. I hope they will consider such moves in the future and will shy away from moves like the recent investment in EGLE, which reflects a subpar allocation of capital versus simply repurchasing or tendering for their own shares.

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