On January 18, 2011 General Maritime Corporation (NYSE:GMR) announced the sale and leaseback of three medium range product tankers for total net proceeds of $61.7 million. The three vessels have an average age of approximately 6.25 years. Under the terms of the deal General Maritime will lease back the vessels for a period of up to seven years with options to repurchase the vessels at the end of each year.
The sale & leaseback deal provides General Maritime with off-balance sheet financing to meet its short-term capital requirements. To determine the effective financing cost for GMR, we first analyzed the terms of the deal to estimate the projected internal rate of return for the new owners.
The projected IRR depends on the vessels’ residual value. In general, the higher the residual value, the higher the IRR, and the higher the financing cost. In this case however the annual purchase options set a ceiling on the IRR, and provide General Maritime with an opportunity to lower its financing cost.
For example, assume that the residual value per vessel at the end of year 7 is equal to $13 million. The new owners will achieve an IRR of 11.80%. If the residual value is $15 million (i.e. equal to the purchase option), the new owners will achieve an IRR of 12.80%. On the other hand if the residual value is $17 million (i.e. it exceeds the purchase option by $2 million), the new owners will achieve the same IRR of 12.80%, since the purchase option will be exercised by GMR.
In the first two cases above, the effective financing cost for General Maritime will be equal to the IRR (i.e. 11.80% if the residual value per vessel is $13 million and 12.80% if the residual value is $15 million). If however the residual value is $17 million, the company’s effective financing cost will then be 11.80%!
On average, assuming that the residual value of the vessels at the end of years 3 through 7 will equal the purchase option price, the internal rate of return to the new owners, and likewise the effective financing cost to General Maritime, will range between 13.90% for year 3 and 12.80% for year 7 respectively.
The range above is obviously a very steep price for General Maritime to pay. The company however will be able to meet its short-term capital requirements and will hold a valuable long-term option to repurchase the vessels and thus lower its effective financing cost.
The sale & leaseback deal provides General Maritime with off-balance sheet financing to meet its short-term capital requirements. To determine the effective financing cost for GMR, we first analyzed the terms of the deal to estimate the projected internal rate of return for the new owners.
The projected IRR depends on the vessels’ residual value. In general, the higher the residual value, the higher the IRR, and the higher the financing cost. In this case however the annual purchase options set a ceiling on the IRR, and provide General Maritime with an opportunity to lower its financing cost.
For example, assume that the residual value per vessel at the end of year 7 is equal to $13 million. The new owners will achieve an IRR of 11.80%. If the residual value is $15 million (i.e. equal to the purchase option), the new owners will achieve an IRR of 12.80%. On the other hand if the residual value is $17 million (i.e. it exceeds the purchase option by $2 million), the new owners will achieve the same IRR of 12.80%, since the purchase option will be exercised by GMR.
In the first two cases above, the effective financing cost for General Maritime will be equal to the IRR (i.e. 11.80% if the residual value per vessel is $13 million and 12.80% if the residual value is $15 million). If however the residual value is $17 million, the company’s effective financing cost will then be 11.80%!
On average, assuming that the residual value of the vessels at the end of years 3 through 7 will equal the purchase option price, the internal rate of return to the new owners, and likewise the effective financing cost to General Maritime, will range between 13.90% for year 3 and 12.80% for year 7 respectively.
The range above is obviously a very steep price for General Maritime to pay. The company however will be able to meet its short-term capital requirements and will hold a valuable long-term option to repurchase the vessels and thus lower its effective financing cost.
