GERMAN KG MARKET

The strong container shipping markets over the past few years have benefited the German KG sector, where shipowning companies have been able to invest in new tonnage, pay down debt ahead of schedule, and pay better than expected dividends. The KG’s, limited liability companies funded by a “general partner” and by individual

German investors (who are considered “limited partners”), became a force in ship finance during the mid 1990’s- when equity in excess of €1 Billion was raised annually for shipping projects. Carriers gain control of capacity (without burdens of ownership), while the traditional owners have an opportunity to gain 100 percent finance. The companies, with their requisite German locus typically being the ship management function, own vessels (generally newbuildings) that are chartered out on multi-year deals ranging from five years out to 12 years, or longer. Originally, the investors would see their returns through the actual operating cash flows coupled with a big tax shield as new tonnage was depreciated. At present, the depreciation tax shield is combined with an application of the increasingly prevalent tonnage tax- where taxes are at lowered flat rate, tied to the tonnage of the vessels, rather than their actual profitability. Beginning in 2007, those KG’s that choose to be taxed based on tonnage must apply this treatment from the inception of actual trading. As the companies moved beyond their familiar ground in the small containership sector, annual capital raises took off during 2003 and 2004, when equity of more than €2 Billion and €3 Billion, respectively, was raised for shipping deals. The KG companies have used debt to complement the equity, in order to fund their vessel purchases, which have gravitated into the realm of expensive post Panamax container vessels, chemical / product tankers and crude oil tankers. Estimates for the year 2004 suggest that KG’s acquired maritime assets of nearly € 8 Billion (with the equity complemented by approximately €5 Million of debt sourced from the large community of German banks). One poster child for the recent prosperity among the German companies has been Nordcapital, an integrated investment group (with ship management and money management services all in-house) closely tied to Hamburg based shipowner E Rickmers, concentrating on container tonnage in the feeder sizes up

through post-Panamax behemoths exceeding 8200 teus . Nordcapital (like other KG packagers) is also arranges property deals in both Germany and abroad. Operating through its in-house ship operating company ER Schiffahrts, it controls 58 existing container vessels and is building another 20 units- with an aggregate capacity of 350,000 TEUs. The ships, including two newbuildings coming out of a Korean yard onto charters with CMA CGM, are chartered out to about a dozen major lines, including P& O Nedlloyd, Maersk Sealand, NOL/ APL, Cosco and Zim. Nordcapital’s recently announced results are impressive, having taken in some €556.4 Million into its shipping funds during 2004. Payouts to investors in existing Nordcapital funds doubled from the previous years. Indicative of the frothy market with various indices of charter rates for containerships peaking in late 2004 and early 2005, a recent report states: “Nordcapital funds paid out $38 Million more than the amounts stated in the various prospectuses, for a total of $183.6 million.” Nordcapital’s transactions include individual vessels (where maybe 800 investors might contribute equity of €27 Million towards the purchase of a 5700 TEU post Panamax container vessel costing roughly €72 Million), or groups of vessels packaged together. Its “Schiffs Portfolio Global 1” owns five container ships acquired since late 2003. In this fund, nearly 2500 investors contributed €70 Million of equity toward the €232 Million value of the fleet. Bank debt of US $151 Million composed the lion’s share of the capital funding the balance. The initial return to investors was pegged at approximately 27%, made up by the cash flow plus a hefty tax shield. Included here was a cash dividend of 4 %.

According to Nordcapital, “Particularly good earnings were achieved in the shipping funds, which were managed by the Nordcapital Group shipping company E.R. Schiffahrt. These were even better than the overall results for Nordcapital shipping funds, with accumulated cash flow for these 34 funds exceeding budget by 33% at year end 2004, and repayments $81.6 million above budget.” There are a number of ways that returns to investors could exceed the original targets- reduced operating costs, and $/ € exchange rate variations. Mr. Dirk Trautmann, Munich based Partner of the Norton, Rose law firm, told JTF “ Of course, if the KG is able to sell the asset at the termination of the KG for a level above the often low assumed residual value, this will support such an extra distribution, above the prospectus estimates.” Mr. Trautmann pointed out that KG’s “…are not in the business of buying and selling assets, will hold the asset for the life of the KG- usually set at between 8 and 12 years.” JTF spoke with Hanseatic Lloyd, a chartering and management company for 33 vessels (23 container and 10 product/ chemical tankers), all owned through single ship companies. Hanseatic Lloyd is also the 50 percent owner of shipping company Hansa Mare, based in Bremen, whose ships are on charter to the major lines. Unlike the larger integrated packagers, Hanseatic concentrates on

developing the shipping deals, and relies on a network of financial consultants throughout Germany to market its investments. In addition to a stable of 1000 – 4000 teu vessels, Hanseatic Lloyd has been operating two Korean built 4700 TEU vessels in KG’s, with another handful now under construction in China. Its tanker fleet includes four clean product tankers trading under ten year charter to Singapore based Mega Chemical Tankers, financed through a KG fund with a profit split above a fixed minimum charter level. In some languages, the same word is used for “risk” and “opportunity”. Where the tenor of a charter is less than the 8 -12 year lifetime of most KG’s, the need to re-charter the vessel provides either risk or opportunity. The case of “HLL Atlantic”, one of Hanseatic Lloyd’s 4700 box units, offers an illustration of “opportunity”- where returns may exceed budgets. HLL Atlantic was delivered from the Hanjin yard into a K-Line charter (trading under the name “Delaware Bridge”), at US $25,125 per day, in December 2002. In the heated market of late 2004, one year in advance of the expiry of the K-Line deal, the owners agreed on a charter with APL/ NOL, at US $28,500 per day, commencing October 2005, extending eight years out, through 2013. According to its report to investors, the KG also put interest rate hedges in place, as well, to lock in cash flow, thus enabling future dividends to investors. How will the ongoing merger and finance activity in the container trades impact the KG’s? The activities of Nordcapital, which claims to control some 8% of tonnage in the 3.7 M teu containership charter market, expose it to a rapidly shifting landscape of charterer financing structures, players and league tables. Consider that COSCO, controlling some 500 ships, has only recently begun financing vessels through KG structures. COSCO launched an IPO earlier this summer, while P& O Nedlloyd is being acquired by Maersk. Zim was recently privatized and is now controlled by the Ofer Group. CMA- CGM, charterers of its two newbuildings- is in the process of acquiring French stalwart Delmas, and was consistently rumoured to have been looking at CP Ships. JTF asked Mr. Christian Salamon, the CEO of packager Salamon AG, for his views on consolidation in the container shipping sector- which has two 2740 teu vessels (each costing US $47.8 Million) on order. He distinguished between the short term, where he said “…the fusion of two companies, it will likely result in a stronger credit, which is better for shipowners…” versus the long term, where “…owners with ships facing renewal of charters will have a smaller universe of acceptable credit worthy charterers.” Mr. Salamon framed his comments by pointing at the strong shipping markets (across sectors) over the past three years, and voicing a concern that “… the risk in the KG deals will come when long-term charters must be renewed, typically 8 – 10 years out in the future.” Mr. Struan Robertson, Partner at London based lawyers Stephenson Harwood echoed some of the same sentiments, noting that "when there is a merger, the charter carries on, and the KG company bears the risk of changes in the

organization of the charterer. In the case of the current consolidation wave, the result may actually be better- with a stronger company." He said that the KG's agreement with their charterers, which are very much based on the name and the standing of the charterer, typically do not provide language regarding a change in control of the charterer. Mr. Robertson, with decades of ship finance experience in Hong Kong and London, added: "Nor do the KG charter agreements contain covenants typically found in debt deals - such as financial coverage ratios, minimum net worth, or asset value to loan outstanding." Robertson also said that KG’s are impacted, albeit implicitly, by undertakings typically found in merger deals, whereby the buyer, or the acquiring company, states that it will carry on existing contracts, or will not compete with sellers in certain areas. For the maritime part of the KG market, the future is now, with expansion into sectors beyond containers, notably tankers- fixed on multi-year charters to acceptable owners, and with more creative structures. The packager Dr. Peters (where Mr. Christian Salamon of Salamon AG was previously the Managing Partner) has invested in numerous tankers chartered, most notably to Frontline, and other Tsakos, MT Torm, Teekay and Euronav. Dr. Peters cites returns between 13% and 17.4 % for a number of modern VLCC’s into ten year deals placed in 2004 with China-based Pacific Star International and - with the returns generated from the front year tax shields. In addition to the two container newbuilds (acquired from German owner Schoeller), Salamon AG’s portfolio includes a VLCC on charter to NYSE listed Overseas Shipholding Group (recently added to the Dow Jones Transportation Average), Suezmaxes on charter to OMI Corporation and Dynacom, and other tankers chartered to Glencore (the same trading entity having a major relationship with financial owner Top Tankers) and Hellespont (Papachristidis). Unlike integrated organizations such as Nordcapital- tied to an in-house ship manager, Salamon AG contracts out technical management to German offices of managers such as Columbia or V Ships, as does Dr. Peters (who draws on the technical expertise of firms such as Reederei "Nord" Klaus E. Oldendorff). One innovative tanker deal in the pipeline, “DS Fund 111”, assembled by Dr. Peters, involves two Chinese built Aframax tankers (built 1999 and 2000) being purchased by the KG company for $59.5 and $62 Million respectively, to be placed on 5 year charters to Maersk at $24,500 with a profit split above this level, and traded in the LR2 pool. The KG will be capitalized with € 115.7 Million, of which € 44.2 Million comes in as equity in two tranches that could possibly yield an aggregate of 220% over a 17 year time horizon. Debt of € 66.7 Million (US $81.9 Million) will come in from a German ship mortgage bank. The calculations use a residual value of $5 Million per vessel in 2022, when the vessels would be sold. The deal takes advantage of the “combination model” where initial returns are enhanced by the tax shield, with a shift over to the tonnage tax – typically as

initial depreciation benefits reduce after two or three years. Norton Rose’s Mr. Trautmann stressed that the new tonnage tax rules do not favor one type of vessel over another. The ability to create market responsive chartering structures, as those developed by Hanseatic Lloyd and Dr. Peters, should enhance the penetration of KG’s into the tanker sector. According to analyst Jurgen Dobert, whose work was quoted in a Salamon AG presentation, nearly 77% of KG newbuilding deadweight tonnage during 2000- 2001 was containerships, with just under 6% being comprised of tankers. Figures for 2004, supplied by analysts Stefan Loipfinger, suggested that 61% of equity went towards container vessels, with 29% going into tankers. As with other forms of ship finance, there are “risks”, paradoxically, even in the strong market. Where charters must be renewed during the course of a KG (as in the medium term charters seen in DS 111 and others with “short” tenors of as little as five years), “renewal rate risk” is a very real consideration. The next frontier for the KG’s may be LNG’s, which have already proven to be suitable for Master Limited Partnerships. Stephenson Harwood’s Robertson said that "the high asset values of LNG's, together with long term charters to large stable entities tied to particular geographic areas (and therefore less likely to be involved in mergers and combinations) makes this sector an obvious target." Interestingly, Teekay LNG Partners has one existing vessel on for 18 years to Spain’s Gas Natural- whose bid for power company Endesa has put it into acquisition mode, and another tied up for 24 years on charter to Repsol- mentioned as a potential takeover target (due to its ties to Gas Natural).