How To Value DryShips' Shipping Business

How To Value DryShips' Shipping Business

When a public company owns a significant portion of another public company, assessing the proper market value can be a bit confusing. DryShips is the majority owner of Ocean Rig . Ocean Rig describes itself as "an offshore drilling contractor providing oilfield services for offshore oil and gas exploration." This is completely different from the shipping business DryShips owns and operates, even though the COMPANY'S financials include results for both. By knowing the market value for the shipping business alone, you can make a better-informed decision of when to buy or sell DryShips.

Ocean Rig shares
DryShips owns 78,301,755 shares of Ocean Rig, making it a 59.4% majority owner. On any given day, the stock price of DryShips should reflect not only its own shipping business, but also the market value of those 78.3 million (rounded off) shares. The first step is to simply multiply the number 78.3 million by the current stock price.

DryShips' ownership in Ocean Rig shares is similar to it holding shares in any other stock as an investment -- at least for valuation purposes. It's true, though, that if DryShips attempted to sell 78.3 million shares all at once, there's no reasonable way it would get current market price, since the selling itself would create downward pressure. After all, Ocean Rig only trades around 300,000 shares per day, so there's a liquidity factor unless a monster buyer or two is somehow prearranged.

What sort of discount should be applied to make up for the lack of liquidity? It's anybody's guess, but I think a 14% discount would be more than fair and conservative. Star Bulk Carriers recently did a secondary offering at an identical 14% discount, and it's much less liquid than Ocean Rig. Star Bulk Carriers averages less than 200,000 shares per day, at half the price of Ocean Rig, providing a recent "worst case" benchmark.

It's conceivable as well that if DryShips were to offer its Ocean Rig shares for sale, they couldn't even be sold in bulk at a 14% discount like Star Bulk Carriers offering got. DryShips owns around 10 times as many shares of Ocean Rig as the amount Star Bulk offered. To be more conservative, I would double the discount of Star Bulk Carriers to 28%.

Collateralized shares
14.9 million of the Ocean Rig shares have been used as collateral for loans. Some may argue that you can't use the full value of these shares in your calculations as a result, but collateral just means that there's a temporary restriction on the company's ability to access that value.

As an example, the fact that you may use your home as collateral for a mortgage doesn't affect the positive equity in your home. Continuing this example, if you owned a $300,000 home with $50,000 left on your mortgage, your net worth is $250,000. It wouldn't change your net worth if that $50,000 was on a credit card instead of being collateralized by the mortgage.

Just because an asset is collateralized doesn't mean that asset has any less value. Likewise, the fact that a small percentage of Ocean Rig shares have been used as collateral is irrelevant to calculating the market-perceived value of the shipping business.

Final calculation
In order to calculate the market value of the shipping business, you need to subtract out the value of the Ocean Rig shares from the market cap. The full value of Ocean Rig shares can and should be used, less maybe a 28% discount for its illiquidity.

To illustrate by example, use the closing prices of Oct. 23. Take 78.3 million shares of Ocean Rig, then multiply it by $18.64 -- Ocean Rig's share price. Then multiply the result by 0.72 to get a 28% discount, and you will get $1.05 billion. This represents the discounted value of the Ocean Rig holdings that DryShips owns. Now subtract $1.05 billion from the DryShips market cap of $1.18 billion, and you're left with approximately $130 million.

$130 million is the approximate value the market is giving to the shipping business alone for DryShips. In the future, when considering a buy or sell decision with DryShips, perhaps in reaction to a dry-shipping related macro event, you will be able to quickly calculate what the current stock price means to the change in the value of the shipping business itself.

Just remember the equation: Multiply 0.86 by 78.3 million by Ocean Rig's share price. Take this result and subtract it from DryShips' market cap. Presto! You have the value the stock market is giving the shipping business.

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