Royal Caribbean (NYSE:RCL) secured its future last week by selling $3.3 billion in bonds. The cash should ensure the cruise line’s liquidity for the foreseeable future. While it’s good news for owners of RCL stock, the savior came at a price.
Here’s why.
The company faced a problem: How to access additional liquidity without running afoul of the covenants on its current debt. The credit rating agencies were pushing its debt to junk status, which meant it would be tougher to pledge its ships as collateral for new loans.
So, the company came up with a fancy maneuver to make the bond sale amenable to debt investors.
Accessing Liquidity
The company sold $1 billion of 10.875% Senior Secured Notes due 2023 and $2.32 billion of 11.50% Senior Secured Notes due 2025. The notes are secured by 28 of the company’s ships ($12 billion in assets) and relevant intellectual property.
However, only half of the $3.3 billion is actually secured by the vessels. The other half, according to Bloomberg reporting, is unsecured debt, that would become secured should Royal Caribbean get its investment-grade rating back.
“To create more investor protections, Royal Caribbean gave buyers priority guarantees in the form of stock pledges tied to the units that owned each ship,” Bloomberg reported on May 17. “That effectively put investors second in line, behind themselves, to access remaining ship collateral if the company fell into even harder times.”
While the interest rates on the bond deals are quite high, it’s unlikely that the company would have found buyers for unsecured debt. Also, the deal structure should allow it to raise as much as $3 billion more in the future should it need additional liquidity.
“We felt this was a creative way to access liquidity,” CFO Jason Liberty said in an interview with Bloomberg. “Investors knew we were securing with very strong assets, while we kept the flexibility to go back for more liquidity if we need to.”
Royal Caribbean is currently using up to $275 million a month in cash due to the idling of its ships during the novel coronavirus.
Good News for RCL Stock
The biggest worry for any equity shareholder is bankruptcy. Once that happens, it’s doubtful that your shares hold any value. That is unlike a debt investor, who maintains dibs on the company’s assets, depending on where that investor’s debt lies in the pecking order.
Currently, Royal Caribbean’s Altman Z-Score, according to Gurufocus.com, is 1.14, which implies it could go bankrupt within the next 24 months. By adding the $3.3 billion in debt, company management has ensured its boats can get back to sailing with passengers, thereby restarting the cash flow machine.
In 2019, Royal Caribbean’s operating cash flow was $3.72 billion, double its net income for the year. The cruise companies have several significant flaws, but cash flow, during normal times, is not one of them.
So, as long as Royal Caribbean can get back out on the oceans of the world, there is a good chance that RCL stock won’t fall much lower than its March 18 low of $19.25.
For the aggressive investor, you have to look at this debt deal as a confirmation that most credit professionals believe Royal Caribbean is going to get back to sailing. As I write this on May 18, RCL is up almost 10% in pre-market trading.
Since the company went public in 1993, Royal Caribbean’s experienced three significant declines in its stock price: January to June 2000, December 2007 to February 2009, and January to March 2020. On each occasion, RCL lost between 60% and 80% of its value.
Although each of the declines was the result of a different cause: 2000 (dotcom crash), 2009 (financial crisis), 2020 (Covid-19), in both previous occasions to 2020, Royal Caribbean’s stock rebounded nicely.
Third Time’s a Charm
The biggest thing to hurt Royal Caribbean at this point would be a major resurgence in the coronavirus in the fall. If that happens and the U.S. is forced to shut down again for an extended period, it’s going to hurt the cruise lines’ business well into 2021.
This is why I believe RCL stock remains off-limits to all but the most aggressive investors. The risks remain very real.
Will Ashworth has written about investments full-time since 2008. Publications where he’s appeared include InvestorPlace, The Motley Fool Canada, Investopedia, Kiplinger, and several others in both the U.S. and Canada. He particularly enjoys creating model portfolios that stand the test of time. He lives in Halifax, Nova Scotia. At the time of this writing, he did not hold a position in any of the aforementioned securities.
