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Next up in the "Tankers in 2013" is Ship Finance International (SFL).

SFL isn't a pure-play tanker company. The company owns different types of tanker vessels,
different sizes of dry bulk vessels, offshore drilling assets and vessels, container
vessels, and car carriers. But, if one grouped the vessels in categories, tankers
would end up being the largest category. So that's how I make SFL qualify as a tanker

The SFL fleet has been clean-up a little since the first-half review of 2012. The oil-bulk-ore
(OBO) vessels have all been sold, as have the single hull Very Large Crude Carriers (VLCCs).
The current SFL fleet is comprised of:
- 17 Double-Hull (DH) VLCCs
- 7 DH Suezmax vessels
- 3 Ultra Deep-water (UDW) drilling assets
- 2 very large container vessels ( > 13,500 TEU units)
- 9 smaller container vessels ( < 2850 TEU units)
- 2 chemical tankers
- 1 Jack-up drilling rig
- 6 offshore support vessels
- 5 Supramax dry bulk vessels
- 7 Handysize vessels
- 2 car carriers
- 4 newbuild container vessels (medium-sized, > 5000 TEU units)
or 61 operational vessels, plus 4 newbuilds

SFL earns revenue from these vessels and assets in a variety of ways, so the fleet is easier
to understand if it is sub-divided into groups/categories. IMO, the groups/categories also
make it easier to understand the risks and opportunities for the company (and investors).
The categories are
I. Vessels leased to Frontline (FRO)
5 DH Suezmax vessels
After Frontline's restructuring in December 2011, the vessels mentioned above would earn a base
rate. The vessels could also potentially earn "cash sweep" and profit-share. "Cash sweep" was
defined as the first $6500 earned above the base rate, and profit-share was defined as a
percentage (25%) above the "cash sweep" threshold. A couple of examples are helpful.
Example 1: FRO earns $27,500/day chartering a vessel. Suppose the base rate is $19,000/day.
SFL would earn $19,000/day + $6500 day (cash sweep) + $500 day (profit-share), or $26,000/day
for that particular vessel

Example 2: FRO earns $20,000/day chartering a different vessel. Suppose the base rate on this
vessel is $18,000/day. SFL would earn $18,000/day + $2000/day, or $20,000/day on this

Some of these earnings flow back to FRO as vessel operating costs. Unfortunately for FRO,
when those agreements were written, the operating costs numbers were either fixed, or not
pegged to escalate correctly. More on this shortly. I should also add this category has
5 Suezmax and 8 VLCC vessels that delivered prior to 2000.

II. Off Balance Sheet assets
3 UDW drilling assets
2 very large Container vessels.

I'm just going to reuse most of the blurb I used last year.
The drilling assets (2 drilling rigs, 1 drillship) are operated by Seadrill while the
container vessels are operated by CMA CGM. All charters are bareboat, so SFL doesn't carry
any of the risk on operating cost increases. Each of the five vessels was originally owned
by their current charterer, and both Seadrill and CMA CGM have options to acquire the respective
assets back at a later date. Sometimes these types of arrangements make sense, and both buyer
and seller end up happy. I just don't know how to value that. One other point, these are expensive
assets- each drilling asset cost $850M, each container vessel cost $171M (or in that ball-park).
Although the rate on the drilling assets step down, SFL is aggressively paying down on the assets.

The bareboat rate for another UDW drilling asset had a step-down adjustment in Q4 2012.
This asset, West Polaris, was refinanced in January 2013. The step-down for the third
UDW drilling asset does not occur until mid 2015. All UDW assets were delivered in 2008, the
two container vessels in 2010.

III. Other vessels
2 DH Suezmax vessels
5 Supramax vessels (dry bulk)
7 Handy-size vessels (dry bulk)
1 Jack-up drilling rig
2 Chemical tankers
6 offshore service vessels
9 smaller (each carry less than 3K TEU units) Container vessels
2 car carriers
4 mid-size Container vessel newbuilds (delivery in 2013)

This category started out with vessels mostly on bareboat charters. It has changed to one
where the charters are some combination of bareboat, time and spot charters. SFL management
indicated some of the container vessels were idle in Q4 2012, but don't recall if they
specified the exact number. The charterer of the two Suezmax tankers is slightly behind
on payments. This adds some complexity as the two vessels are on sale-and-leaseback deals
with the current charterer. Three vessels were delivered in 2003 or earlier. The drilling
rig was delivered to its initial customer in 2007, and acquired by SFL in 2010. The remaining
30 vessels all delivered in 2005, or later. Three of the newbuilds deliver this year (2013)
and the final one in 2014.

Where does SFL go in 2013?
After the FRO restructuring in Dec 2011, the number of SFL vessels that could earn cash sweep
and profit-share was 28 (17 VLCCs, 6 Suezmax and 5 OBOs). FRO pre-paid $50M to SFL, a move
that offered SFL flexibility to adjust loan amounts on the 28 vessels. The total possible
revenue risk for SFL was about $65M/year for the years 2012 - 2015. That represents the annual
cash sweep amount from 28 vessels. SFL earned $52M of the $65M-ish in 2012, or 80% of the
cash sweep in 2012. The OBO vessels have all left the fleet, and one Suezmax was sold
earlier this year. That reduces the revenue-at-risk going forward. For SFL, yes. For
FRO, no. SFL is only paying FRO $6500/day in operating costs for each of the 22 leased
vessels. Especially with regards to the older VLCCs, I think that figure is way below
their true operating costs.

Why is this significant? Well, during SFL's Q4 2012 earning call, the SFL CEO suggested that
if FRO failed in their charter obligations, SFL could just reclaim their vessels and
have someone else charter them. Hah! not so fast, buddy! If SFL move their vessels to another
charterer, their operating costs would not stay at $6500/day. Also, with regards to
VLCC chartering in Q4 2012, FRO did better than their peers. So how does this get resolved?
I don't know, additional smoothing steps by Fredriksen to assist both entities. Fredriksen
tends to intertwine his companies and that creates complexities- SFL has 22 vessels linked
with FRO, 6 with Deep Sea supply, and 3 with Seadrill (SDRL), or 31 of 61 operational vessels
linked with other Fredriksen-backed companies.

As mentioned earlier, SFL refinanced one of the UDW drilling assets in January 2013. Here,
the intertwined Fredriksen-backed entity is Seadrill, an entity in a much stronger position
financially. Also, the drillship already has an existing charter that was extended out to
Jan 2018 (a probable reason it was relatively easy to get the asset refinanced for another
5-year term). What is not so clear, the bareboat rate after the 51st month.

Does the income stay at $23M/year? move higher? move lower? The other two UDW assets are less
of a concern because their next rate step-downs don't occur until 2015, at the earliest. SFL
provided the step down rate for both those assets. Also, while those two assets do need to
be refinanced later this year, with existing healthy contracts, that
should be relatively easy.
SFL refinanced some notes, then opted to upsize the offering by $100M, to $350M. That suggests
some confidence in their business.

SFL had a share offering in Q4 2012 raising about $89M. Shortly after, the company announced
the acquisition of two second-hand car-carrier vessels. Separately, the company arranged
5-year charters for both vessels. These assets got lumped in with container vessels, so
it is tricky to determine the amount of revenue or cash flow these assets are generating.
SFL management suggested all the funds raised from the offering were going towards fleet
growth. Figuring the company spent about $30M on the car carriers, that leaves them about
$60M to spend on other assets. Refinancing the notes added another $100M. That suggests
that SFL has the cash available for expansion, if needed.

The Q3 2012 results surprised me. I did think the company might earn some cash sweep. I
didn't expect it to be a majority of the cash sweep. SFL accelerated the Q4 2012 dividend,
paying it with the Q3 dividend in mid-December 2012. Cash sweep and profit-share doesn't
get paid in the quarter it was earned. Instead, it gets paid once a year, the following
March, or March 2013 for the year 2012. Did SFL management use existing cash to cover
the dividend e.g. funds from the equity raise, with the idea of replacing those funds
when the cash sweep did get paid? It matters to me because if it is replacement cash it
is earmarked for growth. However, if the cash sweep is free cash, it can go towards
maintaining the safety of the dividend payout. The idle container vessels are a small
concern. But SFL management indicated they had no plans to sell them either. The newbuild
container vessels have time-charter contracts upon delivery so that could make up some of
the lost container revenue.

The Q4 2012 presentation:

Small SFL position,
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