Private equity investors who pride themselves on a knack for corporate turnarounds followed by profitable exits have met their match in the shipping industry.
Shipping has been a target for bottom fishing since freight rates and asset prices fell to 25-year lows after the 2008 collapse of Lehman Brothers.
In the wake of the financial crisis, the fragmented, cyclical industry welcomed the professional investors who bet on distressed debt or seized on record-low costs to build ships.
Private equity was hailed as an alternative source of funding that filled the gap left by the exodus of European banks from the sector. The plunge in asset prices led to impaired portfolios and some banks stopped further lending altogether to an industry whose fortunes soared during the economic boom but then fell harder than most.
As of January, private equity financed 22 per cent, or US$278 billion, of global vessel order books, according to Tufton Oceanic, a maritime fund management firm.
Such investments peaked last year and continued to slide this year as the shipping market, plagued by overcapacity, failed to recover.
This year saw only 15 private equity transactions, compared with 30 last year, according to ship finance publication Marine Money International. These deals range from stake purchases in companies to joint ventures and investments in distressed assets.
Most buyout firms, which entered the sector hoping to achieve a 15 to 20 per cent return and make a swift exit in three to five years, may have misunderstood the volatile and capital-intensive industry.
“Many of those [private equity] guys who thought it was going to be so easy to understand this industry didn’t,” said Randee Day, who heads Day & Partners, a New York-based maritime consulting firm. “Shipping is always about cash flow break-even. Asset value is nothing in shipping if you don’t have positive operating cash flow.
“You are going to go out of business if you can’t pay your suppliers, crew, bunker bills and creditors. It doesn’t matter how much the ship is worth.”
The flipside of low shipbuilding costs – a key draw for investors after the financial crisis – has been stubbornly low freight rates.
The cost to build a 180,000 dwt capesize class vessel, the workhorse for global iron ore trade, was US$100 million during the height of the market in 2008. Such ships were then earning more than US$160,000 a day hauling ore from Australia to China. Today, the newbuilding cost is between US$50 million and US$55 million, with daily earnings at US$5,400 – not even enough to cover operating costs.
A favourable exit such as a public listing remains elusive for investment firms. Last year, the global shipping industry saw seven initial public offerings and five over-the-counter listings, mostly in US and European stock markets. But the new stocks have not been well received by investors. The Monaco-based, Nasdaq-listed Scorpio Bulkers – the one-time poster child in the marriage between a traditional shipowner and private equity – traded at US$1.96 on December 26 compared with US$9.50 when it went public a year ago.
The poor market sentiment has prompted the postponements of several listing plans this year, notably Diamond S Shipping Group, backed by prominent US investor Wilbur Ross.
“It looks like many of the professional investors are playing a short-term asset game. Several of them are banking not so much on the expected long-term earnings potential but on finding the next risk-willing buyer prepared to take on an even riskier position,” Christopher Rex, the head of research at Danish Ship Finance, said in a November report. “They are risking other people’s money but hoping to leave the table just in time. We expect that many of them will find it difficult to exit with the expected profits.”
This observation is echoed by Russell Beardmore-Hagelberg, the Greater China and North Asia shipping finance head at Standard Chartered Bank, who has seen “a lot of activity in PE firms selling to other PE firms”.
Lengthening the planned investment horizon might be difficult, too, as most funds were raised on a three to five-year basis, Beardmore-Hagelberg said. “You would expect that a pragmatic investor would agree to extend their investment horizon if current market conditions don’t allow an exit at a sensible price, but that may be damage limitation rather than seeking increased returns.”
Day said top buyout firms, such as Oaktree Capital, Blackstone Group and Apollo Global Management, had anticipated the dire reality.
“The capital markets haven’t been overly friendly to the maritime sector. Those who entered just after the 2008 financial crisis will likely have to wait until [the second quarter of] 2015-16 before realising exits through asset sales or IPO,” she said. “2015 is going to be interesting and complicated.”