Private Equity’s Black Ship
Since the beginning of the shipping crisis, it seems fewer topics have drawn more attention than private equity (PE) funds interested to invest in shipping. When capital markets and shipping banks were frozen while freight rates and shipping asset prices were in a precipitous fall, lots of hope was placed into the institutional investors as both equity providers to provide financing for new projects and also white knights for restructuring legacy deals.
Fast forward a few years later, and the topic of private equity funds still draws lots of attention, mostly heated attention, for the deals they have done and mostly the deals they have not done. There is lots of blame that PE funds are behind the recent wave of newbuildings and therefore for the continuing market malaise and fairly anemic prospects of a market recovery. Also, there is subdued optimism that there will be better days to get PE funds still interested in shipping, disappointment that the best days of PE investing in shipping are behind us, and outright happiness that PE funds got their investments wrong, and that they will be the next wave of players in shipping who will be realizing big losses (after the shipowners buying ships in 2007 and banks lending 120% of peak phase of cycle).
As a quick disclaimer, for those hoping that private equity (and by extension institutional investors, in general) were interested in investing in shipping to solve other people’s problems for the good of their souls or the general good of mankind, probably they were daydreaming. Typically, PE funds have a five to seven year horizon and high return hurdles and they are industry agnostic or indifferent, thus shipping was an attractive proposition to them given the state of the market. Funds are money machines, at least that’s the business plan, and they specialize at solving problems in industries or with companies, but at a very hefty cost. Thus, consideration should be given whether PE has so far approached shipping in a productive way for the many stakeholders involved.
For the widely-circulated blame that PE funds are behind a tremendous part of the tremendous orderbook outstanding in this still trough phase of the cycle, it’s true that PEs have ordered many vessels directly (i.e. Wilbur Ross and Diamond S.’ suezmax tankers early in the crisis and recently more orders in the same sector in a different JV arrangement), in JV with certain shipowners (mostly private, bi-lateral deals), and many more were ordered by hedge funds investing in publicly traded companies (i.e. Scorpio Tankers and Scorpio Bulk are the blaring examples to name in this category). On the other hand, one has to mention that the tremendous outstanding orderbook has also been the handiwork of many independent shipowners, small and large, looking to exploit lower prices for newbuildings and mainly efficiencies of new designs. And, the strangest thing of all is that many orders have been placed in second- and third-tier shipbuilders in China, on speculation, and no financing in place beyond the downpayment requirement in the progress payment process. Thus, putting the blame for the newbuilding orderbook solely at the PEs door may be a bit presumptuous, and rather more introspection is required on why shipowners tend to be their worst enemies by flooding the market with more ships at bad times. It has been said by a pre-eminent shipping executive (of a company with a tremendous orderbook) during a shipping conference that ‘shipping is not a team sport’, but still there has to be a better explanation on this.
Since the beginning of the shipping crisis in 2008, it is estimated that more than $30 billion has been invested in shipping by institutional investors (although all these type of investors are summarily classified under ‘PE’ in most discussions today). Oaktree, Apollo and KKR have been the largest investors of all in shipping, with many more funds having done deals, and many many many more looking into doing deals in shipping. Although the Oakree-s of the world get most of the attention, it has to be noted that many of the PEs interested in having invested in shipping are small or very small and most of the transactions have remained well at the below $50 million equity investment mark. In most of the cases, the PE is providing almost all of the equity but takes the driver’s seat, with often the ‘shipping partner’ relegated to an employee or a very junior partner in the arrangement (although often the ‘shipping partners’ have been exaggerating their involvement, equity participation, sharing of upside potential, and compensation). Truth of the matter is that for many of these partnerships, it has taken a lot of time and effort (and legal fees, due diligence, etc) to agree on the partnership agreement and usually the ‘shipping partners’ had to give up the most to get the partnership agreed to. We suspect, in a sideways moving market, many of these ‘shipping partners’ have been experiencing ‘buyers’ remorse’, and, to a certain extent, are percolating the market with their disappointment inviting PEs to their companies, etc
While most of the investments by PE in shipping so far have been concentrated on equity investments, there seems to be an ever-growing trend of funds looking to provide credit to shipping, and in our practice with Karatzas Marine Advisors, we see an ever-growing trend of shipowners looking harder and harder to obtain debt financing, sometimes senior, but often junior, second lien, mezzanine, work capital, etc Probably it makes more sense to invest in ‘credit’ rather than ‘equity’ in a weak market at present with rather anemic prospects looking forward in shipping, but many of these PEs funds have built their models around industries in distress with little customization for the shipping industry and flexibility on structures or adjusting returns to fit the risk. Most of the funds are looking for at least 8% return for their LPs (Limited Partners), and thus for all projects they see, irrespective of risk, they are sending out term-sheets with at least such threshold or meaningfully higher for ‘deals with hair’. Ten-year old Japanese-built aframax tanker with $23 mil FMV and $10 mil loan (less than 50% LTV and loan just $2 mil in excess scrap value) and employed in major, well-reputed pool, seeking senior loan (first preferred ship mortgage) gets L+850 bps offer (and hefty origination fees), despite the low riskiness of the project. Four handysize bulkers built at 1998 seeking financing, they are offered advance 70% of current scrap pricing at 9%. 2004-built MR1 tanker freshly drydocked seeking 70% leverage while assigning solid two-year charter is offered 11% interest. These are typical projects that there would be no issue obtaining ‘normal’ financing in an average market; however, PEs looking to provide credit in shipping are looking for very high single digit returns, irrespective of risk. Often working on structures like these, shipowners / borrowers / vessel managers come to the conclusion that ‘PEs don’t get shipping’, where ‘one size fits all’ model is applied.
Shipping has not been recovering as many people’s ‘gut feeling’ said or ‘model’ projected. There still is pain in the market, and the prospects looking forward are not as rosy. It’s only natural for people to complain, to allocate blame, to feel envy for the parties having done deals or having second thoughts on deals already done. Private equity funds have been center stage for a long time, but often their website and brochure and their claim to flexibility on structures and access to the different sources of capital seems to be an illusion or in disconnect with reality. Whether for equity or credit, whether for low risk or higher risk projects, whether for new projects or legacy projects, whether dealing with shipping banks or shipowners, whether for tankers, dry bulk or containerships, some counterparties think that all funds have the same term sheet to send around.
Some think that such term-sheet may be for a ‘black sheep’ or for a ‘black ship’.
Some, even they may agree on that.
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