Private equity in the shipping industry: barbarians at the helm?

July 2014 | SPOTLIGHT | BANKRUPTCY & CORPORATE RESTRUCTURING

Financier Worldwide Magazine

The shipping business has always been a largely private affair with publicity-shy families, predominately in Greece, controlling a large part of the world’s tonnage, and only a relatively small percentage of major shipping companies seeking a public listing. Flotations in New York, Oslo and the other key stock exchanges will continue to fall in and out of favour but the private nature of the shipping industry will not materially change, particularly as the equally secretive private equity funds have been increasing their involvement in the industry.

Up until a number of years ago shipping had been largely ignored by private equity houses, which had instead focused on everything from consumer goods to satellite companies, earning their investors some very lucrative rewards in the process. The source of private equity’s interest in shipping as an asset class arguably stems from events as far back as 2003. That year marked the beginning of a golden era in shipping which culminated in 2007 and early 2008 when, buoyed by the rapidly growing Chinese economy, a large vessel able to carry iron ore and bought for as little as US$33m a few years earlier could earn more than US$150,000 a day (the current daily charter rate for a similar vessel is approximately US$12,000). With returns of this magnitude banks were only too eager to lend money to ship owners, and in many cases on a ‘covenant-lite’ basis and with high leverage ratios. Then Lehman Brothers collapsed. The ensuing global financial crisis had a severe impact on world trade and the drop in trading activity, coupled with the substantial oversupply of vessels that prevailed as a result of ship owners deciding to keep operating over-age vessels during the pre-crisis boom rather than to scrap them, put an end to the astronomical charter rates and asset valuations that had so far prevailed in the shipping market.

Debt servicing became much harder, loan to value ratios started to be breached, and as the banks’ indulgence started to wear thin the industry started to show real signs of distress, with well known shipping companies such as STX Pan Ocean in South Korea and General Maritime (one of the largest US-based tanker operators) entering Chapter 11 proceedings. Against this backdrop of low asset values, distressed debt opportunities and the prospect of an eventual recovery, private funds started to invest heavily in shipping with a view to repeating their successes in other industries, albeit in different ways. Wilbur Ross, the American ‘king of bankruptcy’, acquired, together with several other equity funds, Cido Shipping’s 30-strong tanker fleet worth over $1bn in one fell swoop. Others, like Carlyle and Tiger Group, formed joint ventures committing to invest equity capital of US$900m over a five year period to buy container, dry bulk, tanker vessels and other shipping assets. Oaktree Capital, arguably one of the most active funds in shipping, approached the industry from various angles, including providing new debt (to General Maritime) which was eventually converted into equity thereby giving it control of the company, forming various joint ventures with established ship operators (including with each of Oceanbulk and Navig8), and acquiring debt portfolios (including US$750m from Lloyds Bank and US$150m of Excel Maritime’s debt from its lenders (together with Goldman Sachs)).

Given the private nature of these transactions it is unclear exactly how many major private equity investments have been made in the shipping industry. Some estimate that it is over 20-30 transactions involving Greek owners alone, with possibly just as many outside Greece. The total amount committed is certainly in the billions. Indeed, judging by the many new faces and names at Posidonia, the prestigious biannual shipping event that recently took place in Athens, Greece, many would be right to think that private equity funds are a force to be reckoned with in the shipping industry.

However strongly and successfully they invest during this upswing stage of the shipping cycle, private equity funds are unlikely to be a permanent replacement for the traditional sources of ship financing. For a start, as ship valuations increase private equity will find it harder and harder to source deals which will provide the required IRR for their limited partners, particularly since the depth of the recent shipping recession and ensuing low asset values is in large part attributable to the Lehman collapse, which it is hoped was something of a unique occurrence. This may already be happening to some extent – there are certainly indications that the funds are becoming more selective in the deals they are prepared to do and with the shipping partners with whom they are prepared to work. Moreover, given that most traditional buyout funds have a term of 3-5 years they will eventually seek an exit by way of an IPO or a disposal of the vessels, and many may not re-invest (at least not at the time of exit when asset values will presumably be high).

Besides, major shipping players with strong balance sheets will continue to be able to obtain bank financing and tap the capital markets. Ignoring the impact of new banks aimed at the shipping market, such as Maritime & Merchant Bank, in 2012 and 2013 banks still lent significant amounts to shipping companies; in New York Dorian LPG recently raised over US$150m and Scorpio Bulkers over US$300m. For those, private equity will therefore remain at best an unattractive proposition given the difficulties in structuring a venture that will give both the ship owners and the private equity houses the control they are accustomed to having, and at worst a risk to the market. Some of the Greek ship owners who have been in the business for decades and control vessels worth billions are deeply sceptical about the prospects for private equity funds. As John Angelicoussis, a leading Greek ship owner, said in a recent interview with Trade Winds, a trade magazine, “Shipping is only for a few professionals, and I can’t see how private equity funds know what they are doing if we don’t know what we are doing a lot of the time”.

In fact, there is a danger that the lessons of 2008/2009 may be forgotten (or ignored by those that entered the industry later), both by traditional ship owners and private equity funds, and that the increased cash available from private equity funds, coupled with public investor appetite for debt and equity offerings, and the possibility that new and old banks may increase the overall bank debt available to ship owners, will lead to supply materially outpacing demand. When the shipping cycle eventually heads towards a renewed recession and, in the words of Warren Buffet, the tide goes out, it will be interesting to see just what proportion of traditional ship owners and what proportion of private equity funds have been swimming naked.

Alex Kyriakoulis is a corporate partner at Holman Fenwick Willan. He can be contacted on +44 (0)20 7264 8782 or by email: alexis.kyriakoulis@hfw.com.

Alex Kyriakoulis

Holman Fenwick Willan