Saturday, April 5, 2014

A challenging marriage: Private Equity and Shipping

Last December, former banker and well regarded dean of Greek shipping finance, Ted Petropoulos, railed against private equity shipping partnerships, arguing they were entirely incompatible. Yet 2013 proved an incredibly fertile year, where the capital markets window again opened for the shipping sector and private equity partnerships in the shipping space flourished. The predominate investor premise was cyclical asset arbitraging, where investors were convinced to place millions of dollars into shipping assets that they feel are under-priced and certain to rise substantially in value in a few years for hefty and quick profits. Will these ventures justify investor expectations or will many of them end in bad marriages, vindicating the views of Ted Petropoulos? 

Working with NY investment banking firms, the dichotomy between their due diligence vetting and actual placement of funds is striking. Due diligence procedure vets the management team and their past performance as an operating company. It centers on balance sheet analysis and particularly profit and loss performance. 

Yet when these organizations move to the actual placements, the whole emphasis is in asset speculation, with little or no interest in operational profitability. Often institutional money is happy to fund start-ups, where the management team sometimes even puts up relatively little or no money and often does not have much past operating record in the assets purchased. Big ticket name deals abound, centering on well-known shipping personalities - even sometimes with histories of hefty losses in previous ventures that led to bankruptcy and restructuring. The predominate business model is bond trader portfolio, where in this case it is shipping assets. To some degree, it is a country club approach with house entry barriers and old-boy favoritism. 

If the main thrust of the venture is asset speculation rather than building enterprise value, then – of course - past ventures do not really matter so much. In bond trading, a common way to deal with losses is simply to double up and/or close out the past losing positions and move to new asset positions. Enterprise building is not of any importance. 

What drives the investment banking industry is fees, so that the larger the deal, the more money and it is easier to place a large deal with a well-known name in NY circles. 

The whole emphasis is in quick turn over where shares rise on expectations and are sold ultimately to retail investors, The loss risk is on those who hold the shares on a long term basis. Indeed if we look at shipping shares from the last bull period up until the 2008 meltdown, many of these companies ultimately became penny stocks, but a significant number of institutional investors sold their shares and took their profits, rather than holding the shares. 

The irony, however, is that whilst maximization of profit in asset speculation depends on high market volatility, arbitraging reduces the very volatility on which the profits are generated. So theoretically, the more asset arbitraging positions in shipping assets, the less volatility in market pricing for shipping assets and lower profits as the arbitraging process levels out market pricing. 

There are other deeper looming problems, however, that may prove analogous to the iceberg that sunk the Titanic. This is related to the credit crunch and damaged banking system that has created a shortage of money to finance vessel purchases. Right now is very much a 'have and have-not' market for shipping companies that is reducing the universe of potential buyers. We have already seen a few block purchase deals fail for inability to raise funds. This might create a drag on any repeat of the musical chairs block shipping asset deals of the previous decade that made major shipping fortunes until the 2008 meltdown. 

Major investors like Wilbur Ross ardently sponsor industry consolidation. The theory is that few players would also better pricing power. In fact, this has been a predominate trend in the ship supplier space for many years. Telecommunications was extremely competitive with a large number of entrants and now there has been price consolidation with the stronger players, buying out the weaker smaller players, etc. Marine engine makers are now reduced to two major groups: Wartsila and MAN. This again, however, means a smaller universe of players to purchase shipping assets. 

Particularly detrimental to the resale market - especially for older units - would be the demise of the small and medium shipping companies, who are currently starved of bank credit.  This is inhibiting them from properly rolling over and renewing their fleets by selling off the older units often for scrap and buying somewhat younger second-hand units.  There have been an increasingly larger number of cash deals, but deal volume is down.  Many companies will be forced to trade out their older assets and leave the shipping space.  This means potentially a smaller market for older tonnage and lower values.

In a slack demand environment where we are possibly at the end of a globalization cycle and particularly in the case of lower than anticipated Chinese and emerging market growth rates that seems to be the case this year, this surge of investment in new buildings may be very good for the environment with a more modern fleet of new energy efficient vessels. Institutional investment in shipping assets also may be very beneficial to shippers, ensuring a more an adequate supply of vessels for future transport demand at low, competitive freight rates.

In the end, however, the investors in this floating real estate may be disappointed with many of these shipping ventures, following the pattern Diamond S with a much longer time than anticipated for any quick profitability and divestiture. The ultimate in this respect would be an international shipping space that begins to resembles the domestic US Jones Act environment (prior the shale oil renaissance) where there was essentially an oligarchic structure of a very limited number of players – half of them constantly in and out of Chapter 11 bankruptcy reorganization - and very marginal profitability at best. 

Realistically, there will probably always be a certain amount of fragmentation in the shipping industry. If there are not expected results, the institutional money may begin to follow the course of the major oil companies, who divested of their shipping assets some years ago because the shipping investments were a drag on their balance sheets and it was a better use of capital to charter in the vessels from independent operators rather than to get into the transport business themselves.

Tuesday, April 1, 2014

Is Peter G’s sudden foray into chemical tankers a clear signal to short the sector?

 Peter Georgiopoulos in his effort to make a comeback in the shipping space has decided to enter the chemical tanker sector with a speculative order for five firm 25,000-dwt vessels, plus five options at the state-owned Avic Dingheng yard. Well-placed sources say the ships are costing more than US$ 40 million each, with Avic slated to deliver the firm units in 2016 and 2017. Rumor is that Georgiopoulos had teamed up with unidentified private-equity investors to enter the chemical tanker segment. Given the recent history of his tanker company General Maritime in and out of Chapter 11, with massive losses to share and bond holders and his dry bulk company Genco teetering on the edge of Chapter 11 reorganization for some time now, should investors jump in to support this sort of asset play, especially in an entirely new sector where he has no prior operating or commercial experience? 

This latest movement of Peter G could well serve to vindicate the viewpoint of Niels Stolt Nielsen that “the amount of [private equity and institutional] money now entering into shipping is extremely worrisome……”  The Stolt CEO goes on to say: “The orders for new ships are being driven not by increased demand for logistical services, but by the overflow of capital available in the market.”   Finally, he expresses his concern about the acceptance of fee structures where the managers of these new “shipping companies” get fees up front when ordering ships, or for managing the ships they order, without having any equity stake in what is being ordered. 

Peter G’s new venture opens all Stolt Nielson’s concerns. If we take as a benchmark the Georgiopoulos dry cargo venture; Baltic Trading has had fairly steady losses from inception until very recently, but provides valuable source of collateral revenue, shoring up his main dry cargo operation Genco, with a hefty management fee structure to husband Baltic. It is speculative, asset arbitrage driven venture. Not surprisingly, Baltic stock trades very much like a freight market derivative instrument.

The challenge for any investment in the chemical tanker sector is that historical returns on asset have been exceptionally low (less than 10%). The number of players is limited, making for an illiquid sale and purchase market. In the case of the Eitzen Chemical distressed debt, senior lenders preferred to become shareholders and even waive loan spread, staving off any distressed asset sales under these limitations. Finally, this is has been a high cost, low margin business based on contracts of affreightment for base cargoes and the spot market to fill up the remaining empty space. The cargo contract commitments on the vessels further limit flexibility for asset plays in this sector because they create restrictions on timing for sales.. 

The mature groups in the chemical tanker sector have all transformed their business models from vessel  to logistics services provider and diversified into parallel sectors like chemical storage and gas shipping to improve their financial returns and risk profile. They have also kept their finance costs as low as possible and maintain strong balance sheets. None of the major players like Stolt see a quick market turnaround. They are companies with long term commitments to their customer base. 

None of this fits with Peter Georgiopoulos and his business approach. Peter G is above all an asset player. He keeps to the traditional Greek business model of vessel provider. His focus is mainly on acquiring shipping assets in large block deals. Further it is unlikely that he is putting a large amount of his own increasingly limited capital into this new venture and more likely that he is acting as an asset manager in this venture.  Here, however, in contrast to Baltic Trading, he does not have an operating company like Genco to back this new venture, which is fundamentally a start-up play. 

Another interesting twist is that the Avic Dingheng yard is also a newcomer to chemical tanker construction. The large, established players like Stolt and Jo Tankers have contracted larger size units (Dwt 38.000 and 30.000) at Hudong and Minde respectively. They appear to be aiming for lower unit costs, using larger deadweight units for emerging US chemical exports over the smaller competitor vessels. Both these yards have a proven track record in building chemical vessels. 

The Navig8 venture with Oaktree Capital has placed their orders (Dwt 25.000) at Kitanihon Shipbuilding and Fukuoka Shipbuilding, which are well established, first class Japanese yards with a long history of building stainless chemical tankers. By contrast, Avic has only built small coastal chemical tankers.

It will be very interesting to see how this new venture fares, but it likely be challenging for the investors unless there evolved an exceedingly bullish market given the stronger position of competitor peer companies.