Stopford - Covid and Climate Change: Two big challenges to the Shipping Industry

Yesterday listening to Martin Stopford's interesting presentation in a Capital Link event and lengthy Q&A session, it seemed to me that the two major drivers of events shaping the shipping industry today are Covid and Climate change.  They have a number of similarities. They have far ranging effects on world trade and ship technology that will affect the future.

Covid crisis and climate change start with natural phenomena that have morphed into highly contentious political issues due human response to them and the ensuing politics involved, particularly in the EU and US. 

Viruses and microorganisms are as old as life on the planet.  New viruses appear all the time.  Coronaviruses are well known and this is a new strain of this existing family.  We have had virus outbreaks from China repeatedly in the past years like SARS and H7N9.  Nobody panicked  and eventually these new strains took their course through natural means with human immunity and some efforts for vaccine,  Vaccines are simply an artificial means reinforcement of human immunity systems that would otherwise develop antibodies in reaction to exposure to the virus.  Ultimately there is no other way to deal with viruses.  The human race would have long ago become extinct from viruses if there were not biological immunity systems.

What is startling in the case of Covid is the political response to it that was first initiated in China by mass lockdowns/ social distancing of the healthy population and economic shutdown of production. Historically quarantines in reaction to infectious diseases were done by isolating sick people from the general population and holding travelers from infected areas for a certain period before entry into national territory.  

The Chinese government shutdown had an immediate effort on the shipping industry with a reduction of port cargo movement of 20% on the average, affecting the container industry negatively, forced to blank sailings and facing box build ups in Europe from the imbalances produced by the factory shutdowns in China.

Then there was an even more damaging and recessionary impact on the shipping industry with Western Governments collectively adopting the Chinese lockdowns and imposing them on their populations, quarantining large segments of their healthy population in fear of exposure to the virus, something never done before in human history.  

This has caused a great deal of instability for global shipping. There are projections of significant reduction in world trade this year,  Ship operations have become challenged due difficulties to carry out surveys and repairs. Normal crew changes have become a major problem to carry out .  Economic impact varies by sector.  

• Container shipping was looking to recover with Chinese reopening of factories and increase in port cargo volumes in March, when it got slammed by the recessionary impact of the lockdowns in Western economies that created even deeper losses of revenues and blank sailing. Major container lines have been plagued by poor earnings margins for years.  Some were just beginning to turn profits in 2019.  Now all these major liner companies are likely this year to go back into operating losses.  Stopford feels they will eventually muddle through this, depending on the speed that Western government reopen after lockdown and the severity of the global recession.  Stopford feels that large containerships were always a problematical response to the structural problems of the industry.  Globalization is over after Covid and trade is likely to evolve more regionally.  The use of these units will be restricted and the transport needs will be more for regional distribution.

•  Conversely the tanker sector has been enjoying a bull market with record rates.  This in related to failure of OPEC to extend production cuts and a new price war, when at the same time Western mass lockdowns have provoked a significant drop in oil demand.  The system is flush with oil from overproduction.  This has resulted in a surge of demand for tankers both for transport and storage, even backing into product carriers from refinery overproduction.  Ironically this situation will eventually result in obligatory and severe cuts in oil production and a dead tanker market with fewer hydrocarbon cargoes ahead.  Stopford pointed to the inherent weakness of the tanker sector in his presentation.  For now the tanker companies are the darlings of investors and flush with cash and profits.

•  Dry bulk is more mixed and nuanced here.  This sector has not been very profitable for at least 10 years, except for short rate spurts in certain segments.  The large bulk carriers depends on the steel industry,  coal and iron ore cargoes.  This segment had an awful first quarter with BDI indexes going into negative territory. Stopford does not see a very bright future here for these units with a maturing Chinese economy and the likelihood of stimulus spending to be more focused on technology rather than further infrastructure projects.  The smaller units will fare somewhat better. Panamax units carry more diverse cargoes like grain that are driven by other factors than the steel industry. The smaller sizes carry a much wider range of cargoes, including minor bulk trades.  More of this is related to foodstuff and general population needs. These segments will muddle through the crisis but present rates are low.

Stopford sees a secular trend towards regional trading zones with production closer to consuming areas.  He outlined three recovery scenarios.  All this is related to Western governments and how they manage the reopening of their economies.

This is entirely a political issue and it will have big effects on the depth of any recession. The drop in world trade will be milder than drop in GPD, but the effect on the shipping industry will be far reaching.

I see this as complicated political issue, not directly related to the virus. Western governments have taken unprecedented actions imposing drastic restrictions on their populations and curtailing basic civil liberties like freedom of assembly and religious worship.  All this together with significant social and economic cost on their populations that has led to the specter of global recession.

Scientific studies are beginning to indicate that there is nothing novel about this virus.  Infection rates on general population are much higher than originally anticipated despite the lockdown measures.  Death rates are much lower than wildly inaccurate early studies from places like Imperial College.  There is no easy way for the political class to reopen quickly.  They are fearful of the future political cost of their actions.  How this unfolds in the US and EU depends on the boldness of the political leadership and their effectiveness to return to normalcy and limit damages by getting their populations back to work and reflating their economies with the stimulus programs.

Despite the three scenarios, Stopford closed with a hopeful note that by fall, most of this Covid crisis will be over.  We shall see!

Climate change and environment regulation has taken the back seat due Covid crisis but this is a similar case of politics overwhelming natural phenomena and creating considerable challenges.  The earth has underdone significant changes in climate for millions of years. Anthropogenic causes by burning hydrocarbon fuels are a very recent phenomenon.  Carbon is essential for life on the planet.  There is a natural recycling of carbon from plant life back to oxygen.  Science is even more divided over these matters than Covid and human immunity systems.  The climate depends on so many other unquantifiable factors such as solar radiation and tilt of the earth.

But the present political consensus like the massive Covid lockdowns is that carbon is bad and greenhouse gasses GHG must be reduced and eliminated.  IMO has adopted GHG targets for 2030/ 2050 for which there is presently no technological means to comply.  The EU dominated by Northern European Green parties wants even more drastic measure such as a carbon tax trading scheme imposed on the shipping industry.  Like the Covid lockdowns, these measures will have negative economic impact on their populations, particularly the poorer classes.  There have been mass protests like the Gillets Jaunes in France in reaction to government taxes on fuel, just as in the US there are increasing protests against the government lockdowns. But generally the political class stands firm on these matters and it is not easy for them to back down in terms of their positions for the political cost.

For the shipping industry, Stopford points out that diesel and fossil fuels are far more efficient technologically than alternative fuels.  There is much higher energy content in the fuel.  It can easily and safely be stored on vessels and it does not take much space.  For these reasons, Stopford feels that diesel propulsion is the only alternative for the next generation of ships with a lifespan of another 20 years. 

The innovations in shipping for less fuel consumption and GHG levels will come from 'smart' ships with messages via CPU modules replacing wires, as Stopford puts it.  I would add this would also dictate more use of digitalization and software maximization programs in the offices linked to the vessels that they manage.  Metis - a Greek software system -based on the internet of things is a good example and a number of leading Greek Shipping companies have adopted it.

Stopford then outlines a growing use of LNG and dual fuel vessels. New technologies like this are more easily implemented in short sea shipping in early stages. Already this is the case for use of LNG in the cruise industry and tanker feeder vessels in Europe, for example.  This will lead to a new generation of vessels that will start to replace the  'smart' diesel/ fuel oil vessels. 

Then rather far out, Stopford sees electric vessels with fuel cells powered by hydrogen, etc. None of this is close to reality today.  The fuel cells cannot produce sufficient power and the new fuels presently can  only be produced from processed that create GHG that must be sequestrated.  Many of alternative fuels are noxious and difficult to store on vessels.

It is very intriguing to note that the same political class that supports decarbonization and vigorous climate change regulation also support with passion the mass lockdowns in reaction to the Covid virus  Many are extolling the positive results from the mass lockdowns on the environment with the drop in air and land transportation and falling demand for hydrocarbon fuel. They are the ones most critical to attempts to reopen economies and get people back to work. They are advocating universal income guarantees and green new deals for stimulus as long term solutions. 

They are not keen to return to the status quo.  They are not particularly troubled by adoption of  restrictions of movement and civil liberties on the general population. They tend to be indifferent to empirical scientific method and how it may evolve over the particular ideology that they promote to support their policies and actions.  They are not especially concerned about the social cost and economic hardship on the general population from their decisions. They place more important on their longer term ideological political goals that they feel are good for society and their political careers.

We will see in the next few months how this political debate evolves and how soon we reopen. The political climate is looking toxic and divisive. Inevitably we are entering a new post globalization era for the shipping industry with far reaching consequences.  Stopford parallels the challenges as analogous to the transition from sail to steam in the 19th and early 20th century.  The political and economical ramifications are huge.

Hanjin collapses into bankruptcy and receivership: Sursum Corda!

I have been predicting this sort  of high profile bankruptcy of a major liner company as inevitable for years now.  There are just too many loss making liner companies and sooner or later state support would reach its limits.  The whole matter of counterparty risk for the vessel provider companies has been misconstrued for years now on the false assumption that the liner companies were just too big to fail. 

Seaspan's Gerry Wang calls the Hanjin bankruptcy a nuclear bomb and mixing his metaphors a 'Lehman moment', but did not Wang see this coming?  For years, he was ordering aggressively and chartering out to loss makers like Hanjin.  His policies contributed to this!

This industry suffers from chronic overcapacity and low margins.  Further their business model based on China and head haul routes is in risk of becoming outdated with the slowing of Chinese growth and trade rebalancing as well as technologically obsolescent with the robotics, 3-D printing, etc.  I have always been in agreement with my friend Christopher Rex of Danish Ship Fund on this industry and its prospects. 

I have argued this time and again with my Wall Street investment bank friends. Hopefully, with this Hanjin case, they will start to wake up and understand better the container industry dynamics.  See some of my  blog articles on this subject over the years.  For example, I was very early to point out the large exposure of Danaos (NYSE: DAC) to financially weak liner companies. 

Danaos was somewhat fortunate with the HMM charters receiving shares in restructured HMM in return for reduced charter rates.  In the case of Hanjin, DAC has estimated exposure of US$ 560 million on Hanjin.  First estimates are creditor returns of 35% for secured claims. But only 5% for unsecured claims and zero on liquidation.  That is quite a mark down!

Over the years, Wall Street has made some bad shipping calls like the earlier reckless, irresponsible dry bulk speculative asset plays.  Investors in shipping stocks have frequently lost their shirts. 

Of course, the great thing about shipping markets as opposed to politics in the US and EU - where the usual reaction is to double up on failed policies, buy time and hide the truth from the public - is that you cannot hide financial losses, financial resources are limited and there are natural market corrections, asset write downs and consolidation.  Raw Schumpeter capitalism always prevails keeping the industry lean and mean over the long run, but not without significant volatility and market swings. 

It is not a good idea to get lost in the noise and ignore supply chain logistics that generates the underlying cargo demand for marine transport.

Hanjin Shipping wins Seaspan concessions: the inevitable for the vessel provider companies!

The current plight of Hanjin is representative for the Liner industry: substantial operating losses, need for recapitalization and over indebted balance sheet.  The container industry panacea of ever larger units to reduce unit costs and defend eroding earnings margins is not working out as hoped.  This has created more overcapacity with cascading.  Now there is talk of the Panamax sizes going for scrap. 

World trade growth is slowing. It is not clear that the old model of large ships for headhaul lines is going to meet the requirements of the future with trade rebalancing in China, robotics and the sharing economy of the future.

The cold truth is that there are already more liner companies than the market can support.  A large number of liner companies are making losses.  Some like NOL have been put on the block for sale and are being consolidated into other companies like CMA-CGM, others like HMM and Hanjin are staving off bankruptcy with financial restructuring.

Vessel provider companies like Seaspan and Danaos have built their fleets by every larger vessels that they let on term time charter to financially weak liner companies that want the larger units to defend themselves from the ordering and competition of the stronger liner companies but unable to carry the vessels themselves on their balance sheets.

I have repeatedly signaled out this risky business policy of the vessel provider companies on my blog.  I have stressed that it was not a sound and sustainable business strategy.  The vessel provider companies would face inevitable challenges in the future as the financial situation of the liner companies deteriorates, leading to bankruptcy and restructuring that would inevitably entail charter renegotiation.  I pointed out the heavy exposure of Danaos to HMM and Hanjin as major charterers.  I stressed the aggressiveness of Seaspan to service financially weak Asian liner companies with ever larger units.  Cosco for example recently announces losses of over US$ 1 billion in their liner business, one of their customers.

I have always felt that Gerry Wang's assertions about having a leasing company business model were overstated and disingenuous to investors.  Seaspan lets its tonnage on time charter with operating risks.  With Hanjin in financial crisis, Wang took the hard line on charter negotiations for investor ears, but Seaspan is in a weak position with its exposure in large containerships.  It cannot easily withdraw and redeploy its vessels because the market for these units is not large.  Inevitably as its liner company customers begin to face financial difficulties, Seaspan has no choice but to accept cuts in charter rates to keep them going with their creditors as long as possible. 

Since the original writing of this piece, Hanjin's restructuring negotiations have not worked out and they are going into receivership.  Seaspan is hoping for a merger between HMM and Hanjin and that perhaps with some sort of state support, they might be able to avoid cuts in charter rates.  We will see over time how Seaspans fares.  This is a test for their exposure to other weak Far East charterers and possible state intervention to keep them afloat.

I restate again these points because I have often met dead ears in NY investment banking circles, still enamored with the containership industry.  Over time, the bankers and financial industry are going to have to face the reality:

• The containership industry is just as challenged as dry cargo with overcapacity. 
• The growth days from the global megacycle and China boom are over and gone.
• Liner companies will inevitably be forced to consolidate for survival. It is not clear that very large containerships will be needed to extent anticipated.
• Vessel provider companies are going to face a long period of thin margins as their liner company employment base shrinks in the consolidation process.
• Inevitably there is renegotiation risk on their charters that they will not be able to avoid with their liner company customers. 

Seaspan’s Yang Ming moment

Gerry Wang, Seaspan’s ebullient CEO, frequently refers to his business model as a ‘leasing” operation.  I have long questioned this.  In fact, Seaspan is a conventional vessel provider to liner companies.  Their contractual relations are long-term time charters with performance risk.  Yet this latest deal to order 14.000 TEU mega-ships and then charter them to Yang Ming Transport Corporation for their liner service has many interesting parallels to the ship leasing business that are illustrative of the business risks and rewards in the Seaspan business strategy.

Yang Ming recently announced consecutive losses TWD 2.6 billion (US$ 87 million) in the 2nd quarter 2013 earnings conference.  Revenue for the quarter was TWD 30 billion, a year-on-year decline of 14%, but a small quarter-on-quarter bounce of 9%.  The poor performance was blamed on depressed freight rates for the Asia-to-Europe trade lane from which Yang Ming derived about 27% of its revenue in 2012.

Yang Ming suffers from an over-leveraged balance sheet with too much debt and is struggling to shed assets for liquidity by selling off terminal operations and leasing them back.

Consequently, they are in no position to contract 14.000 containerships.  So they have now entered into an agreement to charter in ten additional 14,000-teu containerships from Seaspan, which are slated for delivery in 2015-16.  The logic is the usual in this business of ever-declining margins and over capacity:  “These mega vessels are expected to be deployed on the Asia-Europe route and are expected to bring unit costs to down better complement the fleet of the CKYH alliance,”  according to Jon Windham, a Barclay analyst covering them.

Seaspan initially ordered speculatively these mega-ships, paying US$ 110 million per unit at Hyundai Heavy Industries. With ten new units now committed to Yang Ming, Seaspan is now turning to Taiwan’s CSBC Corporation for five additional 14,000-teu vessels on the same price terms as the earlier Hyundai order as an added sweetener to this Taiwan deal.

No doubt, Seapan is offering Yang Ming a considerable service with these units that they could not afford to contract themselves.  Yang Ming is paying them a rate of US$ 46.000 per day upon delivery for the next ten years.

All this, however, cannot eradicate the bare facts that Seaspan is openly speculating in assets against charters often to financially weak liner companies in an industry that is suffering chronic overcapacity.  They wagering on an eventual cyclical market turn-around with increased box traffic.  Yet the heavy ordering of megaships contributes to over capacity. Unless there is real turn around in terms of increased container traffic and demand for box slots, this almost resembles a Ponzi scheme.

Of course, nobody can deny the tenacity of Gerry Wang and business standing of Seaspan in the liner industry.  Greek-listed container vessel companies like Danaos, Box Ships and Diana containers pale in comparison as poor relatives and much weaker management teams. 

The only really strong and healthy listed Greek containership company is  Costamare, whose largest vessels are 9.000 TEU.  They have a history of sustained profitability and they have not rushed into the megaships.  Many of their units are employed in feeder services, which are a growing and generally profitable subsector due larger ships on head haul routes, use of hub ports and increasing demand for distribution of boxes to smaller ports.

The business risks for Seaspan are similar to finance leasing companies in their business of high cost finance generally to a clientele of financially weaker shipping companies.  Sometimes the companies have liquidity problems and are looking to sell assets and lease them back.     Other times, they are expanding rapidly and have exhausted conventional lower cost bank finance.  The leasing companies bet on company turnaround and stronger markets to prop up their financially weak clients. 

Seaspan’s prime universe for these mega-ships is financially weak liner companies without the resources to order directly the vessels themselves.  Success of the venture depends critically on a market turn around.  Should this growth even finally level off with Far East trade rebalancing and slow recovery in Western economies leading to a belated and major shakeup in the Liner industry with few companies, some major bankruptcies, etc., then Seaspan might find itself badly exposed with such aggressive ordering.

So far Seaspan has managed to weather well the shock back in 2008 without a single order cancellation and is continuing its aggressive growth.

Is Box Ships latest purchase charter back deal with Overseas Orient really as rosy as claimed?

Michael Bodourglou’s Box Ships (TEU) has been a considerable reprieve from current woes of his bulk carrier business Paragon (PRGN), now a penny stock struggling with sagging profits, charter party defaults and loan covenant breaches from declining hull values. By contrast, Box Ships has seen its revenues double from last year and recently had a successful fund raiser.

We have expressed in the past our reservations on Bodouroglou’s diversification play because we see it as a pure asset and market cyclical play without any inherent competitive advantage. Containerships are attractive because they are very cheap. Charter-free 15-year old containerships are going for scrap value, probably the cheapest shipping assets of any sector of the marine market. The vessels require charters from major liner companies, who have had their own problems with stagnant box rates, price wars for market share and investment in ever large tonnage to lower unit costs and defend operating margins.

The Overseas Orient deal is instructive. It is a purchase-charter back transaction from Orient Overseas (OOIL), which is a solid liner operator concentrating on inter Asia, Australia and trans-Pacific container routes and limited exposure on the currently problematic Asia Europe head haul route suffering from the Eurozone’s self-inflicted recession and debt deflation woes. The two 5.344 TEU vessels acquired by Box Ships are built 1995/ 1996.

Whilst charter free box ships of similar age are valued at scrap levels, Box Ships is paying the handsome price of US$ 62,3 million for these two aging units because OOIL will charter back the vessels at rates of US$ 26.800 per day for three years. Nominally assuming continuation of these rate levels on a five-year basis, this business brings returns on equity in the order of 16% per annum, which is very good performance in these difficult markets. After administrative expenses (namely the sizeable vessel management fees to AllSeas Maritime - Bodouroglou's privately held management company) the actual discounted cash flow returns to investors would be somewhat lower, but still this outshines returns on dry bulk and tanker business presently.

The issue is whether these rate levels are sustainable on renewal in three years’ time. There is as well as the matter of potential impairment charges on vessel values on a charter-free basis. So far the impressive revenue increases in Box Ships are mainly because Bodouroglou has been aggressively buying vessels and expanding the fleet. Yet the Box Ship share price has been steadily declining, initially around the US$ 10-11 level and now trading at the US$ 6-7 range.

Like all shipping transactions, these moves are a wager in hopes that the markets will turn around favorably and the cyclicality will boost returns. Bodouroglou could be well be correct in his investment timing.  Certainly he is getting plenty of banking and investor support in tough capital market conditions.

On the other hand there is tail risk here. In an expansion phase of a start-up venture like this, you double the number of vessels and get twice the revenue but does that is not the same as doubling your revenue on your existing fleet earning twice the freight income over the same expenses. Time will tell whether this strategy works out or Box Ships will disappoint and underperform expectations.

Mediterranean Shipping Co (MSC) and CMA CGM join up to stem the Maersk challenge

The latest shipping news is that these former rivals have had to team up on several key liner services in order to compete with Maersk Line on the key Asia-Europe route. As a privately held company, MSC’s financial information is not easily available, but they are just behind Maersk in TEU capacity. CMA is in third place. The partnership is operational for a two-year period. There has not been any discussion of corporate merger.

The direct goal of the MSC, CMA commercial partnership is to offer a liner product comparable to the “Daily Maersk” service.

They are doing this on five Asia-to-Europe services, deploying 53 ships of 9,500 TEU to 14,000 TEU capacity. Four are cover routes to northern Europe (the Swan, Silk, Lion and Condor services) using ships of 11,400 TEU to 14,000 TEU. The fifth is the Asia-to-Mediterranean Jade service using nine ships of 9,500 TEU. Together, the two lines will control one-third of capacity of the over 10,000 TEU fleet (operating and on order), compared to Maersk’s 20%.

This move reflects the lack of volumes in the market as a consequence of the economic crisis and the difficulties of managing the vessels on these liner services. It is likely to make it very difficult to compete on these routes using vessels smaller than 10.000 TEU. Both partners need to bolster their balance sheets and have been selling ships and chartering them back at a time of loss-making Asia-Europe rates. The collaboration will allow both to cut costs and fill ships at the expense of other lines.

It is also likely that this synergy will attempt to tighten the screws on beleaguered vessel provider companies. MSC and CMA are reputed to be among the toughest negotiators in the charter market. There is concern that they might seek to renegotiate charters in the face of falling freight rates, potentially causing overstretched companies like Danaos serious problems. Shippers, on the other hand, are expressing concerns that the two mega lines may attempt to restrict capacity to maintain higher rate levels, making the Asia-Europe route an oligopoly.

There is a window of opportunity in this partnership for the next 12 months as Maersk has no large ships for delivery, while MSC and CMA CGM will receive 21 new buildings of over 13,000 TEU by the end of 2012. This will cause Maersk to lose market share until it starts to take delivery of their 10 Triple-E 18,000 TEU vessels. The Swiss-Italian carrier MSC would keep its fleet employed while allowing CMA CGM to achieve its growth plans, which have been derailed by the crisis and financial problems.

Maersk Line pioneered the advent of larger vessels with its E-class vessels (+15,000 TEU) back in 2006-7 and last year it embarked upon the new Triple E series.

It is clear that the liner industry suffers from serious earning margins problems, and another downturn in expected cargo volume will come with the growing recession in the E.U. Maersk, MSC and CMA are trying to face this challenge with larger vessels for lower unit costs as well as commercial strategies that give them some pricing power over rates, such as this potentially oligopoly of two mega carriers on the Asia-Europe route, squeezing out smaller liner companies.

Danaos exposed to counterparty credit risk with large exposure to some of the financially weakest liner companies

Danaos has been a perennially weak stock since the 2008 meltdown. The company suffers from high bank leverage and a heavy capex budget. Earnings have been marginal at best. In 2010, it racked up a whopping loss of US$ 101 million. This year, Danaos negotiated an excellent restructuring agreement with its senior lenders that also covers its future capex needs. It has significant long term charter cover. Is Danaos now out of the woods?

Danaos has a fleet with an attractive age profile. It has kept pace with changing industry dynamics, with almost 50% of its fleet capacity in the 8,000+ TEU range. Its fleet’s average age is 6.27 years and it has a new building program of 13 containerships to be delivered through mid-2012.

Danaos recently carried out a massive restructuring of its debt. The company raised in excess of $1 billion through a $200 million equity issue and new debt commitments of $818 million. Further, Danaos announced formal completion of the restructuring of its new building capex finance obligations. Fortunately, Danaos is a listed company and has the size and clout to pull off this this operation, underscoring the resilience of the publicly listed shipping company business model.

The fleet is heavily contracted with average length charters between 8 to 10 years. This employment profile facilitated the loan restructuring and capex commitments. Needless to say, the loan repayment was tailored to this cash flow with no bullet payments until 2019. Interest expenses are not negligible with projections of $191/$202/$234 million in years 2011/ 2012/ 2013 respectively, which represent about 50% of anticipated EBITDA (US$ 317/ 433/ 442 million respectively).

The weakest element here would appear to be the 29% exposure to Hyundai Merchant Marine (HMM) and 28% exposure to CMA-CGM as charterers. HMM has a gearing of three times debt to equity. It announced heavy losses of $ 205.080 million for the first semester of 2011. It is a smaller liner company vulnerable to pricing pressures from larger operators like Maerk in the fight for market share.

CMA CGM was downgraded by Fitch to BBB- with negative outlook and then Fitch ceased coverage. Their first semester 2011 profits were down 72% to $237 million from 2010. CMA CGM has been selling vessels at a discount to complete the reorganizing of $7 billion-worth of debt overseen by French court authorities, part of which involved Turkey’s Yildirim Group injecting $500 million into the company in exchange for shares.

Liner companies are generally considered too big to fail (TBTF) businesses. Should a major liner company go into bankruptcy, the fall-out would be substantial given that these companies charter about half their fleet from vessel provider companies like Danaos.

Alternatively, with a deepening recessionary environment, there are prospects of charter party renegotiation as occurs normally in shipping sectors like tankers and dry cargo. Theoretically, liner companies would have substantial negotiating power given the concentration of the industry and total dependence of vessel providers on them for employment.

Will the Maersk gambit succeed in gaining pricing power over the Asia-Europe head haul container route?

Whilst volume on the Asia-Europe container route is dropping off and competitors are struggling, Maersk is doubling up its efforts to dominate this trade in coming years by placing new building orders for large E class (15.000 TEU) and triple E class (18.000 TEU) ships. Maersk is highly dependent on its container division with almost 40% of its total volume carried coming from Asia-Europe trade. Its strategy is to benefit from better supply-demand fundamentals in late 2012 and into 2013.

Container shipping is increasingly a game of larger vessels with an emphasis on lowering slot costs. The one who has the lowest cost structure is able to garner higher volumes by out-pricing competition.

Maersk Line is the world’s largest container line. At the end of H1 2011 it controlled more than 600 vessels – 245 owned and 376 chartered container vessels – with a total capacity of 2.4m TEU. It also operates a major global port, terminal and inland services business – APM Terminals - operating a geographically diverse portfolio of 61 ports and terminals in 33 countries. It has 16 new terminal development or expansion projects underway and 132 inland services locations in 48 countries.

In the container shipping downturn of 2008-09, Maersk carried out a major restructuring drive in its container shipping division. The goal was to target more than $1 billion in cost savings to provide better operating efficiencies and minimize losses. Reduction and stabilization in unit cost is the key operating matrix in the container industry.

Maersk’s major competitors are Neptune Orient Lines (NOL), Hapag Lloyd and OOIL. Each has more than 7% of the greater than 12,000 TEU orderbook and stand to benefit as they are able to lower the slot costs and improve margins even if freight rates are just seen improving marginally. Maersk has the largest share at 13% whereas the each of competitors holds a 7% share. NOL, presently under pressure of earnings losses, is struggling with a very large capex budget and may be obliged to postpone some new buildings.

The second largest player, MSC, is more or less absent in the larger vessel category, which will help Maersk extend its lead further in coming years.

Hanjin Shipping, Hyundai Merchant Marine (HMM) and CMA CGM are highly leveraged. The two Korean line (Hanjin and HMM) have a gearing of three and two-times debt to equity, respectively. In Europe, the focus is on CMA CGM, which bond-market pundits expect to breach its debt covenants in the near future. It is undergoing considerable debt restructuring.

The long haul market will increasingly be dominated by fewer players with stronger standing and prowess, even in a depressed freight rate environment with very large containerships and low unit costs. The smaller peer operators do not have enough large vessels on order and will have to stick with smaller and less competitive tonnage or pull out of the trades completely.

Maersk Line is making an open gambit to gain the pre-eminent position on the Asia-Europe trade beginning in late 2012. It could out-price competitors and even potentially become a price setter on these trades.

Cosco losses could lead to charter renegotiation in the containership sector

Macquarie Capital analyst, Janet Lewis, predicts that Cosco might continue in losses for two years or more. Cosco’s container wing, which was also loss-making in the first half, is set to take delivery of 28 new vessels in the near future. Will Cosco follow suit with containership owners to renegotiate down charter rates as they have done in the dry bulk sector?

There is considerable evidence that financial results in the containership sector are weakening this year. After the restocking boom last year in fight for market share, Maersk (OMX: MAERSKB) announced aggressive new building program for ever larger containership vessels in their on-going efforts to expand market share at the expense of peer companies.

Seaspan (NYSE: SSW), which has a pure vessel provider model and investor darling, followed suit with a new building program of their own. This group held on to all their new building contracts booked prior the 2008 meltdown, managed to cover their capex needs and take delivery. They turned heavily to Cosco (Coscon) and CSCL for employment. Seaspan is inordinately dependent on Cosco as their largest liner company customer relationship (in the order of 50% or more of their fleet from recent investor presentations).

Should Cosco be obliged to refuse delivery of new units or renegotiate existing time charter for lower rates, this would have a profound effect on Seaspan’s fortunes as well as other containership companies, who service their needs.

Seaspan shares have been falling in value since April. They have never fully recovered in share value from their pre-2008 levels.

Are shipping markets heading for another leg down?

Recently private equity group First Reserve bankrolled the Diamond S deal in which 30 product tankers were acquired from ship management company CIDO at a significant premium over prevailing market levels. This speculative spirit reminds me of the General Maritime block deal last year. Similar lust for quick profits of shipping in the early 1980’s led to ill-timed, mispriced major investment decisions and a series of major shipping bankruptcies, and period of severe market disruption. Will the Chinese Eldorado and Fed financial engineering save the day for Wall Street flip-over deals or are we at the end of the 1980’s economic cycle and age of asset inflation?

The major growth driver for cargo demand has been emerging market economies. This year started badly and all sectors are presently suffering. There has been lately some interest in containership and product tanker asset speculation. The only sector really making money is LNG where there is a healthy supply/ demand gap.

Despite the dicey economic environment, the shipping industry staged an unexpected recovery in 2009 and 2010. Dry Bulk benefitted heavily from Chinese stimulus infrastructure projects and commodities stockpiling. Tankers benefitted by oil price arbitraging and storage demand. The container sector managed to reflate demand artificially by slow steaming and then benefitted from a pick-up in Chinese exports.

There is nothing ‘miraculous’ or unique about the Chinese growth model. Well-known China observers like former Morgan Stanley star Andy Xie and political economist Victor Shih at Northwestern University have long maintained that the Chinese growth model is an input driven economy fuelled by cheap money through financial repression to increasingly marginal investments subject to diminishing returns.

Everybody is banking on opportunities of a giant boundless consumer market in China, but as Michael Pettis (senior associate in the Carnegie Asia Program, based in Beijing) has recently written: “Low consumption levels are not an accidental coincidence. They are fundamental to the growth model, and the suppression of consumption is a consequence of the very policies – low wage growth relative to productivity growth, an undervalued currency and, above all, artificially low interest rates – that have generated the furious GDP growth. You cannot change the former without giving up the latter.”

China funds almost all of its major investments with bank debt. It long ago ran out of obvious investments that are economically viable, so any marginal increases in investment must be matched by increases in debt, resulting in an unsustainable debt overhang. Meanwhile, with the US economy at stall speed and the EU imploding into recession, Chinese trade surpluses are no longer desirable with its trading partners.

Rebalancing is not an option for China and it is likely to be very disruptive and for a prolonged period of time. All historical precedents are for a sharp down downturn in economic growth. The decline in Chinese growth will fall disproportionately on investment and this will severely impact the price of non-food commodities.

A sharp Chinese slowdown will have a severe impact on cargo demand and freight rates. The drop in steel consumption from the infrastructure projects will adversely impact the economics of emerging market exporters of raw materials. Liquidity will start to dry up in all emerging market economies. Finally, decline in steel prices will adversely affected vessel values. Scrap prices will fall and replacement cost for new vessels will decline. Vessel prices could drop dramatically.

All shipping sectors will suffer. A recession in the EU and US will quash any increase in demand in the products markets. Emerging markets will not pick up the slack. The larger bulk carriers are very exposed with dependency on China and its steel industry. Container overcapacity will again plague the industry. Recent speculative Greek issues like Boxships and Diana containerships riding on hopes of increased demand for feeder services will fizzle as liner companies reduce their chartered fleet. The most painful aspect will be the drop in vessel values.

In such a scenario, it may take years before any recovery, totally changing speculative business plans and discounted cash flows where time is the biggest enemy to profitability. The nightmare of any short-term player is to be stuck with a losing proposition as a long-term investor. In many cases, the best option is to liquidate in timely fashion not to ride the market down to the bottom. That will be difficult with such a large positions. Maybe this is already being reflected in the recent pressure on shipping shares, even large well-capitalized tanker companies like OSG and TeeKay.

On the other hand, depressed market conditions would facilitate industry consolidation and clean-up of over-leveraged, deadwood companies with failed management. Since the 2008 meltdown, there is a growing list of zombie shipping companies swimming in debt and heavy consumers of lease financing at any cost. This would benefit the financially solid long term players and eventually give them better market pricing power. Lower vessel prices would make the industry leaner and more competitive.

Of course, nobody is a prophet. Next year, we could have a booming shipping markets, a new vessel ordering boom, and the Dow back over 12.000…. Imagine DryShips again trading over US$ 100 per share! George Economou has been a leading advocate of the Chinese unlimited growth story.

Debate and shaky start for Diana containerships IPO

Diana Containerships recently completed a US$ 107 mio follow-on shares offering in New York last week at a steep discount to the company’s net asset value (NAV) and its previous share price. This new IPO follows the Paragon Boxships offering and has many of the same inherent defects as a pure asset speculation play rather than a coherent entry into the containership business.

Credit Suisse recently downgraded the parent drybulk company, Diana Shipping, to 'underperform' status due its exposure to larger bulk carriers in present lackluster market conditions.  Rates have plummeted from the the beginning of the year and the over supply of tonnage is significant with the order book overhang.

Diana Shipping came into the 2008 meltdown with one of the strongest balance sheets and has been considered a favorite by many analysts. Investor pressure for profit expectations led management to move into containerships given the deep slide in containership values in 2009 and the comeback in container market last year.

Like Paragon, Diana has no history in the containership sector and would be solely a vessel provider to liner companies with little added value, very similar to the German KG market, which is heavily invested in this sector. Indeed their strategy is potentially to pick up container vessel assets from beleaguered German KGs.

Both are late in the game to their established and successful peer, Seaspan. Diana management lacks the charism of Gerry Wang and his almost mythological Chinese business connections. It lacks the investor backing/ Far East connections clout of the Tiger Group, related to Seaspan.

Diana Containership NAV before the offering was estimated between US$ 15-16, but the offering was priced at US$ 7,50 to attract investors. The huge discount made the offering popular with investors; but a disaster for shareholders, who bought into the company at the initial price of $15. More significant is that Diana originally had expected to raise as much as US$ 250 mio in fresh funds in the offering led by FBR Capital Markets of the US. But with interest lacking, its own US$ 50 mio contribution to the spin-off wound up giving it a majority stake in the new venture. The result left Diana without sufficient capital to be a player of any size in boxships.

All this makes you wonder what FBR Capital had in mind to back such a venture. In any case, Jefferies, Cantor Fitzgerald and Wells Fargo are touting this nascent "Seaspan" as a 'buy' ostensibly to feed the retail investor 'ducks' on Wall Street.

Whilst they have a plausible argument on low share valuation and container market expectations, Diana Containerships is one of many vessel providers and new ordering by the likes of Seaspan and other established players may leave this company at the station for an adventure that could potentially turn out more like some of the German KG's.

Seaspan aiming for another giant containership order

After penning a US $2.5 bn deal at China’s Jiangsu Yangzijiang Shipbuilding for seven firm 10,000-teu vessels plus 18 options and then inking a letter of intent for 10 vessels of 14,000 teu at STX Offshore & Shipbuilding plus 10 options at $140m apiece, Seaspan is showing interest in 18,000-teu vessels and has approached South Korea’s Daewoo Shipbuilding, Hyundai Heavy Industries and Samsung Heavy Industries. There are never enough container vessels deals for its CEO Gerry Wang!

Seapan is a story of unlimited Chinese export growth. Despite the 2008 container market crash and massive losses of major liner companies in 2009, Seaspan avoided any cancellations in its newbuilding program. Since the market recovery last year, Seaspan has been aggressively ordering additional tonnage.

Whilst box rates have been under pressure, time charter rates have been rising with a moderate, steady increase that is now stabilizing. Margins have been satisfactory. Demand growth is expected to outpace supply with a forecasted 1,7% increase in fleet utilization this year as well as 5% appreciation in asset values.

Liner companies are moving to ever larger tonnage to escape the pressure on box rates and gain market share over competitors by shipping a larger number of containers on the same vessel.

Seaspan has successfully tied up some long-term charters with Hanjin Shipping for several newly contracted TEU-10.000 newbuildings. Hanjin normally fixes in small to medium-size ships for around seven years and large vessels for more than 12 years. Hanjin was a breakthrough for Seaspan given its past close relations with German KG containership investors.

Seaspan has attracted a lot of investor interest this year. As with all listed companies, these large block expansion deals attract investor interest on future expectations. Its shares soared to excess US$ 20 levels in April, only to fall back to present US$ 15 levels. The company has been slowly recovering from it lofty pre-2008 meltdown levels, but it remainsl far away yet.

The question is where Seaspan is going to employ these envisaged TEU-18.000 units? The group has been relying increasingly on Chinese state controlled liner companies COSCO and CSCL to back its new orders.

Full speed ahead for Seaspan targeting a US$ 105 mio preferred offering

Seaspan is continuing its aggressive expansion plans and looks to use the new funds from this offering for further vessel acquisitions. It has been mulling an giant order of 20 units of 14.000 teu vessels at South Korea’s STX Offshore & Shipbuilding yard. The offering is priced like a junk bond with accrued dividends of 9.5% per year.

Seaspan last ordered vessels in 2007. Its fleet currently numbers 55 containerships with 12 newbuildings due for delivery by April 2012. Since the 2008 meltdown, Seaspan held on to its orderbook and made strenuous effort to take delivery all tonnage as ordered. They covered these new units with period employment from Chinese Coscon and CSCL, which now comprises 70% of their total revenue.

Two months ago, Seaspan signalled its intention for up to 22 post-panamaxes of 10,000 teu at China’s Yangzijiang Shipbuilding in a deal worth up to US $2.1 bn. But the company will only firm up orders once it has long-term charters in place.

Seaspan's bottom line only recently turned back into the black. The company said it made US$ 50,55 mio to 31 March on a net basis, from a loss of US$ 36,61 mio in the same three months of 2010.

The company future is intimately tied to insatiable Chinese demand with the strategy of its now almost legendary CEO Jerry Wang.

Box Ships: the ultimate in asset management business models

The Paragon Shipping offspring: Box Ships Inc. is the ultimate in the asset management business model. Michael Bodouroglou's private company Allseas serve as the managers, earning substantial fees and commissions for their services. Apart from vessel technical management, Paragon/ Allseas have no intrinsic value to offer as they have just recently entered the containership sector on a vessel provider basis. They have no special containership industry relationships.

The whole venture depends on speculative improvement in asset values in container vessels and charter rates levels from liner companies. The role that Paragon/ Allseas play in this matter as technical managers is no different than a V.Ships or Bernard Shulte Shipmanagement, except that their pricing for services is a lot higher than a normal third party ship management company.

Their technical management fees are in the order of US$ 310.000 per vessel per annum for investor-owned Box Ship compared to the US$ 150.000 - 160.000 that a third party professional manager would normally charge. They will also earn an address commission of 1,25% on any charter party that they negotiated and 1% on any vessel sale and purchase transaction, which are normal going rates by industry standards.

Paragon's only existing liner company relationship is currently with CMA-CMG. After the IPO and acquisition of the additional units, they will add charters to CSAV Valparaiso for three units and one unit to Maersk. CSAV holds a purchase option in one of the charters. Bodouroglou is purchasing the new tonnage thorough Paragon and his private companies and the two existing Paragon containerships will be dropped down to Box Ships.

Basically, Michael Bodouroglou is the ultimate vessel asset manager for shareholders in this containership venture. His companies earn substantial fees for their services. He gets to decide what vessels to buy, sell and how to charter for them and is nicely compensated for this work with some skin in the game, but most of the risks on the shareholders. It is the dream of anyone in the shipping business!

UBS Investment Bank and Morgan Stanley are the lead underwriters and will be lining up the investors for this IPO. They will have to convince them why to place their money in a Box Ships as opposed to a solid liner company like Maersk, Orient Overseas or Neptune Orient Lines with far more added value in their cargo systems or vessel provider competitor Seaspan with Jerry Wang's China connections.

What will convince the investors that this is good deal beyond the asset speculation? Will they accept this sale pitch without asking for any discounts?

For that matter, investors could go out and buy their own vessels and hire V.Ships to run them with lower transaction costs. It might be cheaper and more effective to hire an ex-liner company CEO to run the operation for them than Bodouroglou.

Maersk gambles on cargo volumes

From suffering US$ 2.09 bn losses for 2009 in its container shipping and back to US$ 4.9 bn profits in 2010 primed initially by slow-steaming, Maersk is now making a record-breaking order for 18,000-teu ships that is raising again the specter of overcapacity on major liner trades. Their sheer size means they can only be fully utilized on the Far East-to-Europe trades. Dependence on a single route has led some to remember the ill-fated ultra large crude carriers (ULCCs) of the 1970s.

Maersk recently signed ten firm orders with Daewoo Shipbuilding & Marine Engineering for delivery in 2013 and 2014 at a cost of US$ 190 mio apiece. Options for another 20 vessels means the deal could end up being worth US$ 5.7 bn.

Maersk is clearly taking a forward position on the freight market after 2013 where The company appears to expect that container volumes will pick up by the time the first of the leviathans is delivered in two years’ time.

2010 marked a significant recovery in the container sector. Freight rates per teu in 2010 rose by about 30 percent from the previous year calculated on a yearly average basis. Freight rates fell in the last quarter, however, after gaining steadily during the first three quarters. The main factors behind the weaker market were a seasonal drop in cargo volumes, higher deliveries and reactivation of idle tonnage.

Freight rates from Asia to Europe experienced the most pronounced upturn in the early part of the year, but also saw the sharpest drop towards the end of the year. On an annual basis, box rates on this trade route rose by 80% compared with 2009. Other trade routes typically saw rates increase by 20% to 30%. Charter rates followed a similar trend with a steady increase over the first three quarters, although they declined only moderately in the final quarter. On a yearly average basis, charter rates rose between 40 - 80% with the strongest gains for ships above 3000 teu.

China’s imports of container cargo grew at a brisker pace than exports. A large portion of the containers imported to China consisted of parts to assembly plants, which to a significant extent were also reexported to other countries. Intra-Asian container traffic increased significantly by around 20%. outpacing the headhaul Chinese export routes to Europe and the US (approx 15-6% increase). Also a notable trend in the global container shipping market in 2010 was a sharp increase in volumes from East Asia to the Middle East, Africa and South America.

Maersk may be looking around for new markets, with chief executive Eiving Kolding alluding to “interesting markets” in the Europe region, namely Russia, Turkey and North Africa, but the development of these kinds of routes does not call for such leviathan vessels.

In 2010, container traffic rose by 2.7 times world GDP growth. Historically, global container traffic has increased by between 2.2 and 2.7 times the world GDP growth. This phenomena, which was the need to rebuild inventories after the economic recession in 2009, is not sustainable.

Based on prevailing forecasts for world GDP in 2011, Platou Markets are forecasting that the global container trade could climb by around 10%. They are expecting biggest gains in container volumes in Intra-Asian trade and on routes from Asia to the Middle East, South America and Africa. Conversely, they expect container imports to Europe and United States to show a more moderate increase this year.

The net fleet expansion is forecast to around 9% on a yearly average basis. Platou Markest are expecting the global container trade in 2011 to rise another 9-10%, representing a balanced picture with likelihood of slacker rates the first half of the year and then a pickup in activity in the 2nd semester.

The container orderbook remains large. Scheduled deliveries in 2011 amounts to a capacity of 1.4 million teu (1.3 mio teu in 2010). Major players like Seaspan have aggressively held on to their pre-2008 fleet expansion orderbook; Maersk is now setting a new trend in increasing the containership orderbook.

 

Seaspan eyes Tiger scheme: structural change in Chinese container market

Seapan's move to raise capital by a US$ 250 mio preferred shares together with a proposed US$ 75-100 mio minority stake in a containership venture with Tiger Group are raising eyebrows. Aside from possible Clayton Act violations stemming from Seaspan CEO Gerry Wang also running the new fund which may invest in competitive container companies, the nature of the fund illustrates Chinese policy to maximize its future container transport needs though Chinese-built vessels and Chinese liner companies.

Seaspan announced recently (January 21), a public offering of 9.5% Series C Cumulative Redeemable Perpetual Preferred Shares. The company had been examining for some time alternatives to raise capital to cover their ambitious CAPEX program. The use of preferred shares appears to be a means of raising capital with minimum dilution to shareholders.

The Tiger investment fund vehicle would invest in container shipping assets, primarily newbuilding vessels strategic to China. Seaspan is placing its future in Chinese liner trades, which now represent more than 70% of their fleet employment.

Seaspan told investors:

“We also anticipate that we would have a right of first refusal for some negotiated duration with respect to any containership asset opportunities that are developed by the vehicle. We believe that any investment by us in the vehicle could enhance our ability to pursue current growth opportunities in the container shipping market by leveraging the vehicle’s access to capital and customer relationships. We also believe that an investment in the vehicle would allow us to continue to increase the scale of our business and realize volume discounts for newbuilding orders that we would not otherwise be able to achieve.”

The role of Gerry Wang, the Seaspan CEO who is going to also run the new fund which may invest in competitive container companies is confusing. Whilst Seaspan is based in Hong Kong, it is a US-listed company subject to the Clayton Act.

The Clayton Act states: "No person shall, at the same time, serve as director or officer in any two corporations that are, by virtue of their business and location of operation, competitors..."

The other aspect of these moves is that Chinese policy seems to be moving more to a Japanese "Keiretsu" model of interlocking business relationships and shareholdings and Seaspan is following along with this trend. We have already began to see a similar direction in the Capesize trades, where a growing share of the iron-ore business is going under long-term contracts including transport and less emphasis on spot markets. Key suppliers like Vale are building their own fleets. Further the Chinese are very keen on supporting their domestic shipbuilding industries, who have increased dramatically their capacity over the last few years to become major players.

Finally, this system depend on perpetually high growth rates in the Chinese export model, where money is constantly being channeled into new capacity. Already there are signs of overheating. Seaspan has a franchise on special relations with China, but should there be a downturn where expectations are disappointed, Seaspan will be affected with such concentration in this market.

For the time being the 'smart money' continues to give strong support to this group. Wells Fargo Securities" Michael Webber upgraded Seaspan to “outperform”, calling the company “best of breed” within the containership sector(among vessel providers to liner companies, as Seaspan has no cargo system of its own and depends on liner companies to employ its vessels):

“Seaspan currently has 11 vessels scheduled for delivery in 2011 and three in 2012, which are fully financed and will increase its capacity by 53% to over 400,000-teu,” he told clients, adding: “We believe Seaspan will have capacity to materially increase its dividend and potentially fund additional growth and pay down debt, as we expect Seaspan to generate roughly US $412 mio and US$ 528 mio in Ebitda in 2011 and 2012, up 43% and 28% [year to year], respectively.”

This mirrors the China growth story with aggressive growth and high returns on growth of multiples. The underlying investment returns on DCF with residual asset value are much lower. Seaspan's asset-heavy vessel provider business model with long-term time charters is by nature a low margin business, where higher returns can only be generated by high capital gearing and rapid growth. What makes this especially appealing is that Chinese business is considered virtually "risk free" counter party risk.

Profit and Growth Opportunities in Container Port Logistics Software

Goldman Sachs Infrastructure Partner's investment in Carrix, Inc signals investor interest in high-quality, core infrastructure software systems. Whilst container shipping has been suffering from overcapacity of vessels, the competitive landscape for container terminal software suppliers is limited to a select number of vendors - TideWorks, Navis, Maher, Advent Inc, Cosmos - in a growing market in the global port operations industry. Goldman saw a substantial growth opportunity in Carrix.

Container liner companies like Maersk have evolved into a highly integrated logistics services with worldwide presence. The container logistics business is moving to a manufacturing business model with forecasting and advanced planning. Often they own their own terminals and are actively investing in new terminals in key locations. The trend is to merge air freight, trucks and container services. The European Union will shortly change customs regulations such that cargo must be declared on departure to the arrival port customs authorities. This will add new demands on container port  terminal operating systems (TOS's). These systems pay for themselves quickly.

Container registration is a core task. It is simply not possible for terminal to keep track of their container cargo without appropriate software systems. Today container logistic systems are fully on line so that containers can be tracked from door to door. Once a container terminal chooses a software system, it is difficult to change and move to another software vendor. Service and backup are essential. Software suppliers compete by leveraging proprietary algorithms. As time goes on, the technology advances in computing power.

The right container terminal operating system (TOS) ensures the long-term success of a terminal by being efficient, adaptable, cost-effective and scalable. Terminal operators need an automation system that enhances container terminal operational efficiency and supports future growth while reducing operational overhead and maintaining customer-focused services. For independent terminal operators, it is essential to have reliable, accepted TOS systems to maintain competitive advantage over alternative port terminals with liner company customers.

The leader in container port software is Navis, which is owned by Zebra Enterprise Solutions, which services over 400 ports worldwide. Cosmos was started by an Antwerp services company. Carrix is the parent company of SSA Marine and Tideworks Technology. SSA Marine is the largest U.S. owned, and privately held, marine terminal operator in the world, with over 120 marine and rail operations worldwide, including 11 container terminals in LA/Long Beach, Oakland, Seattle, Panama, Mexico and Chile. Tideworks has focused more traditionally on truck warehousing and is less interesting to terminal operators than competitors like Navis.

Both Piraeus Port Authority and APM Terminals in Rotterdam use Navis software systems. Latest Navis SPARCS N4 software has integrated two previously separate systems. It is a terminal operating system that is very maintainable and adaptable over the entire life-cycle of the product while allowing customers the flexibility and scalability they need to run their operations - from a single terminal to multiple terminals across multiple geographic locations, all within a single instance. It is priced at the lowest possible total cost of ownership (TCO).  As market leader, Navis systems are sold at a premium to competitor software vendors.

The large terminal companies make annual reviews of their software systems and future needs. APM Terminals, which is one of the largest container port terminal operators in the world, has prepared a comparative report on software vendors for external use with a look into the future with a five-year horizon.

Gremlins returning to haunt container market

This year market a remarkable turnaround in container shipping. In 2009, major container operators took massive losses, 10% of the global tanker fleet was laid up. Projections were for two more years of losses before recovery. Ultra slow steaming soaked up surplus tonnage capacity together with robust economic recovery in Asia. Resumption of exports to EU and US head haul trades have led to a resurgence of profits. Basic over supply of tonnage remains. Head haul routes are weakening again.

Maersk is cutting its Asia-Europe capacity by 10% for the winter period in line with changing market demand. Volumes are expected to remain weak throughout the coming four months, as the seasonally weak winter period approaches.

Conversely, Singapore's NOL Group has posted net profit of US$ 282 mio for the third quarter, turning around a US $138 mio loss last year. Revenue to 30 September grew 55% to US$ 2.4 bn. Its cumulative nine-month profit is now US$ 283 mio. It lost US$ 530 mio during the same period last year. Revenue for liner shipping improved 60% to $2.2 bn in the third quarter. Containership unit APL’s core pre-tax and interest earnings were $301 mio, compared to a loss of $130 mio in 2009. Average revenue per feu was $2,799, up 21%, while volumes grew 29% to 2 mio feu.

Container port operators in mature economies face strong cost competition from emerging markets due to excess capacity and slowing growth rates as this year's sharp rebound in container shipping cools off. Port congestion was returning in the fast growing emerging markets, but sluggish growth in the mature markets meant continued excess capacity in many ports, including New York/New Jersey and Antwerp. Customers seeking the over-capacity are starting again to squeeze the liner operators and there is increasing cost competition.

This has not discouraged more asset-oriented shipping players to move into the containership sector. A number of Greek operators like Paragon and Diana have bought container vessels at current price levels and put them on charter, looking to build up a presence in the sector. More established operators like Seaspan have continued their aggressive CAPEX plans, absorbing all newbuildings due this year, putting them on charter with increasing reliance on major Chinese liner operators.

There remains a lot of optimism in financial circles that pre-2008 growth levels will return rather than a prolonged 'new normal' scenario or at least this appears to be their story to investors in these companies to back their large deals and aggressive asset expansion financied by bank debt and plans for follow-on share offerings. They argue continued robust Asian growth regardless of Western economies. Also, attractive is the long-term employment by liner companies with strong balance sheets or sovereign risk that are considered too big to fail and unlikely to renegotiate rates downwards in poor market conditions. Tanker and drybulk sectors charters are generally for shorter period of time and more prone to renegotiation.

Seaspan's share price has outperformed this year from US$ 8 levels to the present US$ 13.20 despite the weakening conditions in the underlying container freight markets. Seaspan remains highly leveraged but it has long-term employment not subject to these market fluctuations. Still its share price remains very far from the lofty US$ 30 pre-2008 levels, but this is the same pattern for nearly all shipping stocks since the meltdown.

The basic problem is that there is still a large order book overhang of tonnage and even some new ordering. The slow steaming has been masking the existing over capacity and some are even calling for these measures to become permanent. The sector would be exposed to the effects of trade rebalancing when and if this every takes place.

Seaspan's China gambit

Seaspan is a non-operating containership owner with a very ambitious fleet expansion plan. They have been struggling since the 2008 GFC to finance their aggressive CAPEX program. Their business plan is highly dependent on continued Chinese export growth. The two top customers are Coscon and CSCL  (70% total revenue) both Chinese state owned enterprises.  90% of their contracted revenue is from China and Japan. The company is highly leveraged and has recently filed a shelf registration for a new share issue.

Seaspan is a vessel provider business model. It owns and operates container vessels with long term charters to major liner companies. It has no container logistical system of its own as do the major liner companies like Maersk, CSCL, MSC, CMA-CGM, Neptune Orient and Orient Overseas. It is largely an asset play backed by long term charter parties with substantial rate discounts and subject to earnings margin pressures over time from inflation, currency fluctuations and increased repair costs as the fleet ages.

It has a very impressive Board of Directors, including Graham Porter (Chairman of the Tiger Group), John Hsu (partner of Ajia Partners, one of Asia's largest privately-owned alternative investment firms), Peter Lorange (former President of IMD) and Peter Shaerf (managing director at AMA Capital Partners). Seaspan's CEO Gerry Wang appears to have very good personal contacts with the Chinese SOE's in shipping. He is always been extremely bullish on Chinese growth prospects.

The container sector was one of the most sharply hit by the sudden and deep economic slowdown in 2008 GFC. The major liner companies suffered heavy losses in 2009, with aggregate industry losses running into tens of billions of dollars. As an effect of industry wide losses, the liner companies heavily cut capacity, idling their own capacity and returned the chartered tonnage to non-operating owners. Normally, most liner companies own approximately 50% of their tonnage and charter in the remainder to cover their cargo volume projections.

These major operators made substantial adjustments in terms of order cancellations and deferrals of newbuilding deliveries well into 2011-2013. There was probably more speculative vessel ordering in the container sector than any other sector of the shipping market. A very large part of the orderbook are the large post Panamax size vessels for long haul routes.

The great attraction for non operating owners' investment has been the term charter cover from the liner companies. The current order book stands at 30% of the current fleet, down from about 55% at its peak in mid 2008. It is important to understand the current order book mix in terms of the owners.  The German KG market and asset providers in non-operating owners like Danaos Shipping and Seaspan constitute greater than 50% of the current order book, remaining is covered by the liner operators like Maersk, APL, and CMA CGM etc, who actually control the underlying commercial business with end-users in the sector.

Seaspan fared well in 2009 closing the year with record profits of US$ 145 mio as opposed to the losses of the two prior years: 2008 (US$ 199) mio and 2007 (US$ 10) mio. They reported no charterer default or renegotiation problems. This year for the 1 H, Seaspan is again in loss position, but due to sizeable changes in fair value of financial instruments resulting in a loss of $223.2 million for the six months ended June 30, 2010 compared to a gain of $92.5 million in 2009. The change in fair value loss for was due to decreases in the forward LIBOR curve and overall market changes in credit risk.

As of their annual report filed last March, Seaspan had contractual CAPEX obligations on an additional 26 containerships over the next 30 months over an in addition to the existing fleet of 42 vessel in operation. Whilst there have been rumors of possible new order cancellations, Seaspan so far has maintained its orderbook.  It appears that they are highly dependent on COSCO in chartering this new tonnage. The employment contracts with their two Chinese SOE charterers are subject Chinese law and dependent ultimately on the Chinese legal system for enforcement. Indeed, this year, they turned aggressive and also added one additional new acquisition chartered to United Arab Shipping Company for two years and Gerry Wang has made statements about opportunities to pick up units in the troubled German KG markets.

Considering the industry environment with the major liner companies cancelling orders and lately reletting larger post-Panamax tonnage, this represents a remarkable contrarian business strategy with backing from a BoD of major industry figures, who apparently believe strongly in a robust world economic recovery with shipping markets bouncing back to former levels in the near future, ostensibly driven by renewed Chinese export growth and internal infrastructure development as a return the pre-2008 GCF situation.

Financing this program has not been easy. The total purchase price of the 21 vessels was estimated to be approximately US$ 2.6 billion. The remaining five units were covered by leasing arrangements with Peony Leasing Limited, or Peony, an affiliate of Bank of Scotland plc and Lloyds Banking Group. As these units were contracted during the market boom, Seaspan faces a valuation problem with the decline in prices for new orders today. They have "gearing” covenants in their senior debt that prohibit them from incurring total borrowings in an amount greater than 65% of our total assets. Further they were blocked from drawing the remaining approximately US$ 267 million available under their US$ 1.3 billion Credit Agreement on which they were relying heavily to support their CAPEX program.

In May 2010, Seaspan issued 260,000 Series B Preferred Shares for US$ 26 million to Jaccar Holdings Limited, an investor related to Zhejiang Shipbuilding Co., Ltd. of China ("Zhejiang"). These preferred shares are perpetual and not convertible into common shares. They carry an annual dividend rate of 5% until June 30, 2012, 8% from July 1, 2012 to June 30, 2013 and 10% from July 1, 2013 thereafter and are redeemable by the Company at any time for US $26 million plus accrued and unpaid dividends. This appears to be a shipyard-extended credit facility for their reported two orders in this yard.

Compare this to established liner-owner operators like Neptune Orient Lines (NOL) and Orient Overseas (OOIL), integrated logistics players with proven container shipping capabilities available at attractive valuations. For example, OOIL's three principal business activities are segmented under International container transport and logistics services (OOCL, OOCL Logistics, and China Domestic), Ports and Terminals (Kaohsiung and Long Beach) and Property Investments (Wall Street Plaza in New York and Beijing Oriental Plaza in Beijing). OOIL’s container shipping operations is amongst the most cost effective in the container shipping industry with the Company consistently outperforming its peers with the highest profit margin among major container line operators.

OOIL has always had one of the most conservative and strongest balance sheets in the container shipping industry and has consistently kept the net gearing to the lowest. The company has no major issues in meeting its capital commitments and capital expenditure. At the end of FY 2009, OOIL had vessel capital commitments of US$ 712 mio and US$ 1.27 billion in free cash. It's capital gearing is 58%.

Seaspan's second quarter earnings conference presented a very rosy picture of a company with a low debt ratio, impressive built-in future growth revenue of US$ 7 billion and fantastic compound annual growth rate (CAGR) of 40%. Suffice this to be based entirely on their assumptions of a V-shaped world economic recovery and deeming their situation a few years ahead. . Their present leverage is very high and they would be not going through the trouble and expense of a shelf registration if they were not concerned about the need to raise equity to maintain their covenant obligations and cover their CAPEX needs. Indeed, one can presume it likely that this is an exercise to woo potential interest for a possible IPO offering.

The issue is whether peer companies like NOL and OOIL offer more value to investors because of their integrated logistics business models, their diversity of revenues sources, and their stronger balance sheets. All this is in the context of an uncertain environment in terms of economic recovery and rebalancing of trade flows. All these companies are dependent on continued emerging market growth in the Far East.

Is the container sector really out of the woods yet?

Investors have been euphoric over the rate increases in transpacific annual contracts. The container sector attracts keen investor interest due the long term employment with large liner companies like Maersk (OMX: MAERSKB) considered too big to fail. As a result, the sector has been plagued by huge order book overcapacity. The demand driver is the proverbial Chinese export machine. Yet container earnings may be peaking, given slowing US consumption, high retail inventory and Europe’s financial woes.

The global financial crisis hit Maersk and other liner operators very hard. They had aggressively ordered new tonnage as well as chartered in vessels from non-operating owners like Seaspan and Danaos , who had order books as large as their existing fleets. 

Maersk sank to a loss of US $1.02 bn in the historically low rate environment of 2009, overturning a profit of US $3.46 bn a year earlier. The liner operation fell to a $2.09 bn loss for the full-year as income from its containerships collapsed by nearly 30%. Aside from the container losses, Maersk also made a dreadful timing mistake in acquiring the Broström tanker fleet at top of the market prices shortly before the 2008 meltdown.

In this difficult environment, the liner companies fought back earlier this year by slow-steaming to try artificially to reinflate demand and reduce their losses from the dramatic drop in cargo volume. Industry consultants AXS Alphaliner estimate 78% and 53% the Asia-Europe and Transpacific routes strings are still running in slow steaming mode currently. Maersk also became a leader in cost cutting.

During 2010, the container shipping market was been positively affected by growing demand, primarily due to inventory restocking in the US and Europe and, to a lesser extent, growing consumer demand. Growth was seen mainly on the head haul routes and Intra Asia, which increased by 18% and 70%, respectively. Average rates in the first quarter were $2,863 per FFE, up by 18% compared to the same period of 2009 as a result of improved market conditions and higher bunker surcharges.

Maersk banked US $639 mio in the first quarter, overturning last year’s US $ 372 mio loss and smashing the US$ 225 mio consensus among analysts.

Citigroup analyst Ally Ma feels that the return to profitability for many lines may mark the beginning of renewed capacity woes as they begin taking delivery of deferred new building orders placed prior to the global financial crisis, against a backdrop of weakening demand. She reckons that the 3rd quarter rate hikes may indicate that container earnings are peaking, given slowing US consumption, high retail inventory and Europe’s financial woes.

Most new building deliveries to date are directly being employed in strings running on slow steaming effectively dampening the supply growth. The German KG market has for the past decade been a major asset provider to the container operators, owning the vessels and chartering out to the liner companies. KG participants are still facing insolvency issues and despite the recent market surge in charter rates, payments are insufficient to cover the payment of interest and principal in 2010 and 2011.

Non-Operating owners to continue facing financing issues as bank credit remains tight. Danaos Shipping (DAC) announced cancellation of three new buildings of 6,500 TEU which were ordered at Hanjin Heavy Industries and initially expected to be delivered in the first half of 2012. Seaspan (SSW) in a filing to the stock exchange stated funding shortfall for its remaining capex commitments and hinted at further cancellations on the cards.

The future of the container industry hinges on the quality of the economic recovery ahead. The US recovery seems to be slowing down and the EU is facing a serious sovereign debt crisis where austerity measures in Southern European countries are likely to dampen severely demand.

The temptation to buy speculatively container tonnage today has led to a rise in asset prices as each new deal brings new highs. Indicatively, Metrostar is said to have shelled out some US $180 mio to buy five 10-year-old 3,500-teu ships from German owner Claus-Peter Offen. This is double what the vessels might have fetched at the start of the year.

This is driven by the expectation that container rates will soon regain historic norms and present rates are closer to 50% of this level leaving room for improvement. Yet this counter-cyclical investment could prove self defeating in dealing with the overcapacity should the recover stall and we face a longer period of sluggish growth as opposed to the forecasts of politicians and pundits.