Exit Wound

Exit Wound

PE looks likely to lose big in shipping, but we didn’t prove it wrong. It exposed the mess we’re in.

Exit_Wound_featAmongst the rash of Christmas lists of the best and worst and ‘top 10’s’ of 2014 doing the rounds in December was the 5th annual Lloyd’s List ‘100 Most Influential People in Shipping’ report. When drawing conclusions about our diverse industry there is a constant risk of generalisation, but although some sectors have undoubtedly fared better than others, I think it’s safe to say that shipping hasn’t had a stellar 2014. The florid editorial introduction to the Lloyd’s List 100 therefore makes for a rather confusing read.

Far from continuing to over-order and gamble other people’s money on increasingly unreliable gut-feelings, apparently those loveable, buccaneering rogues at the top of shipping have outwitted the bad guy, got the girl, grabbed the best lines, the last laugh and are now charging on to fight another day. Roll credits.

“Another message from the shipping world that’s hard to ignore: if you’re feeling over-extended, just extend some more,” says Lloyd’s List.”You’ll always find the money. With private equity backing, main-street investors and banks can always be encouraged to pony up.”

The fact that credit has continued to roll in shipping at all has been in no small part thanks to the dramatic, last-minute entrance of PE. And yet despite having filled the funding gap left by the exit—stage left, at a run—of all those shipping banks and literally saving the day for many ship owners and operators, it remains shipping’s bad guy.

There is an audible booing and hissing from most of the industry at the mention of PE, and yet plenty were prepared to climb between the balance sheets with them. According to Tufton Oceanic, this time last year PE financed 22 per cent or US$278 billion of the global vessel order book. But things are changing. With Marine Money reporting only 15 PE transactions in 2014 compared with 30 the previous year, it’s pretty clear that the PE boom has peaked. And the reasons why are important.

“Many private equity firms were waiting for the freight markets to really come back, the values to go up and then be able to exit their investments at a profit,” says Svein Engh of CIT Maritime Finance. “This hasn’t happened and has led to many private equity firms opting out of investing in new projects. In addition, we have seen a lot of hedge funds acquire shipping loans in the secondary market with the same expectations…If they are not willing to hold these positions and they want out now, they could be looking at potential losses.”

PE is getting nervy, and with good reason. The expectation is that a significant number will find it difficult to get out with the profits they anticipated and so are switching focus from longer-term earning potential to a short-term asset game where the prime consideration is to find a buyer willing to take over increasingly risky positions. There are already reports of heightened activity in PE firms selling to each other.

But while some PE certainly swoops on distressed debt and weak asset values to make a quick buck, it also prides itself on taking failing businesses in difficult markets and accelerating growth and profitability. The PE firms we’ve consulted for looking to get into the shipping industry aren’t flat-eyed money men, and neither are they overconfident traders. Generally speaking they don’t rely on assurances and past performance either—they rely on data and models. But in shipping they’ve really come unstuck, because the type of data and rigour they usually demand simply hasn’t been available.

With warnings that the shipping industry was too complex for them to understand ringing in their ears many PE firms have relied upon the wisdom of the experienced management with whom they have committed to JVs or invested into. The result is that the shipping market—fragmented and highly cyclical, plagued by overcapacity and over-optimism—has failed to recover in the way ship owners and operators privately assured investors it had to. So let’s be clear here: PE didn’t get it wrong, everyone got it wrong.

PE may be slightly bloodied but the real victim is shipping, and it’s a totally self-inflicted wound.

The fact that PE firms who entered the sector looking for 15 to 20 per cent return and a 3-5 year exit are going to find it tough to realise either, is very bad news. And yet we are being treated to the unedifying spectacle of a shipping industry rubbing its hands in glee.

“Many of those [private equity] guys who thought it was going to be so easy to understand this industry didn’t,” Randee Day, of Day & Partners recently told the South China Morning Post. Basil Karatzas, of Karatzas Marine Advisors is even plainer, “There is subdued optimism that there will be better days to get PE funds still interested in shipping, disappointment that the best days of PE investing in shipping are behind us, and outright happiness that PE funds got their investments wrong, and that they will be the next wave of players in shipping who will be realizing big losses (after the shipowners buying ships in 2007 and banks lending 120% of peak phase of cycle).”

That any industry in the 21st century can find reasons to be cheerful that a slew of investors are about to make significant losses is breathtaking. Talk about biting the hand that feeds you. Now go back and read that quote from Lloyd’s List, and consider who’ll be ‘ponying up’ when PE has decided it’s been backing the wrong horse. But Lloyd’s List goes further. “Shipping is one of the last arenas in global business in which an individual can launch a Grand Plan and find the funding avenues to keep on going,” it crows.

Well that may not be the case much longer. In the last twelve months the industry saw seven IPOs and five OTC listings mostly in the US and Europe, and none of them have been greatly successful. We reported last issue on the woes of Scorpio Bulkers whose share price was trading this time last year at US$10.44 and on 5th Jan this year stands at US$1.86. Investors aren’t impressed and that lack of enthusiasm has consequences. Already several listings have been postponed including Wilbur Ross-backed Diamond S Shipping Group, and the implications for PE, whose favoured exit option is often via the capital markets, are major.

But the colour of the sky in shipping’s world is rather different. Here’s the Lloyd’s List verdict on Scorpio’s year. “Scorpio’s Emanuele Lauro has moved on to dry bulk and most recently into the largest of the ultra large containerships. It’s a bid that would have made Onassis proud.”

One doubts the Scorpio share price nosedive would have made Aristotle Onassis anything other than apoplectic, had he been an investor. Of course Onassis died forty years ago this year, but Lloyd’s List and the industry it serves still seem to be stuck in that 1970’s mindset. It’s beginning to sound like the last days of Rome. “Geopolitical events create risk and opportunity and the canniest shipowners always survive, somehow. It is these survivors, from China to Greece to Wall Street, that colour the industry’s identity. Long may they prosper.”

If this is prospering then it really is time for a wake-up call. Making debt repayment deadlines by the skin of your teeth, over-ordering and then destroying the prospect of anyone getting a successful IPO away until second quarter 2015-16 at the earliest, attracts no censure. It guarantees induction into the shipping hall of fame. As my teenage daughter would say, ‘WTF?’

According to shipbroker Gibsons, Wilbur Ross estimated that PE pumped $16 billion into shipping between 2008 and 2013, which is two and a half times the amount generated through IPOs. And the combined portfolios of these outfits is truly impressive. Golden Tree Asset Management (which has a 4.81% stake in Euronav) is managing $21 billion while Oaktree Capital Management has close to $80 billion under its control, so Gibson’s report.

So while PE’s exit from shipping is likely to be painful, it’ll be no more than a flesh wound, and what it has learnt will be of significant value. That’s why shipping’s smugness is deeply misplaced. Because what PE has learnt is that shipping isn’t somewhere they can do business. And that isn’t PE’s problem. It’s ours. We didn’t prove PE wrong, PE exposed just what a mess our industry is in.

What it also exposed is that there are structural changes driven by new technologies which are already impacting trade flows and business priorities and realities. Shipping has utterly failed to anticipate them, and continues to do so. PE may be slightly bloodied but the real victim is shipping, and it’s a totally self-inflicted wound.

Telling PE we told you so isn’t just shooting ourselves in the foot. It could turn out to be suicide.

Image credit © Getty Images

This article appeared in the January 2015 issue of Futurenautics


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