The Role of Private Equity Funds in the Troubled Shipping Industry

Ioannis Yiasemis

When considering troubled industries in the current economic environment, one of the most obvious examples is the shipping industry. An indication of the problems faced by shipping companies is the dramatic fall over the past two years in the freight rate (the price at which a certain cargo is delivered from one point to another). As of March 2016, it costs around $400 to move a forty-foot container from Shenzhen to Rotterdam, which will barely cover the cost of fuel, handling and Suez Canal fees.

The decrease in the freight rate is not an unexpected consequence, when considering current economic trends. Two main developments have contributed to this decrease. Firstly, concerns about slowing economic growth in China and a fall in commodity prices have led to weak trade growth, and consequently to weak demand for shipping services, which carry approximately 90% of trade. Secondly, an oversupply of shipping vessels in the market, the result of China’s fast-growing exports in the last decade, has led to a lower equilibrium price.

“The (shipping) industry is currently in the grip of the worst recession in living memory and while most of our respondents envisage an upturn in freight volumes in the next five years, any major economic shock would further exacerbate an already fragile industry,” Norton Rose Fulbright’s global head of transport Harry Theochari said.

The consequences of the recession in the industry have been numerous. On 31 August 2016 Hanjin Shipping Co filed for bankruptcy protection in the Seoul Central District Court. Hanjin was South Korea’s biggest container carrier and the seventh largest in the world. Moreover, the transportation ministry of Taiwan has offered Taiwan’s two main shipping conglomerates a $1.9bn relief package in an attempt to bail out its container shipping industry.

Shipping companies, as a response to the recession, have sought to follow the lead of the airline industry and have proposed entering into various alliances with each other. An example is the alliance between Maersk Line and Mediterranean Shipping Company, through which they will seek to resolve over-capacity by sharing space on each other’s ships. Moreover, last month, Japan’s big three shipping conglomerates agreed to consolidate their container arms and end a punishing price war.

This uncertainty in the shipping industry has made banks unwilling to lend to ship owners as they no longer have the appetite for such high-risk investments. Traditional shipping banks are still willing to lend, but unless you are a top-tier ship owner, you must look for other sources of funding as well.

This reduction in the traditional source of finance, however, has opened the door for waves of private equity money flowing into the industry. Private equity funds are collective investment schemes used for making investments in various equity (and to a lesser extent debt) securities, according to specific investment strategies. There are several ways in which private equity funds can make investments within the shipping sector, including entering into joint ventures with ship owners, taking direct ownership stakes in vessels, acting as mezzanine lenders, or purchasing existing debt from banks.

Fund managers already in the sector include J.P. Morgan Asset Management (JPM), Oaktree Capital Management (OAK) LP (OAK), Carlyle Group, Blackstone Group LP, Apollo Global Management LLC and WL Ross & Co. LLC.

As private equity funds increasingly become a major source of finance for shipping companies, ship owners are able to extract benefits from this type of finance. The obvious benefit is a ready and available source of funding when banks are not willing to lend anymore. Industry insiders estimate roughly $100 billion has been invested globally in the sector since 2008. However, there are other benefits as well, including the access to financial markets, gained through the funds’ broad investor base and more flexible lending solutions, since private equity funds are less regulated than traditional banks.

Alongside those benefits, however, there are some downsides as well. Unlike traditional shipping banks, private equity funds do not have any pre-existing relationship with the ship owners seeking funding. This is because private equity funds are schemes seeking high investment returns over a fixed term. The difficulty this strategy might entail in the shipping industry is that the private equity funds do not share the same long-term interest and goals that the ship owners have. The funds’ views on financing strategies are generally more short-termed – buy in quickly when the market is on the down cycle and exit as soon as the light starts to shine. They are not like the traditional shipping banks that are expected to ride the down cycles together with the ship owners, in a highly cyclical shipping industry.

Another issue related to the entering of private equity funds in the shipping industry is the oversupply of shipping vessels, already mentioned above, which contributes to a lower freight price. This is because the readily available private equity cash has made it easier for smaller third-tier companies to enter the market.

A further difficulty is that private equity funds normally expect to be given an extensive role in managing their investment, both when they become owners of the shipping company, but also informally when they are still lenders. This requirement, however, is usually not welcomed by ship owners who are almost always unwilling to give away the control of their business. This difficulty relates to the issue already discussed, about the difference in strategy followed by private equity funds and ship owners. This is because ship owners, when in control, take decisions with the long-term interest of their business in mind. The private equity funds, on the other hand, that are only going to be in control for a short term, normally follow a different approach in their decision making. As a result, ship owners may have to live with the consequences of decisions made by the private equity fund long after the investors have exited.

Since the US presidential election there has been some optimism in the shipping industry, as the promise for an increased spending on US infrastructure may result in increased shipments of raw materials. However, with the president-elect Donald Trump taking a protectionist approach for the US, the future of trade agreements, like TPP and TTIP, and global trade as a whole, is uncertain.

One thing is important to have in mind however: if the recession in the shipping industry persists in the years to come, private equity could be a useful, if not vital, source of financing for ship owners, especially where there is little choice as to the availability of other sources of financing in the industry.



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