Private equity companies have shown increased interest in the shipping industry, and investor Wilbur Ross, who has invested in both tanker and liquefied petroleum gas (LPG) carriers, predicts their investment in shipping could double by 2014 unless the public equity markets “open up.”
He said he plans further investments by his firm.
The entry of private equity companies may even change the management style prevalent in some sectors of shipping, he said, making “swashbuckling, larger-than-life characters typical of the industry” less common going forward.
The depression in charter rates has created a need for new equity capital in shipping, Ross said, giving the keynote address to Marine Money
magazine's 26th annual conference in New York via a video feed from Europe.
Speaking to a crowd of more than 1,000 people, Ross said only a limited number of shipping companies today can access the public markets on favorable terms, and they have either unique sponsorship or particularly attractive business models.
Meanwhile, he said a number of private equity firms, including Apollo, Blackstone, Carlyle, First Reserve, Fortress, New Mountain, Oaktree, and Perella Weinberg, have invested in shipping. Looking at the list of attendees in the audience, Ross said he believes other private equity firms are considering investments in the sector.
Ross said the interest comes despite the fact that shipping is an atypical industry for private equity, he said. A private equity company, he explained, typically “buys healthy companies, leverages them up, and tries to make them better."
They usually avoid, he said, cyclical companies or commodity price-based companies because they deem the volatility and downside risk unattractive.
However, Ross said private equity companies have scads of money to invest—more than $300 billion of unused equity capital, he estimated. And he said some of that money was raised as far back as 2007.
“There is a need to put that resource to work,” he said.
With stock and bond markets at all time highs, he said it's difficult for investors to find bargains, so private equity funds are searching through less traditional sectors that are both large and have fundamental long-term growth prospects but are temporarily distressed.
He said shipping fits the bill, as he estimates there are ships worth $360 billion at sea, even at today’s depressed values, and $100 billion in new ships on order.
At the same time, he said shipping is a growth industry because the world trade carried by ships is growing faster than world trade, which is growing faster than world GDP and faster than the GDP of developed countries.
“So you have a compounding of growth factors,” he said.
While the industry faces challenges because of over-ordering of ships, Ross said in most industry segments ordering is slowing and scraping is increasing. “Therefore, private equity has come to the conclusion that this problem will ultimately will be behind us, whether that occurs as soon as 2014 or as late as 2015," he said.
He said another aspect of shipping that appeals to private equity investors is this: owners can make “a respectable, but not extraordinary current cash return on equity from operations over the entire course of a shipping cycle, but shipowners really make their money by buying vessels low and selling them high.”
That concept is familiar to private equity firms, he said, as most plan to exit their investments in three to five years.
“Does anyone think that the shipping industry will not recover with that long a period? I don’t think so,” he said.
Ross estimated there has been about $3 billion in private equity invested in shipping, supplemented with $4 billion of debt. That $7 billion represents less than 2 percent of the aggregate enterprise value of the entire marine transportation industry and the $3 billion equity investment represents less than 1 percent of that $300 billion private equity companies have to invest.
He predicted that unless the public equity markets open up quickly, there will be at least twice as much private equity commitment to the shipping industry by the end of 2014.
He also speculated that China could be a “wild card” source of private equity, noting that its institutions have more and more freedom to invest outside the country in private equity and that “it might be logical for them to buy into Western shipping companies in a big way.”
Ross said banks with distressed shipping assets may benefit from the entry of private equity into the sector by having willing buyers who want to rejuvenate ailing firms. He also said distressed borrowers may find it very different to deal with a buyer who has purchased a firm at a discount to create equity rather than a bank seeking to minimize a write down of the original loan.
How might private equity change shipping?
Ross noted private equity companies like to do roll-ups of similar companies in fragmented industries. In most shipping segments, single companies don’t have as much as five percent of any class of ships.
“There is no inherent reason why such a capital intensive, global industry should be so fragmented,” Ross said. “It would be far more logical for the industry to be highly concentrated.”
He said this would allow companies that operate tramp ships to reduce the amount of ballasting they do and improve utilization.
A marine transportation company with a meaningful share of the type of ships a charterer needs would “likely get the first call from potential charterers and if so it would be in the best position to triangulate, rather than have the vessel sit idle at dockside or slow steaming to a far away port to pick up the next cargo,” he said.
Ross has seen the dramatic difference better utilization can make at Navigator Holdings, in which his firm has a majority stake. That firm has 30 percent share of the handymax liquid petroleum gas (LPG) market, and the next largest competitor has less than 10 percent and others are even smaller.
He also said private equity companies will probably want to put commercial, operational, and technical management of their companies all under the same entity as the vessels themselves and not outsource work. He said that could potentially save money and eliminate conflict of interest as, he said, many publicly-owned shipping companies “are managed contractually by private entities whose owners have competing interests and sometimes buy vessels from or sell vessels to the public companies they manage.”
Private equity funds, “focus intently on commonality of interest between themselves and operation management and would not be inclined to invest in these types of structures,” he added.
He also said private equity companies may seek a balance between spot and long-term charters, where he said individual shipowners have tended to focus on one or the other. Few, he said, mix the two.
He said such a balanced approach has worked well for the tanker company Diamond S
, which his firm has invested in.
“If, indeed, landlubbers in pinstriped suits do become major factors in marine transport, there may also be some changes in the management style of the industry. Private equity investors tend to be button-down, methodical, numerically executives who use deliberative and analytical process and tend to use outside consultants and this approach is almost the antithesis of the intuitive entrepreneur, who may bet his whole business on a judgment call.”
He also predicted more financial engineering in the industry.
“Whether the more disciplined, quantitative approach will result in better decisions and less violent boom and bust cycles remains to be seen,” he said.
Shipping segments may seek to offer door-to-door transport—for example in the liquefied natural gas business, a company might offer liquefaction, re-gasification, pipelines, storage or railcars.
That might make a capital intensive business even more so, reducing ease of entry to other companies. - Chris Dupin