Could private equity accidentally sink the shipping market?

Over the past 2 years, PE companies have poured US$32 billion into the shipping sector.

The shipping market has traditionally been privately owned, with ownership passed down through the generations of families that have passion for the industry in their DNA. This time-honoured structure was badly shaken by the credit crunch when ship supply fell out of kilter with demand. As a result, owners were forced to refinance to continue as they were, or face the alternatives of scaling back or leaving the sector.

It has been a long, slow recovery for the industry since 2008, but freight rates are finally rising again. The health of industry can be measured in the Baltic Dry index, which peaked at 11,793 in May 2008 and then bottomed out at 647 in March 2013. Shipping is set to grow and the private equity (PE) sector has eyed up the beleaguered industry.

Over the past two years, PE companies such as Oaktree Capital, Apollo Global Management and Blackstone Group have poured US$32 billion into the shipping sector, estimated maritime fund management company Tufton Oceanic, reported CMBC this month.

New arrivals

While the industry was struggling and the bank crisis meant sources of finance were limited, the arrival of PE’s billions brought new life to the shipping industry. The ebullient PE sector arrived with a programme – albeit short term – to turn a profit. The result is a new perspective on an old industry. PE’s influence has necessitated new approaches, such as accelerated growth strategies, and demands on management teams to deliver.

Buoyed with confidence, the ship-owning companies have gone on a buying spree of new vessels. Last year, Clarkson Plc, the world’s largest shipbroker, reported contracts almost tripled in comparison to 2012 to reach 150 million deadweight tons (dwt).

Oaktree Capital Management, for example, has invested in Star Bulk Carriers Corp. Since then, Star Bulk has bolstered its existing fleet of 17 with the order of 11 further dry bulk ships.

Future implications

In theory, the cold focus of PE should increase efficiency – and profits – for its new owners. The conventional model of PE investment is for returns of 15 percent per annum over three to five years before leaving via asset sales or initial public offering (IPO).

The reality is once the new capacity comes on stream, it will bring down rates again and potentially stifle the recovery of the sector. Shipping is expected to feel the first signs of overcapacity in 2016 by which time the impact of 299 million dwt will be added to the current global fleet of 1.7 billion dwt, reported Clarkson.

Meanwhile, PE investors have to reappraise their plans. This year, Wilbur Ross’ Diamond S Shipping Group and Greece’s Stalwart Tankers have halted their planned IPOs. PEs in general are looking to hold their shipping investments for longer than they had intended.

The result is the old days of inherited ownership and passion are sailing into the sunset. The long-term approach required by the shipping sector appears to have crashed into the short-termism of the PE model.

The challenge is for the new investors to move out, when there are few potential buyers and public markets have little appetite for the sector.