WWIID?

The dry bulk market has been in the doldrums for so long now that talks for a market recovery resemble the biblical story of Lazarus’ resurrection. Probably the news are not deadly bad but again shipping is known to be a very moody industry. On the other end of the spectrum, tankers and containerships are performing fairly well, and definitely they are working miracles as far as the dry bulk market is concerned. No wonder that that there is plenty of confusion and head scratching of what is happening in shipping, and most importantly, how shipping will develop from here.

In a way, we are in unchartered seas; in unchartered seas given shipping banks are leaving the industry en masse, in unchartered territory given that the primary driver of the industry (China) is changing course, in unchartered territory given the excess shipbuilding capacity available, in unchartered territory given the low interest rates and boatloads of money looking for industries to be rolled over.

Whatever the course of the shipping industry in the immediate and intermediate term, one factor will keep having a meaningful impact on the industry, and that factor has been fairly unpredictable: the institutional investors and their interests in shipping. In the last five years, institutional investors have committed to the shipping industry more than $30 billion, whether as private equity or through the public markets, whether in equity or debt. Given the state of the market and information publicly available, it’s safe to say that almost all of the investments in shipping by institutional investors are presently underwater, at least – and thankfully – metaphorically so far. Of course, this is based on the presumption of marked-to-market valuation and immediate liquidation, which may not be the case for those with staying timing and financial capacity to carry the position.

In trying to project how the dry bulk industry and the other market sectors will develop, one cannot create a fair opinion without taking into consideration the future action and reaction of institutional investors. This is not only about the famous Keynesian beauty contest, but also the logic and analysis of the investors that are holding money losing positions and how they will react but also institutional investors that may be tempted to enter the shipping industry given the present state of weak freight rates.

What Would Institutional Investors Do?

The game plan two years ago was for institutional investors to buy ships and otherwise ‘go long shipping’, under the prevailing assumption that the shipping markets were on the crest of a structural recovery; in a matter of a few short years, either the vessels would had been sold at higher prices with the investors walking away from the smaller sized projects at a profit, while for sizeable investments, there have been plans for IPOs and floating the business for a much larger paycheck (for the institutional investors but also the management team as well.) Given the state of the market, unfolding positions of two-years-ago at a profit is not doable, and as far as the hopes for accessing the capital markets, let’s forget about it, at least for now; even for the tanker market where freight rates are respectable, there is little conviction that this may be the early stages of a long term bull market. How institutional investors will react it’s important since they are holding more than $30 billion in shipping investments (investments that were deployed in the last five years); and institutional investors control obscene amounts of money, thus how they could deploy them in shipping could affect the market at large, and the lives of shipowners and shipping banks.

What would be the possible scenarios of institutional investors in shipping?

Doubling down on their shipping investments in order to average down their cost basis; doubling down could be in the form of ordering more newbuildings at lower prices, which could be detrimental to the market. One clear example of such strategy has been WL Ross ordering of a few more Suezmax tankers to add to the Diamond S fleet at a lower cost. If the original plane mandated acquisition of secondhand tonnage, then doubling down could mean buying more ships in the secondary market, which likely is a good scenario for shipping; no additional tonnage is added to the world fleet while shipping asset prices are getting supported (more buyers for ships, high demand.) Doubling down means determination, patience and willingness to put more chips on the table, and it’s the path that makes most sense if there is a strong recovery. The ideal scenario would be for the institutional investors to keep adding more ships to their positions from the secondary market; on the other hand, given the low interest rate environment, low commodity pricing environment and excess shipping capacity, doubling down can easily extend to a new wave of newbuilding orders, a scenario least appealing to shipping in both the short and the long term.

Cutting their losses and exiting their positions, at least selectively; it’s not the easiest decision to make and having to realize losses on investments, but on the other hand, when a fund has no specific mandate to be in shipping, the investment is relatively small, and besides the economics of the investment there are additional issues to be considered, then selling sooner and at a loss may be a palatable approach. There have been rumors that several JVs between institutional investors and vessel managers are on a rocky ground and there have been barely contained divergent managerial views, so to speak. Committing more funding to a project already on shaky ground is almost as throwing good money after bad money. There have been sales of shipping assets prematurely and at sizeable loss, such as the sale of newbuildings capesize vessel by Scorpio Bulk in an effort to avoid dilutive equity offerings. Ill-timed sales in a bad market result into losses, result into setting a lower asset market, result into setting an even more depressing market mood, and definitely show the least degree of commitment to the industry or the market, and much more resemble trading and playing the market: sometimes one is right, sometimes one is wrong, just hope to convince your investors that the batting average is favorable over the long term. Untimely sales of shipping assets can definitely have the potential to drive the market lower, much lower than now, and could bring upon the possibility of ‘fire sales’, a wishful scenario much dreamt but rarely materialized in shipping since 2008.

Playing for time, may be the third viable scenario, in the present market, as long as one has the time and the money. Just last week, Star Bulk had another ‘follow on’ to raise additional equity and meet their financial and capital requirements; almost 50% of the offering was subscribed by the company’s three anchor investors; it’s worth noting that the offering took place at approx. $3.2 /share, while shares were trading above $8 a few months ago and the company went public with a double-digit sticker price. Putting more money into the venture whether from the original or additional shareholders seems to be least obtrusive to the shipping markets, as it does not interfere with tonnage supply and demand dynamics and has limited impact on asset pricing. On the other hand, not many institutional investors have deep enough pockets (when asset allocation has to be taken into consideration), the timing or the commitments of the management of the JV.

All in all, institutional investors hold substantial positions in shipping, with allegedly additional appetite for shipping investments; in a market environment that has gotten many players by surprise and patently too unruly to play by the original game plan, these institutional investors can easily move the market in terms of tonnage supply and demand, move the market in terms of asset pricing, and can easily set the tone for the market for the next business cycle, whenever such arrives.

To think otherwise, that the impact of institutional investors on shipping is behind us, and one ought to focus on pure market dynamics, it seems to likely be a miscalculation.

A good question then to be sorted soon is: ‘What Would the Institutional Investors Do?’

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