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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© 2012-2015 Basil M Karatzas & Karatzas Marine Advisors & Co.  All Rights Reserved.

IMPORTANT DISCLAIMER:  Access to this blog signifies the reader’s irrevocable acceptance of this disclaimer. No part of this blog can be reproduced by any means and under any circumstances, whatsoever, in whole or in part, without proper attribution or the consent of the copyright and trademark holders of this website. Whilst every effort has been made to ensure that information here within has been received from sources believed to be reliable and such information is believed to be accurate at the time of publishing, no warranties or assurances whatsoever are made in reference to accuracy or completeness of said information, and no liability whatsoever will be accepted for taking or failing to take any action upon any information contained in any part of this website.  Thank you for the consideration.

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Teekay’s publicly listed private equity fund

Earlier today, January 21^st, 2014, Teekay Tankers Ltd. (Teekay Tankers) (NYSE:TNK) and Teekay Corporation (Teekay) (NYSE:TK) announced the creation of Tanker Investments Ltd. (TIL) with the intent ‘to opportunistically acquire, operate and sell modern secondhand tankers to benefit from an expected recovery in the current cyclical low of the tanker market’.  The new entity will have $250 million initial capitalization of which $25 million will be contributed by each of the ‘parent’ companies for a combined 20% stake in the new entity, while the balance of the equity has been subscribed by institutional investors in the US, the UK and Norway. TIL intends to undertake a public listing of its common stock on the Oslo Stock Exchange in the first quarter of 2014.  Incidentally, it was reported last week that interests affiliated with Teekay had acquired four aframax tankers for a total consideration of $116 million, and in today’s press release, it was divulged that such transaction had been earmarked as the first acquisition of TIL; a speedy second transaction will be the acquisition from Teekay by TIL of four 2009-built Suezmax tankers for $163 million.  Both acquisitions have taken place at competitive asset pricing levels; actually, at more than 10% discount to what it’s considered today to be ‘fair market level’ in a surprisingly strengthening crude tanker market and with almost forgotten $100,000 pd tanker freight rates; WorldScale 300 can be seen on current market reports and not on dated, time-stained market reports.

There are many ways to evaluate the logic and the purpose behind the formation of the new company.  The pricing of the transaction is also indicative of prevailing market conditions and also investor expectations (‘value level’ asset pricing vs ‘market related.) The timing and the expected quick consummation of the transaction are also indicative of the quality of the management of the company (ies).

In previous writings, we have explored the means institutional investors and private equity funds have been looking to invest in shipping, whether by extending credit as second lien loans, mezz financing, leasing or taking old-fashioned equity exposure. Credit investments usually provide downside protection but usually also limit upside potential. At a time when the proxy index for the whole market BDI is at a small fraction of its all glory, and also at a  time when the shipping market seems to be poised for a ‘break out’, most investors logically would prefer an equity investment.

But again, an equity investment in shipping is much harder than it sounds. Of course there are the public capital markets and one can just buy and sell shares in public companies, but again, not many legitimate shipping companies have remained standing in the public markets since the financial crisis that are not penny stocks, have daily trading volume that can attract sizable investments, and most importantly, can provide a clean slate platform in terms of management conflicts and legacy issues.

MT HAMILTON SPIRIT (Image source: Teekay)

Placing an equity investment in shipping in the private markets can be even more daunting for an institutional investor than buying or selling shares in the capital markets. There are the obvious concerns of a passive investors entering physically an industry that is active worldwide with high regulatory and legal barriers – at least to the uninitiated – and will have to depend heavily on a partner and industry expert to maintain, manage and charter the vessels; really, it can be a mind boggling experience sourcing, evaluating and selecting technical and commercial vessel managers and setting a viable commercial course.  A passive investor would have to go through the option sets of setting up in-house technical management (unlikely) to hiring for a flat fee a professional vessel manager (likely) to engaging a ‘partner’ that could provide shipping expertise and also equity contribution in order o have ‘skin in the game’.  Likewise for commercial management, it may be long-term charters, or pool vessel employment or active vessel trading on the spot market where the partner can also have ‘skin in the game’. But again, each time there is a partner and/or manager arrangement, there are also agency concerns and of course lenghty debates about equitable way of sharing the spoils.  Honestly, the history books are rather thin with successful ‘strategic partnerships’ in shipping that worked wonderfully over the long term.  And, sadly, disputes and conflicts often arise from the get-go.

In our opinion, most of the success story of the Scorpio Group, both in the tanker market with Scorpio Tankers (Nasdaq:STNG) and in the dry bulk market with Scorpio Bulkers (Nasdaq:SALT), is attributed to the fact the management of the firms is offering the investors, both institutional and retail, a simplified way to invest in shipping (‘to play the market’ since often investments these days are quite often referred to as ‘bets’): the management devised a business plan, deplete of legacy issues and with a ‘forward looking’ strategy, minimized operational and execution risk by hiring shipping professionals, and thus the risk of an investment has been peeled off to the ‘market exposure’ risk only. However, in Scorpio’s case, with vessel management remaining privately owned and outside the publicly traded ownership umbrella, agency concerns have been raised in certain corners of the shipping investment universe.

This transaction within the Teekay group of companies takes the peeling off of types of risk one layer further to the core of the onion as now the vessel management of the TIL vessels has remained under the publicly owned umbrella of companies.  Although Teekay Tankers (TNK) is acquiring the tanker commercial and technical operations from TK, including ownership of 3 managed tanker pools, as it was disclosed in the same press release, vessel management fees generated from operating the vessels remain under the publicly owned umbrella of companies and available to the benefit of and open to public shareholders.

MT KYEEMA SPIRIT (Image source: Teekay)

The present TK transaction obviously is aiming at capitalizing on the increased interest in the crude oil tanker markets; this segment of the market has been in a multi-year polar-level hibernation and was almost taken for dead till July 2013; since then, however, there has been renewed enthusiasm on the back of strengthening freight rates, lack of fresh waves of massive newbuilding orders – as it’s the case with many other market segments – and a likely a case of the ‘tail wagging the dog’ effect. There still many skeptics about the prospects of a robust recovery in the tanker market, and TK’s investors will have to ‘make a bet’ on the direction of the market, but definitely the timing of the enterprise is much more opportune now than it would have been in 2013, or 2012, or 2011, or … The slate is clean as it is the platform of any conflicts, and now the few hesitant private equity funds and hedge funds, and even the small investors, could easily play the market for a recovery in the tanker market segment; a case so clean and clear that one even gets tempted to say that the small investor is getting on even footing with the institutional investor to participate in a market recovery.

© 2013-2014 Basil M Karatzas & Karatzas Marine Advisors & Co.  All Rights Reserved.

IMPORTANT DISCLAIMER:  Access to this blog signifies the reader’s irrevocable acceptance of this disclaimer. No part of this blog can be reproduced by any means and under any circumstances, whatsoever, in whole or in part, without proper attribution or the consent of the copyright and trademark holders of this website. Whilst every effort has been made to ensure that information herewithin has been received from sources believed to be reliable and such information is believed to be accurate at the time of publishing, no warranties or assurances whatsoever are made in reference to accuracy or completeness of said information, and no liability whatsoever will be accepted for taking or failing to take any action upon any information contained in any part of this website.  Thank you for the consideration.