Private equity as a new source of capital in shipping

10 Oct 2015
2Karatzas

Basil M Karatzas, CEO of Karatzas Marine Advisors & Co., talks to the Shipping Herald  about the state of the shipping market and its prospects. Private Equity as the new source of capital in shipping is also discussed in an exclusive interview.

# Please give us a quick introduction to your firm, Karatzas Marine Advisors & Co.

Our firm focuses on shipping finance advisory, restructurings, private placements, but also the sale of shipping loans and shipping assets and vessels, and providing shipping market expertise including vessel valuations.  We are headquartered in Manhattan in the Financial District, an area that has been dotted with century-old trading houses for cargo and once was frequented by shipowners; now nominally the area is much closer to the institutional investors and the financial market in general and the desired place of any hopeful IPO on the NYSE.  The footprint of our clientele is international with Hamburg and Athens in strong need and desire to access the financial markets, but also Asian clients who are more actively on the outright purchase of vessels.

 

# These seem to be better days in shipping than last year or the year before. Are we finally in the much expected recovery?

World economic growth has been holding steady as well as world trade. Higher levels of growth would definitely be welcomed news, but again, nothing is perfect. Personally, we believe that world recovery will continue at current levels and likely will take some time to accelerate to levels more desirable. In our mind, the greatest concern for shipping at present is not the recovery (or the demand side), but rather still the supply of vessels; in the name of eco design and efficiencies, there have been just too many newbuilding orders, too aggressively, too casually, mostly from the famous ‘OPM’ (Other People’s Money) – amazingly with too short memory after the crisis. We hope that this market recovery doesn’t die young.

 

 

# Which do you find the most and least appealing shipping segments one to get involved with or stay completely away?

Probably one can get many people inside and outside shipping to agree that the containership market is the least appealing market segment at present; too many vessels are kept afloat that are not in sync with the market in terms of spec, size, fuel consumption figures, etc The liner companies have been re-aligning their loops which has a domino impact on the whole market. The fact that the impact of the widening of the Panama Canal is yet to be fully understood and the tail of the charter market in containerships is rather short, further complicate evaluating the prospects in this market. Dry bulk seems to be in favor, primarily with independent owners, while certain segments of the tanker market like aframaxes have been decimated, possibly allowing for good investment prospects given low asset pricing. Offshore has been fairly solid, especially with its high quality, long term charter market that can be appealing to both yield investors and also investors seeking to take exposure on residual values.

 

# There have been rumors for market consolidation; will the ship owners of the next generation just have to bigger in size in order to be able to compete more effectively?

Bigger is not always better, including in shipping. After a certain number of vessels within a fleet, some solid quality owners claim that about thirty ships is the optimal size – the rate of accruing economies of scale diminishes. There is a long tail of small owners, especially in the dry bulk market, and also containership vessels that are expected to be pushed out of the market; just not enough critical mass to support a company in an ever demanding market place. And, banks though their restructurings and active asset management approach will favor certain owners and will ‘guide’ the direction of the consolidation and influence the survival of a smaller pool of players; which effectively will play back to the banks’ hands and appetite for corporate approach to financing in the future.

 

 

# Disappointedly to some, ‘distressed sales’ of vessels never came to materialize; is there still hope that banks will ever sell vessel wholesale at discount?

On a very selective basis; besides the accounting losses and the logistics of selling vessels in distress, banks will be as patient as they can – and they have been, and possibly look for alternatives to selling ships such as selling loans; we already have seen recently a couple of such cases in the very recent path. One has to keep in mind that indirectly – through loan defaults and restructurings, banks actually could be the biggest ship owners in the world. There is a lot of concentration that with some discipline can move the market. This point never came to be used or exploited.

 

 

# Why only a few selective, highly concentrated deals have taken place?

There have been several smaller deals as well where PE funds co-invested with ship owners; we are aware of more than twenty such smaller scale investments. However, a few sizable deals that have grabbed the headlines, like the $500 mil JV between Ocean Bulk and Oaktree and the $500 mil JV between Rickmers and Apollo. These bigger deals have taken place with shipping counterparts where their structure is more or less corporate, with audited financials and management procedures closer-ly aligned with the capital markets. It’s not a coincidence that both of the names mentioned have experience with the capital markets, although these transactions took place on a private basis.

 

# Is Private Equity the new source of capital in shipping, replacing shipping banks?

Private Equity (PE) is, in general, opportunistic and of high cost funding. For equity investments, the return hurdle is relatively high (often in excess of 20% for market risk projects) and also there are restraining parameters in terms of due diligence, management decision making and checks and balances. As such, PE cannot be the natural replacement of bank debt. There are plentiful of PE funds that prefer debt investments, but they could never compete on cost and flexibility with traditional debt providers; especially when compared to the ‘golden years’ of shipping debt finance in the previous decade with light covenants, razor thin spreads, high gearing ratio, etc including minimal requirements on corporate structures. PE funds can be partially owners, partially lenders, sometimes both, but never willingly cheap or subordinated. It’s naïve to believe PE funds will fill the funding gap, but again, this doesn’t mean that they cannot be good opportunistic partners (probably an oxymoron ‘opportunistic partner’, let’s say opportunistic co-investors – whether in equity in debt) in an industry coming out of a crisis.

 

 

# Where will the next meaningful source of shipping finance come from? Shipping banks will still be dominant players?

This is a great question; banks will never again be as generous with lending as in 2008. Never say never, of course, but it’s hard fathoming how the banks, under a more rigorous regulatory regime, Basel III and higher funding costs will be supporting an industry like shipping, which is neither consequential nor of national interest for many banks and/or countries. PE funds and institutional investors are in shipping only opportunistically and likely will be exiting the space once the market swings toward the other end of the pendulum. Given that shipping is a capital intense business, the capital markets seem to be the only viable, long term source going forward where equity investors will be filling the funding gap left from the banks. Equity investors do not necessarily look solely for market risk as they have appetite for yield such as MLPs (Master Limited Partnerships), etc

 

 

# The Greek model of ownership has proven quite effective under the stress of the crisis. Could it still be effective in the future?

Indeed, the unique business model of the Greek shipping with relatively low financial but high operational leverage (trading spot market) combined with in-house shipping expertise and active trading of the vessels – possibly passion or ‘μερἀκι’, too – and a watchful eye on expenses has proven to be a better approach to shipping than let’s say the KG system.

 

Going forward, financial expertise will be as crucial to competitive ship-owning as shipping expertise.  Shipping is a capital intense industry, so access to capital has always been important. However, given the banking crisis post-Lehman and the new regulatory frame, shipping has become a less appealing and more expensive industry for the banks. To the extent banks will be active in the future in shipping, they will opt for corporate lending rather than asset-backed financing. Owners will have to be ‘corporate’ with proper management and organization structure, etc Banks most likely will be asking for it. But for the owners who will be looking to the capital markets, no doubt a great deal will have to or opt to, solid corporate structure and financial sophistication will be important. In the past, several IPO companies managed to dodge or faked ‘being corporate’; just an effort to get pubic but not really substantial follow-up to use the IPO as a springboard to grow properly. It’s noteworthy, the IPO shipping companies that indeed had proper structures and management (and also did fair or good deals) seem to weathered the crisis better and kept accessing the capital markets when other were shut out.

 

Likely Greek ship owners will have to adjust their proven model toward the capital markets. Greek ship owners have managed to change ‘sailing plans’ before to adjust to the changing winds of trade, likely will adjust again. Probably later than sooner, our guess, since corporate structures and capital markets can be counter-intuitive to successful trading in shipping.

Basil M Karatzas is the CEO of Karatzas Marine Advisors & Co., a shipping finance advisory and ship brokerage firm based in Manhattan; the firm represents financial owners, institutional investors, lenders, and ship owners and vessel managers worldwide.  More articles on shipping finance can be found at www.bmkaratzas.com

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