Private equity (PE) is an asset class consisting of equity investment in companies that are not publicly traded on a stock exchange. With the decline in industrial and consumer demand following the worldwide economic pullback beginning in 2008, the shipping industry, still working through oversupply six years later, is an obvious target.
For some ship owners, PE is hailed as the panacea for saving an otherwise distressed market that has suffered from a lack of bank finance – more fallout from the credit crunch.
In recent years, shipping indexes tested record lows, US bankruptcy filings by international shipping companies proliferated. Meanwhile, the still large newbuilding order book, which includes orders for ‘eco’ ships for the future, remains largely unfinanced. Against this gloomy backdrop, PE investors are brightening up the landscape. Increasingly, investors and ship owners are strategically aligning their respective interests and forming shipping private equity ventures (SPEVs).
The shipping industry needs alternative financing sources to fill the vacuum as the banks have pulled back. The current state of the shipping markets is attractive to PE investors, where investment in distressed industries is among the most common investment strategies.
While most industry experts would argue that the majority of PE firms considering shipping private investments have looked, smelled, poked and prodded – but only a limited number have committed. As familiarity grows, however, more are wading into shipping’s waters.
Recent PE investors have included W. L. Ross & Co., Blackstone Group LP, Apollo Global Management LLC and Greenbriar Equity Group LLC.
Clearly, PE investments require careful analysis and market understanding. While the economic terms of a transaction can be negotiated (capital contributions, length of investment period, termination procedures, etc.), PE firms have quickly recognized that the shipping markets clearly have their own nuances and issues. These include the following:
This arcane and sometimes antiquated terminology is but one of the factors that have frightened away PE interests (e.g. is a bareboat charter a net/net lease?)
Shipping has its own risks, including dangerous cargoes, civil and criminal oil pollution liability and the public’s perception of corporate irresponsibility. Furthermore, there are inconsistencies among local, national and international regulatory regimes leading to compliance concerns.
Shipping is an international business with movable assets. The ship, it's owner, lender and insurer are often in different countries and subject to the laws of numerous jurisdictions.
Oversight of management
PE oversight can be difficult, even if formal agreements are in place. Commonly, the technical operation and commercial management of the new entity’s assets are controlled by the minority partner, the ship owner. In addition, it is common for the SPEV to indemnify the ship owner for any actions taken on its behalf without liability other than losses resulting from the manager’s gross negligence, wilful misconduct or fraud. Also, potential conflicts of interest may arise between the ship owner’s existing operations and the SPEV’s business. The SPEV’s corporate documents should outline each investor’s ability to manage and control the investment as reflected in the structure of the governing body (including numbers of representatives, and their powers and classification for voting and operating purposes). However, agreements will need provisions regarding conflicts due to potential vessel acquisitions or chartering opportunities between the SPEV, the ship owner and their clients, counterparties and staff.
The SPEV, the ship owner and the PE interests each will have different investors and hence different tax concerns. For investors located in the US, additional tax considerations need evaluation.
Key to any PE investment is the means of repayment. In a shipping venture, repayment will primarily consist of income from charter hire, and hopefully, asset appreciation in connection with future asset sales. A bareboat charter is the best means of establishing a payment stream to repay the PE investor. In the case of time and voyage charters, the SPEV’s net income can be dramatically affected by maintenance/repair responsibilities and operational costs.
A long term investment for PE has a 5 to 7 year time horizon. By shipping standards, this can be a short and difficult period to plan and control an exit strategy in a fragmented market largely controlled by small private companies. Restrictions on transferability of assets, including rights of first refusal, as well as voting restrictions need to be agreed at the creation of the SPEV. However, the failure to plan against transfers to unwanted third parties (such as competing ship owners or other PE investors) can have dire consequences. A sale of assets or equity in the company, merger or an initial public offering, all of which can be effective exit strategies, also require advance planning. However, in the case of the IPO concerns related to the SEC registration of advisers to PE funds, or requirements to disclose preferential terms or arrangements offered to select investors (in the interest of transparency and protecting rights of co-investors) can have unwanted ramifications.
The sometimes competing interests of the PE investor and ship owner partners, and shipping’s complex jurisdictional and tax issues, all necessitate careful planning. It has taken careful study for PE to address concerns regarding criminal liability for oil pollution, international trade sanctions, and even piracy. Nevertheless, the movement of PE investors into the maritime sector is a significant development in maritime finance.