As shipping continues to be buffeted by economic forces, the sector may be set for a period of M&A activity. But, as Malcolm Entwistle and Mark Walker explain, the drivers for this will be specific to industry sub-sectors.
Companies normally engage in mergers and acquisitions mainly for the purpose of creating higher shareholder value than the sum of the companies involved. The main driver for mergers and acquisitions historically in any industry has been to create greater market opportunities, presence and to achieve economies of scale. Whilst within the various sub-sectors of the shipping market there are some significant large corporations, the very nature of the market is capital intensive and the major assets are ships, the vast majority of which are owned and operated through private one ship-owning companies, albeit that such private companies may ultimately be part of a larger private group. This fragmentation and liquidity of the majority of the companies involved has in the past meant there have not been as many mergers and acquisitions as in other industries, or corporations of sufficient size to attract serious institutional investment.
In order to assess the extent to which the shipping market is set for a period of merger and acquisition (M&A) activity, it is necessary to look at how the landscape of the market has changed over the last 15 years, the changes in the way the market has been financed, together with the expected impact that external forces and current market conditions are likely to have across the various sub-sectors. These combined factors have meant there are other significant reasons beyond the normal rationale which explain why a period of such activity is inevitable.
Pre-2008, the shipping market experienced an extended period of buoyancy due to high freight rates, high ship values and increasing demand for shipping services. This boom, together with a shortage of ships and the amount of wealth generated during this time, contributed to a significant increase in the amount of newbuild orders being placed. It also was a period which saw shipping businesses utilising the increase in profits for mergers and acquisitions to consolidate and expand within the maritime industry or to exploit the thriving market by way of initial public offering (IPO).
Following the 2008 global financial crisis, ship values plummeted and what was a readily available stream of commercial debt finance significantly and rapidly dried up and became difficult to obtain. Demand for seaborne transportation began to decline which had a downward effect on freight rates and the reduction in demand, coupled with the amount of new tonnage being delivered, meant the shipping market began to flatten and the signs were that more moderate and conservative earnings were to be prevalent for some time. During the most recent years there were occasionally signs that the market was improving which saw freight rates in certain sub-sectors spike. Despite the fluctuating market, the order book of many shipyards remained healthy, as confidence remained relatively high that demand from China, the Far East and South America generally looked as though it was set for a period of continued growth.
Historically, the shipping sector has tended to be financed mainly by banks and institutional financiers, including by way of government subsidies or loans. We have also seen other methods of financing, such as loans by the shipyards themselves, equity funds, specialist schemes such as KGs, public investment through equity and bonds as well as IPOs. Since 2008, due to the lack of available bank and institutional finance, there has been a number of additional sources of alternative finance in the form of, amongst others, specialised financial boutiques, significant capitalisation by private equity funds and collaboration between shipping companies and financiers through joint ventures, shipping pools and leasing arrangements. As with all types of financing arrangements, there are significant pressures for reimbursement within the agreed period placed on the borrowing shipowner. Such pressures are only amplified or brought to the fore during periods of market volatility.
The general view of the shipping market was optimistic in the summer of 2014 but since then certain sub-sectors of the market have faced a slightly unexpected dramatic downturn. The increasing dependence on China in recent years, and its reduction in demand for goods and commodities as well as the overall stalling of growth worldwide, have mainly contributed to this downturn.
It is difficult, as it is in all diversified markets, to state that there is a consistent position throughout all shipping sub-sectors. Currently, the tanker market, which itself sub-divides into crude, product and liquefied petroleum gas (LPG) tankers, is holding up with reasonable rates primarily due to the significant distances tankers are often required to cover. Whilst it is felt the crude market will be able to maintain its levels in the next few years, the impending influx of new tonnage in the product and LPG markets, without any significant increase in demand, is likely to lead to a drop in rates.
In contrast, the slowdown of demand from China and other expanding economies in the dry bulk market, as well as the oversupply of dry bulk shipping already in trade or still in production, has resulted in a dramatic fall in dry bulk freight rates and ship values. There is a significant number of dry bulk operators currently trading at a loss which can only be sustained for so long. This position is not expected to change for some time. In the container market, container demand has fallen due to a reduction of demand for seaborne containerised goods and, to some extent, as a result of the manufacturing of goods being reshored. Unless demand in the container market grows, the over capacity will place a ceiling on rates.
Another factor to take into account is that banks and financial institutions tend to lend up to an amount equivalent to a specified percentage of a ship’s value, on the basis that such loan to value percentage is not exceeded during the term of the loan. The fall in ship values has resulted in many of the loan to value covenants set out in loan facility documentation being breached, with the pressures on shipping companies as a result. In addition, a number of banks are under pressure to make positive adjustments to their balance sheets and this has, in some cases, resulted in them requesting early repayment of their loans.
It is difficult to predict how long the shipping market in general will be a ‘bear’ one, as intervening circumstances can often be unpredictable. The level of withdrawal of shipping capacity by scrapping, cancellation, the reconfiguration of shipbuilding order books, a shift in a government’s policy, an increase in demand for certain goods or commodities or an increase in travelling distances, could have the effect of improving the shipping market sooner than anticipated. However, it is generally felt across the industry that an overall market recovery is unlikely until at least the latter part of 2016.
The continued effects of overcapacity of ships, the economic slowdown in China and other previously rapidly expanding economies, as well as the lack of finance coupled with the desire of many banks for repayment of their existing financing commitments, has created very difficult conditions in certain shipping sub-sectors (particularly dry bulk and container). These conditions are expected to continue for the foreseeable future and will result in the market being ripe for a period of merger and acquisition activity. Such activity will be driven by a number of factors which may well be different in the various sub-sectors of the shipping market.
There will continue to be shipping companies wishing to merge and acquire for the normal reason of increasing market share and trying to achieve economies of scale. This has already started within the container and crude tanker sub-sectors – the most recent announcement being the merger of General Maritime Corporation and Navig8 Crude Tankers Inc. to create the largest owner of modern eco very large crude carriers (VLCCs).
In addition, those shipping companies with strong balance sheets will be in a position to acquire shipping loan portfolios or ships in the possession of banks as a result of enforcement activity on defaulted facilities. A recent example of this is Navios Maritime’s acquisition of a 14-vessel fleet from debtors of HSH Nordbank AG. This type of activity is expected to increase in the coming years.
There are also irresistible forces leading to pressure for more mergers and acquisitions as a result of private equity investors seeking an exit route for their investments or to enable shipping companies and investors to reduce their financial risk or widen their foundations to assist, firstly with survival and then, hopefully, growth. Without doubt, the landscape of the market will undergo significant changes during this period.
The shipping market has seen significant periods of volatility in the past but has always survived and has also had periods of significant growth. It must be remembered that over 95% of the world’s goods are transported by sea so there will always be a demand for ships and a recovery and a period of growth is only a question of time. In the interim, a period of mergers and acquisitions is an inevitable consequence of current conditions and will only assist the shipping sector to be in a better position when the good times return.