Shipping and private equity

Abstract

In the aftermath of the financial crisis of 2007-2008 many shipping companies had to find new sources of financing since traditional bank lending, historically shipping’s most important form of financing, had dried out. International trade decreased significantly and banks were unwilling to give out substantial loans. Private equity investors and hedge funds filled part of the gap by using their excess funds to inject both equity and debt into the shipping industry. They primarily intended to take advantage of record low asset prices and profit from improving macroeconomic conditions while increasing efficiency on company level. This thesis discusses to what extent shipping is a suitable industry to invest in for private equity funds. One of the most important factors for private equity investors is cash flow stability. In theory, cash flows in shipping are very unpredictable due to their dependence on shipping rates, thus making it difficult for private equity to invest. However, the correct estimation and timing of the shipping cycle can provide certain stability to ship owners. Therefore, private equity firms have to rely heavily on proven management teams as they lack significant sector experience and hence forecasting ability. The asset intensive nature of the business provides some downside protection for invested funds. The case study conducted in this thesis has found that traditional private equity methods worked in the tanker business even though those methods are not very different from traditional ship management practices. Out of the three levers that private equity usually applies, the financial lever, the tax lever and the legal lever, none of those is exclusively used by private equity owners in the shipping sector. Shipping companies traditionally use a high leverage, operate from tax subsidized headquarters and are often private, not facing the scrutiny of public shareholders. In shipping, private equity funds become more passive investors than they have proven to be in other sectors. The authors present two major findings from their investigation of shipping sector investments. The first finding is that private equity will not be able to generate large abnormal returns on a risk-return basis in shipping since their approach is very similar to that of traditional ship owners. The second finding is that in order to fulfill their return targets, private equity funds have taken on increased beta risk with their shipping investments as traditionally average returns in the shipping industry are rather low.