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Capital Agenda Insights, October 2010 - Running aground: restructuring an equity-starved shipping industry - EY - Global

Capital Agenda Insights, October 2010Running aground: restructuring
an equity-starved shipping industry

For now, container rates are recovering. But lingering overcapacity, a dearth of financing and a still precarious global economy mean that the shipping industry is by no means out of hot water.

Recognizing that future shipping growth will not be enough to provide long-term answers, owners, liners and their banks are now reconciled to finding the means to restructure an industry.

The trend reverses

Following more than a decade of seemingly unending growth and optimism, the 2008 financial crisis provided a rude awakening for the global shipping industry. By 2009, container shipping volumes fell by 10%, making this the first year to see a year-on-year decline since its inception more than half a century ago.

Similar pain spread throughout the industry, eventually encompassing everything from small vessels, larger ships, containers, tankers, and dry bulk to ship owners and liners.

Today, a wide range of shipping industry segments are well on their way to recovery. Certainly, cruise ships and the offshore servicing sectors, for example, are faring reasonably well. By no means is the industry posting record profits, but operating margins are improving, in turn reducing cashflow and balance sheet pressures.

Container markets are also showing signs of improvement. For one, charter rates have climbed significantly from prior lows. For example, the World Shipping Council published figures showing that in May 2010, trade into and out of Europe rose 16.1% year on year, while the key Asia-Europe route grew 20.9%.

In addition, following many months of nearly zero activity, more buyers and sellers are coming together to execute magnates, having sold at the height of valuations prior to the crisis, are now returning as buyers. More transactions are great news, as the ability to buy and sell is an absolutely critical element in rebalancing portfolios and restructuring industry costs.

Nonetheless, the container segment remains plagued by a key structural challenge. Namely: an insufficient financing base built on too much debt and not enough equity.

For example, ships that at one time were financed with as much as 30–50% equity must now head out to sea under nearly 100% debt financing. Such a financing structure introduces enormous risk and cash-burn and for an industry likely to experience relatively slow growth going forward, is unsustainable.

Banks are constrained

Clearly, the industry must find new sources of financing. However, amid a fragile recovery, such financing is proving hard to come by. For instance, Germany’s ship financing partnerships, the Kommanditgesellschaften (KG), are in a perilous financial state.

Having financed a third of the world’s container ships and after pledging enormous sums in construction phase guaranties, the KG’s are today granting little in the way of new financing.

As for more traditional banks, many are heavily exposed to the shipping industry and thus far are maintaining a “standstill” position. But such banks are facing increasing pressure to reduce this exposure.

For now, seemingly all that is preventing a fire sale is the fear of further depressing shipping asset values. So banks have become de facto ship owners in their own right.

Which again leads to an industry in need of restructuring — and in many sectors this is underway. For example, the KG houses are seeking to find financing solutions by intermediating between their own interests and those of the banks, the ship owners and the shareholders. Some have successfully completed first rounds of restructuring, but it remains to be seen whether these measures will be sufficient.

Of course another key tool of restructuring is to reduce operational costs. However, in this regard, the industry needs to take care.

Host governments often grant shipping companies an extremely low rate of tax but in return want to see local job creation. Shipping companies need to make sure that they reduce operational costs and keep their favored tax status.

New financing solutions

Banks, meanwhile, are faced with a choice of working-out individual cases or seeking portfolio solutions.

One possible source of relief could come in the form of special purpose vehicles (SPVs) which allow banks to pool their shipping assets. Such a portfolio might prove attractive to new investor groups such as private equity (PE) funds.

Indeed, PE has been involved to varying degrees in a number of recent transactions. Of course, the value of such an SPV would depend on the quality of the ships, the finance structure and the associated charter contracts.

Moreover, some form of facilitation and mediation between the banks, ship owners and SPVs would be vital. Sovereign wealth funds are also beginning to increase their interest in containers in shipping in general. Noteworthy among these, funds based in China — a nation with a vested interest in shipping and shipbuilding — could very easily take on a more prominent investment role.

But ship owners must also take steps of their own, particularly if they hope to prove attractive to would-be providers of private equity or even publicly traded debt. During the boom, little attention was paid to financial and governance systems.

But the crisis is forcing ship owners to focus on systems, cash and working capital management and in general modernize the way their businesses are run. Indeed, this is proving a prerequisite in order to negotiate refinancing with their banks.

Moreover, if shipping companies hope to attract more capital — and given vast financing needs they likely must — then the industry will meanwhile need to upgrade its governance processes and in particular, its transparency.

This may prove challenging for an industry that traditionally is primarily family held and therefore relatively limited in its information disclosure. But to achieve the level of restructuring necessary to achieve a sustainable framework, shipping companies will need to evolve.

Treading water

Overall, the shipping industry remains in a precarious position.

In the short-term, all routes lead back to the banks that are supporting the shipping market. If such banks are able to continue providing support — by extending loans, deferring interest payments or similar other actions — the industry should make it until the global economy fully recovers.

But if the banks withdraw support; if a major financing provider stumbles; if governments won’t provide bailouts; if the global economy falters: the shipping industry could be thrust headlong back into full-blown financial crisis.

Over the medium to longer term, the industry must find ways to attract new investors and new forms of capital, particularly equity and public debt.

For now, the industry can tread water, paying close attention to the ebb and flow of the global economy. But long term, it must find a more sustainable financing model.

Other editions

Bernd Richter and Glenn Peters

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