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Private equity managers looking to ride new wave with shipping

Firms hoping to push against tide of the past with different approach

Marcel C. Saucy
Marcel C. Saucy didn’t realize how much hedge funds invest in shipping.

Shipping has been a major disappointment for the alternative investment managers that came aboard early, but a new crop of investors expect to reap gains from the industry's and earlier investors' pain.

Newer entrants such as KKR & Co. LP and MC-Seamax Management Ltd. are aiming to garner returns from an industry suffering from too many ships.

Managers already in the sector include J.P. Morgan Asset Management (JPM), Oaktree Capital Management (OAK) LP (OAK), Carlyle Group, Blackstone Group LP, Apollo Global Management LLC and WL Ross & Co. LLC.

“Institutional investors as a whole have not made much money (in shipping),” said Marcel C. Saucy, senior partner in Zurich-based Fincor Finance SA, a corporate finance and asset management firm that has been involved with shipping since the 1970s. “If they broke even ... it's probably not a bad thing for them.”

It is not just private equity managers, but also real asset firms — including infrastructure, credit and hedge funds — that have been investing in the sector, Mr. Saucy said.

“When I realized how much was being invested by hedge funds and credit (managers), it was a big eye-opener” because hedge funds swore off of illiquid assets after the industry hit the wall in 2008, but yet they invested in shipping, Mr. Saucy said.

There is little concrete data on how much exposure institutional investors have to shipping. Industry insiders estimate roughly $100 billion has been invested globally in the sector since 2008.

Still, in the past 12 months, MC-Seamax Management closed a $300 million fund in June and CarVal Investors closed a $252 million shipping fund. Plus, up to 10% of the $1.1 billion credit fund CarVal closed last year can be invested in shipping.

Investors in the MC-Seamax's fund include Dallas/Fort Worth International Airport, which oversees two pension funds with a combined $530 million in assets. Investors in CarVal's credit fund include the $7.5 billion New Hampshire Retirement System, Concord.

That's not counting the private equity, real asset and distressed debt funds aimed at investing in the sector.

Players investing in shipping now say they are taking a different approach from earlier investors that had invested equity and debt in new ships.

“There was a lot of interest in dry bulk two or three years ago as institutional capital poured into shipping,” said Brian Dillard, a New York-based member at KKR who leads the firm's shipping investments. “New ships were particularly popular.”

Dry bulk ships carry transport bulk cargo. Today, the dry bulk trade is focused on moving large quantities of coal and iron ore to China from Brazil and Australia, shipping routes that are shrinking, Mr. Dillard said.

The price of new ships had come down sharply from the peak in 2007 and 2008, and managers could deploy a lot of capital at one time, he said. The investment thesis was that the new generation of ships would be more fuel efficient, which was more important in a $100-per-barrel price environment than it is today.

“The fundamental problem is that in shipping when it looks like a good time to order, everybody orders but the ships don't hit the water until two or three years later,” Mr. Dillard said.

New investors like KKR are investing in different sectors as well as taking advantage of distress in the shipping industry.

KKR is investing in shipping through its special situations business, Mr. Dillard said. KKR is investing mostly in first-lien debt in the chemical tanker market. The firm also is buying assets from international banks, which until recently had been the main lenders to the shipping industry, he said.

KKR's special situations business has about $500 million invested in the shipping sector. Separately, in 2013, KKR raised another $580 million from institutional investors for Maritime Finance Co., a vehicle focused on maritime financing.

Having a hard time

There's a great deal of distress to go around. After investing billions in both the debt and equity sides of the shipping business, alternative investment managers are having a hard time exiting their maritime investments, industry insiders say. Instead of taking shipping companies public, these firms are selling ships a few at a time, if they're lucky.

Mr. Saucy said many alternative investment managers had gone into the sector expecting to consolidate companies to gain size and then take the combined enterprise on the stock market, an idea he called a “pipe dream.”

In the past 12 months, alternative investment firms including Apollo, York Capital Management LLC and Wayzata Investment Partners have sold individual vessels at relatively low prices.

Indeed, some managers say that the shipping sector is too distressed for profitable investment.

“Investors are often tempted by mean reversions — but in this case the oversupply and the under-demand are so large — that container and bulk shipping sectors will be depressed for several years to come,” said Peter Yu, founder and managing partner of global private equity firm Cartesian Capital Group LLC.

How investors fared depended on the subsector in which they invested. While investments in oil tankers and containers are doing pretty well, sectors like dry bulk are not, said Joseph Azelby, managing director and CEO, global real assets, J.P. Morgan Asset Management (JPM), an early investor in the shipping sector.

“The demand for moving stuff around the world is down. There are too many ships on the water” to carry cargo, Mr. Azelby said. “We will see a lot of scrapping in next 18 months where the value of the steel is greater than the ship itself.”

Matthew Chissum, a J.P. Morgan spokesman, said he could not reveal how much the money management firm invests in shipping due to private placement restrictions.

Shippers also will have to be recapitalized, Mr. Azelby said. He added, “It's happening now.”

WL Ross, Invesco (IVZ) Ltd.'s New York-based private equity unit, was in the first wave of investors that invested in dry bulk, among other areas. WL Ross made two big shipping investments in 2012. One investment was in Diamond S. Shipping Group Inc., a tanker company the private equity firm planned to take public in 2014. WL Ross ended up keeping the company private because the price it would get at the initial public offering was too low.

“It is not our policy to comment publicly on the performance of specific portfolio investments or on investments we intend to make, but we continue to be satisfied with the investments we have made in the shipping industry,” said Raslyn C. Wooten, Invesco spokeswoman, in an e-mail.

Executives at Oaktree, Carlyle, Blackstone and Apollo declined to comment.

Some observers said the flood of investment capital led to the oversupply.

Mr. Saucy said shipping industry executives blame private equity and hedge funds for the oversupply of vessels because those firms financed the massive amount of new ships.

KKR invested in shipping for the first time in 2013, but the firm really began investing in earnest over the past 12 to 18 months.

One segment of shipping that is healthier than others is chemical tankers, which carry petrochemicals, Mr. Dillard said. Instead of having one big tank on board, there is a collection of 20 to 30 different tanks, each able to carry a different grade of chemical.

That gives the ship the ability to make numerous deliveries of petrochemicals on the same trip, he explained.

Many credit, infrastructure and other managers are currently raising capital to invest in asset classes that are in distress, which could include shipping, said Cesar Estrada, senior managing director, alternative investment services, in the New York office of State Street Corp. (STT)

Early investments in shipping “made sense,” Mr. Estrada said.

“Ninety percent of the world trade goes by ships,” Mr. Estrada said. “Since 2008 to today, there's been a series of headwinds.”

The economic recovery has never been at the pace many thought it would be, he said. International trade has slowed, with the shrinking demand for oil, commodities and finished goods.

The leverage used by the alternative investment funds that invested in shipping is magnifying the misery, making shipping a sector in distress.

“It's Armageddon,” KKR's Mr. Dillard said. “Demand for vessels is declining and supply is increasing. It will continue to be the case until something fundamentally changes with Chinese demand for raw material or en masse scrapping of vessels to bring things back into balance.” n

This article originally appeared in the February 22, 2016 print issue as, "Managers looking to ride new wave with shipping".