Monthly Archives: October 2013

‘Liner Business Models’ in Shipping

The first decade of this century has been characterized not only by the strongest shipping rates of a lifetime, but also by the rise of a new breed of shipowner who was financially literate (sort of the ‘MBA President’) and capital markets savvy and highly conversant on Wall Street values; while previous generations of independent private owners were going in to great efforts to design their house flags and insignia, modern shipowners were focusing on mission statement and shareholder value optimization hanging high from the yardarm of their ships and their roadshow presentations.

True to the spirit of the decade that made securitization of debt a very profitable alchemy in the financial industry by slicing ‘composite’ into different, distinct ‘trade-able’ tranches where certain investors would appreciate especially, the shipping industry was fast on catching up with the ‘divide and conquer’ strategy of its own.  While private shipowners stack to what had worked best for them in the past, usually by trial and error and exploiting their special trades and relationships, publicly traded owners devised business models that were appealing and sale-able to Wall Street and the institutional investors primarily rather than to the shipping markets.  There were formed companies whose business models were very distinct and ‘pure plays’ such as dependent on spot VLCC market exposure or Suezmax market exposure, companies with ‘yield driven’ strategies irrespective of underlying shipping market conditions, capesize shipowners with full spot market exposure positioned as ‘China play proxy’, dry bulk owners whose chartering strategy to reflect the ubiquitous Baltic Dry Index (BDI) given there is no liquid derivative market for an investor to play directly the BDI; there were even owners who moved into the ice-class products tanker market just to fill the ‘vacuum’ of despite having several publicly traded product tanker owners, there was none in the ‘pure’ ice-class segment. Public ship ownership become a very streamlined business where a financial owner identified a segment that was missing from Wall Street, used Other People’s Money (OPM) to secure the tonnage, involve liberally as much cheap debt financing as possible, engage a third-party vessel manager on a contract basis, and charter out the vessels in the open market.

‘Mono-line’ shipping business models definitely have their advantages.  They optimize economies of scale, operational leverage and cost savings, and they level sufficient critical mass of modern tonnage to entice major charterers and trading houses.  One additional benefit of such business models is that it’s easily understood and explained to the investment community, without undue complications and multiple layers and overlaps with inputs from other market segments and industries.  For example, for a VLCC owner of ten vessels trading on the spot market, the financial model could be sweet in its succinctness: capital requirements and financial expenses were known or easily projectable, operating expenses were contractually assigned to third parties and thus publicly known, and the assumption of expected future rates to be ‘plugged into’ the financial model was really the only big unknown. Modeling out a year or so was rather easy…and unquestionably worked time and again when the times were great.

Not Linear Enough Model? (Image source: courtesy AP Moller Maersk)

Not Linear Enough Model? (Image source: courtesy AP Moller Maersk)

Fast forward to the lower arch of the business cycle and taking another view at vessel ownership, it seems that shipping companies active in markets with a narrow focus that appealed to the investors in the past, have their fair share of problems.  This observation has been valid for both private and public owners who had overweighed exposure to one market.  After all, if the VLCC market is oversupplied, in a burning cash mode for some time and with unfavorable underlying economics, a narrowly focused VLCC owner has few options…the market is the market, and no much can change in shipping in the short term (sparing an exogenous shock like a geopolitical or macro-economic event or other event of unforeseen nature such as military action, embargoes, etc.)  Such an owner, a VLCC owner will suffer in a bad market, whether the capital structure is private or public; the market is the market, as we said.  However, a public company with a VLCC mandate has few options navigating the storm, unless the management or the ‘sponsor’ has the capacity to support the company directly or through their market clout.   Things would not be much better for a private owner, except that the private owner may have saved away some of the excess profits (dividends) from the good times, or had diversified away in less volatile or lightly correlated industries like in real estate those earnings; or even may have used the excess profits to enter other shipping segments that offer different (uncorrelated) characteristics and a better chance of survival when the headwinds hit.  Shipping companies with broader diversification to be considered ‘industrial conglomerates’ like AP Moeller Maersk or MOL OSK Lines with legs in many industries and segments had never had their survival questioned during the days of the absolute gloom.  Also, staying closer to home, without having to reach ‘industrial’ scale, it’s well commented that Dryships would had survival issues when the dry bulk (capesize) market collapsed if not for the management’s ‘thinking outside the box’ and entering heavily the drillship market with the acquisition of Ocean Rig.  The recent filing of private Greek owner for an LNG IPO is also another exhibit that diversification in shipping may pay better than ‘mono liner’ plans, possibly to the extent of making the difference between survival and going under.  Whether horizontal or vertical integration / diversification is best suited is debatable, however it seems that ‘lard’ rather than ‘leanness’ make better buffers in shipping…

This article is an adaptation from an earlier posting on November 5th, 2011, at The Captain’s Log blogspot.

© 2013 Basil M Karatzas & Karatzas Marine Advisors & Co.  All Rights Reserved.

IMPORTANT DISCLAIMER:  Access to this blog signifies the reader’s irrevocable acceptance of this disclaimer and other important information and terms. No part of this blog can be reproduced by any means and under any circumstances, whatsoever, in whole or in part, without proper attribution or the consent of the copyright and trademark holders of this and related websites. Whilst every effort has been made to ensure that information herewithin has been received from sources believed to be reliable and believed to be accurate at the time of publishing, no warranties or assurances whatsoever are made in reference to accuracy or completeness of said information, and no liability whatsoever will be accepted for taking or failing to take any action upon any information contained in any part of this website.  Thank you kindly for your consideration.

A New Way to Make a Million Dollars?

There was a saying about the airline industry that in order for one to become a millionaire, they had to start with a billion-dollar investment.   With the Airline Deregulation Act of 1978 in the US, the regulatory barriers to entry were not stratospheric anymore, allowing for new entrants, like Southwest, to enter the market with a clean sheet, no legacy entanglements (union labor, mostly) and set a business plan – mostly like thereof – to act opportunistically and expand selectively.  With an ever expanding fleet, route and plane offerings, the market grew, ticket prices came down, and once upon entering the internet age with its easy price comparisons and choices, competition became cutthroat, and airline companies were after survival by going after market share and covering variable cost.  It was a brutal business model with a constant round of bankruptcies where legacy airliners were trying to get rid of their legacy fixed costs, such as pension obligations or get out of leases for obsolete planes, etc.  Come the liquidity crunch of the financial crisis that caused the legendary ‘tit to go dry’ of easy lending combined with skyrocketing fuel prices, airline companies had to do a reality check.

In the first decade of the century, the seat mile availability (an industry metric of airline seats available for booking) exploding, while revenue per seat and the financial condition of the airline companies was deteriorating.   Once upon having to face reality and deal with a constrained option set, airline companies started shedding off inefficient airplanes, focusing instead on strategic routes and discontinue flying on marginal ones, and, to the detriment of passengers, started optimizing pricing and charging extra fees for luggage and almost anything else for that matter, and … and … In a rare Pauline moment for the industry, the airliners understood that collective, self-imposed discipline was required for survival, and shifting focus from market share (the typical ‘we lose money on the operations but we make it up in volume’) to revenue optimization and maximizing of profit.  And to make this clear, today’s Wall Street Journal reports that Thanksgiving-week typical airfare is about 9.4% higher than last year, and Christmas-week traveling higher by about 7.3% respectively; given that seat availability is tight, prices could increase further and no last minute madness sales are expected any more from airline companies trying to fill empty seats at the last minute.

Why one should care about the airline industry’s self-discipline about capacity?  As much as we hate such self-discipline as passengers, likely we would have loved it as investors.

Like a Passing Ship!

Like a Passing Ship!

In previous postings we have raised doubts about the shipping industry’s fundamental recovery based on the amount of newbuidings that were delivered in the last few years, and mostly about the newbuildings being ordered today. We appreciate the frustration of investors / shipowners from their market point-of-view as buyers being unable to find quality tonnage in the secondary market for purchase at market related prices, since there are few vessels available for sale given that the system is ‘propped up’ all around: central banks and regulatory authorities with their quantitative easing keeping propped up bad banks which in turn keep propped up bad owners which in turn are allowed to keep trading expensive vessels in default (having earned the banks’ tolerance for servicing properly their shipping loans), and thus expensive vessels have an efficient cost basis to compete with more modern and efficient vessels.

Ordering newbuilding vessels is still a rather tempting proposition: prices are still low, especially when compared to peak market pricing, payment terms for newbuildings are favorable and fairly backloaded, and more importantly, newbuildings are better vessels since they are more fuel efficient and may also provide operational efficiencies as well (usually bigger cargo carrying capacity for same dimensions / asset class vessel.)  The logic goes that a vessel that is 15% more efficient than an existing vessel, she will crowd out the less competitive vessel; whether the vessel were to be employed under a timecharter (where the charterer pays for fuel expenses) or a voyage charter (where the shipowner pays for fuel expenses), the more efficient vessel will offer a lower transport cost per cargo unit, and thus will have preference over the less efficient one.

Looking for Guidance!

Looking for Guidance!

That’s at least what we learned in Economics 101.  What happens when tonnage capacity doubles, as it has or expected to do for certain segments, and there is no sufficient demand for all the available tonnage?  Logically owners will have to accept any charter rate, whether it’s profitable, break-even or unprofitable. What happens when the banks have given up demanding loan servicing from ‘bad’ owners and now these owners – despite their early mistake of ordering peak-expensive vessels – have actually a low cost basis that can remain competitive (only operating cost)? What happens when the ownership and chartering activity is of a very long tail nature, as it is in several market segments in shipping, most conspicuously for the smaller dry bulk vessels? There are jurisdictions and charterers who would accept such vessels that can be kept profitably trading when they are well past their design lives (although clearly top, big charterers would prefer modern, economic vessels, for many reasons.)  What happens when shipowners refuse to scrap vessels when they become economically inefficient? (admittedly, selling a vessel for scrap is a very tough, irrevocable decision that never is taken with light heart).  Frontline, among others, has recently advocated for the early scrapping of relatively new VLCCs in order for the market to get rid prematurely of tonnage that has not yet reached its design life but could clear the way for more efficient vessels and higher freight rates.  As a gesture of setting a good example, Frontline has scrapped earlier than expected a few vessels, and Mitsui OSK Lines over the last year have opted to sell fairly modern capes (sixteen and seventeen year old) for demolition rather than in the secondary market where they could achieve a small premium over scrap. But Frontline has to be a responsible corporate citizen since they are now collectively one of the biggest shipowners in the world and Mitsui OSK Lines is an industrial conglomerate that can absorb losses from shipping; try to explain the logic of early scrapping to independent, trap owners, a long line of them in every sector and in every corner of this planet.

It has been said recently that shipping is not a ‘team sport’ and that certain companies have already been benefiting from the advantages of the ‘first market mover’. No doubt.  One of the ‘charms’ of shipping is the renegade attitude of a worldwide market of perfect competition.  But again, it’s said that shipowners are their worst enemies where self-discipline is an unknown virtue.  Time will tell!

© 2013 Basil M Karatzas & Karatzas Marine Advisors & Co.  All Rights Reserved.

IMPORTANT DISCLAIMER:  Access to this blog signifies the reader’s irrevocable acceptance of this disclaimer and other important information and terms. No part of this blog can be reproduced by any means and under any circumstances, whatsoever, in whole or in part, without proper attribution or the consent of the copyright and trademark holders of this and related websites. Whilst every effort has been made to ensure that information herewithin has been received from sources believed to be reliable and believed to be accurate at the time of publishing, no warranties or assurances whatsoever are made in reference to accuracy or completeness of said information, and no liability whatsoever will be accepted for taking or failing to take any action upon any information contained in any part of this website.  Thank you kindly for your consideration.