Tag Archives: shipping finance

What’s in a number?

Shipping, being an international industry with many service providers necessary to ‘put on a show’, is rather an opaque business by standards long-established in many other industries. It’s not only the potential conflicts of interest and ‘self dealing’ that may be hidden under the cloud of opaqueness, but mainly the fact that many parties in the industry, and for many reasons, use same terminology but different definitions to communicate their message.

In the last decade when shipping was hot due to China’s stratospheric growth and comparable freight rate trajectory, many newcomers, especially institutional investors, started looking into shipping primarily through the public equity markets (think ‘shipping IPOs’.)  More recently, mostly private equity is also is taking a hard look at shipping and acquiring shipping assets. What we find amazing, to a certain extent, is the way information, especially quantitative information, is conveyed that may make certain companies or operators have an advantage or better performance, when in reality the main difference is that a different denominator is used in each case.

When more emphasis was on public equities a few years ago, there was confusion of what were  ‘vessel revenue days’ and ‘vessel operating days’, ‘off-hire’ and ‘utilization rate’, numbers that could affect the ‘Time Charter Equivalent’ (TCE) rate and show that some companies were generating more ‘alpha’ from the market. For instance, vessels have to be dry-docked every so often; a shipowner knowing that they have a dry-dock due coming up next year for a vessel, would they count those ten (approximately) dry-docking days as ‘revenue days’?  The vessel by law has to be dry-docked and those ten days are ‘lost days’ as far as revenue is concerned, no matter what; but some owners were starting their ‘revenue year’ with 365 days for the vessel while others with ten days fewer. Guess which owner has an advantage and why, as far as ‘performance’ is concerned.

More recently, with shipping in turmoil, and a dearth of newbuilding orders (temporarily, at least), shipbuilders had to offer something new, a compelling reason to entice new business in the middle of a deadstill market. How about efficiencies then, namely fuel efficiencies? With bunker prices high, fuel efficiency was a logical card to play. Now, we are not claiming to be naval architects and marine engineers, and also we do not claim that certain yards didn’t work very hard to improve indeed vessel designs. On the other hand, we have seen designs with claims of 30% in fuel efficiency, something that would require a revolution rather than evolution in the science of naval architecture, something that regrettably didn’t happen recently as far as we can tell. But again, some of these efficiencies were due to the fact smaller engines were used to propel the same vessel (definitely lower fuel consumption but at a trade off of under-powering the vessel and increasing the chance of an accident); other efficiencies were calculated at different drafts of the vessel than design draft, assuming certain conditions of trim that were placing limitations on the trade of the vessel, certain (favorable) weather conditions, etc.,  or the result was based on comparisons against patently outdated designs or poorly maintained vessels.  We understand that improvements in fuel efficiency are usually limited at the very best to less than 15% based against previous designs, ceteris paribus. We are not claiming that 15% in fuel savings is a negligible concern, but it’s quite different making an economic decision on whether a company should be undertaking multi-million dollar commitments for newbuildings based on baked information of 30% in fuel savings.

Now that passive investors such as private equity funds (passive at least in the form of vessel management) have been looking for third party vessel managers, vessels operators and pool managers, certain definitions have been stretched to the limit.  Under pool employment and third party vessel management for instance, the more of the vessel expenses and downtime the pool manager passes back to the vessel owner, the better the pool results, which not only means more profit for the pool manager, but mostly, better pool results to brag about that will be used in presentations to convince more owners to bring vessels under the pool. Repositioning a vessel? It may be an ‘owner’s item’, as far as some pool managers can tell. Ballasting a vessel to a loading port? Also, it could be an ‘owner’s item’. Loss of hire due to vetting and port state control inspections? Ditto.  Similarly for technical management, how much of spare parts have to be kept onboard the vessel? Is it an expense or an investment? How about the cost when a minor part is missing and the charterer places the vessel off-hire and refuses to pay freight for the downtime? How about the reputation and goodwill a vessel and her owner create with the chartering community by providing well equipped and maintained vessels? How about the higher demand and potentially higher price the vessel will obtain in the secondary market later on with the vessel coming for sale from a ‘good stable’, as the shipping lingo goes?

It’s the holy grail of business gurus, business schools and management experts  reaching for optimization; not to mention the genuine goal of many good companies and managers. And, no doubt, there will always be debated among bean-counters whether certain business cash ‘outflows’ are expenses or investments / capital improvements.  After all, that’s the ‘nature of the beast’.  On the other hand, there should be a certain amount of transparency on how certain numbers are achieved by the companies, the managers, the pool operators, etc But more importantly, parties receiving such information should look diligently ‘under the hood’ and demand a thorough explanation on how the numbers are defined. Just because one manager is ‘cheaper’ than another, or one pool is ‘better performing’ than another, etc is immaterial unless a common denominator can be established.  As they say, the devil is in the details, and sometimes such details can offer surprises.

© 2013 Basil M Karatzas & Karatzas Marine Advisors & Co.

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The Winds that Crested a Newbuilding Wave in the Middle of a Shipping Cycle Trough

It has been said that if you are in the shipping business, you have to be an optimist by nature. And, optimism with the boatload we have been having over the last few years despite a few bad days here and there …

In a chart in a previous posting, we noted that newbuilding orders placed so far in 2013 are already more than the orders placed in the whole calendar 2012. A proxy index for the market (BDI) in the same graph indicates that we are not faring much better in terms of freight level since last year. So, why the excitement?

The recent newbuilding wave cannot be attributed to any factor alone; however, ever since post-Lehman collapse, many factors have been simmering and eventually are finding an escape valve in the newbuilding market.

For starters, after the collapse, every shipowner and institutional investor worth their salt, they have been salivating about ‘cheap ships’, ‘distressed sales’ and the great number of vessels the bankers would be auctioning on an industrial scale. By now everyone knows that that ‘dream boat’ of business never came to port. The banks held onto the assets, and the ‘cheap ships’ that were sold were few and between, especially if one focuses on good quality, market competitive tonnage.

And, the shipbuilders, who quite a few of them were picking off the shelf designs and started experimenting on a commercial basis (aka ‘greenfield yards’) during the bubble, thought that if they were to manage to convince anyone to sign a new contract in a bad market, they better had to come up with improved designs. We heard of 30% efficiencies, etc, but once all is said and done, all else being equal, on average ‘eco designs’ are about 10% more fuel efficient than ‘average’ vessels. Still, 10% in savings in fuel for a small handysize bulker burning about twenty tons per diem, the savings are about $1,500 pd (nothing to sneeze at when freight rates are below $10,000 pd), savings that nominally add up to $14 million over the vessel’s life (nominally about 60% of a newbuilding’s price). Just imagine what that 10% in fuel savings means for a big vessel that consumers five times as much bunkers as our Lilliputian ‘handy’.

And, the shipbuilders didn’t stop at the ‘eco design’. The sweetened the terms for newbuilding contracts with back-loaded payment structures (30% on signature and 70% on delivery, instead of a more gradual and traditional ‘progress payment’ structure of 5×20% at meeting certain construction milestones.) And, why not, they even got their perspective governments to provide export credit to their qualified buyers, and, in other instances, managed to pocket a few subsidies for themselves as well. After all, they were creating jobs, and helping keep the market oversupplied with vessels (not a goal to be ignored to countries like China).

And then, there were the central bankers worldwide priming the system at levels unforeseen in history, probably for good reasons given the financial scare ensuing the Lehman collapse, keeping interest rates at very low levels; and, more importantly, promising to be doing so for the foreseeable future and ‘at any cost’, using emphatic language to ensure that all got their point crystal and clear. Low interest rates reflectively also mean that the ‘opportunity cost’ for the cash rich buyer is small enough to be ignored, which makes the prospect of a newbuilding even more enticing.

And, while in previous downcycles the market was dominated by strategic players like the shipowners, the cargo owners and the shipping banks, this time things are indeed different. Quite a few of entrants to the market, and some of these new entrants to the market are with deep pockets that could make even rich private shipowners look like paupers, are institutional investors and private equity funds that have raised or have access to multi-billion dollar pockets of money.

So, there is a market when vessels in the secondary market should be cheap but no there is no activity on grand scale, when the market index is less than 10% of its peak (see graph) implying both that sooner or later has to improve and also that till then the ‘revenue forfeited’ will be smal , when the payment structure for newbuildings is favorable and the financing cost low, when the Siren Song of the ‘eco designs’ promises that fuel efficient vessels will crowd out their older siblings even in an oversupplied market when vessels will be idling, and, finally, when in two years we will be reaching the average shipping cycle length (two years is just about the time to get a new order materialize in the form of a new vessel), one can only start appreciating the newfound excitement for newbuildings!

© Basil M. Karatzas 2013 All Rights Reserved  

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Values, Long-term Values, and Vessel Valuations

In an article published a few years ago in the Tanker Operator, a well-respected trade publication about the tanker market, we had discussed the three primary methods of vessel valuations: a) the market comparable approach, also known as ‘last done’ in shipping, b) the replacement cost method, and c) the income approach.

Each of these three methods has its advantages but also shortcomings, and each method may be better suited under certain circumstances. The market comparable approach reflects what the market will pay for an asset in nakedly materialistic, ‘cold money’; this approach is the default method for vessel valuations in standard loan agreements, but it’s also an approach susceptible to the ‘animal spirits’ of the markets, opaqueness, illiquidity, market dislocations, and all.  The replacement cost method has been burdened by its backward-looking mentality and dependence on ‘historical cost’, and thus this approach has been limited to valuing unique, customized and non-mainstream assets.  The income approach ought to be the preferred way of valuing vessels (and all sort of investments) since it depends on expected earnings during the asset’s remaining economic life. However, as ‘fundamental’ or ‘intrinsic’ this way of valuing assets may be, the devil is in the details, as they say; since expectations for future earnings can vary widely based on many factors, including the ability to generate them – a more competent investor (buyer) can generate more profits than a poor performer, and also the cost of capital – better capitalized investors (buyers) have a more effective capital structure with lower costs, the income approach valuation methodology can lead to a wide-ranging values. In the hands of a scrupulous valuator, the income approach may be just a weapon of ‘mass destruction’ to work ‘backwards’ and generate any price for the price of the asset; just presume future earnings trends and justify a low discount rate, and voilá, the price can appear out of thin air.

There have been ‘variations on the theme’ for the income approach, such as Discounted Cash Flows (DCF), Net Present Value (NPV), etc. An income approach variation unique to shipping has been the method suggested by the Hamburg Shipbrokers Association (HVSS) three years ago and has been known as the Long Term Asset Valuation method (LTAV), also known as Hamburg Ship Valuation Standard (HSVS), also colloquially known as the ‘Hamburg Rules’ of vessel valuations.

It has widely been debated whether the ‘Hamburg Rules’ is a proper valuation methodology since the formula inputs for future earnings are ‘backward looking’ dependent on the ‘past performance’ of the last ten years (including the years of the unique super-cycle of freight earnings) will be achievable going forward (as proxy of future earnings, the average of freights for the last ten years is inputted.)  Likewise, the discount rate suggested by the Hamburg Rules has been debated that could only be achieved by exceptionally well-capitalized companies at times that the finance cost is historically too low.

But again, when the market is so illiquid and the market comparable approach can only have indicative consequence, a valuator needs all the help they can get in order to value a vessel. For instance, in the last three years, only four VLCCs up-to-four years old have been sold. Not sure that the market comparable approach offers any better guidance on pricing than the ‘Hamburg Rules’ approach. Probably ‘gut feeling’ is a much better approach, although no self-respected valuator or accountant will accept such approach; but again, shipping is a poorly model-able industry.

In providing vessel and shipping valuations and marine appraisals and surveys, our firm Karatzas Marine Advisors & Co employs highly qualified professionals with Accredited Senior Appraiser (ASA) by the American Society of Appraisers for Machinery and Technical Specialties, Accredited in Business Valuation (ABV) by the American Institute of Certified Public Accountants (AICPA), Certified Marine Surveyor (CMS) by the National Association of Marine Surveyors, among their many qualifications.

© Basil M Karatzas 2013 – present    All Rights Reserved.