Teaming up with shipping

Historically low vessel values make the shipping sector ripe for private equity investment, argues Watson, Farley & Williams' John Imhof. But will the global shipping market rebound?

After a long courtship, private equity and shipping are finally teaming up. Over the last few years, private equity funds closed shipping transactions worth more than $6.4 billion, according to Marine Money International.  

Fund managers sense opportunities in the market, including providing much needed capital to ship owners who are seeking new sources of capital in tighter credit markets and acquiring loan portfolios from the traditional ship finance banks.  Many funds acquiring distressed shipping loans are doing so with the intent of converting these loans into equity in ships and shipping companies through in-court or out-of-court restructurings.

Although funds vary greatly in size and investment objectives, most of those drawn to shipping have been attracted by the potential to earn high returns on relatively short and medium-term investments. These investments can take the form of sale-leaseback transactions or direct equity in shipping companies or joint ventures formed to acquire, manage and sell ships. The tender and due diligence process and sale/purchase documentation for loan portfolios are also now becoming more efficient and standardised.

Over the past 20 years, the shipping industry grew steadily as privately owned shipping companies expanded to meet global demand. To keep up with these demands, many ship owners placed long-term orders for large numbers of newbuildings and turned to the bank and capital markets to finance their growth.

When the global recession hit, demand for goods from overseas fell, which resulted in the fall of both charter rates and ship values. As shipping companies tried to reduce fleets and find financing for vessels under construction, some banks with large exposures to the shipping market stopped making new loans and struggled to restructure and sell existing loans. Private equity has stepped in to buy existing shipping loans and inject fresh capital into the industry.

Although some funds are looking for long-term returns, most look for high returns on short- or medium-term investments. Tight credit markets and historically low vessel values have offered funds the opportunity to invest in ships and shipping companies with the expectation of liquidating these investments and generating above-market returns when the market rebounds.

The business of owning and managing ships offers great potential to funds but is also very different from other businesses. The laws affecting shipping are often arcane and can vary greatly from jurisdiction to jurisdiction. There are also different laws applicable to ships, ship owners and managers.  Funds must also consider the choice of flag as this can have a significant impact on the operation, chartering, financing and taxation of ships. Moreover, the assets themselves can move from place to place, making investments in ships potentially difficult to manage.

Investments in shipping companies and shipping assets can, if structured incorrectly, expose funds to liability under laws and regulations relating to competition, foreign sanctions, boycotts and foreign corrupt practices. Shipping is also subject to special environmental laws and regulations, including the United States Oil Pollution Act of 1990. There are, however, certain ownership structures which limit liability and facilitate financing.

Most countries do not tax international shipping income if the shipping company is located in a country with appropriate treaties or shipping and navigation agreements exempting their own shipping from taxation in other jurisdictions. The United States, however, taxes shipping income based on voyages to and from the United States unless the shipping company and its owners qualify for an exemption.

Joint ventures with ship owners and managers also come with complex issues, similar to many other industries, relating to control, contributions, distributions, taxation, exit rights, transactions with affiliates, bankruptcy and the allocation of opportunities. Special expertise is needed to ensure these complex issues dovetail with the operation and management of a shipping company, including the negotiation of contracts with shipyards, charterers, commercial and technical ship managers and lenders.

Funds are being drawn to the shipping sector as historically low vessel values have created opportunities to generate above market returns when the shipping market rebounds. Owning and managing ships and shipping companies, whether through direct investments, joint ventures or converted investments in distressed shipping debt, present funds with a unique set of issues to explore when considering the potential offered by these investments.

John Imhof is a partner at Watson, Farley & Williams in New York.

Chris Lowe is the global shipping sector head at Watson, Farley & Williams.