Unlike other capital assets whose value depreciates over the economic life of the asset, ships are known to appreciate in value if markets are strong. When freight markets are exuberant, the value (price) of ships can appreciate as investors expect stronger cash slow streams and higher earnings. It’s not unheard of ships having doubled or trebled in value in a matter of years, generating exceptional windfalls for their owners.
It is said that much more money in shipping has been made by timing the purchase and sale of ships by an owner and benefiting from the asset appreciation rather than by generating operating profits. And, conceptually, this is true: over the long term of a business cycle, as markets are efficient, the operating profit cannot be much higher than the risk undertaken from investing in a ship. On the other hand, as shipping is subject to myriad variables – a few of them beyond the realm of logical projection such as geopolitical events or natural disasters – volatility in the shipping spot freight markets is notoriously gigantic (both VLCCs and capesize vessels in the last decade experienced spot rates ranging from $1,000 per day to $200,000 per day), ships prices can vary accordingly.
There have been cases of ships that have doubled or trebled in value in a matter of a few short months, even – and, inversely there have been cases where ships have collapsed in value in a matter of weeks (actually, there has been a well-published Harvard Business School case study – to which we have contributed, whereby two sistership capesize vessels were sold a few months apart in 2008 at a price differential of more than $90m. By timing the market decently, many a shipowner have made a fortune in the last decades by just buying and selling vessels at the right time.
The 2008 market correction saw a precipitous drop in asset prices. Many buyers hoped for vessel acquisitions at distressed prices – mostly from fire sales from shipping banks, but really only a small portion of vessels mortgaged with bad loans ever got to be sold cheaply. There was no doubt in the minds of many people that 2010 asset price levels were strong buying opportunities.
Once the markets normalised, 2012-2015 saw a tremendous interest in newbuilding vessels, which, by boom-year standards, were at competitive prices; and, of course, shipbuilders did their best to encourage more newbuilding activity by actually sharing the subsidy windfalls from their governments with international buyers of newbuilding ships.
Let’s say that a market recovery did not play out as expected and 2016, for the dry bulk market, saw one of the worst times on record; freight rates and asset prices just collapsed. As a matter of proportion, 10-year-old dry bulk vessels were selling in early 2016 at twice their scrap value, while historically ships of that age would be expected to sell at approximately 5x their scrap value. Once again, 2016 was a screaming buying opportunity in the mind of many people, of buying “cheap ships”.
Fast forward two years later, dry bulk asset prices are higher than the lows of 2010 and 2016; but, really, not exuberantly higher; and, definitely, no higher than the highs of 2013-2014. Yes, there have been cases of ships getting flipped at double their purchase price between the low and the high, but such evidence is limited to one-off deals, older tonnage, or transactions where the seller had to sell at any price.
The tanker market, the other main commodity shipping market that’s prone to asset flipping, has experienced similar trends, only in a different sync cycle than dry bulk. Tankers actually are at a cycle low at present with the trade of crude oil being dislocated by OPEC’s production cuts and the boost of shale oil in the US. Tanker asset prices are low – so much so that an institutional investor recently sold a vintage VLCC for scrap – which was bought three years ago; the sale was at a loss by our calculations, and much pre-maturely than the expectations of the tanker’s economic life. Making money on this cheap but vintage supertanker did not work out.
What has happened to the asset play game in commodity shipping? Is the game over? Freight rates still are fair and dry bulk vessels generate positive cash flows; what would it take to pull prices up from the depths of the 2016 crisis?
We wish we had a crystal ball on this, but we think that making money by flipping ships these days is not the ‘game’ it was. The market is getting more complicated, more efficient and transparent, and more demanding; higher demands by all: bankers, charterers, operators, regulators, etc. And, ships have been evolving, and they have to catch up with new regulations; it was ballast water treatment management last year, it’s emissions this year, likely it will be IoT and bunkering fuel in the next few years. And, likely many more factors to worry about.
And, cheap and plentiful financing leverage to lubricate the market to make purchasing of ships easier is only getting costlier and more complicated. And, lack of cheap leverage, among other things, has kept a lid on asset prices.
I’m not saying that asset play is dead; ships seem reasonably priced in today’s markets. But, asset players have to have access to capital and buy opportunistically fleets (not just a ship) when the timing is right (i.e. Angelicoussis and Ofer Groups in the past), and also have the flexibility for financial structuring (while Star Bulk sold have their capesize fleet (at a major loss) in 2016, now they are consolidating the market by paying in paper (shares) to acquire the Songa dry bulk fleet and the Augustea Atlantica / York Capital tanker fleet). By buying and operating fleets, they give themselves the benefit of finding employment with established charterers, accessing the banks and capital, having an operating platform – if the asset play does not work out, they will have the capacity to sustain the cycle and go for operating profits.
Borrowing from a credit fund at 10% interest to play the asset game for one or two ships is like playing with fire. Even worse if the asset player has to put 100% of the purchase money up by themselves.
Several shipowners tried to raise capital since the 2016 crisis based on the investment thesis that buying cheap ships pays off. We are aware of no institutional investor who actually paid much attention to the theme or even funded any project since 2016, despite the tempting theme. At least, some lessons have been learned on this matter from the past.
Still shipping is an exciting industry and there is money to be made. But for now, the asset play game is not the way to make money in shipping. At least not by playing the same game with the old rules.