A colleague’s piece I read recently mixed up some of his financial terms in an obvious market shorthand manner that reminded me how seasoned investors fudge their numbers such that they can side with momentum (‘Mr Market’) when they please, but only through passing risk-returns onto others.
If we go back to what got shipowners in their mess post-2008, it was cheap capital and over-ordering of ships. We are not going back to the exact same problems because banks this time are holding back loan capital from shipowners, even good shipowners. And this has forced on a new problem.
When we look at the cost of capital we need to remember that the cost components of debt and equity are completely different. In short, long term we want a balance of financing between debt and equity based on an optimum capital structure. We all remember the 70-80% ranges for asset level debt finance. At a corporate level this figure might be higher or lower, depending on corporate quality and risk taking.
But what we have now is a pear-shaped mess. On the one hand we have high leverage players either hanging on by a thread or working through the mess of assets they got in at recent cycle highs.
And then we have a combination of new capital and survivors financing principally through equity cash raises.
Recently, we saw quite a few 9% type structured equity (ie, cumulative preferred shares).
And all through the post-crisis periods we have also seen share placements with large discounts or share sales that effectively kill off share prices, most recently Nordic American Tankers and Diana Shipping. But also others.
Often, these have been opportunistic placements just at a time of a small recovery in shares, followed by irresponsible banker and shipowner behaviour killing off their shares.
What these owners and bankers have often missed, or more likely wholesale ignored, is that there is a cost to equity, which is far higher than debt.
We need to focus on the new capital raises from these old and new ship investors. The older guard is made up of established fund or private equity type investors. And many of these are using 100% equity finance.
When we look at WACC, the weighted average cost of capital, equity is usually a far more costly component – and yet many in the market behave as if it is free. Including the long-term tested investors.