Published in: 2011
Matthew McCleery is an advisor at Blue Sea Capital and has been a board member of two Greek NASDAQ-listed shipping companies, a hedge fund and several shipping organizations. The book, which is fiction, is about the fictional Robert Fairchild’s journey from a smooth hedge fund manager to an experienced and rugged shipping man. Fairchild accidentally stumbles across the Baltic Dry Index, which is the start of a global shipping adventure. In a drunken state, he buys his first ship (a 35-year-old “old lady”) from a Greek. Fortunately he starts in a strong market, is rescued from Somali pirates by a Norwegian shipping magnate and then takes a job with him.
STRONG MARKET DUE TO CHINA’S BOOM. When China joined the WTO in 2002, one of the strongest shipping periods in world history began. China’s thirst for raw materials combined with huge export flows led to a rarely seen imbalance in supply and demand for ships. With the high freight rates that followed, new investments could be rationalized and the world’s shipyards was running in overdrive. In the same vein, the Greeks took the opportunity to list their shipping companies on Wall Street – a total of 20 were listed between 2003 and 2008.
A GAME OF COST’S. Shipping is about (1) paying the least for the vessels, (2) having the lowest operating costs and (3) having the lowest cost of capital. There are no economies of scale in the sector – it’s all about the spot market. Everyone except the shipowners have a stable earnings. Ship brokers, investment banks, shipping banks, charterers, operators, lawyers and flag states all gets paid well for their services.
THE FREIGHT COST IS NEGLIGIBLE. The shipping cost for an item that costs EUR 20 for the end customer is often only a few cents. As a result, the market is not particularly sensitive to a doubling of the freight price. But for the owner of the ship, ten cents can mean bankruptcy, twenty cents survival and thirty cents immeasurable wealth.
FLAG OF CONVINIENCE. Everything in the world of shipping takes place offshore and the sector has a “Wild West” character like few other. A large part of the world fleet is registered in “flag states” such as Panama, Liberia, the Marshall Islands, Malta, the Bahamas, Cyprus, Antigua and Barbuda and Saint Vincent. What these countries have in common is that they offer convenient regulations (for everything from ship safety to personnel issues) and non-existent tax levels.
ANONYMOUS BEARER SHARES. In the shipping sector, the instrument “bearer shares” is sometimes used. The holder of these is entitled to the company to which they relate. If you lose the shares, you lose the asset. Within the world of shipping, the “lose” option can have a great value, as you do not want to be the owner of, for example, old ships that break down and release large amounts of oil into the sea.
LAST MAN STANDING. When freight rates are low, it’s all about survival. The faster competitors’ scrap their ships, the faster the market improves. Everyone is patiently waiting for the weakest player to let go. In a bad market, a ship can have a value far below the liabilities it carries, but still have a large option value since a strong market can be just around the corner.
VALUED ON PERCEPTION. The value of a vessel is dictated by the market’s estimated future cash flows. Current earnings are not important, it is the future that matters. The option value is often a large part of a vessels value. The best buys are usually vessels that have a weak or negative cash flow. A cheap ship with a strong cash flow does not exist – then it is not cheap, then the market is good.
AMEND & EXTEND. New vessels are often financed with 25% equity and 75% debt. This can seem sketchy in a world where asset values can double or halve overnight. However, the accounting rules are generous and vessel values very rarely need to be written down. A vessel can be valued based on aggregate undiscounted future cash flows over the next ten years, based on average rates over time.
A CONTINOUS CASH SWEEP. Skilled shipping magnates empty their companies through dividends in good times to have secured capital for new investments in a bad market. In a bad market, lenders constantly carry out a “cash sweep” so as not to be forced to set companies in default – and thus write down their loans. In this way, strong balance sheets are never built up over time within the sector.
THE SPOT MARKET DICTATES. Many US investors have been burned in the shipping sector by investing based on historical financial figures. A shipping company’s book values say no more than what the company paid for the vessels. Even week old financial figures may have become useless. All that matters is the market’s current and future status. Where the previous quarter was good, the coming may be the worst ever, or vice versa – the spot market decides.