The Industrials Group (Part Three): Maritime Shipping Investment Banking

Last time around, we looked at how you transport capital goods and products on the ground via trucking, railroads, and everything in between.

But sometimes oceans, or at least very large lakes and rivers, separate your cargo from its final destination.

Barring the ability to walk on water, you’ll have to use maritime shipping to transport your goods in that case… and just as banks dedicate groups within their industrials coverage teams to capital goods, transportation and logistics, and aerospace and defense, they also have dedicated teams for the maritime shipping sector.

Unlike road transportation, which depends heavily on the consumer / retail sector, or rail transportation, which is strongly linked to commodities, maritime shipping is much more global in nature because clients are often located halfway across the world.

Here’s what we’ll cover as today’s voyage sets sail:

• Who gets into maritime shipping investment banking
• What the maritime shipping sector covers, key metrics, and drivers
• Valuation, modeling, sector, and company analysis
• What exit opportunity port you’ll pull into after your cruise is over (NB: OK, this is IB, it’s more like a ride on the Titanic)

All Hands on Deck

Q: Maritime shipping is pretty niche as far as sector coverage groups run, so what’s your story? Were you always interested in this sector?

A: You’ve brought up attributes common in successful investment banking analysts and associates here before.

I actually like this quote by Cortana, from the Halo series:

“They let me pick, did I ever tell you that? Choose whichever Spartan I wanted. You know me. I did my research. Watched as you became the soldier we needed you to be. Like the others, you were strong and swift and brave. A natural leader. But you had something they didn’t. Something no one saw… but me. Can you guess? Luck…”

Part of the job is being in the right place at the right time; the rest is about being personable, knowing how to sell your value proposition and how to build the best relationships.

I’ve met guys from top schools who are great with spreadsheets and accounting work; these guys claim you need to be super-sharp to succeed, but I don’t agree entirely – yes, you need to know what you’re doing, but at the margin it’s much better to be the most likable person rather than the technical jockey.

I wasn’t a sailor before I joined this group, if that’s what you’re asking. I walked in and was placed in this group very randomly – I just wanted a team that would keep me busy.

It didn’t matter if I’d be looking at machine gun makers or jewelers – I only knew I wanted to get some solid deal experience.

Q: So it sounds like they don’t have a strong preference for certain industry backgrounds?

A: I don’t think so, at least not as much as in a group that’s very different technically such as FIG or metals / mining.

The placement process depends on where there’s the most demand, and where they can put people. The whole match thing is a “nice to have,” but not a “must have.”

Hoisting the Flag: Industry Overview

Q: OK, so then where exactly do you usually see these maritime shipping groups at banks?

A: Depending on the bank, maritime coverage can fall under transportation, industrials, or even oil & gas.

No, there are no harbors in the middle of Texas, but there are plenty of clients who want to transport petroleum internationally. The coverage will be placed within the oil & gas vertical if the group focuses on companies that specialize in oil tankers.

As for the companies we work with, our coverage encompasses all companies that operate vessels to transport goods, including liquids.

Similar to airline companies, these shipping companies may or may not own the vessels themselves. So just as with airlines and restaurants, you run into the “own vs. rent vs. partially own vs. lease” argument here as well.

Geographically, the world’s biggest shipping hub is Singapore and a few others in Asia, such as Hong Kong and Shanghai, are catching up or are at the same level depending on how you measure “big.”

Many IB groups in Singapore focus specifically on maritime shipping since it’s such a huge industry there.

In Europe, the Netherlands also had one of the world’s busiest ports (Rotterdam) until it was overtaken by Singapore.

Q: Great. So before we jump into the technical details of the sector, can you tell us more about the different types of vessels and the various parts of the maritime business?

A: Sure, here are the most common types of vessels:

• Tanker: Mostly of the oil tanker variety.
• Gas [Carrier]: These usually carry liquefied natural gas (LNG) or chemical gases. You might even find them fully refrigerated.
• Dry bulk: Anything you can’t package: think cement, grain, coal, etc.
• Container: These guys carry most of the world’s non-bulk cargo.
• Cruise: These are the ships that roll around the Caribbean or the Aegean and act more like floating hotels rather than like places to take you from point A to point B. For fun, the top cruise line operators include: Disney, Celebrity, Princess, Royal Caribbean, and Carnival.

Here’s a sample list of the makers behind maritime vessels (please note the geography of these companies).

Q: So what drives the maritime sector?

A: I would begin this discussion with the first page of this presentation. It reminds me of the cycle for the economy: there will be ups and downs.

The second page of a similar discussion from the year prior has some great information as well. If anything, these two pages give you some hints on how a sector update might be structured.

Naturally, the health of your client is going to influence how your company performs to a certain extent.

I remember once in analyst training, the instructor asked us about what drove a particular restaurant’s valuation. Well, surprise, this restaurant’s customers consisted of financial professionals – so the health of finance companies could be used to assess the macroeconomic drivers of this particular restaurant’s performance.

In this same way, a company such as Eagle Bulk Shipping lists basic materials, agriculture, and chemicals as cargo, so all of those sectors will influence its performance.

JPMorgan’s Maritime Investment Fund confirms this thought: bulkers are driven by commodity demand, tankers by oil demand, and containerships by consumer retail demand.

Aside from the cargo, where the vessels can port will influence a maritime company’s health. It’s the same issue as airlines having access to certain airports and not having access to others.

The volatility of charter rates is also important when selecting which vessel to specialize in. The number of ships in construction, safety, traffic congestion, and the number of out of service vessels all influence the supply of maritime vessels.

Within the company itself, you actually take a perspective similar to how you would analyze an airline company: how old is the fleet of vessels and how similar are the individual ships to one another?

These two points directly influence the operating costs of the company.

If the vessels are old, obviously they’re going to need more maintenance compared to newer vessels. If your fleet shares a set of common parts, that’s going to be significant cost savings right there. You’re also looking at the capacity of these ships in terms of dead weight tonnes.

Transport contract length and terms also drive a company’s performance.

Generally, the shorter term ones (1-3 years) provide a higher utilization rate and less cash flow volatility. Most of the time, you see fixed semi-monthly payments in advance with those.

You may also see profit-sharing arrangements in order to distribute the risk of the journey.

Maritime companies approach profit maximization by balancing long-term transport agreements with short-term transport agreements; these companies will also spread their fleet across a variety of routes that are exposed to different sectors.

You could say the route from Brazil to China is fueled by commodity prices, for example, or that the route from China to the US is fueled by consumer prices.

Vessels without fixed charter rates may have their rates tied to a particular index, such as the Baltic Supramax Index, and may keep their agreements to one year or less. A shipping company’s clientele might also include other shipping firms, simply so they can expand their shipping capacity.

Adjusting Your Sextant: Financial Analysis, Valuation, and Pitch Books

Q: So let’s talk technical, what do you look at? Any exotic metrics or multiples?

A: When it comes to intrinsic valuation, we’re talking: DCF – no, not Discounted Cash Flow, but rather Distributable Cash Flow.

It’s basically EBITDA less Capital Expenditures. For a maritime company, capital expenditures can be extremely high and they may include: reserve expenses paid, replacement capital expenditures, and dry docking fees.

CapEx can be so high for shipping companies that it’s even more misleading than usual to use EBITDA as a “proxy for cash flow,” so you see Distributable Cash Flow more often.

While you use the Cost of Equity or Weighted Average Cost of Capital for the discount rate in most sectors, certain maritime companies will look more to the “required rate of return,” particularly those firms with Limited Partners.

You can determine the value to General Partners by calculating distributions made to them.

Many maritime shipping companies have this GP/LP structure, which is completely different from most other companies; this structure is something that you usually see at PE/VC funds and hedge funds.

Comparable Company Analysis also differs from other sectors. For starters, the equity value can be separated into what’s attributable to General vs. Limited Partners.

Next, operating leases can influence the net debt calculation because many operating leases need to be re-classified as finance leases in this sector – even before the IFRS 16 rules came into effect (see: our full tutorial to lease accounting).

You see Debt / Capital, EV / EBITDAR, and Price / DCF as common multiples here.

Q: OK, so you mentioned a few things there I want to ask about, but let’s start with EBITDAR. I’m assuming you use that since companies rent their vessels and others own their vessels?

A: Yeah, exactly. EBITDAR adds back the rent or operating lease expense; you also see this metric when you’re analyzing a set of airline companies where some own and some rent, and the point is to normalize between different accounting standards, not to “approximate cash flow.”

The decision to rent vs. buy is mainly a decision about what will influence cash flows: if you own the vessel, you are going to deal with the usual depreciation expense, and if you don’t – you escape that line item, but now you have the annual rental or lease expense to deal with.

Q: Great. And then on the operating vs. capital lease issue, I’m assuming you look at that in-depth in this sector?

A: Yeah, you could say that. Sometimes, we’ll analyze and model each ship individually, or maybe take an “average ship” that a company owns in a specific class and then multiply by the total number of ships in that segment.

Occasionally, you’ll see cases where the total value of the company’s ships minus liabilities might be greater than its current equity value, or even the company’s Present Value from a DCF.

It’s important to get the lease issue correct because you also use a Net Asset Value (NAV) model in this sector.

To make things confusing, this NAV model is once again different from the variations you see in oil & gas, metals/mining, real estate, and insurance.

It’s probably closest to the real estate and insurance variations, though: you estimate the value of the company’s assets and then subtract out associated liabilities.

These sometimes include a discount if they are privately held (there is a valuation premium for information and liquidity).

There are a lot of uses for NAV once you calculate it, from using it in a replacement cost analysis to estimating the appropriate purchase price or disposal value in a deal, or simply comparing the valuation it produces to those from other methodologies.

Q: Sounds pretty good.  Anything more to add on valuation?

A: Hmm… precedent transactions are pretty standard and include a date, transaction value, and the relevant multiples for each deal.

But some exhibits can include specific acquisitions by category such as minority buy-ins. The more qualitative issue is what sort of control is associated with buying a significant, but not majority, stake in a company.

Q: Well, that was quite comprehensive, thanks for the detailed explanation.

Got pitch books?

A: Sure do! Here you go:

• Overseas Shipping Group by Lazard
• Arcade Acquisition Corp / Conbulk Corp. by Lazard
• Maritime Update by Bank of America Merrill Lynch
• Capital Markets Update by FBR Capital Markets

Signaling Friendly Ships: Major Industry Players and Readings

Q: So what major firms specialize in this sector? And where are they located?

A: These days, the biggest shipbuilding companies are in Asia (Japan, South Korea, and China), but New York sees a lot of activity when it comes to deal-making.

As I mentioned before, Singapore is another major hub for maritime shipping IB and you see a lot of firms and groups specializing in it there.

Finally, Greece also sees a lot of shipbuilding and maritime activity. Yes, the same Greece that is perpetually bankrupt on land thrives at sea and has one of the world’s top industries – in fact, it’s one of the few industries that has held their economy up through various crises.

Several of the top boutique banks, merchant banks, and investment firms in the industry include AMA Capital Partners (merchant bank), Dahlman Rose (acquired by Cowen – formerly a boutique that worked across commodities, transportation, and other sector), Clearwater Maritime Investments (invests in marine services, ships, and property), Eurofin Group (IB and corporate banking), and the Seabury Group (works across aerospace and transportation).

Q: Awesome, thanks for sharing.

What do you read to stay ahead in this sector?

A: For a good introduction to the sector, check out this equity research report from Dahlman Rose.

Note that the equity comps list there does not include firms with a military presence. Originally, the firms that produce submarines or aircraft carriers were independent.

At the time of this article, one spun off from Northrop Grumman and called itself ‘Huntington Ingalls Industries’ and the other is still part of General Dynamics.

This is significant because any proposed deal gets additional due diligence to check for national security issues.

Tradewindsnews.com is another great resource if you’d like to follow through on this sector.

The presentations section of the Marine Money site is also a great resource and they frequently post presentations from banks there.

Marine Money Offshore can also be helpful if you want to learn more about ships with an oil/gas focus.

Lastly, Capital Link also hosts online talks that include capital markets updates. There is even a “State University of New York Maritime College.” Yeah, that is new to me…

Exit Opportunities: Time to Abandon Ship?

Q: So suppose you arrive at your destination in the maritime coverage group, what’s next?

A: A lot of people, especially headhunters, come to the conclusion that because you covered maritime transport for two years, you are somehow an “industry expert.”

It makes some sense, but not in a way that would limit you. I’ve seen maritime analysts move into tech companies, or even go into hedge funds with a focus on energy. And then you also see people from maritime companies join banks and vice versa.

The advantage of this group is that there’s a lot of overlap with other sectors such as oil/gas, consumer, and even transportation and defense, so you have more exit opportunities than you might think.

Q: Any specific examples of how you’ve seen people moved around?

A: So here’s a specific example: the maritime group head from Jefferies left to do corporate development at a maritime company, while a different maritime company CFO joined the first guy’s old group to become the head.

It’s a very specific sector at the senior levels, so you do see a bit of a “revolving door” effect.

Q: Great, thanks for your time and all these tips. Any parting words?

A: In all of your endeavors: Godspeed.