Whenever a theory appears to you as the only possible one, take this as a sign that you have neither understood the theory nor the problem which it was intended to solve.
― Karl Popper
Distressed investors searching for a capital intensive investment thesis have set their sights on the shipping industry. It is not so much the conclusion, but the timing of this decision that highlights many of the challenges facing the alternative investment asset class today.
Shipping companies have been facing challenges for several years. The high cost of additional capacity and long production lead times left the industry flat footed when, following heavy investment in the middle of the last decade, shipping companies began taking delivery of new vessels at a time when the prognosis for global growth was unclear at best. Predictably, rates plummeted; and while the worst of rate pressures may have passed (based on the ClarkSea Index), the environment remains challenging.
Signs of Improvement
In recent months the combination of a clear turnaround story (rates having rebounded from a frightening market bottom) and a broad range of entry points (loans to shipping companies totaled $460 billion in 2013) has resulted in considerable private equity interest. The pressure regulated lenders are facing to divest themselves of riskier loans is also seen as a net positive, as eager sellers tend to be less savvy negotiators.
A Problematic Investment Thesis
The pitch is clear, what could go wrong? Two things:
1) Over–Optimism. It seems that the challenge investors face now is the over-optimism of their peers. With reports that some loan portfolios are receiving bids from as many as 20 prospective buyers, enthusiasm could easily dent the historically rich returns that distressed investors have generated, and that their LPs continue to expect.
2) Timing. There is a very real possibility that, in waiting for a clear opening, many distressed investors allowed the best investment opportunities in shipping to be seized by their more risk-tolerant competitors. Undeniably some investors moved faster than others on this opportunity. Diamond S Shipping, a shipping company in which Wilbur Ross holds a 32 percent stake, filed for an IPO recently.
Classically, distressed investing has been most successful during periods of ambiguity. When the consensus view is that an opportunity is a sure thing, most of the potential gains will be consumed by me-too investors. Buying when others are selling, and selling when others are buying is a storied and very successful template for distressed investing. It remains to be seen if the current crowd me-too distressed investments will generate similar returns.