The magic of the IRR: Are high returns prompting the return of investment funds in shipping?
The internal rate of return, or simply the IRR, is the magic figure that private equity fund managers, shipping-focused investors and affluent shipowners alike employ to determine if an investment makes sense.
The investment firm recently launched by the prominent Greek shipowner George Livanos and two bankers, as well as the launch of Schulte Group’s shipping fund, has prompted me to explore the power of IRR and engage in some simple number crunching.
Take a five-year-old, 9,000 TEU containership costing $48 million that can be chartered out for three years at $34,000/d. A fund manager with a five-year plan might be able to secure a charter at $32,000/d over the five-year investment period. This may be below market rate but an all-equity purchase of the vessel can achieve a 15% IRR if the vessel is sold, come mid-2023, for $35 million. A leveraged investment could have an even higher IRR.
Might such returns trigger a flurry of newbuilding orders, or will purchases be limited largely to the secondhand market? Newbuilding and secondhand prices usually go hand in hand, and while an investment in a secondhand vessel can produce immediate revenue for the investor, opportunities might arise in the newbuilding market. Is this an industrywide phenomenon or are these returns confined to specific market segments?
On the dry bulk side assumptions are more complicated, with asset play on the rise. Recent sale and purchase reports suggest that a number of owners are cashing in on vessels purchased during the lows of 2015 and 2016. And while those owners are profiting handsomely on the vessels, some dry bulk vessel prices are still seen as being at a discount relative to their earnings potential.
Take a five-year-old 76,000 dwt Panamax vessel purchased all-equity for $19 million, chartered out on an average daily rate of $15,500. If sold at $13 million in 2023, such a vessel could achieve a 10% IRR. A similar return can be achieved with a $9,000/d bareboat charter.
Meanwhile, the downtrend in tanker rates might present opportunities for some, or avoidance reasons for others. Scorpio Tankers, a large tanker owner, has secured a number of such deals, proving that parts of the tanker sector are active.
Does the instability in freight rates discourage fund managers from entering the sector, or do vessel prices override other assumptions?
Although some returns can appear as an invitation for cash-rich fund managers and shipowners, speculation based on the expectation of such impressive returns results could hinder the recovery in some sectors.
On the other hand, shipowners looking to reduce debt could approach investors with sale-and-leaseback deals. Such deals allow owners to clear debt off their balance sheets and replace it with stable monthly payments, while taking advantage of their perceived ability to secure higher earnings on the vessels’ operations.
Might this recent spur of funding availability lead to a credit risk overexposure all over again? I am hopeful that both fund managers and shipowners do their math and keep in mind the industry’s long history of costly financial missteps.