Question: What do the Formula One motor racing franchise, Heinz tomato ketchup, British supermarket chain Asda, and the North Sea safety standby companies North Star Shipping and Esvagt have in common?
Answer: They're all owned by private equity companies, investment houses famed for taking two per cent of their investors' money every year, and twenty per cent of any profits.
Private equity has created some of the richest individuals in the world, including Stephen Schwarzman, the founder of Blackstone, who has a net worth of over US$33 billion, and Jorge Lemann of 3G Capital, which owns Heinz and Kraft. Lemann has an estimated net worth of close to US$17 billion.
Another twenty private equity managers have personal fortunes of over US$2 billion (here). Over the last few years, private equity has extended its reach into the offshore sector, typically buying medium-sized companies based on more stable, longer-term contracts.
Private equity's exposure to offshore vessel ownership has historically been very small compared to its investment in other sectors of the maritime industry. Tufton Oceanic (here) estimated that private equity invested US$32 billion in shipping from January 2012 to January 2014, which was equivalent to 22 per cent of the total value of the world merchant fleet, including ships on order at the time. Many of those deals soured, as both container shipping and dry bulk suffered years of misery until the markets were set on fire this year.
Offshore just has had the misery since 2014.
We've covered other private equity businesses in our review of the cable business (here), where we reflected that over fifteen years of ownership by three successive private equity businesses has left the former industry leader, Global Marine Systems, bereft of investment, and operating one of the oldest and least attractive fleets in the entire global cable-lay segment.
Global Marine's experience of being passed around from a bankrupt dot-com to various private equity owners before ending up being sold yet again to J.F. Lehman and Company in early 2020 (here) for around US$250 million demonstrates some of the weaknesses of the private equity model.
The previous owners seem to have spent more time and effort on financial engineering and milking its historical leadership position, rather than in investing in the business. Aside from some small, cheap crewboats, Global Marine appears to have bought only one vessel for its core cable business in two decades, the 2000-built Maersk Recorder purchased to support its telecoms installation business in 2017. As a result Global Marine has now been surpassed by its integrated competitors in the Big Five (here) and by cable manufacturers like Prysmian, NKT and Nexans.
Listed companies are often criticised for having short-term focus on their quarterly results. Private equity owned companies have a different time frame – typically three to five years, at which point the owners sell out to an industry buyer or another private equity fund, or publicly list the business on a stock exchange (assuming the business has not gone bust in the meantime). The management team is incentivised to maximise cash flow, but typically has little control over borrowings. Private equity's goal is always to exit and sell a business for more cash than it put in.
Three to five years is not a very long time in the shipping cycle and permits little time for investment in newbuildings. There is a temptation for private equity to put more effort into wringing out cost savings and squeezing more cash flow out of a stagnant business, rather than investing for the future or taking any risks in new business development.
Private equity owned companies typically turbocharge returns by taking on debt and paying themselves dividends from the business – often at the same time, in so-called "dividend recaps," where a company takes on new loans in order to pay a special dividend to the private equity owners. Debt also has big tax advantages, as it is offset against profits to reduce corporation tax.
Lacking a public listing means that private equity owned companies that want to undertake acquisitions have to raise more debt, rather than pay in shares in all-share mergers, such as the Tidewater–Gulfmark deal of 2018, or the merger of Pacific Drilling with Noble Corporation this year, which we reported on here.
In Asia, private equity's involvement with offshore has been little short of disastrous historically, mainly because the companies involved did not possess the stable, longer-term contracts referenced above. Affinity Equity Partners bought a 54 per cent controlling stake in Singapore-based shipbuilding and OSV chartering business Jaya Holdings in 2006, financed with a US$233 million loan.
Then the oil price crashed after the Global Financial Crisis in 2009. Jaya found itself heavily indebted, unable to sell ships it was building, and thus unable to pay its shareholders the dividends that Affinity was relying on to service the loan. Jaya went into a scheme of arrangement, and the Affinity special purpose vehicle that held the Jaya shareholding went bust.
Affinity ended up selling the 54 per cent stake to a consortium of distressed debt investors for US$158 million, according to Reuters here. Jaya was subsequently purchased by Mermaid Marine Australia in 2014 for US$495 million.
The story of Miclyn Express Offshore (MEO) is both a disaster and a success, depending on the timing. Having bought crewboat operators Express Offshore in 2007 from Svitzer, Aussie private equity group Macquarie Capital then merged it with Singaporean entrepreneur Michael Kum's tug and barge operator Miclyn Offshore later that same year. Macquarie took out a US$261 million loan to pay for Miclyn (here).
Just three years later, Macquarie listed MEO on the Sydney Stock Exchange with a market capitalisation of US$470 million, but held on to 34 per cent of the shares in the Singapore-headquartered company (here). In 2011, it managed to sell its stake ("dump" in the uncharitable words of the Sydney Morning Herald here) to two fresh private equity groups, Australia's Champ and Hong Kong's Headland Capital Partners. Champ acquired its stake for AU$199 million (US$146.15 million) in September 2012, whilst Headland bought its stake in August 2011.
With remarkably bad timing, the two private equity groups first increased their stakes in MEO, and then chose to double down on their investment and completely buy out all the minority shareholders in December 2013. The company took out a large Singapore dollar bond (here) and the private equity owners stated that they were confident that they could quickly flip the company with a new listing two or three years later (here).
In 2015 MEO refinanced the Singapore dollar bonds for US$150 million notes paying 8.75 per cent interest. And the company had borrowed US$297 million from DBS Bank of Singapore.
The market timing was terrible. MEO posted a total comprehensive loss of US$98 million for 2016, including an impairment loss of US$57 million on its fleet. The US$150 million of principal was due to be repaid to the bondholders in November 2018, and MEO would need to refinance. It was obvious that it couldn't do it.
So, the company defaulted, and went into a scheme of arrangement. Bankruptcy adviser nTan reckoned in 2019 that in a full liquidation scenario MEO would be valued at US$252 million (here), although it wasn't clear who would buy it and how long the liquidation would take.
DBS Bank decided that the business had more value as a going concern, and took 87.5 per cent equity in exchange for writing off its bank loans; the shareholding is held through by an optimistically named special purpose vehicle, Rising Phoenix (here). Champ and Headland walked away with nothing, although they will have taken various dividends and fees in the period that the company was private.
From the company's updated board of directors, it appears that a fourth private equity group, HPEF Capital Partners of Hong Kong, has now also taken a stake in the restructured MEO entity (here). The cycle begins again. Good luck to HPEF.
Esvagt is now owned by Britain's 3i, a publicly listed private equity company, and by Australia's AMP Capital, which owns a swathe of telecoms towers, hospitals, and real estate through its funds. The Danish-headquartered emergency rescue and response vessel (ERRV) business was sold to the pair by Maersk and Esvagt's founders in 2015, for a price reported in the industry press at the time of US$610 million. At the time of the sale, Esvagt had 43 vessels.
According to its website (here) Esvagt still has a fleet of 43 vessels, but, critically, eight of these vessels are modern wind farm service operations vessels (SOVs), which were delivered between 2015 and this year. Esvagt, arguably, is an example of a private equity owned business with some vision and commitment for the future. Its fleet has been renewed, and it has a new strategic focus in wind, as well as strength in its traditional oil and gas markets.
As we have seen, private equity typically has a five-year time frame, and Esvagt has been under its current owners for six years. As a result, CEO Peter Lytzen has already been dropping hints to the Danish shipping press that its current ownership structure will not last forever.
Given the hunger for wind-based stocks and shares, Esvagt could plausibly follow in the footsteps of Cadeler and list in Oslo, where its proven track record, large fleet, and strong wind presence would likely be attractive to Norwegian investors.
Another option would be a familiar one…
When it sold its shares in Esvagt in 2015, Maersk said that the ERRV sector was outside its core business. Now, with the wind farm industry running red hot, and demand for SOVs soaring, the Maersk Group looks rather underexposed to the renewables segment.
Instead of buildings SOVs, Maersk Supply Services has focused its renewables activity on building an equity position in the subsea mining sector, through its controversial shareholding in The Metals Company (here), in seemingly unsuccessful business development activities in the towage and installation of floating wind turbines (here), and in a curious non-profit enterprise called The Ocean Cleanup, which is devoted to collecting plastic waste from the sea using two large North Sea anchor handlers of 170-tonnes bollard pull, Maersk Tender and Maersk Trader (here).
Nobody has yet explained to me how it is cost effective or scalable to sail around in 10,440kW anchor handlers scooping up litter from the sea, although the new system being deployed now is bigger than the previous ones (here). However, I note that one Maersk press release describes the charter as a "donation," so perhaps this is a nice little tax offset against the parent container company's mega-profits?
Either way, buying Esvagt back might reverse the strategic drift Maersk has suffered in offshore.
North Star was sold by the Craig Group to Basalt Investment Partners in 2017, leaving the Craig family with its global oilfield procurement business, Craig International, a golf retail outlet, and the Kings Links golf driving range. In the Basalt Investment Partners' portfolio, North Star now sits alongside the Madrid Metro, the Wightlink ferry service connecting the Isle of Wight in the UK to England, and a solar electricity farm. From one mixed bag to another.
Like Esvagt, North Star has recently won big in wind, scooping long-term contracts for three newbuild diesel-electric SOVs to work on the Dogger Bank wind farm in the UK sector of the North Sea. The company promptly awarded the shipbuilding contract to Norway's Vard, which is also designing the trio of ships (here). This too should make North Star much more attractive to future new buyers, even as it faces heightened competition in the UK sector in standby services from Sentinel Marine, proud owner of nine "nearly new" Chinese-built ERRVs (here).
But the clock is ticking. As at Esvagt, we foresee a change of ownership at North Star in the next two years as well.
If oil and gas prices rally, we can expect further private equity investments in offshore. Private equity flourishes not in depressed markets, where the strategy of loading up businesses with more loans is unviable, but in recovering markets, where a rising tide allows the new owners to benefit from improved market conditions to sell the company when the turnaround is complete.
Even better for the industry, private equity companies are mostly owned by their very wealthy partners and are not constrained by fears over involvement in oil and gas as public pressure mounts on listed companies in the sector.
Many offshore companies are now owned by their former creditors following the spectacular run of bankruptcies since 2015, which were resolved by debt for equity swaps, where banks and bondholders have taken control of ship and rig owners. These companies owned by their lenders include the largest offshore company in the world, Bourbon, now owned by a consortium of French banks, Vroon of the Netherlands, and nearly all the major American drilling companies. And offshore construction company McDermott, too (although the legacy issues there might just be too toxic).
None of the financiers wanted to own these companies, but like DBS at MEO, they had no alternative when the loans soured and the choice was either to liquidate and lose a lot, or swap the debt for equity and continue with a going concern.
With the oil price above US$70 per barrel stabilising cash flows, and exciting growth stories to be pitched in renewables, many private equity companies will be interested by the now debt-free drillship and OSV owners, which have been restructured. They see the chance for a flip.
We mentioned in the opening part that private equity has created many billionaires in the last few decades. Unfortunately, academic research by Ludovic Phalippou of the University of Oxford in 2020 (here) found that this wealth wasn't the result of outstanding performance.
Phalippou found that private equity funds "have returned about the same as public equity indices since at least 2006… yet, the estimated total performance fee (Carry) collected by these private equity funds is estimated to be US$230 billion, most of which goes to a relatively small number of individuals. If all vintage years are included to 2015, Carry collected is US$370 billion, with a performance similar to that of small cap indices."
So, investors could have simply put their cash into an index tracking fund and they would have achieved the same returns as if they had invested in private equity. But if they had done that, then Stephen Schwarzman and Jorge Lemann would never have become billionaires.
When dealing with private equity, remember – these people don't care about you, your company, or their investors' returns. All they care about are their fees, and for the last twenty years they have been incredibly successful at collecting billions and billions of fees, even as some of their investments (like MEO) have gone bust, or others (like Global Marine) have been driven into the ground.
But given the choice between ownership by the bank or ownership by private equity, many offshore companies will likely prefer the latter.
