INDUSTRY - MARKETS

What’s in the value

of a vessel?
Since the start of the financial (and shipping) recession about a year go,
a lot of attention has been drawn to placing values on commercial vessels.*

I
n normalised and efficient markets, the of a comparable vessel, adjusted for age, cargo trading captive cargoes, and were financed ‘in-
price of a vessel is simply what a buyer, carrying capacity, vessel specifications, etc. In house’ with ‘negative carry’ and thus had a low
cognisant of the relevant facts and overall efficient markets, or in shipping sectors ‘cost basis’.
under no compulsion to act, would pay and shipping assets that are fairly liquid, the
to acquire the asset from a knowledgeable ‘last done’ transaction can offer a definite guide Replacement Cost
seller equally under no compulsion to act. for the value of a comparable vessel. The Replacement Cost method is mostly
In less active markets there are infrequent As an illustration, Aframaxes are the applicable to vessels that are uniquely suited for
transactions to maintain a clearly delineated workhorse of the crude oil trade and in certain trades and projects; usually, they have
asset price curve, while several other variables general there are transactions with a been vessels heavily customised for such trades,
may remain highly uncertain and fluctuate semblance of regularity to provide guidance and therefore there are is a narrow demand in
liberally (ie freight rates, availability of debt for asset pricing and valuations. For other the event of a sale. A notable example of
financing, etc); valuing a vessel in such a assets, such as LPG carriers that are not vessels that the author has valued based on the
market can become an intellectual and bought and sold very often even during replacement method include drybulk vessels
sophisticated assignment and subject to ‘normal’ markets (the reasons being – a niche that had been fitted with accommodation and
numerous counter arguments. Since vessel market, comparatively small fleet, hotel services for 120 people, quarter-deck ramp
valuations have been used heavily for comparatively small number of buyers and to load vehicles and tanks, helipad,
accounting and financial purposes, arriving at sellers, higher barriers to entry, long term containership capacity, heavy lift, and steel-
a proper vessel valuation has thus had relationship business, etc), the Market reinforced, humidified cargo holds for the
practical consequences as well. Approach is less helpful. carriage of dynamite (the vessels were on long-
Valuing assets, and shipping assets ie vessels, During inactive markets, the Market term bareboat charter to an operator with a
has been the subject of professional standards Approach faces additional limitations due to contract to supply with provisions military bases
and well-established practices. There have continuous uncertainty in the market despite in the Pacific). Under the replacement cost
been both commercial and academic guidelines the ‘last done’; one needs to keep in mind that method, the vessel is valued on the assumption
to providing an assessment of the value (Fair in illiquid markets a month’s lapse since ‘last of the value of the vessel is simply the cost of
Market Value) of a vessel. In normalised done’ can be tantamount to eternity as supplanting a replacement vessel in the present
markets, the commercial and academic values opposed to a normal market when a month’s market environment. The obvious critique of
usually converge to the purchase price that a lapse is just the continuance of the status quo. such valuation method is that cost to replace the
rational, well-informed investor (buyer) would While the Market Approach is the tangible vessel is not necessarily the price that a third-
pay for the acquisition of the vessel. proof of what the ‘market’ would bear for the party buyer would pay; in short, the historical
However, in a world of high volatility and vessel, the critique for this method is equally cost is not necessarily a market number; in the
uncertainty (ie shipping rates, future estimates important: during uncertain times weak sellers valuation example above, without the military
of earnings, financial inputs and reality, etc), are keener to sell than stronger players and contract, the vessel would have limited
there is room for the ‘animal spirits’ to push therefore, the weak players get to ‘write the commercial value, the high replacement value
market values to widely aberrant levels from history’ book while stronger players can afford notwithstanding.
the intrinsic value of the vessel; while in early not to act if sellers’ price ideas are deemed too
2008 the sky was the limit in terms of values, low. Further, in certain instances, motivation Income Approach
presently we are talking on how low vessel to sell in anemic markets might not The method of most interest for vessel
prices will get. necessarily reflect a sellers’ compulsion to sell valuations is the value (the net present value,
The three widely accepted asset (and thus due to weakness, but the execution of a properly) of all net earnings the vessel is
vessel) valuation methods - Market Approach, strategy that was put in place in different presumed to generate during her remaining
Replacement Cost and Income Approach - can market conditions. commercial life plus her residual value itself
provide a different perspective and insight into There were examples of drybulk vessel sales (salvage value). While the Income Approach
the value of a vessel, and each one of these earlier this year when the owners were just method is the most academically rigorous
methods has its own strengths and intrinsic exercising in-the-money purchase options on method available, and widely accepted as the
limitations at the same time. vessels (options that were priced in 2002 before proper method of determining the value of
the super-cycle and subsequent correction took assets, vessels included, arriving at
Market Approach place) and immediately ‘flipping’ the vessels appropriate inputs to the financial model can
Under the Market Approach method, a vessel is for a profit, or owners who were selling tankers heavily impact the value of the vessel.
valued in comparison to the recent sale that were built at the shipowners’ yard, were The most crucial assumption in modeling
04 TANKEROperator  November/December 2009
 INDUSTRY – MARKETS

Income Approach is of course the projection

of freight revenue, which in turn is based on
Valuation method Tanker type
assumptions of future market conditions of
MR Tanker Aframax Tanker VLCC
(52,000 dwt) (105,000 dwt) (300,000 dwt)
tonnage supply (available vessels to compete
Market approach (FMV) $34.00 $53.00 $96.00
for same cargoes, etc), tonnage demand
Replacement cost $37.00 $52.00 $98.00
(subject to world economic conditions and
Income approach $34.00 $46.00 $91.00
trade and also trading patterns), and also the
Hamburg rules $59.00 $80.00 $150.00
chartering strategy of the buyer (spot market,
PFandbrief Act $34.00 $53.00 $96.00
sequence of short-term charters or very long-
term charters). The cost and availability of ote: Values in US$ million for vessel delivered in 2009. Author's Estimates, without prejudice.
debt finance will be another major input in the
Income Approach financial modeling. (4.036%) average plus the bank’s margin Such valuations as used for issuing bonds in
Additional assumptions include operating (1.375%) for an overall debt cost of 5.41%. the German capital markets and the law
expenses (such as crewing and insurance Based on 70% leverage, the implied stipulates that the value of a vessel shall be
expenses, bunker fuel expenses), the discount rate is 6.6%, at present. Similarly, the least of a) replacement cost (construction
commercial life of the vessel (taking into the historical 10-year average for scrap should cost for a newbuilding), b) present market
consideration that regulatory framework and be used for the vessel’s salvage value, where value of the vessel, or c) the average historical
technological innovation can impact the the overall vessel economic life is to be 20 value of similar vessels in the last 10 years.
longevity of a vessel), and projections on the years adjusted by a vessel-related coefficient Since this method stipulates for the least of
residual value of the vessel (resale value in case (for vessels presently less than 15 years of the three values, it is usually the least
of an after-sale or scrap value for demolition). age) or 25 years for vessels older than 15 generous valuation method.
Therefore, while the Income Approach offers a years of age at the time of the valuation. For strictly illustrative purposes, the table
fundamental and well documented approach for The most frequently mentioned critique of provides valuations for an MR, an Aframax
the value of the vessel, there is a sizeable the ‘Hamburg Method’ is that relying on 10- and a VLCC delivered in 2009. The author
amount of inputs and assumptions that still can year averages for freight rates, financing costs has used market data provided by Karatzas
render a vessel valuation subjective. and demolition prices rely heavily on the Marine Advisors , and has made standard
assumption that history repeats itself, and assumptions in terms of financing for the
Valuation standard given that the 10-year historical average Income Approach as per industry standard
In an effort to provide a uniform set of criteria incorporates never-seen-before market practices and prevailing rates.
for the Income Approach method, in early conditions, valuing vessels on such guidelines Based on the table, obviously the argument
2009, the Hamburg Shipbrokers Association might resemble driving a car based on the can be made of what constitutes ‘value’ these
(Vereinigung Hamburger Schiffsmakler und images shown on the rear-view mirror. days. But again, ‘value’ and ‘price’ are not
Schiffsagenten, VHSS) established the However, the accounting and auditing firm always equivalent and there is a fortune to be
Hamburg Ship Evaluation Standards (also PricewaterhouseCoopers (PwC) has recently made for those who can take those two
known as the Long Term Asset Value, LTAV) approved the LTAV method, and therefore can concepts apart. After all, Warren Buffett has
by narrowing the guidelines on the income be used for banking purposes. made a business (and a fortune) out of it!
approach method. While these methods are based are open to TO
In brief, for presently charter-free vessels, the interpretation and can be used depending on the
estimate for future earnings can be substituted loan agreement terms between the lenders and *This article was written exclusively for
TankerOperator by Basil M Karatzas,
by the historical average earnings and operating the borrowers as per agreed, there is a unique
managing director at Karatzas Marine
expenses of the last 10 years for each type of valuation method that the author as come upon
Advisors & Co, based in New York. He can
vessel. It is assumed that the cost of financing recently and is mandated by law, in particular be contacted at +1 713 545 5990 or
will also reflect historical 10-year LIBOR the German law under the ‘Pfandbrief Act’. at [email protected]

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November/December 2009  TANKEROperator 05