Cruise Ships and COVID Consequences
As I write this, we are ending 2020 and things are looking both down and up as it relates to the Coronavirus. In America, where we’ve had limited engagement and coordination at the federal level, we are going through the expected and world leading spike in cases and deaths. At the same time, on the up side, some of our larger corporations who are in the business of vaccines have a lot of promising products that are just around the corner. Distribution should start early in the new year and things should start getting back to normal. The economic impact of the worldwide pandemic is going to be studied for years. One segment hit especially hard was the Cruise industry. For them, the effects on their industry were worse by far than any of the other parts of the hospitality or travel sectors. Part of it was dumb luck and part of it was what they brought upon themselves.
On the dumb luck side, the unique structure of cruise ships and the way people interact on them, made them the perfect environment for virus spreading. In fact the majority of news articles at the beginning of the pandemic centered around people trapped on cruise ships who were infected. This is because the ships are small enough where it’s very easy for a virus to spread, but big enough where you can’t control the population on the ship very well. Consequently, as It has been reported in the news, they became petri dishes for the virus.
On the other side of the cruise industry situation, the part they brought upon themselves, is that they are poster children for being the worst type of corporate citizen. I can’t say this enough. They’re like that asshole personality type in the office. The kind who makes everybody miserable, treats everybody like garbage, but the company keeps them around because they are effective at their job. As an example of this poor behavior, the cruise lines flag their ships in nations other than America so they don’t have to pay American taxes wages or benefits nor do they have to follow labor laws. As I’m sure you could guess this means they work people literally to death. Eight month contracts, seven days a week, 15 to 20 hours a day is the norm for their unskilled labor. They recruit their workforce from third world nations where people are desperate for anything and are accepting of such harsh working conditions. There are environmental issues, tax evasion issues, and many other criticisms of the industry. So why do we keep them around? One reason is that investors love a good return on their investment. By leveraging their international structure they made their shareholders, i.e. their bosses, very happy. Also people like cheap cruises. Like any corporation, they’ve become pretty good at providing a product that people really enjoy and are willing to pay for. So for years and years of trying to break the rules by structuring themselves as a quasi extranational corporation, they can’t justify federal subsidies during a crisis.
Another way they shot themselves in the foot, similar to many other corporations, is their debt load. The cruise lines took advantage of the historically low interest rates to build billion-dollar cruise ships using debt. This isn’t a problem if you’re doing business as usual and the ships are working 24/7 as cash making machines. It’s a huge issue if those massive billion-dollar floating cities are not generating revenue to service the debt. Altogether, this put them into intense crisis control mode.
One of the ways they helped control costs and bring in a little revenue was to eliminate ships, or tonnage as they call it in maritime lingo. In at least one instance I know of they sold a ship to people who wanted to operate them independently, but in most cases they simply sold them for scrap. Why do this? Well it’s probably worth a moment to review the business model of the cruise lines. The cruise lines will spend hundreds of millions to billions of dollars to build a boat with all the new whiz-bang features. They put this on rotating seven day cruises in the hottest and most competitive markets and are able to charge a premium to customers clamoring for the next big thing in cruising. As the next generation of ships come out, they downgrade the former best ships to secondary markets. As the years and decades go by, eventually the world’s greatest ships from 1990s and the early 2000s become the products for the company’s value cruise offerings. They are targeted at people new to cruising and typically have two to four day itineraries. By default this means that the profit on these older ships is shrinking vs the new mega-ships as the lines charge less per day on the lower demand routes and the ships aren’t as efficient as the newer ones. That doesn’t matter that much as the ships are paid for, they still break even or provide a modest profit and are great entry points for new customers curious about cruising or at the early part of their careers where their incomes are more modest. Eventually, the oldest ships are moved to partner lines that serve even smaller markets. For example there are cruise lines that target just overnight Bahamas cruises, or just customers from single european countries. It’s a great way to drive more revenue out of a niche market and to create additional incremental profits. This is not unlike a family purchasing new cars and passing the older ones down to the the kids who are hitting the age where they can drive the parents’ old cars.
I had written about the idea that we were on the precipice of another transition in the market for these old ships. There had been some successful experiments with condo cruise ships. They weren’t owned by big cruise lines but by very wealthy people who loved the big-ship cruising lifestyle. They paid an annual management fee and either lived on the ship full time or part time and had the option to lease out their condo when they weren’t using it. It was a ship based model very similar to other vacation properties in exclusive areas. I knew there were some companies emerging who were going to use the oldest tonnage and take that ownership concept, and sell it down market to the middle class. Once a ship was at the end of its commercial cruising life, they would buy it for cheap, refurbish it and sell the cabins piecemeal to upper middle class cruise afficanados, of which there are now hundreds of millions of people who cruised their whole life. When I wrote about all this, I advised caution when moving forward with these cruise condo companies. I was thinking caution because I knew that it would take some time before this new market segment built around refurbished condo ships settled out and there was less risk in buying a condo on one of them. Also, as I opined, I was going to jump in when it was time for the ships with balconies, i.e. the second wave of purpose built cruise ships, was released into the condo cruise ship market. The earliest purpose built cruise ships still sailing were built in the 1980’s and 1990’s and didn’t have balcony cabins. I figured by the time the second generation of ships hit, everything would have figured itself out and the condo cruise ship market targeting the average consumer would be a stable place to buy a vacation property. COVID changed all this.
As I said, instead of this secondary market developing, the lines mostly just sold the ships for scrap. I understand why they did this. It was simple math. These numbers are fake, but are good enough for demonstration purposes. Lets say it costs $10,000,000 a month to keep a ship in working order while it’s not being used. If newer ships make 50,000,000 in profit and the oldest ships were only generating $2,000,000 a year in profit, they would have to sail the older ships five years for every month the lines aren’t allowed to sail. With the ships all being laid up a year or more, these older ships would never last the 50–60 more years in service to make back the money to pay down the cost to keep them around. On the bigger and newer ships, the lines only need to keep them in service an extra few years to make back the money it cost to keep them in working order while the industry is shut down. Consequently, it’s better to cut their losses.
When I started seeing reports of older ships going to the breaker yards to be cut up for scrap I couldn’t stop thinking this is such a huge waste! I thought: we can flip houses, but we can’t seem to flip cruise ships. It blew away my theory that all the old tonnage would go to condos or other uses.
Even if the condo market didn’t materialize, I was sure that the ships would find homes as floating hotels, office space, etc.. It’s not that far fetched. It’s been done before by savy corporations led by unique personalities. To my reckoning only one of these ships has been repurposed by wealthy block chain currency traders looking to start a libertarian utopia. I don’t understand why other more legitimate business interests and corporations aren’t leveraging the opportunity to help operations. I can think of things like housing for remote workforces, a problem corporations often run into, especially those in high cost of living areas. Cabins are also perfect for inexpensive office space. It could also be used as an inhouse retreat for meetings, sales awards etc. Upon reflection, the only issue was related to time. It takes a little bit of time to see something and figure out what you want to do with it both on the buyer and seller sides. The ships weren’t on the market for a minute. The Cruise lines didn’t have the time to engage creative types to get the top dollar for their old asset. They wanted to stem the bleeding and simply sold it to the breaking yards, i.e. shipping industries version of a pawn shop, or maybe I should call it a pawn ship. They got maybe four million per ship, but it wasn’t about the cash. That’s nothing to a big line. The quick sales were all about curbing spending at all costs as quickly as possible. The line CEO’s also believe that having less inventory on the market will push cruise pricing up as the lines eventually come back online, which is expected in 2021.
I think this is all the more upsetting when you consider the savings glut. The savings glut is the problem of too much cash held by investing organizations with too little supply of investment grade assets. There are real macro-economic ramifications that stem from this problem but that’s outside the scope of this article. There is a good conversation to be had about the savings glut, its effect on the wealth gap and the economy and maybe one day i’ll write about it. For our purposes today, the point about the savings glut is that there is more than enough money out there for ship repurposing and conversations to happen. I just don’t think we had the time to build the infrastructure needed to make those conversion businesses viable to institutional investors. Investors like safe and understood investments. It’s much easier to quickly take a small group of profitable businesses and build them than it is to take crazy unproven business ideas and start them up from scratch.
I don’t think this ship repurposing idea is going away. It still makes too much sense. I think it’s just been pushed out a decade or more. I suspect that if there was more time, the trend of repurposing old cruise ships as condos and other things would have accelerated like everything else that was accelerated by COVID. Let’s face it, things like remote work and telemedicine among others are the norm moving forward. We just need some entrepreneur with access to enough money to prove it to be a success a few times before it takes off.
Ironically the best people to pull this off are actually the cruise lines. They would simply create another tier of redeployment. The model would look like ships are built as the main product offerings. They are then deployed to secondary / tertiary cruises as the next generation comes online. After decades they get rebranded to secondary specialty lines and finally to sold piecemeal as condos. Unfortunately the thing is you need to make this all happen is cash, lots of it. Unfortunately the lines are so overleveraged from decades of low interest borrowing to create the next biggest, baddest, and worlds best ships, that they didn’t have enough retained savings for when things went really bad, let alone for starting whole new segments of their industry. Fyi, this is a perfect lesson for why having a year or more of operating cash on hand is hugely valuable no matter if your a business or an individual..
So why am I so interested in this? I have to admit I have a special affinity for refurbished things. Lots of things in my life were purchased for pennies on the dollar as a refurbished item. My Keurig coffee maker, most of my electronics, even my dog (not kidding, but again, a story for another day). There is huge value in refurbished items. Take something nearly new with a minor flaw, fix the flaw, and sell it at a discount. Yes, on rare occasions I’ve been burned by refurbished purchases, but most of them have been really successful moves on my part. Manufacturers typically are the best people to refurbish an item because they already own the asset and it’s in their best interest to get some revenue out of it, even if it’s at a loss. Also they are the experts in their widget. If a third party does it, they have to purchase the item, refurbish it, possibly without expertise so the quality is questionable, and then resell it at a profit. The value to the consumer of the refurbished item is diminished. If we look at the model, you can see why I say the businesses that’s in the best position to create the cruise ship condo market are the actual lines themselves. Unfortunately, as I said, they aren’t in a position to do it right now.
So what’s going to happen now? Well my guess is the multi-decade long ship building boom is over except for ships already under construction or in the queue. Once cruise lines get back to making money I suspect retained earnings (savings) and lowering leverage position (paying down their insane debt levels) will take priority over infrastructure investments including newbuilds. I think the idea of condo cruise conversion ships will persist but it will happen later as the surviving ships will be used longer than anticipated. It still will be third parties that buy and rebuild the ships. Only once the lines see that there is huge money to be made with their old tonnage by converting it into condos will they try to get involved.
Eventually we’ll get another boom in cruise ship building in a decade or more and then I suspect the oldest ships will get a second look and the condo cruise ship idea for the middle class will rear its head again. This could be a good thing at least for me, because it means I’ll be right there in the retirement age when the refurbished condo ships hopefully do start to take off. I always said I wanted to wait until condo conversions included ships with balconies anyway. Now, sadly, that’s about all that’s left.
This article is dedicated to all the people who made great memories for their customers on ships scrapped because of COVID.
Sovereign of the Seas Year built 1987 / Age : 33
CMV Astor Year built 1987 / Age : 33
Orient Queen Year built 1989 / Age : 31
Carnival Fantasy Year built 1990 / Age : 30
MS Karnika Year built 1990 / Age : 30
Monarch of the Seas Year built 1991 / Age : 29
Carnival Imagination Year built 1995 / Age : 25
Carnival Inspiration Year built 1996 / Age : 24
Costa Victoria Year built 1996 / Age : 24
And others not named here.
May the pleasant memories created on these ships live on forever.
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