Hapag-Lloyd successfully pulled off its IPO, but are investors' funds now at risk?

© Khunaspix Dreamstime.

The outcome of the IPO of Hapag-Lloyd didn’t surprise me at all, but if I had known that the tide was turning in the shipping industry, I would have been even much more cautious over the outlook for the world’s fourth-largest box line.

A profit warning from market leader Maersk last month – which hit Hapag in the process of pricing its IPO and clearly affected its valuation – is not the only element that signals possible downside risk for the shareholders of the German group.

“In response to queries received following Maersk’s update on Friday, October 23, (…) Hapag-Lloyd reiterates its outlook for 2015 as provided in the IPO prospectus published on October 14,” the company said on 26 October, some 10 days before its underwhelming market debut.

A much lower price range at IPO was needed to get away with the float in a tough market – its valuation of €20, which is where the stock currently trades, came in at the low end of a revised €20-€22 range.

Hapag raised precious funds at a critical economic juncture, and even though it initially sought to price its stock at between €23 and €29, it eventually accomplished a decent result – in similar cases, deals are often pulled from the market rather than downsized.

However, its strategy could now put shareholders’ funds at risk, which is another critical issue because one of its nearest rivals, France’s CMA CGM, could bulk up by acquiring Singapore-based Neptune Orient Lines. It emerged on Saturday that the two companies had entered exclusive talks that may or may not lead to a deal.

Key metrics

On November 6, Hapag-Lloyd “successfully completed its IPO, generating gross proceeds of approximately $300m that will be invested in new vessels and containers,” the German group said when it reported its third-quarter results.

With no growth in sight and freight rates continuing their rollercoaster path, the first question is whether Hapag should focus on expansion or instead devote time and funds to a different capital deployment strategy.

In the third-quarter release, chief executive Rolf Habben Jansen said that proceeds from the IPO will allow the group to invest to “further improve efficiency and profitability.” He did not express the intention to invest in new containers and vessels (although there is an existing order for a series of 10,500 teu vessels, and he has previously stated publicly that an order for a series of ultra-large container vessels might still be placed).

The total number of Hapag-Lloyd vessels has already risen to 175 units, up almost 20% from 147 one year earlier. Aggregate capacity of vessels and containers has grown at a much faster pace than the number of vessels so far in 2015 – 24% and 39%, respectively, on a comparable nine-month basis.

Bunker prices halved, true, but freight rates plunged by 12%, and the speed at which third-quarter rates declined accelerated by five percentage points year-on-year. And although transport volume rose 28.3% to almost 5.6m teu in the first nine months of 2015, once you strip out the acquired container shipping activities of Chile’s Compania SudAmericana de Vapores (CSAV) on a pro-forma basis, volumes fell 3.9% during the period.

Hapag-Lloyd key figures, third quarter 2015

Its income statement has markedly improved following the acquisition of cash-strapped CSAV, and Hapag has actually managed to be in the black for the third consecutive quarter, but its balance sheet and leverage metrics remain problematic.

Debt

Mr Habben Jansen said he was satisfied with the financial performance of the group this year, given the challenging market.

Adjusted net leverage, however, remains pretty high, and Hapag will likely need to raise more funds if it doesn’t deliver on its ambitious plan, in my view. At about four times net debt/Ebitda, its unadjusted net leverage is already much higher than that of market leader Maersk (at less than one times), but once certain non-cash adjustments are included, it rises above six times, according to my calculations.

In fact, some 60% of its enterprise value is represented by net debt, which totalled €3.4bn in the third quarter, up 13% year-on-year. Hapag’s balance sheet has not carried that amount of debt in recent history – gross cash, meanwhile, fell 32% to €484 from €711m. That drop in its cash balances mainly reflects the lower amount raised at IPO, which initially targeted proceeds of $500m.

The problem with high leverage metrics for public companies operating in cyclical sectors such as the shipping industry is that if larger rivals notice the stretched capital structures of their smaller competitors – and in most cases they do, of course – they could become more aggressive in their pricing and volume strategies. Freight rates are going down anyway, and could become even more competitive at a time when the industry landscape could change, once again, on the back of M&A activity.

As we reported yesterday, CMA CGM is now in the driving seat to acquire NOL, and a deal between the two could put more pressure on Hapag, widening the gap between the top three and the smaller players in the industry.

It remains too early to speculate, but I am nonetheless not entirely sure that the float and the visibility that came with it were strictly necessary at this point in time.