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Has Hapag-Lloyd become overly optimistic about the prospects for the integration of CSAV’s container business? If so, shareholders will have somebody to blame if the boat sinks – the bankers who structured the deal.

What is clear is that life could well get worse before it gets any better for the combined entity, I gathered earlier this week from senior sources debating the risks surrounding the merger. In particular, they said it would take time to figure out which big risks hanging over the merger will prevent management achieving its ambitious targets.

Let’s start with goodwill impairment risk – the figures in company’s balance sheet are revealing.

The value of goodwill and intangible assets has more than doubled, to €2.7bn from €1.2bn, following the CSAV acquisition and now represent 27% of total assets, versus 17% in 2013.

To put things into perspective, under liquidation those items tend to be worth very close to zero.

This may mean little if things go according to plan and the combined entity delivers the coveted $300m of annual synergies by 2017, but if execution is not flawless and downward pressure on rates persists – as Hapag-Lloyd expects it to – those assets whose intrinsic value depends on a mere accounting adjustment could generate big economic losses.

That is a problem for a business that lost €604m in 2014. Last year, the goodwill and intangibles to equity ratio rose from 41% to 65%, which could lead to low-quality earnings.

Enough equity?

Hapag-Lloyd remains adamant its equity position is safe.

“Gearing [net debt/equity] fell to 72.1% (previous year: 84.7%),” it said in its annual results.

But an impairment charge that wipes out just 10% of the value of its total assets could reduce its €4.1bn equity position by 25% (€1bn), pushing the “gearing ratio” up to 100%.

What’s more, if Hapag-Lloyd was a listed company, which remains its medium-term target, its equity would be worth very little, so its gearing would be much higher if it was calculated – as it should be – on the market value rather than on the book value of its equity.

As a listed entity, it’s reasonable to assume Hapag-Lloyd would command an enterprise value likely in the region of €3bn, most of which would be net debt. As a result, Hapag-Lloyd stock would trade on a 0.5 times earnings value/sales multiple.

However, such a valuation would push gearing through the roof, if it was calculated on a market value of its equity, possibly in the region of just a few million euros, which would be an appropriate assumption.

I am more inclined to consider the sustainability of a capital structure based on a company’s net leverage, as gauged by net debt/ebitda, rather than on gearing, as measured by Hapag-Lloyd. By that measure, the situation is even worse, because net leverage currently stands at 30 times, against 6.3 times one year earlier.

Even if one assumes that Hapag-Lloyd hits its synergy target earlier than expected, say in 2015 – which is virtually impossible –  its net leverage would still hover above eight times.

Are you surprised, really? That’s because you have probably overlooked our previous coverage.

Recent annual results have confirmed our initial view: The Loadstar argued in December that “closer analysis of the carriers’ balance sheets suggests considerable financial challenges lie ahead,” when we ruled out the possibility of an IPO. I reckon Hapag-Lloyd managers still believe they can get away with a much-needed float.

What our sources had to say on the matter left no room to the imagination, however. A float is not really an option right now.

No easy way out

“There’s no agreement on how to value the business,” one senior ECM banker told me this week. “The capital structure of the combined entity is not entirely appropriate,” he added.

“The market won’t carry on its shoulders the risk of unsuccessful execution,” another said.

A third senior source noted that unless Hapag-Lloyd engineered a way to attract strategic partnerships, its shareholders may “eventually be left empty-handed.”

Or, quite simply, they will be asked to commit additional funds to the business to keep it going.

“Hapag’s strategy carries huge risks and is not going to work in this freight market.”

In a market where the gap between the top three container liner shipping companies, Maersk, MSC and CMA CGM, and their rivals is immense, both financially and operationally, the market leaders have two options: they can either put more pressure on ailing players such as Hapag-Lloyd, or they could bail them out if things get really bad.

The latter becomes a real option only if assets are valued at a massive discount to fair value, unfortunately for the fourth-largest liner shipping company in the world.

In December, we argued that Hapag-Lloyd needed to strike a cross-border deal to stay afloat – but we also wondered whether the deal was the brainchild of Hapag’s management or its bankers, who needed synergies to materialise before the end of this year.

“It is our aim to tangibly benefit from these cost effects as early as 2015 and to have fully harnessed these synergies by 2017 at the latest,” Hapag-Lloyd said.

The jury is still out, although the pessimists have so far been proved right.

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