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COSCO Shipping Holdings has no place to hide now the takeover of Orient Overseas International Lines (OOIL) and its container line arm, OOCL, has gone through.
Financially, the tie-up justifies its existence as a multi-billion US dollar business with a market cap of Rmb43.5bn ($6.5bn) in Shanghai, but it is worth considering that COSCO would likely be worth just a fraction of that had its OOIL cash deal – which valued the target’s equity at $6.3bn – not happened.
But what’s next?
As its focus now shifts to the integration of OOCL, its cash management and funding plan in the past 12 months is indicative of what we should expect through to 2019.
Having fulfilled all the pre-conditions, there remained some minor issues with the US Committee on Foreign Investment in the United States (CFIUS) until last week.
The opportunity offered by the consolidation of OOIL was simply too good to pass up, and it simply had to shell out top dollar.
Unsurprisingly, COSCO and compatriot Shanghai International Port Group – which will have around a 10% stake in the combined entity – agreed to give up some strategic assets, although it is unclear why CFIUS considered the Long Beach Container Terminal to be vital to national security, given the extended Asian ownership profile among the other box terminals in Los Angeles and Long Beach.
While some resistance to this transformational tie-up had to be expected from day one, one interesting aspect is that since the announcement last summer the stock of OOIL has slowly risen to the agreed take-out price. But the excitement that followed COSCO’s M&A plan has completely vanished – to the point where its own market cap now almost coincides with the purchase price for OOCI, excluding the target’s net debt.
Cosco is trying to achieve growth via M&A, executing a strategy that has also been embraced by its global rivals, Maersk Line, CMA CGM and Hapag-Lloyd.
While the transparency of COSCO’s own accounts leave a lot to be desired, OOCL’s standards and operational efficiency led the industry.
With new debt added to its already bloated balance sheet, COSCO gains heft while growing inorganically and looking to fund the purchase of other vessels via $1.9bn of new equity. It is smart as it consolidates OOIL’s cash flows and it can target new synergies, which will accrue to existing cash flows, but its resulting capital structure suggests that it will continue to dilute shareholders on the road to growth.
Given the premium, OOCL received a top valuation and COSCO did just what it had to do to get it done.
Wall of worry
According to my calculations, without OOCL, COSCO’s projected net leverage (net debt/ebitda) for 2018 would have been 5.7x, which implied an enterprise value (EV) of almost $14bn. Post-OOCI, net leverage will rise to between 8.5x and 9.5x, once new debt and cost synergies are factored in, while its EV will hover around $22.3bn – compared with $12.4bn for the derived EV of CMA CGM, which is private; a similar EV number for listed Hapag; and some $11bn lower than the entire Maersk group.
The $41bn net debt implied in the aggregate EV valuation of four of the top five container shipping companies in the world is not a wall of worry only if you think the direction the world has taken since the 2008 crisis is ok.
COSCO says the OOCL deal will allow it “to grasp the historical opportunities arising from the Belt and Road Initiative of the PRC, become bigger and stronger through merger and acquisition and reorganisation, and change from ‘product-oriented’ to ‘user-oriented’, which can therefore promote the overall optimisation and innovation of the company’s business model”.
It adds that it expects to “enhance its international competitiveness, achieve synergies between container shipping and terminal businesses in the aspects of investment and operation, and ultimately improve the profitability of the company and create returns for shareholders”.
It is certainly possible that from these levels, higher returns for shareholders could be on the cards, but it will not be an easy task, given dilution risk to a share count that already stands over 10bn (against Hapag-Lloyd’s 175m shares outstanding, CMA CGM’s 15m and Maersk’s 21m).
Look at the latest figures of OOCL and COSCO, combine them and it is clear why COSCO levered up (it didn’t have any other options) and what could be next (additional equity issuances) at a time when the group, as it says, will take its material capital expenditure for 2018 into consideration – most pertinently the “construction of containers and expenditure for terminal infrastructure projects”.
It also said it would “formulate relevant financing arrangements, enhance capital management, optimise the utilisation efficiency of funds and control the scale of debts effectively”.
What else would you expect?
In 2017, its free cash was negative, given that rising operating cash flow couldn’t offset rising capex and heavier acquisition-related outlays.
Revenue rose, and so did its cost base, albeit at a lower annual clip.
Financing cash flow was up, but cash balances fell in 2017, and the situation deteriorated at the end of the first quarter. Compared with 2017, it is worse off, to the tune of $1.5bn in terms of gross cash.
The $1.5bn cash it burned in 2017 it is roughly that which it is raising via new equity to fund its expansion, and there’ll be more dilution coming if it wants to align its debt-to-equity ratio to the current economic conditions.
At the end of March, the balance of its cash and cash equivalents amounted to Rmb20.9bn ($3.1bn), down 18.8% since the beginning of the year.
The former is highly unlikely, given the latest remarks of its strategic shareholders, and similarly CMA CGM is virtually unreachable.
There are of course other options with Asian carriers. But if Cosco learns from OOCL how to run its business as well as how to disclose its accounts, there is potentially a big, well-managed world leader in the making.