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Some 70 years after it was founded by CY Tung, market reports have again emerged that suggest Hong Kong-based OOCL could soon cease to exist as one of the largest, independent container shipping lines in the east and join the Cosco Shipping Holdings family.
As it did earlier this year, OOCL reportedly dismissed takeover talk as rumours.
However, if latest reports are right (and even if they aren’t, surely a takeover cannot be permanently ruled out?), its prized brand could fall into the hands of a Chinese neighbour that has adopted an almost geopolitical quest to become more influential in global container shipping circles.
Whatever the odds that Cosco will end up owning OOCL, it is a great time to guesstimate what a top-end take-out valuation of OOCL could mean for its Chinese suitor.
The more Cosco decides to pay to secure OOCL’s assets, the more trouble the unsinkable Chinese box line might be in for – at least in terms of reputation – until it has sorted out its own restructuring. That is my immediate, bearish reading of this rumoured deal, which comes before gauging other possible side consequences from Beijing’s M&A actions.
OOCL’s parent company, OOIL, said in its annual results that “in this environment, (…) OOIL generated a loss attributable to shareholders for 2016 of US$219.2m (2015: profit of $283.9m), with 2016 loss per ordinary share of $0.35 (2015: earnings per ordinary share of $0.45.4).”
The charts below clearly show the extent of the problem.
Boosted by takeover rumours, OOIL stock has appreciated 70% since the end of last year, but nonetheless 2016 was a painful year for investors as the board decided not to recommend the payment of a dividend.
This was not unexpected. Loadstar readers were warned in December that OOIL could have been in the red in 2016: “a very likely scenario given first half losses and appalling trends for the reminder of the year”, I argued at the time, in a column headed OOIL may be under stress, but it has time to look at the right deal.
Regardless of any deal, let’s focus for a moment on the financial side of the Cosco/OOCL story: how is it possible that OOIL’s main subsidiary OOCL could be worth several billion dollars following such a bad year in an industry where containerships are still barely worth scrap metal despite more encouraging dynamics for supply and demand of late?
OOIL’s numbers are a decent proxy for OOCL, its core business. The oft-rumoured price tag making the rounds is “at least $4bn”, which implies that OOCL’s equity could be worth in line with its parent’s shareholders’ equity of $4.5bn, if “at least $4bn” actually refers to OOCL’s equity value.
One methodology by which we could value OOCL is to screen its consolidated accounts and then determine how many times the book value of its equity is worth against its own market value. At the same time, checking whether its most liquid assets are supportive of a book-value vs market-value approach, based on the assumption that outstanding debts will be rolled over forever.
I’ll spare you the pain of the latter scenario – OOCL’s equity could be worth $3.1bn on a liquidation basis – but in going with a book-value versus market-value comparison and measuring that ratio against those of its “peers”, it is inevitable to point to the few container shipping lines acting as pure-play, public entities in this shipping market.
The most prominent “comparable” is Germany’s Hapag-Lloyd. On this basis, it can be argued that Cosco would be paying for OOCL almost double the amount implied in the fair value of the bigger German carrier’s stock, assuming $4bn is the number associated to OOCL’s equity value, rather than its enterprise value (EV, or equity value plus net debt).
We are blind here, given the little disclosure provided, but it’s possible that $4bn might include its net debt position, currently at about $1.8bn, pushing down the value of its equity to roughly $2.2bn.
OOCL is a much, much smaller entity than Hapag-Lloyd (market cap €4.2bn; EV €9.8bn), and is hardly as appealing as the German company in a takeover scenario. In fact, on paper, Cosco would be better off looking at Hapag rather than OOCL in my view, although in reality that’s a dreamland scenario.
It doesn’t take a financial genius to understand that Cosco – whose stock was suspended in early June, one month after we highlighted downside risk for its restructuring, among other risks – would be showing very little financial discipline if it decided to pay over $4bn for OOCL’s equity.
After all, if it went for it, it could be perceived as a rookie in the international M&A market, which is never a good thing when targeted companies know public subsidies are effectively funding takeovers.
It is not only that. Beijing has a problem with worldwide appeal, and here there is a lesson it might want to learn from Alibaba: certain financials are better left unsaid only at times when steep growth rates are achieved and achievable.
In these situations, investors are forgiving and tend not to worry much about whether, as in Alibaba’s case, financials are opaque or unclear, because they run the risk of missing the boat – Alibaba stock has more than doubled in value since January 2016.
But Cosco’s corporate story is not Alibaba’s.
However, if there is something the transport and logistics industry should learn in this context – and here is where Cosco should lead the pack – it is how to read the financial signs from intertwined industries, where the main players provide precious know-how and there is potential for future partnerships. Vertical research, call it that, along the supply chain should be performed to identify the right financial strategy as well as the most effective communication/PR campaign.
This is to say that, as its asset base continues to change, Cosco’s corporate structure is both unknown to many and unpredictable, which inevitably makes it look bad financially, although it is not constrained over the short-term based on reported figures which nobody seems to trust.
On a pro-forma basis, the consolidation of OOCL would likely increase COSCO’s top-line by about 50%, to $15bn from $10bn in 2016, before synergies are considered.
Adding OOCL to a rapidly changing assets mix could backfire in marketing terms, as it would dilute the target’s brand power. Also, can Cosco crystalize the value of OOCL, which is a relatively well-run company?
Finally, cultural hurdles are one of the main culprits of value destruction in M&A.
“COSCO is a party-dominated organism, much more so than the China Shipping Container Line (CSCL) that they devoured below cost at the party’s instruction. Profitability is not a primary priority for the company in any of its divisions, which means that customer service is typically a middle management concern,” one reader noted when I covered Cosco earlier this year.
“Only the cooperation it holds with other carriers in consortia will keep COSCO sailing on a relatively even keel,” he said, adding – and I could have not put it better – “reliance on financial statements and annual reports in this case should be done with exceptional caution: auditing in this case is more than usually difficult. I strongly suspect that debt valuation is opaque.”
And there’s more: “COSCO continues to be an extremely bureaucratic enterprise with poor computerisation integration globally. Beijing can do better than this, even in the current lousy market, but not without serious privatisation reforms emanating from the Central Committee.”
Thank you, Mr Oldersachem01 – CY Tung would probably agree with you.