container ships © Jennifer Thompson
© Jennifer Thompson

We witnessed the typical ‘long squeeze’ on Friday, when the shares of Hapag-Lloyd collapsed 20% soon after the German carrier announced its revised guidance.

Hapag-Lloyd

Source: Hapag-Lloyd

Source: Yahoo Finance

They haven’t recovered since, which is something M&A arbitrageurs closely monitor; also because the stock of AP Møller-Maersk Group (APMM) has been more resilient in the past few days after testing new lows, almost daily, in recent weeks.

Source: Yahoo Finance

 

Source: Yahoo Finance

While Hapag was on the path to recovery, at least in terms of corporate decisions and stronger earnings power, the situation of APMM has been more critical since last summer. But what a great opportunity this could be for the Danish group if it exploits its rival’s weakness and drafts an opportunistic proposal for the carrier that lost almost $1.2bn of value in less than a week.

Deal or no deal?

Is it worth APMM waiting, without acting, for six to nine months of trade that might push it into the red again this year? It can trim cash outlays by cutting the dividend, but what then?

A takeover of Hapag would be transformational and it could be funded by a rights issue in disguise, given that APMM, if I am right, might need new equity capital to shore up its balance sheet after reporting combined losses of over $3bn the past two years. The dividend payout doesn’t reassure the bulls now, while its bonds continue to signal more uncertainty than its credit rating should warrant.

The logic is simple. APMM must pay up – from a relatively low base, given Hapag’s fall from grace in the past week – to entice the diverse shareholding base of the German carrier to join its family, funding a multi-billion deal via a very large chunk of equity, say 50%-100% of the financing package backing the deal.

Source: Hapag-Lloyd

The goal, of course, would be to gain scale and boost both finances and market share prospects while gaining access to a management team, Hapag’s, who should be in the driving seat if such a tie-up materialises.

Recent headwinds – market rates dynamics, bunker prices, lower returns, debts above acceptable levels and so on – could accelerate such a deal, even before the latest profit warning from Hapag.

Hapag chief executive Rolf Habben-Jansen could be the right man, with the blessing of the Maersk family. He could give the board of the combined entity direction at a time when APMM still needs to take serious decisions concerning how its assets base should look in the future. The separation of the energy and logistics assets, and the disposals that followed in the former unit, are certainly not the finished article, and APM Terminals still dilutes value.

APMM and Hapag… why not?

Financially, there are smart ways to make it work, I think.

Based on their projected adjusted cash flows multiples, the stocks of the two carriers trade broadly in the same ballpark. A large stock deal could be dilutive for APMM, but that is just a nuisance given that its earnings per share have been negative for two years in a row. And it doesn’t look like this year will be any different, judging by prevailing trends in this third quarter.

To get the deal over the finishing line, APMM would have to offer a hefty premium that covers between three and five years of Hapag’s growth, which means about 10% of normalised growth in annual ebitda to 2022, in my model. This is tricky, of course, given the cyclicality of the container shipping industry, but is reasonable nonetheless under a base-case scenario.

Assuming a constant ebitda multiple of 7x, I derive an enterprise value of €12.6bn, which makes a lot of sense.

Consider this: if APMM offers a 50% premium (€42 a share; 10% above its record high) against Hapag’s undisturbed share price (€28; not far off a 52-week low), it would value the German carrier’s equity at €7.35bn, regardless of how the deal is financed. Including the target’s net debt (€5.4bn), the take-out price would imply an enterprise value of €12.75bn.

Before synergies, that you could assume at between 3% and 5% of Hapag’s revenues, APMM would value the target at 10.6x EV/ebitda, and it’s likely, based on other cost-saving assumptions (cost of capital and tax rate), that the premium being offered to Hapag shareholders would not cover the net present value of the synergies, which is very bad news for the purists in the M&A world.

However, a rich valuation must emerge to convince Hapag, whose managerial skills, funding diversification and deep pockets would be of great value to APMM management and shareholders.

Value

Hapag’s financials are stretched. The Danish carrier’s balance sheet is deteriorating, and its corporate structure remains poorly balanced.

With Hapag under its belt, an enlarged APMM would likely reach $50bn of revenues (2017: $33.5bn); even taking a conservative view that APMM/Hapag’s adjusted operating cash flows, or ebitda, could amount to only $5.2bn (pre-synergies), its implied net leverage in an all-stock deal would be 3.8x (slightly above APMM’s 3.3x, but well below Hapag’s 5.4x).

Throw in $400m of annual synergies, and the combined entity – with implied net leverage of 3.5x – might even preserve APMM’s solid credit rating post-deal, as Hapag’s debt could be refinanced at much cheaper rates, given APMM’s stronger credit rating profile.

That said, if a deal was 50% financed by new equity, APMM’s net leverage would rise beyond the comfort zone (4.6x, pre-synergies), so it could be worth the risk only if APMM found additional cost and revenue synergies from the combo.

But is the Maersk family up for it? And how about the core shareholders of Hapag?

I am aware there are big egos, on both boards, making big decisions.

Options sought

Consensus among my sources is that Hapag is open to options, but on its own terms, and for APMM it’s a no-deal situation, unless the current market turmoil turns into a recessionary meltdown. But why does it need be?

APMM could also lure Hapag by paying a special dividend as part of the deal considerations. Under my two scenarios, with a 50% premium, the target’s shareholders would end up with a 14.9%-25.9% holding in the combined entity, assuming the takeover is half or fully funded, respectively, by new equity.

Projected revenue and earnings numbers for 2018 and beyond are incredibly bullish for both carriers, based on consensus estimates from Thomson Reuters, which means there remains plenty of downside. For APMM, there are a fewer assets to sell too, while Hapag, as I noted in September, could do with some help after its talk of “qualitatively enhanced growth” has clearly gone into the bin.

And then it would be easier to be damn bullish if its management team had the Maersk Line engines under their operational control.

After struggling for a year or so post-IPO, Hapag – whose stock is more liquid than APMM’s – has surged on the stock market, although some of its recent decisions have been questionable. Its extraordinary dividend allocation in 2017 was premature, for example.

The deal could also include a stock split option to boost the liquidity profile of the investment, but that’s surely not top priority, considering the shareholders involved from both sides. However, what is obvious is that if APMM waits much longer, its stock could fall further and its shares – currently not far off their seven-year lows – could be worth peanuts by the time it might think it could make some sense perhaps to entertain negotiations with its German rival – or any others with a large asset base.

Alessandro Pasetti does not invest in the companies he covers, as he abides by WSJ rules. Alessandro Pasetti and The Loadstar team have no positions in any stocks mentioned in this Market Insight column, and have no plans to initiate any positions within the next 72 hours.

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