The acquisition by CMA-CGM of APL and the merger of COSCO and China Shipping sent shivers through the marketplace. Is this the start of another round of ocean carrier consolidations or a far more complex market shift?
In the past few months, two major mergers have shaken up the shipping industry: In December, French container line CMA CGM announced it would acquire the Singapore-government owned APL for $2.4 billion. Two months later, under intense pressure from Beijing, China’s two biggest shipping lines - COSCO and China Shipping - combined to form one of the world’s biggest fleets, China COSCO Shipping Corp.
The question now is whether these two events signal the beginnings of a merger-driven consolidation within the industry. The answer isn’t necessarily straightforward.
All things considered, consolidation should take place, much as it has in other areas of transport. But despite a depressed shipping market that shows no signs of recovery, consolidation probably won’t happen quickly. And it will take place only when creditors pressure distressed owners to sell and for a price that is attractive to potential buyers. Those are big unknowns.
The real truth behind all M&A activity in the containership sector is that they are arranged marriages generally with a highly motivated “matchmaker” bringing the two sides together. Often the broker is a State interest as was the case for both COSCO-China Ship and CMA-CGM-APL.
“I do think there’s more to come,” said Brett Esber, a Washington-based partner with Blank Rome LLP, with a focus on the maritime industry. “The container sector in particular is in real need of consolidation. It will happen,” he said, “but slowly.”
Liner owners so far have resisted merging interests for a variety of reasons. That includes everything from the family ownership structure to a still widely held belief in shipping as a national interest, with governments aiding in the propping up of an industry, even one that loses lots of money. Add to that banks which have been far too willing to finance expansion instead of demanding sales.
Why hasn’t there been more consolidation? “I honestly don’t know,” Esber said. “Players have tended to hang on.”
Thomas Söderberg leads Hong Kong-based ship investor Tribini Capital and expresses a more skeptical point of view. “In very simple terms, [a merger] makes sense,” Söderberg said. “There are millions of other reasons why it doesn’t make sense.”
One of the reasons a merger or acquisitions “makes sense” is the time honored ocean carrier concepts, scale and market share. Ocean carriers feel the need to be large to compete – a cursory view at the big three mega-carriers, Maersk, MSC (Mediterranean Shipping Company) and CMA-CGM illustrates the disparity in size between mega-carriers (all over 2 million TEUs), large carriers and everybody else. And one way to build scale and market share is to buy it.
Right now there are plenty of rumors swirling about that support the thesis. For example, Hapag-Lloyd, which bought CSAV (although merged may be more appropriate), is rumored to be in the hunt for another acquisition because shareholders/management believe the carrier needs more size (171 ships – 930,514 TEU) to effectively compete.
Lars Jensen, the CEO of Copenhagen-based, SeaIntelligence Consulting, has long advocated the need for industry consolidation. He has over the years predicted the 16 or 17 global carriers of today will be reduced within a decade to six to eight. “Everyone on that list is a potential candidate to not being around,” he said. “The next merger will not be a surprise,” Jensen said.
Many of the smaller lines will suffer a different fate, Jensen continued, and will probably just go out of business. “One by one, they will disappear.”
On the world’s main shipping routes, “you can’t have this degree of fragmentation and be profitable,” he said. “Too many players start competing on price.”
It’s a race to the bottom and Jensen maintains the “key competitive factor” is access to capital, the “ability to get a cash injection before you run out of money.”
Creditors hold the key, Jensen and others believe. And Jensen, for one, believes these banks will finally force the issue. “This year, you’ll see pressure magnify,” he predicted.
Part of this pressure, Jensen maintains, is because shipping lines face an even tougher slog in 2016. Carriers last year benefitted from falling oil prices and the lag between rate cuts and what they were paying for bunker fuel. For the major lines, that amounted to a one-time profit totaling more than $4 billion. That won’t happen in 2016. “Carriers face a very bad situation,” he said.
So far, at least, creditors have shown little appetite for forcing what would amount in almost all cases to distressed mergers. Part of this reflects their own bookkeeping and what amounts to a slight of hand. Banks value on their books ship assets at far more money than what they are actually worth in today’s market since, according to one estimate, values have dropped 30% in just the past year. Any distressed sale of a liner would immediately cause a massive write-down for the creditors and would add pressure on other banks as well. (Of course, a bankruptcy would trigger this as well.)
What’s more, the last thing banks want is to end up owning the companies – and the ships—themselves.
The bigger lines have credit facilities from many different lenders. Some of these loans are unsecured. And it’s difficult even when companies face bankruptcy for creditors to work together.
“The question is how can creditors push to do something in the best interests,” said Esber, who added, “There’s only so much creditors can do.”
For What it’s Worth
The gap between artificially inflated valuations and what these lines and their ships are actually worth complicates potential deals in other ways as well. To begin with, the bigger and more financially stable carriers may see little need to acquire other lines unless the purchase price is highly advantageous. True, a merger may bring some added value over, say, an asset purchase. These include greater administrative efficiencies, new customers and reduced competition. But with shipping so commoditized, many of these supposed advantages can be elusive.
In today’s market, it’s a lot cheaper to just go out and acquire a newer and more efficient fleet.
Add to that some sobering examples of past mergers. Söderberg cited Maersk and its acquisition of Sealand Corp. and then Royal P&O Nedlloyd. In both of those cases, he said, Maersk at first gained market share, but couldn’t retain those additional customers in the face of other competitors. “After two or three years, they were back to where they started.”
What’s more, Söderberg continued; customers “don’t want to put all their eggs in one basket. They need flexibility so there’s a cap to what shippers will put into one shipping line.”
So, merely taking on ships that ply the same routes make no sense, especially with various shipping alliances in place. In announcing the merger with the APL, CMA CGM vice-chairman Rodolphe Saadé talked of the necessity of scale. In fact, CMA CGM gained not only some newer ships, but complementary routes. That includes routes within Asia, across the Pacific and intra-US trade, because APL is a US-flagged carrier.
The consulting firm KPMG expressed the contradictions inherent in the industry, “The market sentiment in the shipping industry has deteriorated even further since our analysis in November last year. This has exerted enough pressure on some of the larger operators to look for mergers in order to scale up their business and compete with the leading liners. This is why we expect not only restructuring efforts in shipping to continue but also to see some larger (distressed) M&A activity of shipping operators over the course of 2016,” wrote Tobias Wölfel, of the firm’s travel and leisure group, in an email that he called an abstract of the firm’s view. But he added, “At the same time, the numbers in 2016 do not yet support these expectations as we have only seen transactions of shipping companies worth US$1.5bn (whereas in the whole of 2015, shipping transactions amounted to a total value of US$14bn).”
KPMG, for one, believes it will happen. “Since sustainable recoveries are nowhere in sight, we expect that consolidation will ultimately be adopted by the smaller players, as banks and shareholders push for M&A as a last resort over the course of this year.”
A Complex Situation
Others aren’t so sure.
Korea’s two major container lines illustrate all these complexities. Late last year, speculation washed through the industry that the Korean government would force a merger of Hyundai Merchant Marine Co., the struggling shipping arm of Hyundai conglomerate, and fellow Korean line Hanjin Shipping, much the same way the Chinese government did. (The main creditor of both Korean lines is state-owned Korea Development Bank.) The Korean government’s Ministry of Oceans and Fisheries in November threw cold water on that scuttlebutt with this oddly worded statement, “There is a need to maintain the existence of the two companies when considering the impact a merger could have on South Korea’s import and export-driven economy and global shipping alliances.”
In fact, Hanjin, the world’s eighth largest carrier and one that was profitable last year, has no incentive to take on the smaller HMM, unless it extracts acquisition terms that are extremely preferential.
HMM, the 15th ranked fleet, is drowning in debt and awash in red ink. Last year, it lost $$377 million. Some $600 million in loans mature this year.
Reportedly, HMM has received the approval of its creditors for a “self-rescue” and currently looking to choose a preferred bidder for the sell-off of its brokerage arm, Hyundai Securities. It is believed Korea Investment Holdings, KB Financial Group and Hong Kong-based private equity fund AKTIS submitted the bid for Hyundai Securities. This will be the third sale of HMM assets, including its Bulk Liner Division and its container terminal Hyundai Pusan New-Port Terminal in Busan.
Business Korea reports that with the proposed sale, Hyundai Group is now able to roll over 1.2 trillion won (US$1.03 billion) worth of debt which will at least provide some breathing room, even if it is not full resuscitation.
A self-rescue program is not a legal restructuring program but rather an agreed set of steps to satisfy creditors and bring a company back into the black. In this case, the next step is negotiating with the ship-owners of chartered vessels and getting an extension on its corporate bond maturity.
According to reports, HMM spent 1.88 trillion won (US$1.61 billion) on charter costs compared to 5.77 trillion won (US$4.95 billion) in sales.
The Korean carrier would like to renegotiate and cut the charter rates by 20%-30%, which would put them in line with the current market. Considering bankruptcy is looming with little or no payback on the chartered ships, there is incentive to make a deal.
The corporate bond issue may be more difficult to deal with. The HMM debt to corporate bonds exceeds the debt to banks. Without addressing the issue of the interest on the bonds, liquidity even with the sell-off could scuttle rescue. Many believe the Korea Development Bank could pull support at any time and engineer a bankruptcy…but it’s as they say, complicated.