Sweeter deal for acquirers COSCO (1919:HK) & SIPG than for target OOIL (316:HK)

10 July 2017, Asia Pacific – This Voluntary General Cash Offer of HK$78.67 per share is a sweeter deal for acquirers COSCO SHIPPING Holdings (1919:HK) and Shanghai International Port Group, SIPG (600018:CH) than for target company Orient Overseas International Limited OOIL (316:HK). Nevertheless, we expect most of OOIL’s public shareholders to accept the Voluntary General Cash Offer.

GENERAL OFFER IS LIKELY TO GAIN MAJORITY ACCEPTANCE FROM BOTH SIDES

The implied valuations of the HK$78.67 per share Offer price are quite fair at 1.4x Price/Book (P/B), 31% above OOIL (316:HK)’s closing share price prior to this general offer announcement, a level not seen since October 2007.

Some investors could potentially hold out for a better Offer price given that the acquisition valuation is at only a 15% premium to the global container shipping sector’s average valuation and 40% below OOIL’s all-time high P/B of 2.3x in May 2007. It is too early to sell OOIL when the global container shipping industry demand-supply balance has only started to improve this year and we expect OOIL to achieve a net profit of US$134m this year from US$219m net loss in 2016 and rising to a net profit of US$255m by 2019.

However, given that OOIL’s Controlling Shareholder has already irrevocably undertaken to accept the Offer at no less than HK$78.67 for its 68.7% stake in OOIL, we think the upside to the Offer price could potentially be limited.

Moreover, OOIL’s shareholders will need to consider that SIPG’s acquired 9.9% stake in OOIL will count as OOIL’s public float following the acquisition. COSCO SHIPPING only needs to maintain at least 25% of OOIL’s total shares outstanding as public float when the transaction is completed to retain OOIL’s listing status in Hong Kong. This implies that the effectively active OOIL free float held by minority shareholders could fall to as low as 15+% when the transaction is completed. This could eventually reduce investors’ interest in OOIL and dampen the trading liquidity of OOIL’s shares, resulting in a liquidity discount in OOIL’s valuation in the longer term.

Chart: OOIL Price/Book valuation range (1997 to 2017)

Chart: OOIL Price/Book valuation range (1997 to 2017)

We also expect most of COSCO SHIPPING Holdings’ minority shareholders to approve this acquisition as OOIL is a superior asset to own and the acquisition valuation is undemanding. It would have taken COSCO SHIPPING Holdings much longer, and with a lower probability of success, to build up its Intra-Asia/Australasia network and lucrative reefer shipping business organically. Specifically, COSCO SHIPPING Holdings’ Intra-Asia/Australia route region container shipping revenue would nearly double (+95%) while its Transatlantic/Others, Transpacific, Asia-Europe/Mediterranean route regions container shipping revenue would surge 68%, 66% and 35% respectively. This will result in a 53% gain in COSCO SHIPPING Holdings’ total container shipping revenue following the acquisition of OOIL. In addition, the acquisition elevates COSCO-OOIL to become the largest carrier on the Transpacific trade and third largest carrier on the Asia-Europe trade. COSCO-OOIL will also be the first Asian carrier to rank among the top 3 largest container shipping players in the world – a game changer for the industry.

OOIL is a well-managed carrier with a young, fuel efficient fleet (averaging only 8 years old versus the sector average of 11 years), one of the lowest cost structures and strongest profitability track record among its container shipping sector peers. Even if COSCO SHIPPING Holdings remains a passive investor, letting OOIL operate as an independently managed and operated company in the long run, OOIL is still expected to contribute significantly (we estimate 50%) to COSCO SHIPPING Holdings’ recurring profits when times are good while its share of OOIL’s losses are likely to be limited during industry downturns based on OOIL’s strong historical track record, which are superior to COSCO SHIPPING.

 

BACKGROUND

COSCO SHIPPING Holdings and Shanghai International Port Group (SIPG) intend to make a voluntary general offer to acquire all of the issued OOIL’s shares held by qualifying OOIL shareholders at HK$78.67 per share. The Offer is subject to pre-conditions by the long stop date in June 2018, including shareholder approvals, regulatory approvals/waivers and anti-trust reviews by the authorities in China, the EU and US.

OOIL’s Controlling Shareholder (Fortune Crest Inc. and Gala Way Company Inc.) has irrevocably undertaken to accept the Offer at no less than HK$78.67 for its 68.7% stake in OOIL. In the event that this Offer is not made, OOIL will receive a reverse termination fee of US$253m. 58.8% will be acquired by COSCO SHIPPING Holdings and 9.9% will be acquired by SIPG. The rest of the public shareholders’ shares that are tendered for acceptance under the Offer will be acquired by COSCO SHIPPING.

Chart: OOIL’s current shareholding structure

Chart: OOIL’s current shareholding structure

 

Chart: OOIL’s potential shareholding structure following the general offer by COSCO Shipping and SIPG assuming OOIL’s public float falls to 25%

Chart: OOIL’s potential shareholding structure following the general offer by COSCO Shipping and SIPG assuming OOIL’s public float falls to 25%

VALUATIONS QUITE FAIR; MINORITY SHAREHOLDERS LIKELY TO ACCEPT GENERAL OFFER

The all-cash general offer of HK$78.67 per share is quite a fair one. The implied valuations are at 1.4x Price/Book (P/B), 31% above OOIL’s closing share price prior to this general offer announcement, a level not seen since October 2007.

Some investors could potentially hold out for a better Offer price given that the acquisition valuation is at only a 15% premium to the global container shipping sector’s average valuation and 40% below OOIL’s all-time high P/B of 2.3x in May 2007. It is too early to sell OOIL when the global container shipping industry demand-supply balance has only started to improve this year and we expect OOIL to achieve a net profit of US$134m this year from US$219m net loss in 2016 and rising to a net profit of US$255m by 2019.

However, given that OOIL’s Controlling Shareholder has already irrevocably undertaken to accept the Offer at no less than HK$78.67 for its 68.7% stake in OOIL, we think the upside to the Offer price could potentially be limited.

Chart: Global container shipping sector Price/Book valuations

Chart: Global container shipping sector Price/Book valuations

INVESTORS’ INTEREST IN OOIL AND THE TRADING LIQUIDITY OF OOIL SHARES COULD DWINDLE LONGER TERM POST TRANSACTION

Moreover, OOIL’s shareholders will need to consider that SIPG’s acquired 9.9% stake in OOIL will count as OOIL’s public float following the acquisition. COSCO SHIPPING only needs to maintain at least 25% of OOIL’s total shares outstanding as public float when the transaction is completed to retain OOIL’s listing status in Hong Kong. This implies that the
effectively active OOIL free float held by minority shareholders could fall to as low as 15+% when the transaction is completed.

This could eventually reduce investors’ interest in OOIL and dampen the trading liquidity of OOIL’s shares, resulting in a liquidity discount in OOIL’s valuation in the longer term.

GAME-CHANGER IN THE GLOBAL CONTAINER SHIPPING INDUSTRY – FIRST ASIAN CARRIER TO RANK TOP 3 IN THE WORLD

Historically, the European carriers have been the dominant players in the global container shipping industry while the Asian carriers have small global market shares and limited pricing power.

COSCO SHIPPING Holdings’ successful acquisition of a majority stake in OOIL would be a game-changer in the global container shipping industry. It will catapult the combined entity to the world’s third largest liner position with 12% market share, ranking after Maersk (16% market share) and MSC (15% market share). The combined COSCO-OOIL entity will have a fleet of 421 containerships amounting to 2.4m TEUs. Including their existing newbuild vessel orderbook, the combined entity will have a fleet of 458 containerships amounting to 2.9m TEUs with a combined orderbook-to-existing fleet of 21%.

Chart: Global container shipping sector market share

Chart: Global container shipping sector market share

COSCO SHIPPING WILL GAIN SIGNIFICANT REVENUE EXPOSURE TO THE INTRA-ASIA/AUSTRALIA ROUTE REGION

Following the acquisition of OOIL, COSCO SHIPPING Holdings will gain significant revenue exposure to the Intra-Asia/Australia trade lane which would have taken much longer to build organically with a lower probability of success.

On a pro-forma basis using 2016 actual revenue, COSCO SHIPPING Holdings’ Intra-Asia/Australia route region container shipping revenue would nearly double (+95%) while its Transatlantic/Others, Transpacific, Asia-Europe/Mediterranean route regions container shipping revenue would surge 68%, 66% and 35% respectively. This will result in a 53% gain in COSCO SHIPPING Holdings’ container shipping revenue following the acquisition of OOIL.

We estimate that OOIL could potentially contribute half of COSCO SHIPPING Holdings’ recurring profits in the next 2-3 years.

Chart: COSCO SHIPPING Holdings container shipping revenue gains in each major route region after OOIL acquisition (2016 pro-forma)

Chart: COSCO SHIPPING Holdings container shipping revenue gains in each major route region after OOIL acquisition (2016 pro-forma)

COSCO-OOIL COMBINED WILL BECOME THE LARGEST CARRIER ON THE TRANSPACIFIC TRADE AND THIRD LARGEST CARRIER ON THE ASIA-EUROPE TRADE

COSCO-OOIL will become the largest carrier on the Transpacific trade with 18% market share, surpassing Maersk and the third largest carrier on the Asia-Europe trade with 15% market share, surpassing CMA CGM. We are unlikely to see major changes in the OCEAN Alliance which has 41% and 35% combined market shares on the Transpacific and Asia-Europe trade as both COSCO SHIPPING and OOIL belong to the same shipping alliance but the balance of power within OCEAN Alliance will now tilt in favour of COSCO-OOIL from CMA CGM.

COSCO SHIPPING Holdings’ revenue exposure to the Transpacific trade lane will rise from 30% to 32% while its Intra-Asia/Australia revenue contribution will rise from 20% to 26% following the acquisition of OOIL. On the other hand, COSCO SHIPPING Holdings’ revenue exposure to the more competitive Asia-Europe/Mediterranean trade lane will fall from 24% to 22% while its China domestic routes revenue contribution from also be reduced from 17% to 11%.

Apart from the bread-and-butter East-West trade lanes, the combined entity will also focus on growing its North-South route network. COSCO SHIPPING Holdings has been expanding its reach in the North-South route region. Historically, the East-West trade lane accounted for 59% of COSCO SHIPPING Holdings’ total capacity but its share has fallen to 47% this year. In contrast, its capacity exposure to Emerging Markets and Regional routes has increased markedly to more than 50% this year. COSCO SHIPPING Holdings’ container shipping volumes have risen 50+% y/y on Intra-Asia routes and 60% on Africa routes in 1H17.

It is pragmatic to retain OOCL’s shipping brand and management team to minimize customer disruptions and market share loss near term which tends to happen in such M&A transactions. Synergies can be reaped from COSCO SHIPPING Holdings’ upgrade to OOIL’s latest IT systems and improve its yield management, optimize the two shipping lines’ route network and fleet deployment with the opportunity to further upsize their vessels on key trunk routes, thus driving down unit costs and increasing their competitive advantage versus sector peers. COSCO SHIPPING Holdings and OOIL are also less likely to place new vessel orders in the near term until they have worked out which vessels they need or do not need. OOIL’s current financing costs are lower than COSCO SHIPPING Holdings’. With its improving profitability, COSCO SHIPPING Holdings targets to lower its average financing costs in the longer term.

The increased global container shipping market concentration is likely to support freight rate recovery and profitability over time. The stronger than expected shipping demand had already helped to lift rates on the East-West trade lanes this year. COSCO SHIPPING Holdings managed to achieve an average Rmb300/FEU increase in its Transpacific contract rates that were concluded in May 2017. The Asia-Europe head-haul annual contract rates also rose Rmb200-300/TEU although this accounts for only a small proportion of total Asia-Europe business. Back-haul Europe-Asia rates also rose around Rmb300/TEU. COSCO SHIPPING Holdings just issued a positive profit alert, expecting to achieve a net profit of approximately Rmb1.85B, mainly driven by the 35% increase in container shipping volume and higher freight rates plus a one-off gain in 1H17 versus its net loss of Rmb7.2B in 1H16.

Chart: COSCO SHIPPING Holdings existing container shipping revenue breakdown by route region (2016)

Chart: COSCO SHIPPING Holdings existing container shipping revenue breakdown by route region (2016)

 

Chart: COSCO SHIPPING Holdings + OOIL combined container shipping revenue breakdown by route region (2016 pro-forma)

Chart: COSCO SHIPPING Holdings + OOIL combined container shipping revenue breakdown by route region (2016 pro-forma)

ACQUISITION IS VALUE-ACCRETIVE TO COSCO SHIPPING HOLDINGS BUT RAISES THE RISK OF SUBSTANTIAL EQUITY-RAISING LONGER TERM

OOIL’s acquisition valuation of 1.4x P/B is still well below COSCO SHIPPING’s own H-share valuation of 2.0x P/B. However, this would increase COSCO SHIPPING’s financial leverage which is already high at 1.4x at the end of March 2017 (notwithstanding OOIL’s small net debt position of only 0.4x) and raises the probability of equity raising to strengthen its balance sheet.

COSCO SHIPPING Holdings could potentially need to shell out HK$36.9B cash for its maximum 75% stake in OOIL, in order to maintain OOIL as a listed company in Hong Kong with a minimum public float of 25%.

In fact, COSCO SHIPPING’s total maximum cash outlay could well exceed HK$36.9B if all the public shareholders accept the Offer, implying that COSCO SHIPPING will need to first pay HK$44.3B cash to acquire the 90.01% stake in OOIL and subsequently sell its excess OOIL shares, most likely at a discount to HK$78.67 per share, in order to pare down its stake to 75%.   

HK$36.9B amounts to 89% of COSCO SHIPPING’s own market capitalisation. COSCO SHIPPING plans to secure a bridging loan from Bank of China (3988:HK) to fund this substantial acquisition. Roping in SIPG as a joint offeror also helps to ease slightly the financial burden of this major acquisition for COSCO SHIPPING.

However, this still raises the risk of sizeable equity-raising longer term. An A share placement would be less dilutive compared to a H share placement given COSCO SHIPPING Holdings’ substantial A shares valuation premium of 50% versus its H shares prior to the trading suspension of COSCO SHIPPING’s A shares.

Related Reports:

Orient Overseas (International) Ltd. Initiation Report – Still good value based on key fundamentals and potential takeover

Global container shipping outlook: Capacity discipline is needed to lift freight rates; increased industry concentration helps

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