OOIL (316:HK) Fair value – HK$50
21 June 2017, Hong Kong – Orient Overseas (International) Ltd, OOIL (316:HK)’s share price has shot up 9% in the past two days, likely driven by market speculation that OOIL (316:HK) could be a potential takeover target by COSCO Shipping (1919:HK). While OOIL (316:HK) is an attractive takeover target, the timing might not yet be ripe as there are significant obstacles in the short-term.
SIGNIFICANT OBSTACLES IN THE SHORT-TERM
COSCO Shipping (1919:HK) is still restructuring after absorbing China Shipping Container Lines (CSCL) and will be unwilling to acquire OOIL with cash
COSCO Shipping is still in the midst of streamlining its operations after absorbing China Shipping Container Lines’ (CSCL) capacity and working on its long-term restructuring plan.
OOIL’s controlling shareholder, the astute Tung family would likely want at least a 20% premium to OOIL’s current market cap in cash (which would value OOIL at 1.2x P/B).
This would require US$5 billion cash from COSCO Shipping which is equivalent to 70% of COSCO Shipping’s current market capitalisation.
Given its financial leverage and capex commitments, COSCO Shipping will be unwilling to finance the acquisition of OOIL with cash. Should COSCO Shipping want to expand its network further, it would be much easier to secure financing to order new containerships to be built in the Chinese State-owned shipyards than to acquire OOIL. Currently, brand new vessel prices are at trough levels and present a more straightforward and faster way to grow.
COSCO Shipping would prefer a share swap agreement with OOIL but OOIL’s shareholders are unlikely to agree given that OOIL’s current valuations (0.9x P/B) are at half of COSCO Shipping’s (1.8x P/B) levels.
Potential Political Fallout If Chinese Government Intervenes
Even if OOIL’s controlling shareholder, the Tung family were to agree to a substantially discounted price as a favour to the Chinese government; there will be significant opposition by OOIL’s substantial minority shareholders.
The Chinese government will also not want to risk the political fallout from such a blatant attempt to benefit the Chinese State-owned COSCO Shipping in Hong Kong especially when the Hong Kong SAR Establishment Day approaches on 1st July.
Chart: OOIL (316:HK) Shareholding Structure
Other Major Potential Acquirers Also Face Short-Term Constraints
An acquisition of OOIL is more likely to happen in the longer term, mainly due to short-term constraints faced by COSCO Shipping as well as other possible potential acquirers. Most of them are in the midst of integrating with another carrier(s) or are focused on growing organically. Brand new and resale vessel prices are at trough levels and present a more straightforward and swifter way to grow.
- CMA CGM (member of OCEAN Alliance)
The world’s third largest liner CMA CGM is still digesting its acquisition of Neptune Orient Lines and OOIL may not add significant value to its network since it already owns APL.
- Evergreen Marine (member of OCEAN Alliance)
The world’s 7th largest liner (as its global ranking has fallen after Hapag Lloyd’s merger with UASC raises its ranking to the world’s 5th largest and the 3 Japanese carriers’ integration of their container shipping lines into Ocean Network Express raises its ranking to the world’s 6th largest) Evergreen has traditionally preferred to grow organically through vessel acquisitions.
- Maersk (member of 2M Alliance)
We believe the world’s largest liner Maersk may be interested but it needs time to integrate Hamburg Sud first. However, Maersk is known to drive a tough bargain and a share swap agreement may not necessarily be acceptable to OOIL’s shareholders either as Maersk (1.3x P/B) is trading at a 40% valuation premium to OOIL (0.9x P/B).
- Hapag Lloyd (member of THE Alliance)
Hapag Lloyd also needs time to integrate with United Arab Shipping Co. (UASC) first and it may be financially challenging to acquire OOIL.
- Ocean Network Express (members of THE Alliance)
Meanwhile, the three Japanese carriers K-Line, MOL and NYK are integrating their container shipping business segments into a single joint venture entity Ocean Network Express (ONE) and are unlikely to consider any external acquisitions until ONE is launched smoothly.
Astute OOIL (316:HK) Tends To Time Its Assets Sales At Their Peak
OOIL has historically been astute in timing its asset sales and we believe that any proposed takeover or merger offer will only be considered if the valuation is highly attractive to OOIL’s shareholders and OOIL’s current market valuation is still below its book value.
Chart: OOIL Price/Book valuation range (1997 to 2017)
Recall that OOIL sold its Terminals division for US$2.4B in November 2006 and its OODL property division for US$2.2B in January 2010. OOIL’s current market capitalization is only US$4.3B even after its recent share price rally.
Moreover, OOIL may first divest its Wall Street Plaza property in New York and Hui Xian stake before putting its liner business up for sale to maximize the value that it can unlock. The valuation of Wall Street Plaza is HK$1.7B as at Dec 2016 while the value of OOIL’s stake in Hui Xian is HK$684 million based on current market cap. The combined value of these amounts to HK$2.4B or HK$3.84 per OOIL share.
TOO EARLY FOR OOIL (316:HK) SHAREHOLDERS TO SELL AS GLOBAL CONTAINER SHIPPING MARKET TO IMPROVE
We believe it is too early for shareholders to consider putting up OOIL for sale as we expect the global container shipping market to improve more significantly in the coming years as the industry supply growth moderates. This will lend support to freight rates and profit margin recovery for OOIL and in turn drive its share price and market valuation higher.
Therefore, it would be more pragmatic to focus on the key fundamental drivers for now. OOIL remains one of the most competitive container shipping companies globally.
Chart: Global container shipping demand and supply growth and idle fleet ratio versus freight rate growth
OOIL (316:HK) IS AN ATTRACTIVE TAKEOVER TARGET LONGER TERM
OOIL is indeed an attractive takeover target given its competitive cost structure, above sector average profitability, strong balance sheet, young and fuel efficient vessel fleet, extensive Transpacific and Intra-Asia Pacific route network, strong presence in the reefer trade and quality management team.
The key “push factors” for OOIL’s shareholders to sell would be the rising capital costs needed to grow due to the industry’s continued vessel upsizing, persistent sector overcapacity as some of the weak carriers continue to be supported by their governments, excess capacity may not be removed from the industry even when carriers go bankrupt and profit margins tend to be razor-thin.
Potential Impact Of Combining With COSCO SHIPPING (1919:HK)
Combining with COSCO Shipping will raise the merged entity’s global market share to 11%, ranking them as the third largest container shipping company in the world.
COSCO Shipping has close historical ties with OOIL, adopted OOIL’s IT systems in the past, and both are part of the new OCEAN Alliance (which comprises of CMA CGM, COSCO Shipping, Evergreen Marine and OOIL).Synergies can be reaped from greater economies of scale, joint procurement, route rationalisation, expanded customer base and geographical network reach.
Chart: Global container shipping companies market share ranking (2017)
1+1 does not equal to 2 if COSCO SHIPPING (1919:HK) & OOIL (316:HK) merge
However, the combined entity may potentially lose some customers due to the uncertainty during the integration period and 1+1 is unlikely to equal to 2 as some customers may choose to diversify their cargo transportation risks and would not want to put the same amount of cargo they used to ship in both liners into a merged carrier.
OOIL (316:HK) EARNINGS OUTLOOK
We forecast OOIL’s revenue to grow 11% per annum, reaching by US$7.2B by 2019. We expect OOIL to turn profitable this year, delivering a net profit of US$137m in 2017 versus US$219m net loss in 2016. We expect 2019 to be a much more profitable year for OOIL as the global container shipping industry demand and supply balance becomes more favourable, enabling OOIL to earn a net profit of US$258m.
OOIL (316:HK) VALUATIONS
We value OOIL at HK$50 which is based on 0.9x P/B, assuming ROE of 4% and 0% long-term growth. This is also in line with our estimated “liquidation” value assessment of HK$50 per share for OOIL.
Chart: Orient Overseas (International) Limited – Gordon growth valuation model
Chart: Orient Overseas (International) Limited – Estimated “liquidation” value
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