COSCO finds even with a ‘perfect bride’ like OOCL, getting married is expensive.
Rare is the day in the corporate world where an unprofitable business can afford to, and then does, buy and take over a competing company that has a lengthy history of profitability.
But that’s exactly what began to happen in early July, when COSCO Shipping Holdings announced that it and partner Shanghai International Port Group (SIPG) made a $6.3 billion all-cash offer to purchase Orient Overseas (International) Ltd (OOIL). Under the terms of the offer, which still requires approval from shareholders and regulatory authorities, COSCO would acquire a 90.1 percent stake in OOIL, and SIPG would hold the remaining 9.9 percent. It’s the latest blockbuster development in what for the maritime shipping industry has been a crazy couple of years filled with acquisitions, alliances and even a large-scale bankruptcy. Even though COSCO posted a net loss of over $1 billion in 2016 and has only had one profitable year so far this decade, the firm is now poised to take ownership of OOIL, which for decades has reported consistent yearly profits of anywhere between tens and hundreds of millions of dollars.
The key factor here is that 48-year-old, Hong Kong-based OOIL has been privately owned up to this point, while COSCO is operated by the Chinese government, which has made it clear that it’s less concerned with economic performance in the the short term than it is with scale. The deal would further consolidate the Asian shipping market, as COSCO and OOIL subsidiary OOCL are among the 10 largest container shipping companies in the world. Following its merger with fellow state-run line China Shipping (CSCL) last year, COSCO currently ranks fourth in the world behind only Maersk Line, Mediterranean Shipping Co. (MSC) and CMA CGM—all European companies—and OOCL seventh in terms of vessel capacity.
The combined entity would sport an operating fleet with an aggregate capacity of 2.31 million TEUs, still just shy of the recently merged CMA CGM-APL and its subsidiary lines with 2.38 million, according to current data from ocean carrier analyst BlueWater Reporting.
OOCL’s current fleet of 100 containerships has a total capacity of 640,260 TEUs, an average age of 9.5 years and average nominal capacity of 6,403 TEUs, according to BlueWater Reporting. The company is set to receive its first 21,000-TEU vessel, with five more still to be delivered and options for another six. After the purchase, COSCO Shipping Lines and OOCL will continue to operate under their respective brands, providing both container transport and inland logistics services, the companies said in announcing the deal. COSCO has said the company is committed to retaining OOIL’s current pay and benefit system, and that it won’t lay off any OOIL employees for at least two years after the sale closes. OOIL’s current global headquarters and presence in Hong Kong will also be retained.
For Richer, Poorer. Financially speak-ing, COSCO and SIPG’s offer price of $78.67 Hong Kong (U.S. $10.07) per share represents a 31 percent premium on the last closing price for OOIL’s stock prior to the offer announcement of HK$60.00 a share, its highest in five years. That number, however, may already have been slightly inflated. The firm’s stock has been surging since mid-April on speculation surrounding a potential sale to COSCO, despite consistent denials and “no comment” statements from OOIL. According to an analysis of the deal from Seatrade Maritime, in the 30 days leading up to the announcement, the average share price for OOIL was HK$50.69, meaning the offer price was actually more like 55 percent higher than the current market valuation. New York-based analytics firm Panjiva Research noted that as of a few days after the deal was announced, shares were still trading 8.8 percent below the formal offer price. This could reflect concerns that the deal may not be completed, or assumptions about an extended regulatory approval period.
“I don’t know that it’s worth $6 billion. I think the general consensus around the industry is that that number was a little bit inflated versus what the actual value of OOIL was,” Michael Bentley, a partner at pricing and revenue management consulting firm Revenue Analytics, said in a recent interview with American Shipper. “My hope is that now that this [acquisition] is taking place, everyone will kind of stop for a few minutes and let the dust settle and see what the market looks like, because there’s just been so much change in the market in so many different areas. Hopefully this, long term, will provide a little more stability to the industry and a little more rational pricing, so the industry can get healthy again.”
As for why the Tung family would sell a company it has owned since it was founded in 1969, long-time container shipping analyst Charles de Trenck said the reason is obvious.
“Price,” he told American Shipper. “The Tungs always said they would only sell at top dollar. And this is top dollar.” Earlier reports speculating on a potential purchase by COSCO suggested the valuation of the deal would be closer to $4 billion. “At $6.3 billion, the price does seem a bit steep,” London-based maritime research consultancy Drewry said. “OOIL’s book value stood at $4.5 billion, based on FY16 numbers, meaning OOIL was able to extract a sizeable premium.”
For that premium price, de Trenck said, COSCO would benefit from OOIL’s “better technical knowhow,” something with which Drewry concurred. “OOIL and its container unit OOCL have a good track record for above-average profits in a challenging market and a reputation for being a very well-run company, earning the moniker ‘The Perfect Bride,’” Drewry Maritime Financial Research said in a state-ment after the purchase was announced. “Retaining the management team, processes and systems is a wise move and could be of enormous value to COSCO, in our opinion.
“Operationally, fitting OOCL into the bigger company should not be too difficult as both OOCL and COSCO already belong to the OCEAN Alliance (alongside CMA CGM and Evergreen) that operates mainly in the east-west container trades,” the firm added. “OOCL is not a major player in the north-south trade lanes that fall outside the scope of the carrier group.”
Regional Chemistry. The biggest im-pact, according to Drewry, is expected to be felt in the intra-Asia trades, where both carriers already have a large presence, as well as in the Asia to Middle East trade lane. “From a marketing perspective, the acquisition of OOCL will enable COSCO to broaden its customer base, having previously [been] perceived, rightly or wrongly, as China-centric,” Drewry said. “OOCL’s reputation and history with global shippers will provide COSCO with an inroad to a wider selection of big Western shippers with volume.”
But from a revenue perspective, the “cross-selling” opportunities may be minimal, according to Panjiva Research, because the two groups’ revenue streams have a similar geographical mix.
An analysis of OOIL’s financial state-ments conducted by Panjiva found that COSCO is slightly less exposed to trans-pacific traffic—14.8 percent of the firm’s total revenue compared with 26.3 percent for OOIL—but more exposed to the Asia-Europe trade—21.6 percent compared with 16 percent.
However, as Panjiva noted in its analysis, “The move would not address shortfalls in both companies’ transatlantic operations. Presumably more details will emerge as the deal progresses through its regulatory approvals.” Bentley said COSCO may have made the move to overpay for OOIL now because such opportunities are starting to dry up after all the big mergers, acquisitions and alliance reformations of the past couple of years.
“I think everybody’s kind of felt that this era of consolidation amongst the industry is reaching its end; I hope that’s the case,” he said. “I think that [COSCO] felt that if they didn’t do something now, they were going to miss the opportunity, and that the merger and acquisition craze of the last few years was coming to an end.” “The sale of OOIL/OOCL means there aren’t many other takeover candidates left on the shelf,” Drewry said in its analysis. “Such is the scale of the carriers within the top seven that any merger within that group would find it difficult to pass regulatory approval.“There could still be some minor regional acquisitions but the big wave of container M&A looks to have been concluded with this deal,” the research consultancy said.
“I think that any further consolidation, the governing bodies will have some issues with from an anti-competitive nature,” he said. “There’s an awful lot of noise in the market. People need to let the dust settle and do some price experimentation and see where the market really is. If people don’t get a handle on what is really driving performance or lack of performance, I think they’re going to start making some bad decisions.”
Regarding the deal’s impact on the industry, Drewry said the consolidation that’s already occurred, as well as brighter market prospects and a recent moratorium on new ships, offers carriers “a golden opportunity for far greater profitability” in the near future.
“With fewer carriers, that in time will become financially stronger, the pendulum is swinging back towards those that have grown to survive,” Drewry stated.
Terminal Interest. Another likely factor in COSCO’s decision to pursue OOIL is that it will now gain access to the most state-of-the-art automated container terminal in Southern California, OOCL’s Port of Long Beach facility, which is undergoing a massive redevelopment that will see the existing one-berth Long Beach Container Terminal at Pier F shuttered and replaced by the three-berth Middle Harbor Redevelopment Project.
Phase I of Middle Harbor went live in April 2016 and is now in full operation; the second phase is expected to be operational by the end of 2017.
“COSCO already has two terminals in LA/LB so this will be a third, and by 2020 these three terminals will account for nearly 30 percent of the capacity of LA/LB,” Drewry said. “So, while the capacity in LA/LB remains physically fragmented, the ownership is at least consolidating.”
Panjiva said the biggest issue for the deal could be regulatory approvals, which at the time of writing COSCO had not yet set a deadline for completing.
It’s still too soon to know whether there will be any specific regulatory obstacles, but Drewry said that since recent mergers and acquisitions like Maersk Line’s takeover of Hamburg Süd and the proposed ONE merger of Japanese carriers have encountered minor issues, it’s possible some conditions could be applied by non-Chinese competition authorities.
Safety In Numbers. In general, shippers seem to be taking a matter-of-fact approach to the rampant consolidation in the container shipping industry. Most realize that although it may not be what’s best for their business, carriers were left with few options after rates fell to below operating expenses on several trades last year and the industry as a whole sunk deep into the red.
As Drewry pointed out, just because OOCL will remain a separate brand, that doesn’t mean it will remain independent from an operational and customer service standpoint.
Fewer carriers to choose from, coupled with the ever-increasing size of container-ships, may mean fewer options for shippers when it comes to direct port pairs, transit times and other important service differentiators like visibility tools and data analytics capabilities. And if the carriers are to achieve their stated goal of returning to profitability, rates will at some point have to not only increase, but stay up for an extended period of time.
“Effectively, shippers will be losing yet another carrier from the pool that increasingly resembles more of a puddle,” the firm said. According to Drewry, once the latest mergers and acquisitions have been consummated and the newbuild vessels currently on order are delivered and deployed, “the top seven ocean carriers will control approximately three-quarters of the world’s containership fleet. Back in 2005, the same bracket of carriers held a combined share of around 37 percent.”
In January 2015, 21 different carriers operated vessels in the transpacific trade and 16 operated vessels in the more highly consolidated lane between Asia and North Europe, Drewry said. After OOCL is absorbed into COSCO, those numbers will have fallen to 15 in the transpacific and just eight in the Asia-Europe trade.
“The accelerating trend towards oligopolization in container shipping will reduce shippers’ options and raise freight rates,” the consultancy said. “It is the unfortunate price to be paid for years of non-compensatory freight rates that have driven carriers to seek safety in numbers.” Bentley said the consolidation could be indicative of a shifting mindset in the industry.
“What I think we’re seeing in the industry is that people that have done all these operational things are suddenly tasked with making commercial decisions and for the first time, they’re thinking commercially,” he said.
Looking ahead, Bentley said he thinks carriers and other industry stakeholders will finally begin to unlock some of the true value behind so-called “big data” initiatives.
“Through this digitalization, there’s a huge amount of data being created and I think that it’s a really exciting time because we’re going to see people start to leverage that for the first time,” he said. “Looking at it in terms of the industry and its progress in general, I kind of see it moving more towards this data-driven decision making.”
This could lead to a period of rapid change for the entire industry, Bentley said.
“I’m excited to see what will happen. I think there’s the potential to really make some gains and get the industry healthy again, but I think it’s going to require people making the right decisions, and really to me, that boils down being able to isolate the signal from the noise,” he said. “Right now there’s a lot of noise and I think people need to start leveraging that data to isolate the signal and determine what the brave new world looks like and how they need to compete in it.”
All that will take time to play out, but perhaps the more immediate lesson from this particular acquisition is the one that COSCO—like almost anyone that has ever gotten married—had to learn the hard way: no matter how “perfect” the bride might be, weddings are expensive.