The Baltic Dry Index has retraced most of its 55% surge from March, yet the mild recovery in shipping fees since early last year appears to have revived appetite for a renewed wave of consolidation in the shipping space. For a price of $6.3 billion (HK$78.67 a share) - equivalent to an eye-popping premium of 112% of the stock’s one-year trading average - Cosco Shipping's purchase of Hong Kong-based Orient Overseas makes the Chinese state-owned firm the world’s third-largest bulk shipping company, and the largest servicing the lucrative Asia to North America route, beating out Copenhagen-based A.P. Moller-Maersk and France’s CMA CGM.
The deal also makes Cosco the biggest container shipping company servicing the Pacific.
Measured another way, the sales price represents a 49% premium, based on the average 20-day trading price before the announcement – the biggest premium for a major container-shipping deal since 1997 when Singapore’s Neptune Orient Lines bought APL for $833 million, offering a premium of 57%, according to Bloomberg calculations.
Cosco currently has a market share of 8.4 percent while Orient Overseas has 3.2 percent, according to Alphaliner, a shipping data provider. Their combined 11.6 percent share would make the merged entity the third-biggest container-shipping company, overtaking CMA CGM with 11.2 percent. The enlarged company will operate more than 400 vessels with capacity exceeding 2.9 million twenty-foot equivalent units, including order book, according to Bloomberg.
As Bloomberg Gadfly columnist Shelly Banjo noted, the acquisition is hardly a surprise; what is surprising is the premium paid for the Hong Kong shipping firm in the deal:
"Cosco's initial bid for Orient Overseas more than six months ago hovered around the $4 billion mark, according to the Wall Street Journal. That figure hardly budged as recently as June, and for good reason: Most shipping deals in the last two years or so have been done at a price-to-book ratio of about one. CMA-CGM SA's acquisition of Neptune Orient Lines Ltd. was done at a ratio of one, and Maersk's purchase of Hamburg Sud represented a 1.3 multiple, according to Jefferies research. Cosco is set to pay around 1.4 times Orient Overseas's book value.
A company in a weakened position has few chips to bargain for a higher offer. And it's not as if there was a white knight for Orient Overseas, whose year-on-year revenue dropped by 11 percent in 2016 and 8 percent the year before.”
While state-owned firms often overpay, there’s one reason this purchase could be worth the higher price: It will allow Cosco to raise container rates on the line.
“The consolidation may help raise container rates on the Americas route - the second-busiest in the world - a critical piece in the survival of the shipping industry that has been battling slumping charges and overcapacity. Earlier this year, Maersk and Hyundai Merchant Marine Co. said that they managed to get higher fees from customers on their annual rate-negotiation talks on the trans-Pacific routes. Moving goods to Europe from Asia is the world’s biggest shipping trade route.
The Cosco-Orient Overseas combination would have the capacity to move a weekly average of 77,208 containers between Asia and North America, based on end-May data from Alphaliner, a shipping data provider. In the Asia-Europe trade lane, the combination will become only the third biggest.
Shares of Orient Overseas surged 20 percent to HK$72 on Monday in Hong Kong, the biggest gain in eight years. Cosco shares jumped 5.4 percent following Friday’s 11 percent advance.”
Officials also said Cosco has no plans for further acquisitions and has no timeline on when it expects to get all the regulatory approvals needed to complete the transaction. However, the union – between a state-owned firm and a company controlled by the family of Tung Chee-hwa, the first chief executive of Hong Kong after it was returned to China in 1997, is almost guaranteed approval, as officials acknowledged. The mainland shipping company will finance the purchase with bridge loans from the state-owned Bank of China. Chief Financial Officer Deng Huangjun told reporters in Hong Kong Monday.
“There’s a very good chance we will get all the regulatory approvals because we always comply with all rules,” Casco’s Executive Director Xu Zune said at a press conference in the city.
To some, the purchase signifies the diminishing influence of Hong Kong’s dominance in shipping amid further inroads by state-owned companies and the rise of other centers on the mainland such as Shenzhen, Guangzhou and Shanghai.
“Rather than being one shiny spot, Hong Kong is now more seen as part of the Pearl River delta,” said Yu Zhanfu, a Beijing-based principal at Roland Berger Strategy Consultants. 'For the companies being acquired, there’s more to gain than to lose. They will benefit from having closer access to the broader market in the mainland.' Mainland Chinese companies can also learn from the city-based firms that have thrived in a market-based environment, he said.”
While global trade expanded at the slowest pace since 2009 last year, it’s expected to rebound in 2017, growing 3.8% this year and accelerating to 3.9% in 2018 (based on the IMF always overoptimistic China's estimates).
Some of Cosco’s competitors said the new combined company was a threat that could steal business along the Asia North America route, while others backhandedly welcomed the rise in shipping fees that would likely result from the consolidation.
“That is the example of a sudden new competitive challenge and we have to react and move quickly against that,” said Jeremy Nixon, chief executive officer of Ocean Network Express Pte., the operating company for the combined container business of Japan’s three biggest shipping lines.
The industry is ‘fragmented’ and consolidation can help transform the business for the benefit of customers, Maersk, the world’s biggest container operator, said Monday in reaction to Cosco’s takeover. A representative for Hyundai Merchant said the company is “closely monitoring to see how this development will impact the industry.”
Investors will be watching to see if the deal leads to a sustained pickup in the Baltic Dry – and if that in turn leads to higher consumer prices. Andrew Lee, an analyst at Jefferies in Hong Kong, believes earnings of shipping companies will improve in the second half of the year, “driven by higher trans-Pacific annual contracts.” And a follow up question: if the deal unleashes consolidation amid the dry bulk shippers, and prompts price increases, will customers be able to pass on prices to already challenged consumers, or will the end result be an even bigger cut to what are already razor-thin margins.