Analysis – how long before CMA CGM heads to the stock market?

I believe that it is no coincidence that France’s CMA CGM, the third-largest container shipping line in the world, emerged as the leading acquirer of NOL soon after its closest rival in terms of capacity operated, Germany’s Hapag-Lloyd, priced its IPO below range in early November. The French group had little choice but to chase inorganic growth, hoping its lenders would back its plan by providing cheap funding.

By then, market leader Maersk – which had been increasingly cautious with regard to capital allocation and acquisitions – had warned the shipping market that its profits were tumbling, and it is likely CMA was already aware how difficult it would to turn a profit in the last quarter of 2015.

As it turned out, it ended up reporting some minor losses, but the trend is worrying, as the table below from Alphaliner shows.

Source: Alphaliner

Last autumn, speculation of a repeatedly rumoured IPO emerged, but unfavourable financial/shipping market conditions forced CMA to find a viable, alternative plan. In hindsight, a blown-out offer for NOL was the most obvious choice.

Once completed, the deal would represent the largest consolidation “in the history of liner shipping – in terms of capacity – overtaking Maersk’s acquisition of P&O Nedlloyd in 2005″, my colleague Mike Wackett pointed out in December.

With the shipping world in flux, CMA essentially had to decide what kind of risk was worth taking.

“Our operating performance once again illustrates the strength of our business model and our capacity to adapt,” said CMA CGM vice chairman Rodolphe Saade, when its annual results were announced recently.

CMA was able to offload M&A risk onto lenders, which are competing for a smaller number of borrowers and have lowered bank fees in a fast-changing industry.

CMA is of a different scale to Hapag, and its fortunes also mostly depend as much on how Maersk reacts to its deal-making as well as on its own corporate strategy – and I foresee possible problems in this respect.

Business model

There are warnings signs that the cash-burn rate of shipping companies could become unbearable if asset portfolios are not properly diversified – and CMA is more exposed and less diversified than Maersk to withstand the vagaries of a business cycle that can leave it short of options. Maersk, with a market value of $28bn, dwarfs CMA, and while its valuation suffers from a conglomerate discount, it’s more defensive than those of undiversified shipping firms.

It could be argued that, if CMA’s stock is successfully listed, Maersk may be tempted to spin-off its shipping unit at a premium valuation while retaining similarly cyclical, but less capital-intensive, business divisions – but would that be wise?

Since early November, Hapag has lost 17% of its market value while Maersk stock is down only 10% over the period. Short-term share trends do not dictate corporate strategy, but they demand caution and pose questions on what is the appropriate business model.

CMA is growing inorganically, but has decided not to diversify.

This is a plausible choice – given its asset base and 38-year shipping history – but comes at a time when the main players should consider a corporate strategy that goes beyond traditional capital allocation in shipping and to the heart of diversification.

Keeping a lid on costs while looking to exploit synergies is one possible path, with NOL a possible answer – but a legitimate question is whether Maersk, which is financially stronger than most rivals, abandoned the NOL takeover because it thought other sectors offered higher returns than shipping, which is in structural decline as most leading and lagging indicators show.

CMA would not comment on whether changes in its shareholding structure should be expected – one core shareholder, Yildirim, has been said to be looking to sell its 20%-plus stake for some time – or on the possible timing of a public offering.

Times are changing

The takeover of NOL is financed by $750m of cash and $1.65bn of undrawn credit facilities that were syndicated to relationship banks. The NOL cash commitment contributed to the drop in its gross cash pile, and will contribute to rising future debt.

The cash flow statement was inevitably hit, with cash flow from investing down $772m – the “company has deposited in escrow account an amount of $772m” related to the acquisition – and that weighed on its free cash flow profile (-$55m) and on its gross cash pile, which dropped from $2.2bn to $1.2bn at the end of 2015.

CMA is committing most of its hard cash reserves to the deal and – in what I believe to be a very unusual choice for a French company – it is stretching its balance sheet at a critical juncture.

Call it crazy, but all this could make a lot of sense if shipping trades and rates have bottomed out, but it is also a strategy for the brave – which will suit CMA shareholders if the takeover of NOL, which is expected to close by mid-2016, works out.

Either way, it’s lenders’ money, so why stress?

Equity

To paraphrase the thinking of loan bankers – who will profit if existing facilities are amended and corporate debt is restructured – covenants are safe unless they are breached, and a covenant breach would not be the end of the world.

On the face of it, NOL’s troubles spell a cost-saving opportunity, even more so in a low-rate environment, where relentless cost-cutting will persist across the industry this year and next, when CMA could become a public company, in my view. Assuming a price multiple of book value in line with that of its rivals (0.4x-0.8x), its market cap today would range between $2.1bn and $4.3bn, yielding an enterprise value (EV) of $5.8bn and $8bn before the consolidation of NOL.

On this basis, CMA would carry a net leverage of just about 3x – but it will surge, however, to more than 5x once NOL’s net debt is consolidated. The combined entity’s pre-synergy ebitda, or adjusted operating cash flow, will rise to $1.5bn, but its net debt will more than double to $8bn from $3.7bn on a pro-forma basis, according to my calculations.

CMA may also be forced to pursue a public offering sooner rather than later, because its bondholders may also have something to say about the plunging value of their holdings. French companies tend to listen very carefully when bondholders speak, and the debt-funded acquisition of NOL adds operational risk, and I understand bondholders are pushing for a stronger balance sheet.

Collateral and securitisation

NOL may be a risky bet but management has proved to be on the ball in recent months. It had one of those years during which margins deteriorate at a fast pace; despite a $1bn drop in revenue to $15.6bn, core operating cash flow and earnings held up well and its cost base was properly managed, falling by $1bn.

CMA says its financing arrangements are subject to compliance with the main following covenants: maximum gearing ratio; loan-to-value ratio (financing/market value of related asset); minimum cash balance; maximum long-term chartering commitments; and maximum capital expenditures.

After NOL is consolidated, net leverage will rise, loan-to-value metrics will carry more risk, cash balances will be down, certain chartering commitments could become more problematic and CMA could lose flexibility with regard to heavy capital investment.

“As at December 31 2015, the carrying amount of property and equipment held as collateral of financial debts amounts to $6.12bn ($6.4bn as at December 31 2014),” it said, an amount that is only marginally lower than the book value of its vessels, at $6.4bn, and is not the kind of collateral that should give lenders sleepless nights in this market.

Finally, there is its securitisation program and debt maturity profile.

“As at December 31 2015, the company transferred $1.08bn of trade receivables as collateral under its securitisation programme ($1.18bn as at December 31 2014).”

There are not many details on this and it’s hard to fully gauge the risk it carries, but CMA’s overall debt maturity schedule is shown in the table below, where you’ll find its total funding needs and how much its securitisation programme weighs in 2017.

Source: CMA CGM (edited by Alessandro Pasetti)

However, it suggests an IPO could happen as soon as in the fourth quarter this year.