Analysis: could floundering HMM take a leaf out of ZIM's book when restructuring?

The successful restructuring of ZIM Integrated Shipping Services has captured the attention of many industry observers over the last couple of years. After all, its debt-to-equity swap was meant to be just one of many waivers set to flood the ailing shipping industry, serving as a blueprint for other box liners that had been fighting hard to avoid bankruptcy.

The Haifa-based group said on 17 July 2014 that banks, shipowners and bondholders signed up to a restructuring plan “as a result of which creditors converted approximately $1.4bn of ZIM’s total $3.4bn debt and liabilities into a 68% ownership stake in ZIM”.

After lengthy negotiations, its capital structure was seriously amended, and events have turned so favourable that ZIM was mooted as a prime IPO candidate in New York in October, when it reportedly hired Bank of America Merrill Lynch and Barclays to arrange a public offering.

Although the floatation didn’t happen, its financial performance is only partly to blame for this failure to tap the public markets.

Financials

ZIM is shrinking, which is almost inevitable in a shipping market as battered as this, but in doing so it has become a more profitable entity – one whose more balanced capital structure played an important part in its survival.

The challenging environment notwithstanding, its financials speak volumes about the improvement. In the 12 months ending 31 December, adjusted Ebit hit $118m, versus a $12m loss the year before, with adjusted Ebitda soaring to $217m from $116m in 2014.

Lower freight rates and overcapacity hindered revenue growth across the industry, so a 12% fall in sales to almost $3bn was less relevant than its cash flow performance, and an adjusted Ebitda margin of 7.2% – which more than doubled year-on-year – surely represents a respectable level of adjusted cash flow profitability.

The world’s fourth-largest box line, Hapag-Lloyd, pursued an IPO at the end of 2015 – arguably during the most challenging quarter for the shipping industry in decades – and currently boasts an Ebitda margin of roughly 10%, with its enterprise value at just over six times Ebitda.

There are significant operational differences between ZIM and Hapag-Lloyd, but a back-of-the-envelope valuation shows that applying a similar trading multiple on ZIM would value the enterprise at $1.2bn – although this would not take into consideration its lower cash flow profitability, the typical 20% discount at IPO and a few other factors.

In particular, fourth-quarter results showed that, as with its peers, ZIM struggled to deliver acceptable returns on invested capital, having reported adjusted Ebit at -$5m ($5m in the fourth quarter of 2014) and adjusted Ebitda at $20m ($30m the year before). During the last quarter of 2015 it carried 590,000 teu, up 5% year-on-year, while its full-year carryings fell 2% to 2.3m teu.

A performance blip that is line with the industry shouldn’t raise eyebrows, and any possible IPO discount could be offset by a premium stemming from an offering in the more liquid US market and an encouraging orderbook, so on this basis, ZIM investors could have reasons to be upbeat about the value of their holdings – although its current debt burden suggests that only a float valuing the enterprise in the region of $2-$2.5bn could be worth the risk.

Management risk

Perhaps unsurprisingly shareholders should be more concerned about changes in the management team. Its president and chief executive, Rafi Danieli, resigned in early January, reportedly only a few days after the IPO was pushed back.

Mr Danieli played hard-ball with the Israeli government in order to secure a deal that would allow ZIM to grow and access external capital, very possibly knowing that the public markets would have helped ZIM crystallise the value of its equity while making it a more palatable takeover target in an industry which is finally beginning to embark on serious consolidation.

Its core, long-standing shareholder, Israel Corporation, surely needs a float to recoup the cash it splashed to bail out ZIM in the restructuring.

“Israel Corporation invested $200m of new equity in return for 32% of shares in ZIM, and will also provide a $50m receivable financing facility,” ZIM said when the restructuring was completed.

Read-across

One obvious question now is whether other carriers in danger of sinking should follow its example: how about Hyundai Merchant Marine (HMM), the troubled shipping group from South Korea, for instance? Should it take a leaf out of ZIM’s book?

A similar capital restructuring would do no harm, but HMM is swiftly shedding assets to fend off a liquidly crisis, and who knows what will be left of its asset portfolio at the end of the process.

The latest twist in that particular take came today, when HMM signed a stock purchase agreement for a $1.08bn sale of its stake in Hyundai Securities to KB Financial Group

While some sort of debt-to-equity deal will likely be engineered, it could be argued that HMM would be better off trying to tie the knot with its domestic rival, Hanjin Shipping – something HMM rules out at present as a “half-baked rumour”, despite the fact that options appear thin on the ground when it comes to satisfying bondholders and shipowners alike.

“HMM will convene additional bondholders’ meetings within June to restructure all its public bonds due this and next year, and pursue a restructuring of bonds including debt-equity swap with bondholders,” it recently said.

The problem with HMM is that its demolition value is only $287m, according to vesselsvalue.com, and its market cap is just above $400m, both of which are a tiny fraction of its net indebtedness. HMM creditors – were they to agree a debt-to-equity swap – would still be betting on a bounce in freight rates and more benign economic conditions. And what chance of that?

As far as HMM goes, any restructuring that doesn’t include some sort of tie-up with another major shipping company should fall on deaf ears, in my view.