Analysis: NOL/APL buy a big deal for CMA CGM, but a missed opportunity for Maersk?

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This month, Singapore container shipping line Neptune Orient Lines finally agreed to be acquired by France’s CMA CGM in a cash deal that values its equity at $2.4bn. Do not feel sorry for the other potential buyer, market leader Maersk, which has been left with limited options for its shipping line division – I believe it did well to bow out and avoid a bidding war.

I expected acquisition to value the enterprise (market cap plus net debt) at over $5bn.

For CMA CGM, this is a massive deal, of course – but also a necessary one on the road to public markets.

It resembles Hapag-Lloyd’s purchase of Chile’s Compañía Sud Americana de Vapores (CSAV) in 2014, and similarly will likely need the backing of shareholders and new equity investors at some point to recapitalise the balance sheet of the combined entity if CMA CGM/NOL does not manage to hit synergy targets and finds executing divestments difficult.

“The offer will be launched without delay after approval of the relevant authorities, which is expected by mid-2016,” CMA CGM said on 7 December. This means that the final price of S$1.30 per NOL share could be tweaked down if market conditions deteriorate significantly. Credit rating agency Fitch reviewed its global industry outlook from stable to negative last week.

The deal

NOL’s balance sheet carries $2.6bn of net debt, so the implied pre-synergy EV/EBITDA multiple associated to the takeover is about 15 times, which would be insanely high for a buyer that doesn’t have a plan B up its sleeve, given that such a valuation is based on the assumption that NOL will ultimately be able to generate record-breaking annual EBITDA.

That level of adjusted operating cash flow, or EBITDA, is consistent with trailing figures (2014 EBITDA was about $320m), but NOL’s recent underlying profitability has been volatile in recent years, so it could be lower, going forward. After all, NOL is not exactly a money-making machine and the name of the game in container shipping is relentless cost-cutting, which is essential to preserve margins.

But even if NOL manages to hit over $400m of EBITDA in future, its valuation would look stretched.

By comparison, Hapag-Lloyd stock should currently trade on a 2015 EV/EBITDA multiple of about six times, assuming the German group reports a normalised annual EBITDA in the region of €1bn, which would be consistent with its nine-month performance. Elsewhere, the shares of Maersk – whose valuation suffers from a conglomerate discount – trade at about  four times EBITDA.

One caveat is that, given the different amortisation and depreciation schedules of these shipping companies, it might be more appropriate to compare their valuations based on EV/EBIT multiples, but the problem is that NOL has reported a core loss of $7m year to date. Although that loss represented an improvement of $52m year-on-year, I’d need a fully functioning time machine to predict an appropriate run rate for operating income, or EBIT, given the decline in global freight rates.

Hence, the comparison based on adjusted operating cash flows.

Opportunity

The wide gap between the market valuation of NOL and those of other shipping players presents an obvious opportunity for the buyer, however. In fact, if you valued at zero the net debt of NOL, its take-out multiple would drop to a reasonable level of 7.5-times, and one immediate element supporting the deal is tied to benign credit conditions.

NOL’s debt is being repackaged and refinanced at convenient rates by CMA CGM management. At some point in the future, possibly 2017, the debt load of the combined entity will likely be repaid or cut using proceeds that CMA CGM might try to raise via an initial public offering (IPO).

“The transaction is valuing NOL at a price to book ratio of 0.96 times … and will be financed by a combination of available cash and bank financing provided by a syndicate of international banks,” the French group said.

Relationship banks are keen to join the deal, sources told me, due to its risk & reward profile.

“With the upcoming IPO, there’s ancillary business on offer as well as a decent yield,” one of the participants in the syndicated debt financing backing the deal told me today.

Synergies

CMA CGM eventually plans to flip some assets to other trade buyers, but given current market conditions, I remain pessimistic on this front. Currently, the deal hinges on synergies.

According to CMA CGM, combining the two groups would create the following competitive advantages:

• the optimisation of vessels and occupancy rates on routes
• economies of scale in terms of purchasing costs, logistics costs and chartering costs
• a larger and more flexible fleet, allowing deployment of the most efficient vessels on any given route

Overall, “the trade portfolio of the combined group would be better balanced”, with increased resilience in times of market volatility, CMA CGM said, emphasising its substantial experience liner takeovers.

NOL is expected to report $6bn of revenues in 2015 while CMA CGM is expected to pay a premium of $785m – according to my calculations – which is derived from the undisturbed share price of NOL of about S$0.8 earlier this year. Its synergy target must exceed the premium being paid to NOL shareholders, so I think CMA CGM must have identified cost synergies of at least 4% of NOL’s top-line, or $240m pre-tax, which is not very much in deal-making terms.

The net present value of those synergies, based on certain assumptions of tax rates and the cost of capital, indicates that CMA CGM might be able to save and retain millions in synergies, although it is a little early to speculate – my best guess is that $200m of additional synergies can be achieved for any incremental 100-basis point rise in the floor synergy target which, as I’ve outlined above, I assume to be 4% of NOL’s top-line.

In other words, NOL could have asked for a bigger premium.

Alphaliner commented last week: “The failure of NOL’s shareholders to obtain a premium over its book value will still have significant implications for the industry, especially for other potential sellers seeking to make an exit from the container shipping market.”

However, book value is not a financial metric that always tells the entire story of a deal and its implied valuation, and is not closely watched by rainmakers. But other potential sellers, Alphaliner added, could expect to receive discounts to their historical book value in the event of further consolidation moves in the industry.

Finally, it noted that “this would also have significant implications for carriers which are seeking new public listings”, with the average market capitalisation of 15 publicly listed main carriers currently trading at an average valuation of just 0.86 times book value.

In my view, the French carrier paid a fair price, and had no choice but to pay up to secure a deal that appears necessary to buck the trend of declining profits. While all the main carriers have had significant problems during this earnings season, loss-making freight rates and falling earnings simply cannot last forever.

On a pro-forma basis – before synergies and excluding asset sales – the combined CMA CGM/NOL entity could end up being leveraged at over six times EBITDA, according to my calculations.

“We are seeing net leverage at over 10 times EBITDA for some deals, so that level for CMA/NOL would be fine,” the global head of a syndicate loan desk in London told me this week.

“A few traditional lenders are out, funds are in, yet otherwise it’s not much different from 2007.”

While its rivals stretch their finances, Maersk maintains a solid capital structure, so on that basis NOL should be considered a missed opportunity.

However, if CMA CGM fails to delivers, plenty of value could be up for grabs at distressed prices over the next few years, and with its cash pile ready for use, Maersk could profit from that.