By Gavin van Marle

“So, how about this merger between Hapag-Lloyd and United Arab Shipping Company – what do you make of that?” (‘It’s not going to be a fairy tale’, was what initially sprang to my mind when my editor asked, but I didn’t say it). For over two weeks, I have tried to come up with something really good to satisfy The Loadstar editors. But I am still nervous, and not only because all the voices feeding the rumour mill at Loadstar Towers believe the deal has just a slim chance of falling apart, given current market conditions.

I think the voices might be right. Deutsche Bank bankers and a few others surely hope so.

Market share

On 24 April, soon after talks became public, The Loadstar’s shipping guru, Mike Wackett, warned me about Hapag’s fall from fourth to sixth in the container shipping rankings. A lower market share based on capacity operated added insult to injury to the debt-laden company, which has grown via acquisitions to stay afloat, but is finding it difficult to remain in the black. From the outside it seems that the benefits of front-loaded synergies stemming from the integration of Chile’s CSAV are slowly fading away.

$2bn orderbook

Maersk continuing to dictate strategy and CMA CGM’s first-quarter results reminded us just how challenging the environment is for shipping. My editors pointed out that for Hapag “the prize is UASC’s big ships,” and the combined value “of its newbuild orders in the last couple of years is around the $2bn mark”.

In truth, we are blind on financials. Bloomberg got so confused about the identity of the company that it talked of USAC shares listed in Cairo, while Reuters argued about a successful merger that “would create a group with an estimated enterprise value in the region of €7-8bn ($9bn)”.

I was told: “There are no financial metrics at all for UASC. The best thing you can do is to determine the asset value of its fleet and make some assumptions as to the value of its staff and buildings, although most would likely go in the event of a merger because Hapag already has a global network of those.”

For his part, Mr. Wackett noted that since UASC’s 1970s inception by the UAE, Bahrain, Saudi Arabia, Iraq, Kuwait and Qatar, “to my knowledge it has never published financials”. Nonetheless, I am keen to determine whether this merger – which, of course, would end up being a takeover of USAC by Hapag – could reveal more about what Hapag is doing, and how much USAC’s capital could be worth.

72 per cent stake

One key number we know is that Hapag aims to retain a 72 per cent stake in the combined entity. “The parties are basing their discussions on a relative valuation of the two businesses at 72 per cent (HL) and 28 per cent (UASC), subject to a mutually satisfactory completion of the negotiations and the mutual due diligence exercise,” it said on 21 April. There’s no certainty that agreement would be reached, but the terms will likely be disclosed by the end of June, if the deal goes through. UASC will hold an extraordinary general meeting on 2 June to discuss the matter, among other things, and shareholders “shall vote whether to approve the conclusion of a business combination agreement with Hapag,” it said on May 18.

More details needed

I managed to unearth some figures dated 2008, according to which, UASC reportedly generated $1.4 billion of revenue and had over $3 billion of assets.

Just a handful of sheiks and emirs and their advisors know what the balance sheet and cash flow statements look like nowadays, although according to vesselvalues.com, the current demolition value of the target stands at $467 million, and has been steadily declining for several years. That’s something to consider – but is it also a good proxy for its equity value?

Well, we need more details about the capital structure of the combined entity, and particularly how much debt currently sits on UASC’s balance sheet. The group wrapped up a $1.2 billion syndicated loan co-ordinated by Deutsche Bank in December 2013, which was part of a larger $1.7 billion debt financing package. Deutsche Bank was also one of the three bookrunners and co-ordinators of the Hapag IPO at the end of last year.

So, it’s possible that €1bn of net debt is a reasonable estimate, based on the median net leverage for the smaller players in the industry and the amount of operating cash flow that I assume UASC churns out. Clearly, Hapag remains in the driving seat, given its size, although its debt pile is so high that it amounts to 61 per cent of its enterprise value, currently at €5.7 billion. With hindsight, its IPO also makes more sense because Hapag tapped the public markets in order to be able to grow inorganically on the back of a solid market valuation that would give it strength in deal-making. USAC, by contrast, doesn’t disclose its financials, which puts it in a weaker position in the negotiations. In this context, a few banks are exposed both to Hapag’s debt and UASC’s, and to the successful merger of the two.

Comfort zone

I could be wrong, it would certainly not be the first time, but assuming UASC’s net debt is not significantly lower than €1 billion, Hapag could value its equity close to zero, or well below its demolition value. Such a scenario is based on an all-share deal, according to which Hapag retains a 72 per cent stake in the combined entity and UASC’s equity would be worth close to nothing, even assuming rich take-out multiples for Ebit and cash flows. If my guesstimate is accurate, the net leverage of the combined entity should rise to 4.8x from the current 4x level for Hapag, pre-synergies.

Any other financing scenarios – according to which Hapag uses either borrowings and stock or just debt to finance a deal – would push up the net leverage of the combined entity well above the comfort zone, so they should probably be ruled out. When I stressed my guesstimate, it emerged that UASC’s equity value could be well below its demolition value unless its debt pile is much, much lower, or close to zero, which it could be of course given the cash-rich nature of its owners, particularly the Emir of Qatar, with 51 per cent of UASC. In that case, Hapag’s equity could be worth up to about 3x its demolition value. Either way, it seems plausible that UASC’s enterprise be valued at about €1.1-1.3 billion, regardless of the equity/net debt split.

Speculation 

We can also speculate that the deal could be triggered by an opportunistic view from Hapag with regard to recent developments in the oil sector. In January, Reuters reported that UASC was “resuming business with Iran following the lifting of western sanctions, despite the deep-seated political rivalry between the Islamic republic and Saudi Arabia, one of the shipping line’s main shareholders”.

What else?

“We learned that UASC is controlled by Qatar with 53 per cent when it requested an exemption from the FMC in 2014 as a ‘controlled carrier’,” Mr. Wackett said, while adding that, according to sources, “UASC UK staff received a directive from Dubai last week with an immediate ban on non-essential travel and entertaining.” Which confirms that UASC needs to show higher underlying margins to fetch an equity premium. As UASC presumably knows, Hapag needs deal-making to enjoy a happy ending, and so do the bankers that were involved in the Hapag IPO, in the Hapag/CSAV merger and in the huge financing arranged for USAC. I nearly forgot that I asked an M&A banker in London what he made of the merger between Hapag and UASC. “Don’t ask Deutsche Bank if the deal falls through,” he replied.

Reprinted courtesy of The Loadstar (www.theloadstar.co.uk)