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Cosco – China Shipping merger: Can you make a national champion out of failures?

After many years of rumours, we now have confirmation that China’s government is moving to reorganise its largest shipping companies.

China’s mandarins may have little recourse but to hire the likes of McKinsey or potentially other consultants, accountants and banks in trying to sort out the mess that will be a Cosco-China Shipping merger-reorganisation.

NOL’s management, under the partial guidance of Temasek, and let’s not forget McKinsey, allowed the APL business model to continue drifting further into an abyss where old container lines go to get further picked apart. The Koreans, some Japanese, Taiwanese and many others have drifted to one extent or another into the same abyss. And the Chinese state carriers, as we well know, fell deepest into the abyss of financial disorganisation.

There have been several obvious what managements and markets often saw as uncontrollables during the economic and global trade sea changes of the last few years, especially on the container side of business. Some of these include:

  1. Continued massive subsidisation by governments;
  2. Continued free-for-alls in top managements, poor industry controls and borderline corruption;
  3. Massive pass-the-buck mentalities among controlling groups;
  4. Global trade growth slowdowns.

A mix of these issues could be seen by a few managements early on. Either it was Maersk or family businesses (OOIL, Wan Hai; Hamburg Sud) that would have seen these problems coming a little earlier. None of them were new. We saw many of these issues in large global banks as well. Citigroup. Bank of America. And so many others.

When a company has a group of people who jockey their way to the top and then get handed the purse strings of a behemoth with hidden nooks to hide things, seemingly bottomless pits to continue reorganising, free money from governments, it is easier to pretend to be competent. Until the music really stops.

Family owned businesses and companies truly answering to controlling shareholders cannot afford the above luxuries. If they pretend to be more than they are, they are quickly no more.

Going back to the laundry list above, in short summaries:

Continued massive subsidisation. In the name of national interest (an early form of TBTF, too big too fail), merchant fleets, national shipbuilding programs, over the centuries have enjoyed support of national shipping line flag carriers. NOL benefitted from state-backed low cost of financing for longer than most, until it mattered less in recent years (low rates came for too many if not all!). China’s flag carriers certainly got similar support for financing. And they got every form of kitchen sink assistance on top, from lower cost ship replacements to higher margin opportunities in dealing with Chinese government red tape. All this did was further bloat the corporate structures to provide semblance of quasi-normalcy.

Management free-for-alls. Some managements have been better than others. Maersk in recent years has been the role model. Most public company managements in the sector have not been up to the task. A poorly built ship will sink at first opportunity. For containerisation, leaks in the ships came from improper pricing and remuneration structures. Containerisation was still relatively new in the 1980s as an independent business. But what was clear early on was that it was a complete falsehood to claim revenue/TEU as ‘revenue’. Of course some managements tracked the real core data properly. But too many people relied on the false reporting practice of these ‘gross revenues’.

People got the wrong commission structures, accounts were improperly triaged. And some senior managers, especially in state-run companies in places such as China had every opportunity to seize self-gain where there was none to be had. Cosco had bought IRIS-2 from OOCL, and yield management should have been easier. But only people on the inside can reveal how far Cosco would have been from having many accounts run based on true profitability.

Pass the buck mentalities (Who will do the work? Who will pay?). No different than the British government about 100 years ago bailing out its shipyards. China created the biggest of massive bubbles the world has seen as a result of government-induced wasteful and self-enrichment industrial policies. It follows that we will continue to see the biggest of massive bailouts as well. We’ve been on about this for years. But we have yet to visualise the full impact in perspective. Plunging commodities recently has been one key ramification. But for there to be a quasi-orderly deflation, we need to proceed in stages. Cosco, CSCL and other companies will need to spend years reorganising container services and customers. Cosco Bulk and CSCD has the potential to be easier, though the economic impact could be huge. And China Merchants and Sinotrans may be significantly affected. Bulk fleet integration should, in the final analysis, be run like a property business.

The integration of Cosco-CSCL should be more scientific. In most cases, McKinsey and investment banks have not found proper solutions that pay for anyone’s effort to date. But most likely similar methods will be used again. And we will have to see where the Cosco+CSCL equation comes closer or further from equaling 2. We all know that 1.X is the answer. But none of us know what X will be until we see the numbers after the fact. Can an X output of two merged China companies be similar to an X from more developed economy companies? And do the state mandarins need to pay money to outsiders to merge these behemoths? Since companies are still top-down driven by the state, we might expect something quite different than a Maersk takeover of P&ON or Sealand, or even NOL-APL. Will equations handed to shareholders in Shanghai and Hong Kong contribute to share value longer term? In developed economies shareholders would stand a good chance of taking rude beatings. But somehow in China shares go up on this type of news.

Global trade slowdowns. Corporate managements in China as well as many other corporates missed all the boats in calling a shift downward in global trade growth. Not even slow steaming, low interest rates on relatively high debt on balance sheets, vessel design modernizations (a double edged sword to be sure) as well as any number of government subsidies saved Cosco and China Shipping.

Ultimately the twin catastrophes of 1) global container slowdown, and 2) the once in a lifetime bust in bulk following the once in a lifetime boom could have and should have been managed very differently for China’s leading shipping companies. China will likely create a behemoth container line – a national champion – that will hold its own in the Top Player leagues. … But it should really farm off the bulk into a completely different corporate animal.

Last Thoughts

According to press reports the reorganizations of Cosco, CSCL, and CSD (and others) could be completed in 2017. The container merger of operations will face many of the laundry list issues presented above, and most notable will likely be the problem of 1 + 1 does not equal 2. On the bulk side, the work of reorganisation could be much cleaner. We may yet get back to the 1980s and massive vessel lay-ups. Only vessels that can pay their way at exceptionally low rates should be reorganised into clean and lean vehicles. Foreign professional vessel managers could also be brought in with shared profits and BOT structures. No need for consultants or banks to reorganize here.

Who, in the end, can we blame for the disasters leading to reorganisation? Incompetent business managers such as Wei Jiafu were only drops in a bucket of far larger geopolitical games.

Both China and the US created massive global bubbles. China created a mostly physical one which has impacted global volumes of commodities in a very direct way. The US created a mostly paper and monetary bubble which has affected bonds and money indicators such as sinking volatility of money more directly.

Both China and the US extended their bubble machines post 2008-09 in their own ways. China’s efforts post 2008 led to continued property and commodity price increases, continued large influxes of bulk commodities, and continued large monetary outflows by leading cadres, etc. The US efforts post 2008 led to massive rallies in bonds and equities and large wealth effects amongst a narrow segment of society.

And yet unwanted price deflation in the physical world of goods has been the outcome for all. In the past, deflation from China was good for containerized trade (more goods for Wal Mart took more space in containers). But in the post-08 GFC world things changed. All of sudden for senior managements on cruise control, demand for containerised transport of manufactured goods went from 9% long term growth to 5% long term growth, while larger container vessel innovations combined with massive China overproduction (and while Korea continued to turn out its own fine ships) continued downward pressure on revenues/TEU. Deflation is a very bad word in the lexicon of economists.

A Cosco-CSCL merger does have the potential to lead to opportunities to gain a greater share of business from some customers if the new merged China national champion consolidates some accounts. But who will pay the bill of a more efficient Cosco-CSCL? We may have to wait until 2018 to see the results.

Charles de Trenck

Charles de Trenck began his study of China in 1980 and eventually got in on the ground floor in China's equities boom of the early 1990s through work in Hong Kong and China shares. By the mid-90s he shifted to containerised trade, ports and shipping, eventually leading Citi to #1 rankings in Asia transport equities.
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