Johnson Leung, an equity analyst at Jeffries, provides readers with an excerpt from an in depth report he published today on China’s big maritime merger.
Cosco and China Shipping companies have similar segments from container, dry bulk to ports and container box leasing entities although some are very different in scale. Without much colour from the management, we could only guess the format of such reorganisation at this stage. We figure the government could either (1) consolidate all the different listed entities into one listed platform, or (2) carry out a dozen asset swaps to keep all entities separately listed with each focusing on one shipping sub-segment.
Either way, there is a very high risk, in our view, that the plans are not able to be executed due to minority’s objection. Reorganization between these two shipping groups would be considered as a connected transaction given they are both controlled by SASAC. Majority approval of these minority shareholders is required to pass any motions for connected transaction, which can be challenging since the company has little influence over these minority investors’ decision and the motions may involve seven different groups of shareholders for the seven listed entities within these two shipping groups. The minority investors that are not controlled by the government hold about 45%, 53% and 59% of the shares for the three listed Chinese shipping companies namely, Cosco, CSCL and CSD.
Plan 1, i.e. consolidating all different listed entities into one listed platform
This entails privatisation of all the other listed companies within these two shipping groups. After all the companies are privatised within one entity, e.g., Cosco (1919.HK), the management could re-arrange the operating lines how ever it deems fit without involving the minority investors. However, Plan 1 could be the most expensive way to handle such a re-organisation because cash may be involved and a premium valuation may have to be given to buy back shares from minority shareholders. Payment in shares may not work because the share price of Cosco is currently at so large a premium over its peers that CSCL and CSD minority investors may not agree with the valuation of Cosco’s shares.
Plan 2 entails multiple connected transactions.
First, it may involve more rounds of minority shareholders’ approvals compared to Plan 1. Second, the consequences of the asset swap could make some listed companies change completely into something else, which may not be desired by the minority shareholders. For example, Cosco Pacific (1199 HK) may end up operating either container box leasing or port terminals. If the container box leasing business, which has been struggling, is being sold to another listed entity, there could be a fair amount of pushback from the minority shareholders of the receiving entity. Vice versa, the existing minority shareholders of Cosco Pacific may not want to be left with the container leasing business if the port business is being disposed of. Similarly, most minority shareholders may not want exposure to the dry bulk business, which could continue to struggle for a long time on potentially declining bulk commodity demand from China, in our view.
Navigating through the shareholders’ approval is only step one. Post-merger integration could often prove even more challenging. One just needs to look at the past examples of the state owned shipping group mergers in China. Executives’ resistance due to disagreement over management control could still halt the integration exercise and in some instances destroy the value of listed equities.