Pressure prompted Japanese container line merger

Nov 7, 2016 – Nikkei Asian Review – TOKYO — Three Japanese marine shipping companies, Nippon YusenMitsui O.S.K. Lines and Kawasaki Kisen Kaisha, jointly announced on Oct. 31 plans to consolidate their container shipping operations, in the face of silent pressure from financial markets.

“Shareholders’ equity accumulated over the years disappeared in an instant,” said Nippon Yusen President Tadaaki Naito.

When the three shipping lines announced the merger of their container businesses on Monday, Nippon Yusen said it expects its group net loss to hit 245 billion yen ($2.37 billion) in the fiscal year ending March 2017. As a result, the company’s capital ratio fell to 24% from 34% at the end of the previous fiscal year.

Capital ratio of Mitsui O.S.K. Lines is 22% and that of Kawasaki Kisen is around 23%, far below 40%, the average of financially stable listed companies that are unlikely to go bankrupt.

Three shipping lines logged net losses in five years out of the nine years from the global financial crisis through the current fiscal year, mainly due to slumping container line business, which is the subject of the merger. Over the period, Kawasaki Kisen’s container line business logged a net loss six times, compared with Nippon Yusen’s seven times and Mitsui O.S.K. Lines’ eight times.

In addition to business fluctuations, “it took shippers a long time to notice the structural change,” said Ryota Himeno, an analyst at Citigroup Global Markets Japan. Shipping lines continued to pump money into new ships even when the global trade volume began a constant stagnation due to China’s economic slowdown. That created an oversupply, making it increasingly difficult to continue the business.

While a ship’s service life is 20-30 years and it takes about three years from order to delivery, container line contracts are normally one year. Freight rates are determined by market conditions.

The container line business has been hit hard by market conditions, compared with bulk shipping, which has long-term, stable contracts with large customers, such as steel and car makers. The benchmark freight rates for the U.S. are about half of the level of before the global financial crisis.

Tacit pressure

Tacit pressure from financial markets may have prompted three shipping lines to consolidate their container operations. Total market capitalization of the three shipping lines shrunk to 10-20% of the 2007 peak, before the global financial crisis struck.

Amid these circumstances, Mitsui O.S.K. Lines drew attention in late September by announcing that it would raise 100 billion yen through a 60-year hybrid loan.

While regular loans are classified as liabilities, hybrid loans can be included as shareholders’ equity to a certain degree at the discretion of credit rating agencies. Hybrid loans tend to have high interest rates as they rank low in order of repayment in the event of the issuer’s bankruptcy, like other subordinated debt. High-yield hybrid loans are popular among portfolio managers as interest rates go negative, but hybrid loans show borrowers’ harsh financial conditions.

In Kawasaki Kisen’s case, the large shareholder might have exerted unconscious pressure on the shipping line. Effissimo Capital Management, the hedge fund set up by former colleagues of activist investor Yoshiaki Murakami, became the shipping line’s largest shareholder this year.

Although Kawasaki Kisen President Eizo Murakami said the company had not consulted with Effissimo about the merger beforehand, the intention of “activist shareholder,” which requires the invested company to show at least 8% return on equity in the medium and long term, cannot be ignored.

If the merger produces about 110 billion yen as announced, pretax profit is expected to come to about 13 billion yen. That said, a V-shaped recovery, which is usually seen after restructuring, is unlikely.

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