OOIL’s terminals, property divisions sales set focus on its container shipping business and put funds away for a rainy day.

By Eric Johnson

      In mid-January maritime news service Alphaliner    released a collated list of all the major container lines that had sought to raise capital in the last 10 months.
      The list of 12 lines, which includes some of the industry’s biggest and most well-respected carriers, raised $12.7 billion. That’s a staggering figure, even more than the $7 billion in losses the liner carrier industry is expected to have accrued in 2009.
      Later in January, Drewry Shipping Consultants pegged capital raised industry-wide at $15 billion through November 2009.
      Whatever measure one uses, it’s important to note that all those capital-raising efforts can be filed under two broad categories — debt or dilution of equity. All of the measures taken by lines to generate cash involved either borrowing money from lenders, shareholders or governments; or issuing shares or rights in the company.
      The effect of those two types of measures is similar — a drain on the future profitability of the company for its current owners, either because of debt repayment or because more owners would share in any future success.
      Noticeably absent from that list is Hong Kong container line OOCL. In 2009, OOCL suffered with the rest of the container industry, but it didn’t take on additional debt, nor did it issue additional shares in the company.
      In fact, the line didn’t do anything extraordinary, even as its revenue fell 35 percent and its volume dropped 14 percent. To know why, one has to look back more than three years — to November 2006.
      That’s when OOIL, OOCL’s parent company, made the eyebrow-raising decision (at the time) to sell its terminals division, which consisted of two terminals each in the ports of New York-New Jersey and Vancouver, British Columbia.
      The sale, to a teachers’ pension fund in the Canadian province of Ontario, netted OOIL $2.4 billion — a pretty healthy sum, especially with the current knowledge that the industry was headed for an unprecedented tailspin. But at the time, the sale was questioned. Container shipping was going great guns, containership demand was actually surpassing supply, and the container terminals business looked lucrative both in the short and long terms.
      Half the money from the sale went to shareholders by way of two special dividends while the other half was retained in OOIL for expansion of its remaining businesses in container transportation and logistics and property development. Roughly half of what was retained was invested in the property development business, with the balance available for the growth of OOCL, said Stanley Shen, OOIL director of investor relations.
      The money from the sale essentially acted as a rainy day fund, and the rainy days came hard and fast.
      OOCL is more reliant on the transpacific trade than Asia/Europe. As part of the Grand Alliance — along with NYK Line and Hapag-Lloyd — it pools ships on major trades, using the various members’ strengths to maximum benefit. OOCL, as American Shipper noted in its September issue (“Top 20 container lines,” at www.AmericanShipper.com/links), essentially acts as the Grand Alliance’s specialist express transpacific carrier.
      Most of its east/west vessels are deployed on this trade and, most importantly, its volume on the transpacific surpasses its volume on the Asia/Europe lane by nearly 50 percent. So it’s important to note that the slowdown in world shipping actually hit the transpacific well before Lehman Brothers folded and the world economic crisis fully took hold in September 2008.
      That made the $1.2 billion in cash OOCL retained from the sale of its terminals all the more important. It could be argued that OOCL was positioned as well as any line in the world for the downturn, based on its cash reserves and conservative vessel order book. Indeed, no line was set up to actually succeed in such a depressed volume and rate environment as existed in late 2008 and early 2009, but the Hong Kong line was well prepared to weather the storm.

Another Sale, More Cash. American Shipper sought perspective from OOCL on the issue in early January. As it turns out, the request appeared prescient, because on Jan. 18, OOIL announced another cash-raising salvo. The line said it had sold all but two properties from its considerable property and development division for another $2.2 billion.
      Just after the sale of the property division was announced, American Shipper spoke with Shen about the impact the terminals unit sale had on OOCL’s business during the downturn, and how the upcoming property division sale would affect its cash position.

Shen

      “I think the story is about how a company quite diversified back in 2006 has narrowed its focus to a single core business,” Shen said.
      He added there’s “never a perfect time to sell; the question is when is it the right time for the company.”
      The sale of the terminals came at a time when the container industry was beyond buoyant — some might say overheated. A Goldman Sachs report on OOIL in March 2006 — several months ahead of the terminals sale — painted a favorable portrait, saying its share price didn’t reflect its full value. The report said OOIL’s value should have taken into account the viability of its three divisions.
      “We believe that OOIL should be increasingly valued on the basis of the sum-of-the-parts methodology encompassing its diversified business: container shipping, container terminals and property,” the Goldman Sachs report said. “Not only are the latter two businesses growing, but we believe there are also catalysts that could unlock their real value.”
      The report specifically mentions the high price DP World paid to acquire P&O Ports in January 2006 as a reason to value its
assets beyond ships. The analysts further said OOCL’s container shipping business was undervalued because it wasn’t appropriate to apply typical rules to the valuation of its assets.
      “We do not believe in (book value) impairment due to the prospect of falling vessel prices: like aircraft values, container vessel values are cyclical,” the Goldman Sachs report said. “We think that current fleet (book values) undervalue the fleet by 25 percent.”
      To underscore the point about the volatility of ship values, a 6,500-TEU vessel ordered in 2006 for $100 million was selling for $35 million in 2009.
      In any case, smack in the middle of the sourcing boom out of China, OOIL decided to sell its terminals. Then, months later, demand fell off a cliff, leaving lines strapped for cash as rates plummeted below costs.
      “All the analysts gave a lower valuation than what we sold it for,” Shen said.
      Indeed, the Goldman Sachs report valued the terminals at nearly $500 million in March 2006, or less than a quarter of what OOIL fetched in the sale.
      Despite its apparent readiness for difficult times, Shen said OOCL was as surprised by the depth of the downturn as any other line.
      “We were caught off-guard, but we were fortunate in being financially sound and with sufficient operational flexibility,” he said. “We had cash (more than $2 billion counting the remaining proceeds from the sale of the terminals and previous reserves), and our mix of owned and chartered-in vessels meant we were able to manage our overcapacity without having to lay up vessels.”

Financial Health Table. A recent review of the financial health of the parent companies of 18 shipping lines, released in January by London-based Drewry, found that OOCL was in the best shape of those surveyed.
      Drewry’s survey used the Z-score, an economic benchmark that weighs a company’s revenue, assets and liabilities and predicts the likelihood of it declaring bankruptcy in the next two years. OOIL, along with Maersk Line parent A.P. Moller - Maersk, were the only companies not to be considered in a distressed state.
      The table was formulated mostly using half-year or three-quarter-year financial reports for 2009, before many of the government or shareholders rescues, or bond and share issues, had occurred.

Heaney

      “Nearly $15 billion had been raised … as of the end of November,” Simon Heaney, editor of Drewry’s new Freight Shipper Insight, wrote in January. “By far, the most common way of raising cash was through equity/share issues, to the tune of $8 billion. Bond issues are also contributed about $3 billion, while government guarantees and other measures added another $3 billion or so. The rekindling of interest by shipping companies in the equity and bond markets is in part a response to bank lending becoming harder and more expensive to access.”
      OOIL, unlike Maersk, was able to eschew such measures, content in its ability to weather the storm using cash reserves and its ability to secure low interest rates.
      “The sale of the property division will put another $1 billion in the bank, which gives us the ability to ride this out,” Shen said. “We didn’t have to raise debts. We didn’t need to borrow money. We didn’t offer additional shares or promote rights issues. With cash in the bank, we’re also able to borrow at advantageous rates.”
      OOCL’s vessel ordering activity over the last decade-plus shines a further light on its conservative but strategic methods. It ordered 5,000-TEU vessels in 1993, with those vessels coming online in 1995, in time to take advantage of China’s accession to the World Trade Organization. In 2001, it ordered 8,000-TEU ships, with the first of those vessels arriving just in time for the demand boom between 2003 and 2006, and the last two to be delivered in 2013.
      OOCL has avoided orders for so-called mega-ships, content with the sufficient size and flexibility that the 8,000-TEU vessels offer on major trades — after all, it’s far easier filling an 8,000-TEU ship in a downturn than a 13,000-TEU vessel.
      OOCL’s current order book looks downright sparse compared to the huge orders placed by its rivals in the top 20 list of container lines. OOCL operates 73 vessels, of which 41 are owned and 32 are on charter. It has 11 more ships to be delivered (four in 2010), and that coming capacity represents less than a quarter of its current capacity.
      Only three other lines among the world’s top 20 are in such a favorable position. And only one other line has an average fleet age younger than OOCL’s 5.5 years. Hapag-Lloyd’s average fleet age is 5.4 years, while the industry average is 9.7 years, according to Containerisation International. A half-dozen other lines are in a similar position as OOCL in terms of vessels ordered, but of those, none have been able to escape the borrowing or share-raising measures as OOCL has.
      Now, instead of awaiting dozens of vessels that will likely be surplus to demands over the next three years, OOCL is sitting with cash in hand from two major sales.
      OOIL seemingly has the financial wherewithal to see it through the current downturn in container shipping. As of June 30, the company had $7.1 billion in total assets (including $1.6 billion in liquid assets), with $3 billion in total liabilities. And that doesn’t take into account the sale of the property division.
      Compare that to a handful of other lines, which have had to lean on shareholders and ship owners to provide billions as they restructure their debts. Such measures have been required at CMA CGM, (where debts are said to be more than $5 billion), at OOCL’s Grand Alliance partner, Hapag-Lloyd and at Zim, a partner to the Grand Alliance carriers on a handful of Asia/Europe and transpacific services.
      It should be noted that results for all three of those carriers have picked up significantly, with CMA CGM announcing late in 2009 that it was breaking even on operations and reports in late January suggesting similar developments at Hapag-Lloyd.
      Zim may have also turned a corner by canceling some of its boxship orders and securing interim funding as ocean freight rates firm.

No Second Thoughts. The sales that OOIL made have risks, of course. The different business units were a way to diversify OOIL’s revenue streams. Maersk Line, for example, has oil assets upon which to rely if the ocean transportation business continues to struggle. Its terminals division performed well in 2009 despite the global container downturn. Other lines with terminal divisions have largely held on to those assets, and in fact have grown them.
      But Shen said that while there are no regrets or second thoughts, the sales of the terminals and property divisions were difficult decisions.
      “Both businesses had been viewed as strategic and there was no ‘moment of clarity’ in terms of the decision to sell the terminals division,” which earned the company operating profits of nearly $100 million in the 12 months through June 2006, he said.
      The decision to sell the property division was equally difficult.
      “We have the utmost confidence in the economic growth of China and were very comfortable with our property development activities given our positive view on the outlook for that sector in the mainland,” Shen said.
      He added that the time and investment required to manage the property division can now be focused on the OOCL liner and logistics business.
      When the property division sale was announced, OOIL Chief Financial Officer Ken Cambie said, “OOIL intends to use the sale proceeds from the transaction for general working capital purposes and to fund growth opportunities in its core business of container transport and logistics service.”
      Those capital reserves will only become more valuable as the depth of the capacity overhang becomes clearer in 2010 and 2011. Rates and revenue may recover over that period, but will it be enough to overcome the debts lines have accrued? Will lines quickly return to the “supernormal profits” (as characterized by Goldman Sachs) they enjoyed from 2003 to 2005? If not, the backing of governments and shareholders may not be so easy to secure going forward.
      Carriers who borrowed money will have the burden of debt, and perhaps the creditors who have helped a handful of lines will be telling management teams to focus on returns rather than market share.
      As for OOIL, Shen said the company benefits from a tight integration between its shareholders and executives.
      “There’s a direct link from our shareholders to our management and that’s central to our success,” he said. “It means stable plans can be put in place over the long term.”
      Its stable and profitable ways — 2009 will be the first loss-making year for the line since 1992 — has stood it in good stead among the global giants with more fleet capacity and market share.
      “Based on our fleet size, we are a relatively small carrier in the industry,” Shen said. “Our alliance membership and cooperation on capacity through slot sharing with other liners is essential to us in delivering the best service to our customers.”

Container derivatives floated as tool to fight freight volatility.

By Chris Dupin

      The Shanghai Shipping Exchange launched its Shanghai Containerized Freight Index on Oct. 16, 2009. The SCFI is based on the weighted average of the cost of moving freight from Shanghai along 15 different trade routes around the world.
      To create the index, 15 shipping lines and 15 forwarders or shippers submit weekly to the exchange their estimate of the spot rates, quoting “all-in rates” in dollars per 20-foot equivalent units, or in the case of the U.S. West Coast and East Coast trades, 40-foot equivalent units.
      On Oct. 16, the SCFI pegged the cost of moving an FEU of freight from Shanghai to the U.S. West Coast at $1,369. The Transpacific Stabilization Agreement, which represents 15 leading container carriers in the Asia-to-U.S. trade, said that rates had fallen for many commodities by $1,000 per FEU.
      That spurred the TSA to announce in October initiatives to restore rates, first with an $800-per-FEU general rate increase for West Coast cargo to take effect in May and June when contracts expired, and a peak season surcharge of $400 per FEU after Aug. 1. Then it announced in December that it would not wait that long, but on Jan. 15 seek to impose a separate “emergency revenue charge” of $400 per FEU on shippers.
      By Feb. 5, the SCFI’s estimate of the freight rate on the Shanghai-to-West Coast route was 50 percent higher, $2,061.
      That kind of price volatility may spur interest by both carriers and shippers in a new product — container freight derivatives based on the SCFI or its components.
      In January, London-based Clarkson Securities Ltd. announced it had arranged the first trade of a container freight swap agreement based on the SCFI.
      The trade took place between the investment bank Morgan Stanley and Delphis, whose subsidiary Team Lines operates container feeder ships in Europe.
      Financial derivatives for the container shipping industry have been long discussed — even energy trading company Enron discussed the idea prior to going belly-up in 2001.
      Freight derivatives are commonplace in the dry bulk and tanker markets where they have been in use since the 1990s, based on indexes created and updated daily by the Baltic Exchange.
      “We have been working closely with the Shanghai Shipping Exchange to ensure the SCFI will be a suitable mechanism for container freight derivatives such as this and firmly believe this index heralds a new era for marine risk management,” said Alex Gray, chief executive officer of Clarkson Securities.
      The forwards or swaps are “principal to principal” derivative contracts that are traded over-the-counter, not on an exchange. They are agreements between two counterparties where one takes the view that freight rates will increase above some agreed level in the future, while the other believes they will decrease.
      The contract is settled against the price of an index — in this case the SCFI or one of its components — with the difference between the agreed price and the index paid to the company that made the correct call by the other counterparty.
      There is no “physical delivery” of space on ships, as there might be with, say copper futures, where a contract might be settled by delivery of metal to a warehouse.
      Benjamin Gibson, a freight derivatives broker at Clarkson, said the first contract was a small one, covering the movement of only five containers in each of two months.
      As of early February, no additional trades had been made, but Clarkson was marketing the concept to container carriers and logistics companies and working with a clearinghouse for the trading of the derivatives.
      He did not say which clearinghouse will handle the trades, but three groups — the London Clearing House, NOS Clearing in Oslo, Norway, and SGX AsiaClear in Singapore — do clearing work for bulk freight derivatives.
      Companies trading container freight derivatives will have to pay clearing costs and a fee to a broker for arranging the trade. Gibson said Clarkson will charge $30 per container.
      Clarkson believes there is big potential in the market, not only among shippers and carriers that may want to hedge their risk, but also by financial firms looking for a new product to trade.
      Gibson noted there have been previous proposals to trade derivative products based on containerhip charter indexes such as the ConTex index published by the Hamburg Shipbrokers Association. But Clarkson believes there will be broader interest in a derivative based on the actual freight rates, he said.
      “The freight market has so much more potential because of spot market volatility and also the wider customer base,” Gibson said.
      To come up with a reliable estimate of dry bulk shipping rates, the Baltic Exchange averages freight rates estimates from a panel of brokers. The brokers who develop the Baltic Freight Index are seen as neutral since on one day they may be representing ship owners seeking cargo for their ships and the next day a cargo owner looking for the best rate to move its commodities.
      The container industry doesn’t have an equivalent to brokers, so to come up with a neutral estimate of container freight rates, the Shanghai Shipping Exchange is using a panel of companies with 15 carriers and 15 freight forwarders or shippers who buy transportation to get a neutral opinion.
      Eleven of the 20 largest container carriers are supplying panelists to develop the index, while the shipper-forwarders are mostly Chinese firms.
      Amir Alizadeh-Masoodian, a reader in shipping economics at the Cass Business School in London and co-author of the book Shipping Derivatives and Risk Management, notes the Baltic indexes are updated daily.
      The fact the SCFI is determined on a weekly basis and that container freight is generally purchased over a long period of time — sometimes for months or on an annual basis — could make them more difficult to trade.
      He also noted that when dry bulk trading started up, trading was based on the Baltic Dry Index, an index based on the cost of moving several different commodities on several different routes with several different size ships.
      That proved not to be popular, he said, and today most trading is based on different components of the Baltic Dry Index which focus on a particular trade.
      Derivatives based on the SCFI may be attractive to speculators, but Alizadeh suspects that “for a company like Wal-Mart or Target in the U.S. that wants to use the index to secure their transportation costs or even shipping companies operating between Shanghai and the U.S., they are not going to want to use an index where the trades they are interested in may represent only about 20 to 30 percent of the index weight.”
      Clarkson’s Gibson agreed, and noted it will be possible for companies to trade either the comprehensive index or individual components. For example, the Morgan Stanley-Delphis contract was based on the Shanghai to North Europe component of the SCFI.
      Gibson said Clarkson is focusing most of its attention on marketing derivatives based on the four largest export trades out of China which are also the most heavily weighted components of the SCFI:
      • Shanghai to North Europe.
      • Shanghai to the Mediterranean.
      • Shanghai to the U.S. West Coast.
      • Shanghai to the U.S. East Coast.
      “Overall, I think it’s a positive move, because about 25 percent of the world trade is containerized shipping, so to have a liquid market in container shipping to be able to hedge exposure and manage risk is quite important,” Alizadeh said.
      While shippers and carriers can hedge risk by entering into long-term contracts, he said financial instruments give greater flexibility.
      “If you enter into a physical contract for a certain volume of cargo, then it is more difficult to get out of the contract if the market moves against you,” he said.
      It also gives traders or speculators a chance to bet on downturns in the market, he said.
      “A third advantage is that you can break your hedge into different periods — you can have short-term risk management, long-term risk management, and the physical contract. In the physical market you can have long-term and short-term contracts, but by using paper instruments you can rebalance these short-term/long-term exposures as you go along.
      “Also in the physical market you have exposure to one counterparty who either performs or delivers against a contract or not. But if you have financial contracts and they are cleared, then you can eliminate counterparty risk,” he said.
      Of course, companies must have the expertise to use derivatives and he noted there are also costs and accounting issues for which companies using freight derivatives have to be aware.
      “From my discussions in the past, there is some interest among shipping lines for financial products of this type to hedge some of their market risks, but there is no interest from shippers,” said Philip Damas, division director of Drewry Supply Chain Advisors. “It is very different from the bulk shipping sector, because shippers in container shipping are exposed to relatively low risks of freight cost volatility,” defined as freight cost spending in dollars as a percentage of product landed costs in dollars.
      “For this reason, I do not think that container derivatives will catch in container shipping, due to lack of demand from shippers,” he said.
      The SCFI is based only on freight routes out of China. Shippers of low-value exports from the United States and Europe — things like waste paper, scrap metal, hay cubes and grain — would like to hedge their container shipping costs like shippers of bulk products, Damas said, and in fact may use both bulk ships and containers to move their commodities.
      But he also noted it is “not these low U.S.-outbound or Europe-outbound freight rates that container shipping lines would like to hedge. They have such a marginal importance in the overall business of carriers, both in volumes and in revenue generation terms, that they hardly register. So the two sides have no common ground in this respect.”
      Gibson agrees with Damas’ point about the importance of freight as a component of total landed cost, but said his firm has gotten interest in the concept of derivatives from shippers moving a wide range of goods, from commodities such as coffee and forest products, to more expensive products such as white goods.
      Derivatives have also been a success in the tanker market where freight is much less as a total component of landed cost than in the dry bulk market, he said.
      Interestingly, Delphis, which made the first trade is not a participant in trade out of Shanghai, but operates feeder ships in Europe.
      But Gibson said a carrier like Delphis might find that its business is strongly influenced by what’s happening in the Shanghai-to-Europe trade. If business is booming from Shanghai to Europe and rates are strong, for example, demand for its feeder services may be strong and vice versa.
      Gibson also noted that container freight derivatives can also be used for speculation as well as hedging.
      “We have a lot of interest in this product by the financial industry, mainly banks, but also hedge funds, who come from outside of the container shipping industry, but see a lot of potential in using their experience in other markets to predict where freight rates are going in six to 12 months and want to use this product to speculate,” he said.
      Traders will be able to trade futures as far forward as they feel comfortable. Initially, Gibson said he thinks it will be possible to arrange trades for rates three or six months forward, but said he would like to see trade going 12 months forward.
      In the dry cargo futures market there are trades on freight up to three years out, he said.