Lessons of Corporate Finance from the Maritime Industry
When a corporate offer gets one thinking on shipping capital markets and shipping company valuations
On June 19th, 2020, Hafnia Limited (“Hafnia”, OSE ticker code “HAFNIA”) made an unsolicited offer to acquire Ardmore Shipping Corp (“Ardmore”, NYSE ticker code “ASC”) in an all-stock transaction. At first sight, it would appear another consolidation transaction in the much touted consolidation trend in the shipping industries, driven by economies of scale and similar operational synergies.
We think that the transaction provides a wealth of observations as it’s a microcosm of the universe of publicly listed shipping companies during the last decade. There would appear that several of the parameters used to analyze the proposed transaction would defy The Efficient Market Theory, religiously taught that the corroborate finance classes of business schools and MBA programs; we may dare say that the circumstances of the proposed transaction and investing in shipping even defy logic.
Hafnia’s offer was to acquire Ardmore at 100% of NAV as of June 12th, 2020; NAV is short for Net Asset Value (NAV), a benchmark upon which publicly traded shipping are valued, defined as net worth of the vessels in a fleet, that is the prevailing market value of the ships less outstanding debt. First, it would appear peculiar that a going concern shipping company (its vessels, management expertise, contracts, brand-name, etc) are valued at what is the net worth of the company’s floating steel. Multiple of earnings such as EBITDA (Earnings Before Interest Tax Depreciation Amortization) or multiple of cashflows, or some type of multiple of the company’s earnings (and potential) would be more appropriate, since, how a great deal of publicly listed companies are valued at. Imagine, if you will, being a medical doctor, and the practice is valued at what the furniture and other fixed assets are valued at; forget the flashy (and expensive) framed MD diploma on the wall, the doctor’s reputation and articles to the scientific journals; just the hard assets is the value of the practice. Thus, the choice of the metric of valuation, in and by itself, is not very flattering to those in the shipping industry. Think if TESLA was valued at the NAV of its plants and hardware! Elon Musk will never be able to fly to the moon literally or TESLA-valuation-wise!
Once one has the time to wrap their heads around the NAV metric valuation, then the real shock comes: most shipping companies, in general, are valued below their NAV, and sometimes, substantial below their NAV. For example, on June 12th 2020 ASC’s closing price, the date used for Hafnia’s offer, ASC was trading closing to 40% of its NAV; in other words, one could (theoretically) buy all outstanding shares of ASC at $40, take control of the company’s assets, sell them in the open market, pay off all loans and laugh all the way to the bank with $100 left to deposit. Potentially a great arbitrage opportunity, but really, insulting to the management of any shipping company (and its investors): effectively, the market not only does not think that the management add any value (“alpha” or α, as we say in business school), but actually destroys value from the company by destroying value from its fleet and business prospects. Really, this cannot be very flattering for those investing in publicly shipping equities, especially for the management of the shipping companies. And, to make clear, ASC is not the only tanker company trading at a steep discount to its NAV; with a couple of exceptions of publicly listed tanker companies that trade at a manageable discount to NAV (Double Hull Tankers at appr. 90% of NAV), the majority of the tanker shipping companies in the US trade below 60% NAV. Really abysmal numbers, especially when one takes into consideration that tanker rates were white hot just a few weeks ago when every oil company and oil trader were scrambling for storage space onboard tankers.
So, the question any rational investor that has to ask is why anyone would want to be a (heavily discounted) publicly listed company? Because, the $100 worth of tankers has to actually be bought in the open market paying real world sellers in hard cash, and then, voila, immediately after the Initial Public Offering (IPO) that one-hundred-dollar bill turns into two twenties; you could not even fool an elementary school kid with this trick! Why any rational investor do this, and invest in a public company? And, by association, why the shipping company’s management and main investor would want to doo this? There is the joke: “How one becomes a millionaire in the airline business?” one asks; and the reply comes back “Well, that’s easy, you start by investing a billion!” It would appear that shipping is not much better than the airline business (at least before airline companies started showing more discipline in the last decade by cutting capacity, increasing prices, etc)
There are many and good reasons why companies go public, and we have argued in the past in favor of publicly listed shipping companies. On the other hand, and we try here to be as delicate as we can, one has to abstractly posit on the Agency Theory, fiduciary duty concept, executive compensation, and in some case, interest conflicts and self-dealing, among some of the possible causes. And, once again, one can never ignore that shipping is a notoriously volatile industry, which affects risk and the type of investors that attracts, and also the valuation methodology.
Coming back to Hafnia’s offer for Ardmore, as mentioned, this was an all stock offer, meaning that Ardmore shareholders would had exchanged their (discounted to NAV) shares at a value equal to the net worth of their tankers. So far, so good, as they say. However, Hafnia’s offer was not in all or partial cash payment but in Hafnia shares, which is another discussion point from a corporate finance viewpoint. Cash offers, in general, are considered the most solid offers, as the buyer seems to have the cash at hand ready (or almost ready) and thus they have the credentials and they have done their homework, and payment in universally accepted hard cash speaks volumes to any seller’s language. There are nuisances to be considered, and sometimes all stock offers have validity, if for instance a buyer believes in the great good of the new entity, but again, a buyer selling means likely wants to exit the business they were in. Thus, the Hafnia offer, although at par to NAV, was not fairly articulated; after all, no seller of ships would really accept shares and other paper for their ships in the secondary market; hard cash would be a non negotiable point, when buying ships in the secondary market (and the definition of Fair market Value (FMV) is predicated that payment is made in cash and not any other form). There has been no talk of a premium of any kind, not even for the costs associated with Ardmore being a publicly listed company whereby the publicly listed “shell” itself has a value in the range of million plus. And, some more goodies coming along with the ships brand name, management team, going concern business, etc) And, to add salt to the injury, the Hafnia share price is itself discounted to NAV, as Hafnia belongs to the same universe of poorly loved tanker stocks; not as much undervalued as Ardmore, but nevertheless under-appreciated. Thus, for an Ardmore share seller, the truncation (and value?) would had been that of exchanging one heavily discounted financial instrument for another not-as heavily discounted financial instrument. To put it in more pedantic terms, exchanging a two-year old iPhone with a one-year old iPhone: still a good deal but one wouldn’t find many teenagers fall for it. It’s yesterday’s “fashion”, no matter what.
There is a saying in the energy world that “when the price of oil is too low, the best place to dig for oil is on Wall Street” by buying cheaply undervalued energy companies with oil wells. Given that the prospects of the shipping market do not seem too promising (again, till a month ago tanker freight rates were making front page news for tankers committed for storage at exorbitant rates and still tanker stocks were deeply undervalued), probably undertaking M&A and building up fleets in the financial world may make more sense than chasing actual ships across the oceans for purchase. And, probably something needs to be done with the long tail of vessel ownership worldwide.
However, when NAVs are so low and yet many shipowners still look to have their fleets IPO’ed on the first occasion (that is put $100 worth of ships to have them valued at $40 soon thereafter), it means that there are fundamentally wrong issues of how the shipping industry thinks of the capital markets, and vice versa, how the capital markets have learned to “value” shipping equities. There are no saints on this planet and investors tend to be rational; thus, something does not exactly dovetail between theory (efficient market theory) and life (shipowners begging for IPOs, even today).
The Hafnia offer was too low and really did not offer to the Ardmore shareholders much of a business opportunity mostly in hope and not so much in good will (literally and accounting-ly speaking). Long hope that already had in abundance. There will be more episodes, most likely, in this transaction, and more lessons to be drawn for the shipping finance students.