London - Shares in China Cosco, China Shipping Development (CSD) and China Shipping Container Lines (CSCL) were suspended from trading on Monday 10 August following news reports that the Chinese government is preparing to merge these state-owned shipping entities. Details remain patchy but it seems Cosco and CSCL are part of a much broader effort to consolidate China’s state-owned enterprises that was announced earlier this year. Leading executives from the companies are understood to be working on a preliminary plan to be released before the year is out. There is a hint of double-standards about this story as it was Chinese competition regulators that blocked the proposed P3 alliance between the world’s three largest carriers Maersk Line, MSC and CMA CGM in 2014. It seems now that China is happy for the number of major carriers to shrink by one. In other words, operational alliances, which arguably maintain competition and help reduce costs, are the subject of misdirected criticism by some regulators and some shipper groups. A more serious competition risk – the reduction in the number of carrier competitors (APL is also up for sale) – seems to be encouraged by governments. In the container market, Cosco and CSCL currently sit in sixth and seventh place respectively in the rankings of carriers by operated teu.
Based on today’s fleet the combined entity would comfortably move into fourth place with a total fleet in excess of 1.5 million teu, giving a world share of around 8%. Of the two carriers CSCL is the new guy on the block having only started operations in 1997. Through an aggressive organic expansion it has quickly risen through the ranks to become one of the leading Top 10 carriers although it has fallen short on its previous ambitious target to make it into the top three. The rationale for a merger is entirely sound from a financial viewpoint and calls into question why China has persisted with the two-carrier strategy for so long. It makes little sense to have two national (ie state-controlled) carriers competing fiercely against one another and against non-Chinese carriers in the same markets.
Both China Cosco and CSCL have seen their financial performance deteriorate materially since the global financial crisis and have seen major value destruction for stakeholders. Overcapacity in the underlying markets didn’t help either but their individual operating and financial performance has been far worse than their peers. Between them the two carriers have lost $911 million in operating losses (EBIT) from container operations in the previous five years.
A merger would likely entail much better financial efficiencies and prudent use of the capital. The combined entity will be able to get access to better financing synergies from banks and capital markets.
There of course remain many obstacles to the merger taking place, but assuming the will of the Chinese government is strong and does not waver, there seems every chance that it will happen at some point in the near future. The next question to ask therefore is: what will happen to the carrier alliances the two lines participate on the East-West trades? Cosco is a long-standing member of the CKYHE Alliance alongside K Line (Japan), Yang Ming (Taiwan), Hanjin (South Korea) and Evergreen (Taiwan); while CSCL is a part of the Ocean Three consortium alongside CMA CGM (France) and UASC (Qatar) that was set-up at the start of this year.
A merger of the Ocean Three and CKHYE alliances would mean a combined market share above 40% and unlikely to be approved by regulators. Instead, both the CKYHE and Ocean Three will be faced with a major void to fill were they to lose either Cosco or CSCL to the other carrier group. Based on the deployed vessels in the East-West container trades (Asia-Europe, Transpacific and Transatlantic) as of July 2015, both Chinese carriers contributed approximately one-quarter of each alliance’s fleet in teu. As the smallest of the existing alliances the remaining carriers in the Ocean Three grouping, CMA CGM and UASC, would find themselves even further down the pecking order were CSCL to abandon them.
While both carriers between them have around 570,000 teu of newbuilds on order (not all for Ocean Three services) they will most likely look to find a replacement carrier to bridge the shortfall. This maybe explains why UASC is now considered the front-runner in the speculated sale of APL, as purchasing the Singapore-based carrier would nearly cover CSCL’s share. It would also reduce the share of the G6 Alliance that APL is currently a member of. Depending on which alliance wins or loses its Chinese member, the Ocean Three alliance and the CKYHE alliance will decline to a market share of just 13% or rise to a market share of 28%.
If and when the merger occurs, will other countries be forced to consider similar consolidation of their shipping lines? Only the Taiwanese carriers (Evergreen, Yang Ming and Wan Hai) have returned an operating profit ($1.2 billion) in that time frame, whereas the Big 3 Japanese lines (MOL, NYK and K Line) have lost approximately $550 million and the South Koreans (Hanjin and HMM) nearly $400 million. None though match the $900 million deficit of Cosco and CSCL.
Drewry’s view: A merger between Cosco and CSCL makes sense for China, but the ramifications for the container shipping industry could be far-reaching.