Korea shipping and the art of the deal

Problems facing the shipping scene in South Korea look tough — but companies there have a knack at living to fight another day

SC Lowy Co-Founder & CIO Soo Cheon Lee
Co-founder & CIO Soo Cheon Lee

DEMOCRACIES are commonly criticised for political theatre and chaos; so too South Korean maritime affairs takes its lumps. Its faults — blundering, failure to compromise, “kicking the can down the road” and folderol on an Olympian scale — are in plain sight. Yet allowing flaws to spill into the open can have its points.

Don’t look to China or Japan for a visible battle of constituencies in the common struggle to come to terms with a problem as vexing as a shipping recession. As messy as Korea can look, solutions emerge there more quickly than in rival Asian maritime nations.

This year has presented what looks to be a conga line of intractable problems. The three major shipbuilders in South Korea all face big financial trouble, a legacy of their diversification into offshore construction. Daewoo Shipbuilding & Marine Engineering has suffered shocking and unexpectedly deep losses and now faces allegations of unethical accounting.

Meanwhile, such is the condition of Korea’s mid-sized shipbuilders that struggling majors have been asked to look after several of them. Samsung Heavy Industries, for example, has been given oversight of strapped Sungdong Shipbuilding, in a deal arranged by the Export-Import Bank of Korea, which is the main creditor of Sungdong, having extended Won1.1trn ($959m) and guarantees worth Won900bn.

SHI, the least-troubled of the Big Three, will get a substantial benefit for its foster care: SHI will be given priority when Sungdong is put on sale after completing a restructuring programme and Kexim will offer financial assistance in the form of soft loans for SHI’s offer, if it should arise.

Elsewhere, Hanjin Shipping and Hyundai Merchant Marine are struggling to tread water in the dismal freight market hobbled by overcapacity. Rumours that they are planning to merge have been denied by both companies, and the government, which was said by local press to be encouraging a deal, said it would not force a merger. As it stands, a merger would be difficult given the heavy indebtedness of both lines, their alliance partnerships and because of their business overlap in many areas — and most of these areas, such as Asia-Europe trade routes, face capacity overload for years to come.

But there’s another side to the South Korean way of doing shipping that takes its problems head-on. Recall that the major shipbuilders’ foray into building for offshore looked brilliant for several years, as shipbuilders struggled in China and Japan. It looks disastrous now, but only because no one foresaw that the collapse in oil prices that began in August 2014 would shut down new offshore orders.

SH Hwang, a prominent Seoul shipbuilding broker, believes this is short-term thinking. “The government is either invested in, or a lender to, or both, to the three major shipbuilders. Its participation can be seen as a long-term investment, and a smart one. When the offshore market bounces back and demand for new offshore vessels rises, the yards will be prepared to seize the opportunity — and they will.”

Fight another day

Examples of living to fight another day already exist in South Korea’s dry bulk market. The bankruptcies, reorganisation and sale to new owners following the Korea Line bust in 2011 and the Pan Ocean bankruptcy in 2013 left both companies greatly limited in size compared to their original scale. However, both are still alive, and have the ability to expand again once the dry bulk market turns around. If fact, given that the Baltic Dry Index hit an all-time low of 498 points in November, being lean now could have its advantages.

The Pan Ocean story had its denouement in June this year, when a company called Harim acquired a 58% stake in the company for $910m. In the deal, unsecured creditors received 83% of their money, with about two-thirds of that money coming in the form of new stock and another third in cash by 2023. Old shareholders lost 92% of their capital.

Still, the terms seemed attractive enough to clinch the deal while it was on the table, with some 87% of the creditors and 61.6% of the company shareholders approving the deal, given the highly depressed condition of the market and the outcome of other dry bulk court-led reorganisations and sales, such as the earlier case of Japan’s Sanko Steamship, in which creditors and shareholders walked away with less.

The road out of bankruptcy was a very Korean affair, albeit led partly by a Hong Kong-based fixed income specialist that happens to have a Korean national as a co-founder. Soo Cheon Lee of SC Lowy joined the Korea Development Bank in directing the workout and negotiating with other creditors. SC Lowy eventually surpassed Korea Development Bank as Pan Ocean’s largest creditor.

The 2015 M&A deal has turned out to be one of the world’s biggest in shipping for the year. As it had done with Korea Line earlier, SC Lowy entered the situation early, by purchasing a portion of Pan Ocean’s debt. After attaining the position of major creditor, it was able to draw on its previous experience with Korea Line to make the argument that unity of the creditors’ group would provide the most beneficial outcome.

The argument was given more heft by SC Lowy’s ability to provide interim credit support to counterparties, relieving their financial strain due to the collapse of Pan Ocean. Damage claims were converted into debt and immediately tradable equity. According SC Lowy’s Mr Lee, this proved to be the breakthrough that allowed the Harim M&A transaction to go forward and ultimately paid out the debt portion in cash in a relatively short period of time.

Regarding the process, Mr Lee says: “You have to have a constant dialogue with all parties — not like talking to strangers, but building trust. The company was able to trust us. Eventually, the buyer trusted us. And we were able to talk to the shipowning counterparties in ways they understand, because of our experience in this business.

“They are not just financial investors, but operating business people with a tremendous amount at stake with companies they’ve built themselves. Understanding this is the key.”

Level of debt

Hanjin Shipping, which is owned by the same conglomerate that owns Korea Airlines, has the distinction of having the highest proportion of leverage on its balance sheet of all the major lines in the container shipping industry, with a 5.05 debt-to-equity ratio. Alarmingly, it has about Won2trn of bonds outstanding with Won1.8trn coming due by 2017.

Given the level of debt in Hanjin and HMM, it would be difficult to see how a merger could be enacted without a significant retirement of debt that would entail slashing jobs and selling more assets in the companies’ core businesses of container shipping. Both HMM and Hanjin have sold assets, with Hanjin hiving off its liquefied natural gas and bulk business last year; likewise HMM sold off its LNG shipping business in 2014.

That prospect may underlie the Ministry of Oceans and Fisheries’ response to a recent query about whether it favours a merger between the two. The regulator said that it wanted to see the two shipping lines stay separate for the good of the nation. If so, a deal worked out with private participation and some clever intermediation from the financial sector could lead to an eventual outcome that would prevent a wholesale collapse.

Fortunately, in South Korea, there are precedents for such workouts. Whether there is a will to draw upon them remains to be seen.

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