How State-owned Shipper Sailed into Stormy Seas
(Beijing) – One of the country's most prominent liner shipping operators, China COSCO Holdings Co. Ltd., is struggling to avoid being kicked out of the Shanghai Stock Exchange five years after its debut.
It lost 6.5 billion yuan in the first three quarters of 2012 after a 10.4 billion yuan loss the previous year. Analysts expect it to post a loss of under 10 billion yuan for all of 2012.
If it is in the red again in 2013, it will be forced to temporarily suspend trading until a profit can be turned. If losses continue for a fourth straight year, it will be delisted.
However, the chances it can turn the tide this year seem to be long. Analysts say management is more incompetent than it cares to admit. Problems have arisen because of strategic miscalculations and bungled investments with hedging tools.
The company blamed weak demand and high fuel prices, but other international shipping carriers have dealt with those challenges and not seen their bottom lines hit as badly.
COSCO Holdings is 52 percent owned by China Ocean Shipping (Group) Co. (COSCO Group), a state-owned shipping giant whose lines cover over more than 160 countries and regions.
It handles the majority of the parent's important businesses, including manufacturing and shipping, dry bulk shipping, building terminals and other sea transport logistics.
COSCO Holdings went public in Hong Kong in 2005 and in Shanghai two years later, raising about 7.8 billion and 15.1 billion yuan, respectively. The last year it did not lose money was 2010, when it posted a profit of 6.8 billion yuan.
In good years, COSCO Holdings prided itself on owning the world's largest fleet involved in dry bulk shipping. Now there is talk among analysts that the entire line of business should be jettisoned so the ship does not sink with it.
One analyst familiar with the situation, who asked not to be named, said the dry bulk shipping business alone may have caused a loss of up to 10 billion yuan in 2012. Logistics and terminal operations were making a profit of almost 2 billion yuan, he said, enough to offset the loss of about 1.5 billion yuan from the container shipping arm of business.
COSCO Holdings is also heavily burdened by ship leasing contracts. Some 117 out of its 337 dry bulk vessels were leased from other companies, the firm's third quarter report says. That alone could have cost the company at least 3 billion yuan in rental fees last year, the analyst said.
The exact amount of leasing expenditure is not known because the company does not publish all information needed to complete a calculation, he said.
An alternative way of looking at the matter lends further insight into the depth of COSCO Holdings' problem.
This method uses the Baltic Dry Index (BDI), an indicator compiled by the London-based Baltic Exchange, which reflects the supply and demand for global shipping capacities and serves as the basis for all shipping companies to set their transport charges.
The BDI needs to be between 2,000 and 2,500 points, a range based on several analysts' estimates, for a normal shipping business to break even if it uses its own ships. If lease payment is included, the index would have to be higher to cover expenses.
However, throughout 2012, the BDI averaged only 920 points, down from the previous year's 1,549, COSCO Holdings' third-quarter report says.
The index may pick up a bit this year, analysts said, but any significant improvement is improbable because the global economy remains weak.
COSCO Holdings blamed its loss to a large extent on market weakness. But foreign competitors Danish Maersk Line and Japanese Orient Overseas Container Line have produced much healthier balance sheets.
Its closest Chinese rival, China Shipping (Group) Co., managed to control losses much better because of its relatively strong domestic service. This prompted some critics to say that COSCO Holdings could have been in a much better situation if it had shifted business priority in time to serving domestic clients, such as steel manufacturers and traders.
The SOE Problem
Other critics have been harsher, saying the company made a strategic mistake a few years ago that laid the groundwork for its present plight.
Until 2004, COSCO Holdings had stuck to a plan of developing business in an all-around way that put as much emphasis on shipping capacity as complementary services, such as land transportation, an executive of state-owned ship manufacturer said.
It abandoned the strategy in favor of a lopsided approach that focused on liner shipping and boasts manufacturing, which were much more lucrative than other types of business at the time. That change eventually cost COSCO Holdings an opportunity to build an empire resilient to slowdowns, the executive said.
By late 2008, it was obvious to some COSCO Holdings employees that it was unwise to continue expanding the fleet size even though the business was still making money.
Proposals were raised to sell some ships, or at least abort a plan made in 2007 to expand the merchant fleet with another 400 vessels.
But COSCO Holdings went ahead and signed leases for some 200 vessels. Some of those leases have yet to expire, and the exorbitant fees they charge have been a large contributing factor to the losses, a company insider said.
"Everyone was crystal clear at the time that the bubble may pop any time, but there were too many people's interests involved, and there was no way to stop," he said.
An analyst familiar with COSCO Holdings' track record said the company repeated mistakes it made in the past. "COSCO Holdings' huge loss was a result of blind expansion during good times … and a lack of long-term strategy and preparation against cyclical risk factors. A number of cycles have passed, and its business still relies on the mercy of heaven."
Adding to operational losses was the company's bungled investments with a financial derivative called a forward freight agreement (FFA) that enable shipping companies to hedge against price fluctuations.
COSCO Holdings used it the wrong way, betting on the BDI to touch 10,000 points, which implied a huge jump in shipping prices, said a source with knowledge of the matter.
The company suffered a 4.1 billion yuan loss in 2008 from FFA investment, its financial report shows.
An investment banker, who had been briefly involved with COSCO Holdings' FFA investment in 2008, said the way the company made investment decisions was severely flawed, and that the problem was common to all state-owned enterprises he had known.
In a bureaucratic environment where the top bosses focus on short-term interests, he said, "even newly recruited professionals with a decent educational background would gradually change and lose their ambition and sharp grasp on market trends, under the influence of a servile culture and nepotism."
The company's management has also come under fire. Some retail investors who hold company stock started calling for Wei Jiafu to be removed as chairman of COSCO Holdings and COSCO Group in February.
They blame Wei for steering COSCO Holdings into a quagmire. Zhang Yuanzhong, a lawyer at Beijing Wen Tian Law Office was the person who started the petition. He said Wei should be held accountable for flawed management that led to loss-incurring derivatives investment and ill-timed fleet expansion.
COSCO Holdings said it respects shareholders' opinions, but there was no indication that it was considering their request.
The most optimistic observers, including analyst Nie Di of investment bank China International Capital Corp. (CICC), said COSCO Holdings could avoid losses this year through acceptable accounting tricks such realizing losses before they actually occur, which could shift an anticipated loss to last year's balance sheet.
Others doubt the company can avoid a loss without a huge amount of borrowing or selling some of its assets.
Raising money from bonds is out of question, a source familiar with the company said, because COSCO Holdings had sold bonds worth 40 percent of its net assets, the regulatory limit.
An internal document from a large state-owned bank shows that the loan officers were advised to reduce their credit line to COSCO Holdings over concern about its worsening financials.
The company's subsidiary, COSCO Pacific Ltd., which is 42.7 percent held by COSCO Holdings, is helping. It is putting up for sale its entire 21 percent holdings in China International Marine Containers (Group) Ltd., a container shipping operator.
Those shares are valued at around HK$ 7 billion, or 5.6 billion yuan. That means a net a profit of 2 billion yuan for the seller, analysts said. Some institutional investors, including CICC, BOC International (China), and private equity investor Hony Capital, have expressed an interest in acquiring the shares.
Some analysts said COSCO Holdings should offload its dry bulk shipping business to its parent, but critics doubt this is legal and practicable.
Wei has reportedly appealed to the central government to bail out troubled shipping companies, including COSCO Holdings, to little avail. The state-owned assets regulator is unlikely to step in, as long as there is no egregious mistake on part of the state-owned company, an executive of an SOE said.
Staff reporters Yang Lu and Yu Ning also contributed to this article
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