Mercator Lines Singapore

[mrEngineer]

After being inspired by nextwave to take a look at IPO prospectus to check out the dilution impact on IPO investors, I was shocked at what I saw for Mercator's IPO. Here are the figures.

[Image: MercatorLinesSingapore.jpg]

In other words, IPO price was 94cents and there was an instant dilution of 69 cents to 25cents worth per share!
The most ridiculous thing is that it will take 5 years (2 years left) of current divident yield and Mercator International will get back the capital of 44mil it has put into the company!

Lesson learnt:
1) Always look at IPO prospectus for penny stocks before purchase
2) Start to own a business and find all means to list it to become instant millionaire in net worth.

Anyway, it is still trading way under NAV at the current price. Although NAV is not exactly a good way to value shipping companies, due to capitalization of the shipping asset and depreciation impacts, I do not know what other better ways to value. Using FCF isnt so accurate either as income is dependent on fluctuating BDI charter rates.

IMO, short term to mid term bad for the stock due to the large supply of ships coming into play and pulling down the BDI. Long term wise, perhaps if BDI will rise back to former glory. One inherent positive and negative point about Mercator is that its business are more or less limited to deliveries of it Mother company. One can view it as a solid provider of income for the company with its brand name in coal markets or one can view it as Mercator International trying to obtain financing from the market to recapitalise and not continue to draw burden on its B/S.

Vested regrettably.

[Nick]

Hi MrEngineer,

I believe $0.96 was the maximum possible offering price. But it was lowered to $0.76 eventually and the company raised S$205 million through its IPO. (http://info.sgx.com/webcoranncatth.nsf/V...E005A304C/$file/Balloting_Announcement_Final_121207.pdf?openelement ). Since then, Mercator the stock has been sliding downwards. Credits to MIL for timing the IPO to perfection !

Essentially, I have learn a lesson from investing in shipping/property stocks - it is hard to profit from investing in a company whose profitability is dependent on factors (BDI, office/industrial asset rentals, property/commodity prices) which it has no power to control. A poor Management will screw the company up in bad times, a decent Management will keep the company afloat and its profits will track the market trend while an excellent Manager, which conserved cash by not over-expanding in boom era, will seize opportunities in bad times to experience a powerful turnaround in the upswing. Sadly, it takes an industry down-turn to determine what type of Manager your company have and by the time you figure it out, you may be too late ! This makes it difficult to accurately value such industries unless you have intimate working knowledge.

With regards to your figures, it does explain why companies love to spin-off their subsidiaries in an IPO. I won't begrudge Management for having a much lower cost of capital because it under-took a big risk in setting up a company years with a very big chance of failing. But as Nextwave pointed out, don't automatically assume the Manager feels the same pain as you would when the price plunges. His entry cost may be very different from yours !

Perhaps a good reason to invest in venture capital companies ! If you can't beat them, then join them.

(Not Vested)

[mrEngineer]

A review of my personal investing mistake
I used a simple top-down investing approach to evaluate a position in Mercator Lines in early 2009 to be proven terribly wrong.

Top: Economy level
Believed in a commodities market and energy trading related boom that will lead to increase in demand of iron ores, coal. Naturally, demand for shipping these materials is expected to increase

However, I was blinded to not take note of the overbuilding of ships in the past few years that will lead to a sustained fall in BDI where the increase in demand will not be able to catch up

Lesson Learnt
1) Was overly focused on the demand side and did not study the risk of supply side or why BDI was extremely low in the first place.

Middle: Industry level
Mercator Lines was one of the best shipping companies with positive OCF and profits at relatively high ROE.

Lesson Learnt
1) No dispute for this conclusion. The only possible comment would be a wrong analysis made in the macro would filter down to the wrong industry as well.

Down: Company fundamentals
High attractive historical ROE (actually not much history to speak off), high dividends, low P/E, low P/B, positive cashflow & stable income. Ignored the impacts of BDI as assumed that Mercator is able to mitigate the BDI fluctuation as it locks in long term contracts for most of its ships.

However, I did not tried to understand why the company IPO in the first place or even why did the IPO price fell and almost never recovered.

Lesson Learnt
1) High ROE, if it is not sustainable and simple to understand, is almost useless. It is more important to understand qualitatively how the cashflows, income can grow without much interference by the market or in other words the moat to sustain the margins. Either it has to be proven for 5 years at least or the business model is able to do so (for e.g. for every cent plough back to company will able to expand its capability and emjoy at least the same ROE)

2) It is important to know why the company is in the capital market in the first place. It’s historical and future intention.

3) Did not fully study the impacts of capitalization of depreciating assets and its impact on the income, ROE and eventually the P/E.

Others: Diversification
Was searching for a shipping related industry to try to diversify industry cycles. Believed that industry cycles will shift in short term of few months. In actual fact, there was a period where there was a mini boom in shipping industry due to slight blip in BDI. However, I simply thought that the good times will last forever.

Lesson Learnt
1) Diversification is for the fools if you do not understand what you are diversifying about..

Any comments please feel free to shoot.

---

Perhaps a good reason to invest in venture capital companies ! If you can't beat them, then join them.

You mean Hotung? haha. VC companies are high risk as well. What if the companies fail to garner enough interest for the IPO?

[stilicon]

Hello MrEngineer,
Actually, at S$0,265 - 0,27, I think Mercator Lines is a decent proposition. As you said, it has mostly LT contracts, its business is mostly geared handysize routes to and from India. And the BDI is mostly influenced by others things. I bet that buying at 0,265, you would make a decent return over 5 years (with interest compounded).
However if your error was to buy at the time of the IPO, then indeed the fall is steep. I didn't make that error, but I made so many others ...
Personally, I forbid myself to buy at an IPO, for as you pointed out, if the owners want to sell shares, it must be for some reason...

[Nick]

A firm which can generate high returns with minimal capex requirement will rarely ever choose to list or raise funds from the equity market. There is simply no need to and hence there is no reason to even contemplate splitting of profits to few thousand individuals. A good example would be law firms - high return (if well-run) with minimal capex - few (if any) are listed. Locally, ARA, bucks against the trend since I think it is a terrific business which doesn't need much capital. So not too sure why it listed, but either way, local shareholders should be thankful to be able to get a piece of this very lucrative business.

(Not Currently Vested in ARA)

[mrEngineer]

Hello MrEngineer,
Actually, at S$0,265 - 0,27, I think Mercator Lines is a decent proposition. As you said, it has mostly LT contracts, its business is mostly geared handysize routes to and from India. And the BDI is mostly influenced by others things. I bet that buying at 0,265, you would make a decent return over 5 years (with interest compounded).
However if your error was to buy at the time of the IPO, then indeed the fall is steep. I didn't make that error, but I made so many others ...
Personally, I forbid myself to buy at an IPO, for as you pointed out, if the owners want to sell shares, it must be for some reason...

Hi stilicon,

My average purchased price for Mercator is around 0.31 which is relatively on the high side. And I agree that Mercator makes a good bet in the long term like 5 years as you mention. However, my investment profile is only mid term (around 3 years max) so I realised that it didnt suited my appetite after taking the bite.

However, if I studied earlier the IPO dilution and realised the start equity was worth around 25cents, then it makes sense to invest in companies that are minimally profitable and dividend rewarding during crisis period if the price is trading way below the inital capital, 25 cents. The lowest that Mercator went was around the region of 12cents so possibility to revert to starting capital is very likely.

A stock trading below NAV and probably stay so for a long time is possibly due to the lack of stability in the ROE. Taking a bet on Mercator is almost equivalent to taking a bet on the BDI where even the industry experts have no idea when the reversion to mean will happen. Thus, the loss is the opportunity cost incurred while waiting for the unknown to happen.

A similar mistake was made in Hupsteel where steel prices dominate the share performance. Till now, I can steadfastly conclude that investing in companies subjected to volatile material prices or indexes are not exactly good investment proposition unless there is a severe mispricing and to take advantage of the seemingly abitrage opportunity. Now I am starting to rethink my positions in Hiap Seng and Boustead..

[freedom]

the NAV of Mercator is difficult to value.

the valuation of vessels kinda volatile, the market value of their fleet could be much lower than the valuation in the balance sheet.

quite a risk, imo

[Musicwhiz]

Hi MrEngineer,

Why is purchasing Mercator Lines almost equivalent to tracking the BDI? Perhaps you can explain to me since I am quite clueless on this?

Perhaps what I am asking is - how closely does the share price or intrinsic value of Mercator fluctuate with the BDI?

As for other bulk carrier companies out there (e.g. Courage Marine), is this also the case?

[freedom]

Mercator chartered out their vessel on long term fix charter rate, actually not really subject to volatile BDI.

most of their vessels are chartered out on a rate much higher than spot charter rate.

[mrEngineer]

Perhaps what I am asking is - how closely does the share price or intrinsic value of Mercator fluctuate with the BDI?

As for other bulk carrier companies out there (e.g. Courage Marine), is this also the case?

Hi MW and freedom,

Although Mercator have almost 70% of its charter contracts locked in the previously negotiated charter rates, Mercator share performance fluctuates with respect to BDI sentiment. If BDI has an upwards trend, Mercator share price would tend to rise as well as it means it will be able to renew some of its long term charter contracts in high charter rates in the future as well and the vessels it own become more valuable as it will be able to generate higher future income (similar to properties when prices are higher).

As for CM, if I not wrong, they follow mostly the charter rates from BDI so which means the actual revenue fluctuates with the actual BDI movements.

So who is better in this case. I would say Mercator is better now as BDI rates are low. However, in the scenario of high BDI, CM will defintely be better in revenue growth. To judge between the two companies, one has to look further into the B/S performance and cost management.