Korean shipper sets sail for Singapore

After China Cosco, another shipping company attempts an IPO. The difference? This stock offers a 20% dividend yield.

After the lacklustre response to China Cosco's IPO - which priced at the bottom of its range - it may seem counterintuitive for another shipping company to attempt to list only a few days later. And yet that is exactly what Korea's STX Pan Ocean is attempting.

However, the Korean dry bulk shipper leaves port with a kicker that China Cosco lacked: a massive dividend. Indeed, while China Cosco offered investors a respectable dividend yield of 5%, the annualized dividend yield being offered by STX Pan Ocean is an incredible 20%. That fact alone has sparked considerable interest in the deal.

The other factor that might aid STX Pan Ocean is the view that some now take that shipping freight rates may be about to spike again. The best measure of these rates is the Baltic Dry Index, which had declined by 45% in the first half of the year. More recently it had declined from 3430 on May 24 to a yearly low of 2510 on June 21.

It was against this headwind that China Cosco sought to market its equity story with limited success. In comparison STX Pan Ocean has benefited from the fact that the index started to rise again on June 22 and yesterday stood at 2621. Optimists on the sector note that a similar market turn happened last year - indeed, at roughly the same time - with the index and freight rates rising in the second half.

Why Singapore?

Headquartered in Seoul, STX Pan Ocean is nevertheless listing in Singapore - making it the first Korean listing in the Lion City. The reason for listing in Singapore are twofold: first, the company wants an international acquisition currency, and felt it would attract greater liquidity in Singapore than in its domestic market; second, it believed it would benefit from the fact that shipping-related stocks such as NOL and Noble are also listed there.

However, a Hong Kong listing was also considered. This was ruled out because according to Hong Kong listing rules, a company needs to retain the same owner for three years prior to the listing - and as will later be explained, STX Pan Ocean does not meet this criteria, and no waiver was possible.

Billion dollar company

The company's business is very closely linked to the commodity cycle. About 91% of the company's revenues come from dry bulk shipping - meaning the shipping of commodities such as grain, steel, wood, coal and sugar. The remaining 9% comes from tankers, containers and car carriers.

On listing it will have a market capitalization of close to $1 billion and be the largest dry bulk shipper listed on any Asian exchange. It currently owns 57 vessels and charters a further 200.

The Korean company was founded in 1966, and has a somewhat complicated history. It got into trouble in the 1980s when government policy forced it to merge with weaker, non-profitable companies - which resulted in its final bankruptcy. KDB then auctioned the company off, with fellow Korean company, STX being the eventual winner.

Three STX Group companies took shareholdings: STX Engineering, STX Shipping and POS Ship Management. These businesses variously own shipyards and other ancillary nautical services such as provide crews. After the auction, the STX Group ended up with 78.5% of the business - a stake which it felt was too high. The purpose of the current IPO is to get its stake down to a level it feels more comfortable with. In this case, should the deal's greenshoe be used, STX's stake would be reduced to 40.8%.

The IPO will see the sale of 600 million shares, of which 400 million are old shares (ie those of STX Group) and 200 million are new shares. The deal's size will be anywhere between $344.8 million and $456.2 million - and if the greenshoe is exercised as high as $525 million. The deal's distribution will see 95% go to institutional investors and only 5% to retail.

The public offer was launched in Singapore yesterday. The deal will price on July 8 and start trading on July 14.

Fair value?

With shipping stocks taking such a hammering of late, lead manager Goldman Sachs knows that pricing power is overwhelmingly with the buyside. After China Cosco sailed into such choppy waters, the fund management community feels that any shipping deals need to be priced to sell.

On a PE basis STX Pan Ocean is being priced (pre-money) at 2.9 times 2005 earnings at the bottom end of the range and 3.8 times at the top end of the range. On a post-money basis those same two multiples translate to 3.25 times and 4.3 times respectively.

Two comparables that fund managers will look at are Pacific Basin (also brought to market by Goldman last Summer) and Precious Shipping (of Thailand). Precious Shipping is currently trading at 3.2 times 2005 earnings and Pacific Basin at 4.2 times.

That brings us back to STX Pan Ocean's considerable dividend. In comparison, Pacific Basin's current dividend yield is 13% - versus the 20% bumper dividend STX Pan Ocean is offering this year.

The receiving date for the dividend is Friday December 30, which means investors will have to hold the stock till then if they want to earn their 20% dividend return. One danger about the stock is that a lot of short term money may wait for that tidy return and then dump the stock the next day.

Indeed, a big issue for the deal is investors' perceptions of the company's prospects in 2006. The company wants to use money raised from the offer as well as debt to buy more ships. Given a forecast glut of new shipping capacity coming online in 2006-07, that prospect has some investors worried that the company's 2006 earnings will fall. The rising price of oil is also likely to put pressure on the company's margins.

All of this makes the company's equity story a complicated mix. In the short term the income yield is an enticing carrot in world of low interest rates. But general uncertainty on the direction of the sector in 2006 means the company and comparable shipping stocks look risky.

If you believe China and India will continue to boom, and that the US will retain momentum, clearly this is a risk worth taking. However, for those who are bearish and fear a slowdown in the world economy next year, these stocks may be viewed as proverbial sinking ships.

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