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GE Shipping: Demerger’s off! - Views on News from Equitymaster

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GE Shipping: Demerger’s off!

Aug 3, 2006

After much confusion and notices, the managemnt of GE Shipping (GES) has finally called off its demerger plan for the offshore business into a separate company called Great Offshore. The arrangement was announced in September 2005, and was supposed to be effective April 1 2005. However, due to delays in filing all approvals with the Bombay High Court, and consequent to the lapse in deadlines, the ‘much-awaited’ demerger has been called-off. In our meeting with the managemnet during the later part of the previous year, we got the view that the demerger of the offshore business would have unlocked great value for investors. The management had indicated that the demerger would allow the relatively stable offshore business to leverage higher that what, traditionally, the company had done in the past. The rational given was that, since shipping was a volatile business, companies across the world leverage only up to 1 time their networth (have a debt to equity ratio of 1:1).

However, offshore companies can go for an aggressive leverage due to the stable nature of the business on account of absence of spot markets and longer-term duration of contracts. In fact, the debt to equity ratio in this business can go to as much as 2:1 or 3:1. The de-merger would have, thus, enabled Great Offshore to borrow more for furthering its expansion plans, which are still dependent on the larger shipping business.

Another rationale given for the de-merger was towards unlocking value for investors. This is because globally, while shipping stocks trade at 4 times to 6 times price to earnings, stocks of offshore companies command price to earnings valuation of around 20 times.

What to expect?
One of the key reasons for our ‘Hold’ recommendation on the stock (in November 2005, at Rs 222 and with a target price of Rs 285) was that it would have enabled investors to “be a party to the demerger and get a shareholding in the much stable and growing offshore business.” We still were concerned on the shipping business on the back of cyclical nature of the industry and oversupply situation in tanker tonnage globally. Over this period, our concerns have increased further, especially considering consistent oversupply situation in the global tanker market and consequently increased volatility in freight rates (see right hand chart below), and more signs of softening of the global economic growth.

Since our last recommendation, the stock has touched a high of Rs 300 and a low of Rs 171. At the current price of Rs 217, the stock is trading 1.0 time our estimated FY08 book value. We shall update subscribers with our latest view on the stock post a research meeting with the management scheduled for the earlier part of the next week.

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