M&A announcement

Apr 12, 2018

Summary

The acquisition adds Turkey’s leading freight ferry operator, expands European routes and is expected to be earnings-accretive from year one. Plans target EUR 30 million in EBITDA improvement by 2021, with June 2018 closing expected subject to approvals.

Ladies and gentlemen, welcome to the DFDS conference call. Today, I am pleased to present CEO Niels Smedegaard. For the first part of this call, all participants will be in listen only mode, and afterwards there will be a question and answer session. I will now hand the call over to Niels Smedegaard. Please begin your meeting. Thank you, and welcome everybody to this conference call. A little bit unusual. We are very excited to have you on board. Together with me, I have our CFO, Torben Carlsen, and we will take you through a number of key elements. First of all, the strategic rationale behind this transaction, a brief overview of the target, U.N. Ro-Ro. We want to talk a bit about Turkey and the macro perspectives, and then the financial highlights of the transaction, and then we will thereafter open up for any questions you may have. Let's turn to page 3 in the presentation and dive into the strategic rationale for the acquisition of U.N. Ro-Ro. This move is not a restructuring case. This is an expansion of our route network to a high growth region, and that will also give us an increasing market diversification. We are acquiring the leading operator of freight ferry routes with a strong market position connecting EU and Turkey. By this move, we will be combining our network with their network and will create a very powerful European coverage to the benefits of all of our customers, whether they come from U.N. Ro-Ro or DFDS. U.N. Ro-Ro has a similar business model as we have, and also on the fleet side, there are lots of similarities, and that do create a lot of opportunities for synergies in this transaction. We will have increased flexibility of our fleet deployment and both in our network and theirs, as well as synergies on the investment side. Some of you will know, very exciting new generation of Ro-Ro vessels under construction in China, and these will potentially fit very well into also the U.N. Ro-Ro network. The company is extremely well-managed. It's highly profitable, 42% EBITDA margin in 2017. More importantly, of course, is that this transaction will be earnings enhancing and accretive from the first year on. Let's turn to page 4, quick transaction overview. Torben will come into more of the details, but basically, we acquire 98.8% of U.N. Ro-Ro on a debt-free basis of 950 million euros. It's 9.8 times 2018 expected EBITDA, and this multiple, I think, compares reasonably favorable to recent industry transactions. We have committed term loan financing in place. We will recommend, or the board will recommend a share issue of around 1 billion, where the Lauritzen Foundation will participate pro rata. The net interest bearing debt EBITDA multiple expected to increase to around 2.5, which is well within the target we have. The transaction is subject to the customary approvals. We expect to be able to close in the June timeframe this year. As I said, more details later in Torben's presentation. Let's now look at U.N. Ro-Ro and turn to page 6. We are, as I mentioned, acquiring a leading ferry freight operator in the Mediterranean. U.N. Ro-Ro was established in 1994 on the back of the tragic situation in Yugoslavia at that time. It is the number one Ro-Ro operator in Turkey in terms of market share, and the both number and capacity of the vessels operating in this market. U.N. Ro-Ro has a 33% market share of the Turkish Europe exports, and that's twice that of the next competitor. The company operates 5 routes between Turkey and France and Italy with a fleet of 12 new or modern Ro-Ro vessels. The average fleet age is 11 years. U.N. Ro-Ro's operation, that's based on an intermodal setup, which is combining both land, sea, and railways for trucks and containers. It's a very interesting setup. The company caters to international transport companies, importers, and exporters in Turkey. A very important piece here is, and we can talk more about that later, is that the business is EUR denominated, and through that, we are minimizing the exposure to the volatility of the Turkish lira, which of course, is slightly different from the currency environment we have within the EU. There's a small table on the right-hand side at the bottom giving you the historical development from 2014 till and including 2017 on revenue, EBITDA, and EBIT margins. There are, of course, a few events during this four-year period. One of the most noteworthy is back in 2013, one of, I think, probably the largest customer of U.N. Ro-Ro, Ekol Logistics, started up their own Ro-Ro service. That meant a drop in turnover from 2013 to 2014, but also as they moved more and more of their cargo to their own operation, that has impacted the top line of U.N. Ro-Ro. That situation, however, has stabilized during the past three years. There is now a well-balanced competitive situation in this market. In 2016, there is a slight underperformance due to two technical issues on two U.N. Ro-Ro vessels and due to unavailability of critical spare parts. Those vessels were out up to 60 days. When that happens to 2 out of 12 vessels, it does have a top line and bottom line impact for that matter. Turning to page 7, you have a map of the routes of U.N. Ro-Ro, including some indications of the intermodal network, which is really a key feature in the whole concept of getting the trucks to and from various EU countries and Turkey and vice versa. We will later talk a little bit more about that. This network, when you combine that with the DFDS network, you really get a powerful combination with great offering to our respective customer bases within the same network and system. Moving on to Turkey, a few macro perspectives on page 9. It is a very attractive growth profile despite the past political volatility sometimes in Turkey. Some of us have followed and done business with Turkey for the past 25, 30 years, and it has just been one amazing story on the economical development side for Turkey. Today, Turkey is among the world's top 20 economies. I guess it's probably number 18 by now, and with ambitions of moving further up on the list. This is based on a population of 81 million. Turkey is a high growth market historically, and we expect also going forward. The average historical real GDP growth is around a little over 5% versus 1.5% for Western Europe, where we typically operate. Looking ahead with the indications from IHS Global Insight, they expect to grow around 4% on average over the coming years, whereas we're talking 1.8% for Western Europe. That's illustrated on these graphs here. The country itself has a very high and attractive growth rate. If you turn to page 10, and we zoom in on the EU trade relationship, you will see that EU is probably the most important trade partner, and there's a very balanced trade pattern with Turkey. The biggest partner by far is Germany, and then you'll see the different countries coming down this tail, Italy, U.K., France, Spain, Netherlands, Belgium, Poland, Romania, et cetera. What is also a very interesting feature here is the balance of trades. DFDS trades, for instance, with the U.K., where U.K. is typically an import market. So you have more filled trailers going into the U.K. and half empty trailers coming out of the U.K. That puts some pressure on both our customers, the logistics providers and operators there, but also balance on the vessels itself. But you'll see both with Germany, but also Italy, U.K., France, Spain, et cetera, there's a high degree of balance between import and export, which we consider perfect. Moving on to page 11. Another very interesting element in this market is the land-to-sea conversion. What I mean by that is we're not just looking at an attractive growth in Turkey, but you have almost 45% of the traffic between Turkey and the rest of Europe is today still by land. We have seen that land market share, of course, decline rapidly when Ro-Ro was established in 1994, but every single year, the sea routes, the sea infrastructure is taking market share from land. That makes good sense because there's a lot of hassle when you go through land in border crossings, customs formalities, security issues, permit visas, et cetera, congestions and so forth. On top of that, the whole driver issue, which we see in many of the markets today. So that's where the ferry routes come in, offering a smooth solution. We expect on top of the growth in the market that we can improve the ferry market share as a whole going forward. That is one of the very attractive features of this. You can see on this graph on the right-hand side that from 2013 to 2017, there is a 7% compounded average growth rate in this market. You'll see the ferry market share increasing from just under 50% in 2013 to close to 55% in 2017. We will do ours to, of course, accelerate that development. Moving to page 12, zooming in then on what will this actually do. As I mentioned before, it's a geographic expansion of our network. It's a combination of networks, but there are also, even though this is not a restructuring case, there are a number of synergies. Of course, on the top line, the land conversion, the organic market growth I mentioned is attractive, but we can, with the vessels we have under construction, relatively fast drive additional capacity, a better service for the peak departures for our customers and also the associated lower unit cost. We will be offering new intermodal solutions to the existing DFDS network. We'll have a wider network and range of services to existing customers on both sides. There is a strong base for further business development opportunities in adjacent markets with the very strong platform we now have in Turkey with the management team and the organization there. Today, we have probably 10 people managing our Marseille-Tunis route in the Med, and that's not the platform needed if you want to do expansions. There are a Black Sea just around the corner and other opportunities. It's not factored in right now, but it's something which midterm we'll be looking at. The fleet flexibility I've talked about, and that's a big thing for us here. There are additional operational synergies, the integration of our respective Mediterranean activities, integration into our core operating systems, the whole DFDS way of working. We will be learning and picking up things from the U.N. Ro-Ro organization as well. They're doing a fantastic job and taking the best from both organizations will drive success going forward. To just be a little bit concrete at this very early stage before completion, we want to give you an insight into what we are looking at. If you combine all of these elements I talked about here in our own plan, you will see from historical 2017 U.N. Ro-Ro result of 94 million, we expect to increase by 30 million euros by 2021. So that's what is going into our plan in form of EBITDA improvement during this period. With that, I will hand over to Torben for the financial highlights. On page 14, we start by illustrating the numbers on a pro forma basis 2017 for DFDS and U.N. Ro-Ro combined. So had we owned U.N. Ro-Ro during 2017, how would the numbers have looked like? As you can see, our revenue would have been 12% higher, increasing from DKK 14.3 billion to DKK 16 billion. Our EBITDA would have seen a lift of 26% from DKK 2.7 billion to DKK 3.4 billion, and our employees would have grown by 500 colleagues to 7,700 people. Our fleet would see an addition of 12 Ro-Ro vessels for a total of 76 vessels that are operated. Turning to page 15, we give a high-level overview of the investments that we foresee in the new business. Historically, the U.N. Ro-Ro have lengthened two of their vessels. We did a similar investment in some of our so-called Flower class vessels that are similar to U.N. Ro-Ro vessels. They have committed a further two lengthenings during 2018. Turkey will be subject to IMO low sulfur legislation from 2020 onwards. The current plan is to equip the 12 vessels with scrubbers in time for the new legislation in 2020. Due to the growth that the business has experienced, the terminals are very busy. Management in Turkey have plans for how to solve that. We have, during the due diligence phase, have our specialists talking to and visiting the terminals, and there will also be investments to accommodate the further growth in the main terminals in Istanbul and Trieste. Furthermore, with the growth that is needed to achieve the numbers Niels was mentioning on the previous slides, some of the fleets, the smaller ships need to be replaced for bigger vessels. We don't foresee more vessels as such, but more a swap of smaller vessels for larger vessels over the next 3-4 years timeframe, which will also add to the investments of the DFDS group. Turning to page 16. Based on an acquisition in June of U.N. Ro-Ro, having cleared the different condition precedent that Niels briefly mentioned before, our revenue will grow by 8% rather than the until now, 2% that we have communicated. Our EBITDA before special items will now for the year be DKK 3 billion-DKK 3.2 billion, versus DKK 2.65 billion-DKK 2.85 billion in our previous guidance. Investments will jump to DKK 5 billion, up from the DKK 1.1 billion on a standalone basis. The DKK 5 billion consists of the equity value of the acquisition of around DKK 500 million, when the EUR 950 million has been adjusted for debt, plus the lengthenings that I briefly mentioned before. So a total investment of DKK 5 billion for the 2018 outlook. On page 17, we explain in some more detail how we intend to finance this and how this impacts our capital structure. Basically, with this, we have canceled our shareholder buyback program and will not see that coming back in 2018. We have also suspended the planned DKK 7 dividend that we mentioned when we announced our Q4 results that we expected to pay out. In 2019, following release of Q4 for 2018, we will review these capital structures and dividend policies. As part of the acquisition, we will call extraordinary general assembly to authorize a 5% share issue equal to DKK 1 billion. Lauritzen Foundation, the current controlling shareholder, will participate pro rata to maintain its shareholding. We expect this to take place shortly before completion of the transaction. After the transaction, there will be a leverage of 2.5 times EBITDA, debt to EBITDA, which is in the middle of the range we have communicated to the market as our sweet spot leverage of 2-3. The financing is secured other than the share issue, which will, as mentioned, take place shortly before closing through our existing banks that have committed term loan financing for the transaction. EUR 480 million of the debt will stay in Turkey with U.N. Ro-Ro, partly vessel financing and partly senior debt. The rest is an unsecured acquisition facility. With that, I will turn back to Niels, who will sum up the elements. To round up this presentation, what we are getting here is access to an attractive and growing Ro-Ro market with a nice land conversion feature on top of it, and a platform for further expansion opportunities. It is a very solid, profitable operator with a strong management and strong market position. We expand our customer proposition to the DFDS customers and vice versa for the U.N. Ro-Ro customers. We have opportunity to apply our capabilities to further develop U.N. Ro-Ro, the increased fleet deployment flexibility we talked about. Then it is a transaction being earnings enhancing and value accretive from the outset. As Torben just explained, we do maintain our financial flexibility through the share issue. There may be smaller things coming up in the future, and it would be nice to be able to have a chance to add that to the portfolio if it makes sense strategically and price-wise. That concludes our presentation, and we will now hand over for any potential questions you may have. Ladies and gentlemen, if you do wish to ask a question, please press 01 on your telephone keypad now and you will enter a queue. After you are announced, please ask your question and please hold until we have the first question. First question is from the line of Dan Touro from Handelsbanken. Please go ahead. Your line is open. Thank you, and congrats with the transaction. A few questions. Firstly, depreciation of the lira here the past couple of years, how has that affected volumes? I expect primarily out of Turkey. That would be the first question. Second question would be on the logistics side, would you need to build a logistics, so to say, business or to what extent is it in place already like you have done in the northern part of Europe? A third question would be on CapEx. Torben, could you put some numbers on that for coming years? How will this boost your CapEx expenditure in coming years to scrubbers, vessel extensions, et cetera? I guess if you replace some of the vessels that you have in order to Turkey, then you will need to supply your Northern Europe network with additional vessels. And then finally, are there any restructuring costs, transaction costs related to this that will affect 2018? Thank you. Thank you, Dan. If I take the first couple of questions, Torben can take the rest. A depreciating Turkish lira is what people are used to. When you have these interest and inflation differentials, then you see that. That is why the company is having all their sales denominated in euros to partly compensate that. When you then go one step up or down, you will of course have a tendency to a more favorable and more push on the export and that has been seen as well during the past years. But it has not really stifled the imports level either. A lot of the import into Turkey is composed of stuff you need in the production, in Turkey, which is then sent back as export out of Turkey to the rest of Europe. Potentially, of course, it can put a little pressure on the domestic consumption and spending, but so far, the Turkish economy is running at actually a very high pace. On the logistics side, we do this transaction for the shipping part. That is our primary focus to complement our shipping network. Will we, over time, also have a presence on the logistics side in Turkey? Sure. That can happen, but that is not initially on the radar screen. It is on the shipping side. On the CapEx, we do not provide guidance further out, then also not on this transaction. But your considerations are correct, of course, and I think with the overview slide, you will have to do with that for now. There will be costs connected to the transaction, not particularly integrating costs, but more transaction costs, and that we will guide more specifically on when we do the closing of the transaction. But we have had advisors, of course, to help us with this transaction. Thank you very much. Great. Next question is from the line of Lars Heindorff from SEB. Please go ahead, your line is open. Yes, good morning. I do not know if you can help us a little bit about the tax regime that U.N. Ro-Ro are under and how much they pay in tax. Yes. They pay same tax levels as the DFDS shipping division. So that is a tonnage taxation regime with no regular income taxes. They have some income at the port terminals, and there could be some on the intermodal services, but that is negligible. Okay. Then secondly, regarding the growth outlook that you mentioned a little bit about as well, I understand there is a big competitor down there. Is it likely that the growth that you have seen in recent years can actually continue going forward? We think so, due to the two factors Niels mentioned with the road to sea conversion. Yeah Also the fact that the main competitor on the ferry side primarily carries its own captive volumes, and we can see a leveling off of the growth on the logistics side for that competitor. So we are quite confident that U.N. Ro-Ro will get its share of the growth, if not a little bit more than the market growth. Okay. Then finally, just maybe out of curiosity, I do not know if you actually know or will answer the question, but do you know why the seller is actually selling now? We have some ideas. They have been the owner since 2014. It is primarily a very successful Turkish private equity and they need to manage their portfolio and do some exits and they had decided, apparently, for an IPO on the stock exchange in Istanbul. Through our contacts with them over the years and intelligence, we managed to hook up earlier this year and get into an exclusive process and it is speculation on our part, but there may be also some advantages for them in selling to us in one go versus a listing where they have restrictions on exiting their investment. This is pure speculation on our side. Okay. All right. Thank you. Next question is from the line of Finn Bjarke Petersen from Danske Bank. Please go ahead, your line is open. Yes, good morning. Question to the extraordinary high EBITDA margin of 40%. When you are looking into 2021, in your assumptions there, what kind of EBITDA margin do you see in this operation? Do you have anywhere else in your network where you have such a high return? When we look into the plan, again, without guiding too much in future, we will be able to maintain the margins also as we see larger vessels replacing smaller vessels and therefore reducing unit costs. We also do not give guidance on specific routes in our own network. We have, of course, routes that have very high margins. But this company does have a uniquely high margin based on their very strong market position in Turkey and their very sophisticated operation and leveraging the low cost of Turkey in a primarily international market and with international customers. What is the risk for this to be diluted? Why do not we see competition if the returns are so extraordinary? Well, you also need investments, of course, to generate these things. You have seen competitors move into the market, as you saw in 2013 with Ekol and their own volume. However, it is terminal capacity, right locations, the necessary infrastructure, a lot of different elements are coming into play here. Given the almost traffic machine they have, it is just the most efficient setup for the customers. When you can maintain that and provide the service and the customers can grow, you are not putting restrictions on them, then you are able to maintain or improve margins like this. We have seen that elsewhere, also outside DFDS, that companies with unique market positions are able to maintain those. So it is a combination of different factors which results in this result, in these margins. Finally, how have you considered the potential political risk of Turkey? We have spent a long time evaluating that. When we looked at U.N. Ro-Ro back in 2014, we were probably too careful, also because of the newness of the region, political situation, et cetera, and all of those questions. I think we have matured in our thinking since 2014. We have followed the market very closely. We have looked at competitors down there. We have engaged in discussions and of course, we have recently spent a lot of time with experts in and around Turkey. We are not judging the political situation in any countries. That's not for us. We are facilitating trade. We believe that's in everybody's interest. There are some strong fundamentals which will secure trade between Europe and Turkey going forward. That's what we are doing. We think it's sustainable. There will be headlines in Danish newspapers from time to time around the political situation. That goes for the situation in China, in the States, for that matter. But we focus on what we know best, and that's trade and making sure that that will work for our customers in the best possible way. Then we think we'll be successful. Okay. Thank you very much. Next question is from the line of Søren Bu from Safat. Please go ahead. Your line is open. Yes. One of my two questions was answered in the last session concerning the political turmoil around Turkey. Also, DFDS's second main market, the U.K., with Brexit, is connected with some uncertainty. So only one question here, and that is, will the integration of the U.N. Ro-Ro be under the DFDS brand, or will the Turkish company continue under its existing external identity? That's a good question, which we will address as we do the integration planning. We, of course, want to make sure we take the best from both companies, and eventually it will be the DFDS way of operating, et cetera, which will be dominating. We will probably look at this in a pragmatic manner, and we need to understand sensitivities with customer base and other things. So that remains to be seen how we end up. DFDS will definitely somehow be involved in this and over the whole thing. Thank you. Next question is from the line of Simon Roe from Janus Henderson. Please go ahead. Your line is open. Oh, hello. Good morning. I didn't listen to the beginning of the call, so I apologize if you already talked about this, but can you talk about the management team at U.N. Ro-Ro and whether they're staying, how you can keep them, if presumably that would be advantageous if they did stay? Absolutely, and it's our hope they're staying. Of course, we have had numerous discussion with the management team. Of course, they were on a path to an IPO, and then we suddenly popped up. This has been on top of our minds jointly. I'm pleased to say that they have convinced us that they prefer DFDS. They see the benefits for our customers, for Turkey in joining our network and vice versa. Also, the professional development opportunities of coming into a family where this is our core business, has been for 150 years. Together, we can take both companies to new levels. It's a really great team with a good mix of people who have been around for a while and know the history and a new blood coming in within the past couple of years. All very solid backgrounds, theoretical and practical from different industries in or around shipping and logistics. Also, people worked in international companies, so I don't think we could have hoped for a better management team, and we can really hit the ground running here together, in making this a success. We are very comfortable and all the indications we are having is that they are as well. They, of course, knew us, some of them from 2014 and has followed us, and some of them expressed that they have had us on the secret wish list for a new owner. Let's see. But so far, so good. How does that work? That works. We have standard compensation schemes. On top of just working for DFDS is a fantastic thing in itself. We do have some monetary compensation, so I am sure that that will not be an issue. Sorry, just one question. I am sure you covered this before, but you mentioned the big competitor. I understand it is a pretty much a duopoly. Who is that? There is a shipping company called Alternative Shipping, owned by a logistics company. The major client is Ekol, and there seems to be some cross-ownership there. There is a third competitor called Ulusoy as well in this market, in Ro-Ro, and there are different other operators, both with containers and also some Ro-Ro capabilities. So there is a number of players in this market and have been for years. Is the capacity constraint at terminal level, is that the thing that determines the constrained competitive environment? Is it terminal capacity in Turkey or terminal capacity in Trieste? I don't know if there's any sort of hard constraints. You can always find land and places, and Alternative have recently shown that move to a new terminal. U.N. Ro-Ro just has prime locations, and that's, of course, a very strong position to be in. Okay. Is there a significant overlap in terms of the customer base? Can you say anything about that? There's overlap between the customer base. We know some of their customers and vice versa. Of course, there's a whole range of new customers which we do not have a direct relationship with, but which will be possible in the future when we open up, in a different scale, the DFDS network to stock which needs to go to the U.K. or to Scandinavia or to the Baltic, for that matter. Thank you. As a reminder, if you do have any further questions for the speakers, please press 01 on your telephone keypad now. Our next question is from the line of Jørgen Bruusgaard from Nordea. Please go ahead. Your line is open. Thank you. So two questions from my part, and apologies if you have already addressed this, but could you just provide a simple breakdown of the CapEx guidance you provide for 2018? Also, will there be booked any, or are you able to quantify any integration costs to be hit in 2018? Thank you. Both questions have been replied, but I can very quickly say that the DKK 5 billion consists of our current DKK 1.1 billion guidance plus an equity value of the target here of EUR 500 million and then some additional CapEx planned in the target. That is the DKK 5 billion. There will be transaction costs, primarily, which we will detail further at the time of the closing. And the same goes for, you can say, integration costs between the organizations. We will come back to that when the transaction completes. Excellent. Thank you so much. Thank you. The next question is from the line of Ruairi Cullinane from RBC. Please go ahead. Your line is open. Hello. One question which follows on from the questions on political risk. I was wondering what scope there was to flex services and costs in the case of volatility. What share of cost is fixed and variable in the Turkish business? I think the cost structure sort of reflects what we see in the rest of the business. The good thing is when you now add a new region, which sometimes runs a little bit out of sync with some of the other areas, take the U.K. for instance, where due to the ongoing Brexit situation, it seems like the growth is hampered a little bit. You may have one point something percent growth in the U.K. economy right now, where the rest of Europe tend to be above 2%. You can say by adding Turkey, we will have flexibility and possibility to move the vessels around and thereby, leveling off if there is a different growth pattern. But otherwise, it's the well-known features of frequency, number of departures, scale up and down, and the other cost levers. It's very similar to what we know in the rest of the business. Next question is from the line of Eleanor Fox from Morgan Stanley. Please go ahead. Your line is open. Hi, just a quick question. You mentioned in the presentation that you are looking to potentially invest slightly in the Trieste terminal. Given that Trieste is currently at max capacity, can you just put some details around what this entails and whether this is more geared towards the logistics end of the terminal or whether this is to do with the shipping component? I am not sure we would say it is at max capacity today. There is still more we can put through. U.N. Ro-Ro has just recently extended and secured additional land, and has done significant investments in that terminal. So there is definitely room for more. We are open for business, but eventually with the growth scenarios we are looking at, and we do expect higher growth also going forward, eventually within the next four-year period, we need to do something in Trieste and probably also in Pendik. The management has plans in the drawer, which we will assist them with. So we can accommodate the growth on a four to five-year horizon. Thank you. Just a quick follow-up to that. Do you see any potential regulatory hurdles with any expansion or investments in ports in Turkey? No regulatory issues with this transaction, and going forward. No, we do not see that. Thank you. That was our final question for today as no one has registered, so I will hand the call back to the speakers. Please go ahead. Thank you everybody for joining us on this exciting day. Thank you for the good questions, and we wish you all a wonderful day, and goodbye. This now concludes the conference call. Thank you all for attending. You may now disconnect your lines.