Synopsis

After booming for more than five year, the global shipping (maritime) industry experienced a dramatic crash in late 2008 as the global financing system froze and the global economy slid into recession. Ship charter rates (revenue) in the spot market fell by as much as 95% causing prices of used ships to fall by as much as 80% or more. As Ship prices (and values) fell, ship owners began to default on loans and new purchase contracts while banks holding loans secured by ships faced the possibility of increasing defaults, foreclosures and write-offs. For Germany, one of the leading countries in terms of ship ownership, and for Hamburg, the largest port in Germany and global center for container ships, the crisis in the shipping industry had major economic ramifications.

At the press conference on September 22, 2009, VHSS, the Germany Shipbrokers Association, announced a proposal called the Hamburg Ship Evaluation Standard (HSES) to value ships using discounted cash flow analysis rather than the traditional method of using market prices from comparable transactions. Thomas Rehder, the Chairman of VHSS, argued this approach was necessary because market prices did not reflect fundamental values in current economic environment. The new approach generated long term asset values (LTAV) for ships which, according to Rehder, were currently above market prices, and would help prevent additional defaults due to loan-to-value covenant violations. Rehders key challenge was to convince industry participants ship owners and bankers to adopt the new valuation methodology, and bank regulators and auditing firms to approve its use.

Learning Objective

The case illustrates two valuation methodologies:

1. mark-to-market (comparable transactions where value equals market price) and,
2. mark-to-model (discounted cash flow analysis where value equals calculated net present value). This analysis leads to a discussion of why and under what conditions market prices should be equal fundamental or intrinsic values

Important

The key objective for you is to Illustrate and contrast two valuation methodologies; Market to market (comparable transactions or the market approach as it is called in the case) and Mark to model (discounted cash flow analysis or income approach as it is called in the case)Because the forma assumes values equals market price and the latter assumes value equals calculated net present value (NPV) also known as fundamental or intrinsic.

Guiding points in Case Analysis

1. Explain the concept of fundamental value and discuss the conditions under which market prices are likely to converge towards or deviate from fundamental values (i.e. examine the role of liquidity, competition, limited arbitrage, etc)
2. Illustrate the transmission of financial distress from a single firm (ship owner) to a single bank, then into the entire financial system and the policy challenges of trying to resolve system insolvency in financial system
3. What problems is VHSS trying to solve?
4. Discuss the traditional approach to ship valuation method before the crisis and when this approach broke down after September 2008. Comment on the sale of two sister (twin) ships; the sale of Bet Performer in May 2008, before the financial crisis was in full force in fall of 2008 and the sale of Golden Wing in January 2009 after the crisis was in full force.
5. Contrast between the two valuation mythologies and discuss in detail the methodology and application and implications of each approach with reference to the two sister ships.