Vereinigung Hamburger Schiffsmakler Und Schiffsagenten e.V. (VHSS): Valuing Ships (A Case Study on the Mechanics of and Policies for Valuing Large, Capesize Ships During the Financial Crisis)
Posted: 27 Aug 2010 Last revised: 13 Sep 2010
Date Written: August 26, 2010
After booming for more than five years, the global shipping (maritime) industry experienced a dramatic crash in late 2008 as the global financial 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 the global center for container ships, the crisis in the shipping industry had major economic ramifications.
At a press conference on September 22, 2009, VHSS, the German Shipbroker's 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 the 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. Rehder’s key challenge was to convince industry participants - ship owners, appraisers, and bankers - to adopt the new valuation methodology, and bank regulators and auditing firms to approve its use.
From a teaching and research perspective, the case has five objectives: 1) Illustrate and contrast two valuation methodologies: mark-to-market (comparable transactions analysis which yields a price) and mark-to-model (discounted cash flow analysis which yields a net present value).
2) Explain the concept of fundamental value and discuss the conditions under which market prices are likely to converge towards or deviate from fundamental values. The case provides an opportunity to explore why, when, and for how long market prices might diverge from fundamental values.
3) Illustrate the transmission of financial distress from a single firm (ship owner), to a single bank, and then into the entire financial system, and the policy challenges of trying to resolve systemic insolvency across the banking industry.
4) Provide a vehicle to discuss the US housing crisis. Although this case analyzes the shipping industry, it maps nicely into the housing crisis (falling real estate prices, fire sales, and bank insolvency) and provides a way to discuss the impact of and possible solutions to the crisis.
5) Provide a vehicle to discuss a range of theoretical and applied topics related to capital markets: the concept of market efficiency, the formation and collapse of asset price bubbles; the concept of value investing; the impact of Basel II capital adequacy standards; the advantages and disadvantages of mark-to-market accounting; and the impact of the global financial crisis.
Given this range of topics, the case can be taught in a variety of settings and courses. On the one hand, it is appropriate for advanced corporate finance or valuation courses to teach valuation mechanics. Alternatively, it can be used in courses on capital markets as a way to teach concepts of market efficiency, liquidity, limits to arbitrage, and systemic financial distress. Both a detailed teaching note and courseware (exhibits in an Excel workbook) exist for this case.
Keywords: Valuation, Market Efficiency, Financial Distress, Banking, Bubbles, Shipping, Basel II, Contagion
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