Description

I am proposing Eurokai as a value investment for members of this board. I should point out that it has already tripled in a year but I believe that it has further to go. The market cap is €1298m ($1880m).

Why ports are attractive?

Before delving into the company specifically it is probably worth discussing why ports and in particular container ports are attractive.

(1)  Growth – typically in recent years container ports have been growing volumes at faster than GDP because of (a) movement of manufacturing to Asia (b) increasing economic ties across the world (c) increased containerisation (the convenience of this cannot be underemphasised). Some reports suggest global container trade will grow 8-10% to 2015.

(2)  Ports are local monopolies – it is worth remembering that ports are not just a set of berths but a whole dockside infrastructure including storage and processing facilities and transport links and hence customers cannot easily move elsewhere. Typically there are only one or a few operators at each port – and in Europe due to cities having grown around the ports land for further development is limited. Hence pricing pressure is limited.

(3)  Ports are not the final destination – typically products need to be moved from a port to a final destination elsewhere and so port operators have become solution providers eg HHLA runs its own trains across Europe

(4)  It is worth looking at a map of Europe – the opening of Eastern Europe has created demand. Due to history (lack of investment in ports and rail / road infrastructure) and geography (Denmark leads to additional mileage for ships travelling to the Polish ports) many logistic companies prefer to ship to the North Range of German ports (eg Bremerhaven and Hamburg) and then use rail to reach Central / Eastern Europe.

Background

This is a family controlled firm founded in 1865 by the Eckelmann family. I should highlight that the big moves this year are I believe because (a) the IPOs of Hamburger Hafen Und Logistik (HHFA GR) and DP World (DPW DU) have raised the profile of terminal operators – especially in Europe (b) a couple of banks (MM Warburg and Merrill Lynch have made visits to the company and written notes on it (3) as a consequence a general realisation that this is one of the top shipping terminal operators in Europe.

The company is very conservatively run. The company is a classical German KGaA structure (ie as a non family shareholder you are a passive investor). The listed tradeable shares are actually prefs – there is a 45% freefloat (the Eckelmann’s own the rest). Of the ordinaries the Eckelmann family owns 75% and Mueller & Sohn own 21% and employees own 4%.

The company is reluctant and nervous to see investors. The annual reports and investor relationships section of the company website is in unhelpful – the key documents are in German.

I am going to highlight transaction values in this note however I would highlight that I do not believe that in the short term the family will sell. However I do believe (see catalyst section) that there are reasons why transaction valuations will become increasingly important.

Assets

The holdings and structure of the company is complex. I would strongly recommend looking at the following page of the company website http://www.eurokai.com/live/eurokai_site/show.php3?id=6&nodeid=6&p=0&_language=en – however without commentary it is hard to identify the important assets in the corporate structure.

In summary – EuroKai owns 50% of EuroGate (the other 50% being owned by the city of Bremen (via BLG Logistics)). In addition EuroKai directly owns 66.6% of Contiship Italia (the remainder being owned by EuroGate – hence there is a also an indirect ownership in Contiship as well – thus the total participation of EuroKai is 66.6% + 50% of 33.3% equalling 83.25%).

A lot of the underlying ports or terminals have involvement of either local municipalities or shipping lines – hence the complex structure referred to earlier.

The following table from a Merrill Lynch note (9 Jan 2007) is the best summary of the current capacity and ownership.

Port	TEU (m) 2005	Owned via	% owned	Owned Capacity TEU (m) 2005
Gioia Tauro	3.09	Contiship	56%	1.71
Hamburg	2.64	EuroGate	50%	1.32
Bremerhaven	3.73	EuroGate	25%	0.94
La Spezia	0.87	Contiship	50%	0.44
Cagliari	0.61	Contiship	40%	0.24
Livomo	0.48	Contiship	25%	0.12
Ravenna	0.16	Contiship	15%	0.02
Salerno	0.27	Contiship	7%	0.02
Lisbon	0.22	Eurogate	8%	0.02

Thus the total current owned capacity was 4.83m TEU.

The company is in the process of developing a number of new facilities which are (again using the Merrill Lynch note):

Port	TEU (m) 2005	Owned via	% owned	Owned Capacity TEU (m) 2005
Bremerhaven CT4	3.4 (starting 2006)	Eurogate	50%	1.70
JadeWesserPort	3.5 (starting 2010)	Eurogate	35%	1.23
TangerMedGate	1.6 (starting 2008)	Eurogate / Contiship	27%	0.43

Several points are important in the above table – (1) that even Merrill Lynch publishing a note in Jan 2007 was using 2005 numbers – showing how poorly covered this company is and its poor communications (2) Gioia Tauro, Hamburg and Bremerhaven are amongst the top 5 busiest container ports in Europe (3) I believe that the market may be missing the expansion occurring at Hamburg (the 2005 annual report – which is available in English – mentions that on 6^th July 2005 EuroGate signed a deal with the City of Hamburg to expand the terminal run by EuroGate with new berths (the Elbe Berths and associated onshore facilities). This project is estimated to cost Eur 350m and will start handling shipments in 2010. The Port of Hamburg website (www.hafn-hamburg.de) suggests that the Eurogate owned terminal (CTH) will increase in capacity from 2.4m TEU in 2005 to 4m TEU in 2010). (4) Part of the reason for the complex structure of the company is that in the case of specific terminals the company has gone into joint ventures with shipping lines (particularly Maersk and MSC) which in turn guarantees volumes. (5) In Hamburg the major player is Hamburger Hafen Und Logistik (HHFA GR – owned mainly by the City of Hamburg – recent IPO). (6) This policy of partnership also applies to the new ports at JadeWesser and TangerMedGate

I believe that JadeWesserPort and TangerMedGate have strategic significance which is being missed by the market. JadeWesserPort is being built at Wilhelmshaven – on the North Coast of Germany (ports on the Northern Coast of Europe in this area are known as the ‘North Range’). The key points about this port are that Maersk (one of the major global shipping lines) will have a 30% shareholding and due to its position this port will be able to handle large container ships – this is important as both Bremerhaven and Hamburg have issues with draft (though the Port of Hamburg is seeking to commence deepening the River Elbe for this reason). JasseWesserPort is being positioned as a transhipment port (ie large cargos broken down for distribution in smaller ships (eg to Scandinavia) or by train (eg to central and Eastern Europe)). I believe that if it is successful this port will challenge Rotterdam and Antwerp for transhipment volumes.

In a similar manner TangerMedGate is positioned on the coast of Morroco at the Straits of Gobraltar as a gateway to the Mediterranean. In this case there are three shipping lines (Comanav, MSC and CMA CGM) which are the partners. Again the design is for next generation container ships which cannot be handled by smaller ports in the Mediterranean.

Valuation

For EV I am using the capital structure and EV estimates as per Bloomberg which gives a EV of €1.491bn (6.7m prefs (EUK3 GR) trading at €96.13, 6.76m ordinaries at €92.5 (EUK2 GR) and 0.294m unlimited partner shares at €94.32 – giving a total market cap of €1.297bn. Adjusting for cash / debts and minorities as per the last Bloomberg numbers gets a EV of €1.491bn)

I think that there are several ways to value this company (1) on a per TEU basis (2) EV/EBITDA (3) DCF

On a TEU basis I have data on five transactions (from MM Warburg):

Port	Yr	EV/TEU (€/TEU)
Orient Overseas	2006	731
P&O	2006	413
Montreal Gateway	2006	398
CSX World	2004	288
Halterm	2006	228

This averages €412 per TEU. (Unfortunately I do not have enough data to cross check on a weighted basis).

As a cross check HHLA has a EV of €4.9bn (€4.4bn equity and then minority and net debt as per Bloomberg). Currently HHLA handles 6m TEU so EV/TEU is €816 for that port on a current basis (though large expansions are planned).

Using the above numbers and a current owned capacity of 4.83m TEU and €412 per TEU gets an EV of €1.989bn for EuroKai. Assuming the ordinaries and the preferred have equal value attribution as a result (which is what most analysts are assuming) this comes to €36.18 per share so a valuation of €132.31 per preferred share (ie 38% upside).

However there are two specific issues with this (1) different ports have different value depending on location, competition, type of traffic, expansion potential, profitability and investment commitments (often when a city or government issues a license for a port various investment commitments are required) (2) EuroKai has significant upside potential from CT4 / JadeWessePort and TangMedGate – these could 3.36m TEU when they reach their full potential.

Given that there is a time lag to these ports coming online I suggest using a valuation of €200 per TEU – ie half the value of current capacity. On this basis this adds €672m or €48.83 per share. It should be noted that Bremerhaven CT4 started going live in 2006; and that the TangerMedGate will start in 2008. I appreciate it takes time for a new port or terminal to come on line so a discount to current capacity is reasonable but over the next couple of years the terminal utilisation at the new ports should reach industry levels.

On an EV/EBITDA basis the closest comparator is HHFA which is (on consensus estimates) trading at 13.5x 2007; and 11.62x 2008 numbers. In comparison EuroKai appears to be trading on 9.4x 2007 numbers and 8.24x 2008 (EBITDA of €158m and €181m for 2007 and 2008 respectively). Using the HHFA multiples for 2007 and 2008 gets EVs of €2.1bn for 2007 and 2008 so a price of €140 (ie an upside of €44 or 46%).

Transactions over the last couple of years in the port sector have ranged from 13 – 22x EV /EBITDA.

On a DCF basis the key issues are that (1) the company has been undertaking expansionary capex (as described in the port expansions above) which will unwind (2) over the next few years the company will benefit from volumes from the new ports (3) possible price increases. Based on these points it is possible to get an EV for EuroKai of  €1.9bn (FCF of 121, 126, 135, 145, and 151m for 2007 onwards with a 2% terminal growth rate and 10% discount factor). Taking the discount rate to 9% takes the EV to €2.17bn. It is worth pointing out however that even in 2010 the new terminals will not be matured and therefore a fade before a terminal growth rate is probably justified.

Conclusion

So in conclusion it appears that Eurokai has an upside of 38% or more.

Catalyst

I think there are several key catalysts (1) the new ports coming on line and maturing (2) the company may make further port acquisitions or investments (3) the increased interest in the port sector will mean this company will be better covered.