Horizon Lines, Inc.

ICMF 475

Case Studies in Finance

Case 36: Horizon Lines, Inc.

By:

Methavee Taveekitvatee 5480153

Yi Xue 5480400

Company Overview

Horizon Lines, Inc., together with its subsidiaries, engages in Jones Act container shipping business with primary service to ports within the continental United States, Alaska, Hawaii, and Puerto Rico. Horizon Lines, Inc. was founded in 1956 and is headquartered in Charlotte, North Carolina. The company transports a range of consumer and industrial items that are used every day, such as refrigerated and non-refrigerated foodstuffs, household goods, auto parts, building materials, and various materials used in manufacturing. It also offers vessel loading and unloading services for vessel operators at its terminals; agency services for third-party shippers lacking administrative presences; warehousing services for third-parties; and other non-transportation services. The company serves consumer and industrial products companies; and agencies of the U.S. government, including the Department of Defense and the U.S. Postal Service. It owns 11 vessels; and owns or leases approximately 22,300 cargo containers. Its stock trades on the over-the-counter market under the symbol HRZL (Bloomberg, n.d.).

Shipping Transportation Industry

By that time, global economic activity remained steady, having a global GDP growth rate of 3.9%, considerably lower than 2010 which the growth rate was 5.3% (IMF, 2012). For the overall of shipping industry, 2011 was a tough year as various economic factors could affect negatively on the volume of orders. This led to the reducing in deliveries and pressure to the market. On average, working capital of shipping industry has become negative in 2011, which is a cost efficient way of financing (PwC, 2012). Furthermore, the industry has been protected by Jones Act, which is a regulation for shipping and transportation industry. The law’s purpose was to support the U.S. maritime industry by requiring that all goods transported by water between U.S. ports be carried on ships constructed and flagged in U.S.. This results that the industry becomes difficult to enter. Only 27 vessels were qualified due to the high capital investments and long delivery lead times to build a new vessel created a barrier for new entrants. On the other hand, Jones Act will result in a high labor rates to the shipping companies, as vessels which need to maintain standards of Jones Act will have higher construction, maintenance and operation costs compared to foreign vessels.

In this industry, Horizon has a few strengths. It owns 11 vessels that have already passed Jones Act. Also, U.S. government is considered as a big customer which can ensure its sales. Additionally, Horizon has utilized its empty vessels with the strategic alliance with A.P. Moller-Maersk since the 1990s. This alliance set a good foundation for Horizon to enter another long-term lease agreement with Ship Finance International Limited to charter five container vessels that are not qualified by Jones Act to travel on its Asia-Pacific route. Yet, its’ weakness can be seen as it had a previous management team who has committed to crimes of price fixing with its competitor. This can lead to a bad publicity as it faces huge civil claims and criminal fines to pay, and current financial problems. Also, Maersk's unilaterally exit the strategic alliance in 2010 made Horizon locked into this long-term lease until 2018-19. This creates high leasing costs to Horizon. It is unable to compete cost efficiently and profitably with foreign competitors, due to an increasing fuel cost and dropping freight rates led to a a shutdown on its Pacific route.

Case issues and problems

Horizon was going to be in technical default on its debt. In 2007, the shipping business seemed to have a bright future and Horizon’s share was trading at an all-time high, the company completed a major round of refinancing to consolidate its debt into two sources – first, a senior secured credit agreement that used all Horizon-owned assets as collateral, which included a $125 million term loan matured in 2012 and a $250 million five-year revolving credit facility provided by a lending group of major banks. Second, $330 million of unsecured, 4.25% convertible senior notes matured in 2012, which held by three large mutual fund companies. Both sources carried covenants that specified minimum interest coverage ratio of 2.75x and maximum leverage ratio of 3.25x for 2011.

However, after that, Horizon was unprofitable and making losses every year since. Together with burdened debt, the company had two major setbacks in 2010: loss of a key strategic alliance and $65 million paid out in criminal & civil fines. In October 2008, three Horizon executives and two Sea Star Line (its’ competitor) executives were committed to price fixing crimes for nearly six years that they fix prices, rig bids and allocate customers. The court imposed a fine of $45 million to be paid out within the next five years from 2011 and nearly 60 civil lawsuits against Horizon resulted to pay a $20 million legal settlement in 2009. The management dealt with this situation by cutting common dividend for 2010 and stop paying completely by the first quarter of 2011. As a consequence, investors start to sell Horizon shares – price dropped from $5 per share to $0.85. On the other hand, convertible notes price had fallen to $0.8, raise the yield on notes by over 20%.

Furthermore, by 2010 the company’s poor earnings performance and its payments for criminal & civil fines made it clear that the company would be unlikely to satisfy these covenants in 2011. This will put the company in technical default and give debt holders the right to call the loan (demand immediate & full payment of the principal outstanding). Unless Horizon can negotiate a change to the covenants to remove the default, or else the company will be impossible to raise new debt/equity. Even though the covenants have been satisfied, the company will face increasing burdens to meet its cash obligations of paying future interest & principal.

Case analysis

What the management team had already done were: first, shutting down the unprofitable Pacific route, second, reducing headcount – very limited attempt, since most of the work force was protected by the trade union. The next step for the management to think is to