Strategy paper the international mercantile marine companyDocument Transcript
Gabriel Bowers, W0755688The International Mercantile Marine CompanyThe White Star Line is most famous today for the sinking of its flag-ship, the RMS Titanic. Anotherdisaster associated with this line, one of epic financial proportions, has long since faded in memory.This financial disaster was the White Star Line’s merger into “The International Mercantile MarineCompany” (IMM) that in 1902 nearly bankrupted two successful US businessmen and blemished therecord of J.P. Morgan & Co. This paper links the warning signs visible during in the formation of theIMM to those of Deflated Roll-ups described in “Billion Dollar Lessons”.The merger of the IMM was first proposed in March of 1900 to J.P. Morgan by Clement Griscom, thepresident of the Red Star Shipping Lines. Griscom sought a merger large enough to dominate theEastern US international shipping routes. He argued that the recent upwards trends in shipping and USexports over the past five years indicated that such a merger would grow in both revenue and profit.1J.P. Morgan himself was impressed with the prospects of a large US shipping fleet. A plan was made toacquire controlling interest in three other fleets: the American “Atlantic Transit Line” (ATL) as well as theBritish “Leyland Shipping Line” and the “White Star Shipping Line”. The estimated cost in shares andcash to purchase these lines was $59,500,0002 and the total capital structure of the company wasplanned to be $110,000,000.1 Recent trends in the shipping market supported Griscom’s outlook on future profitability and growth for such amerger. US trade exports had grown by over 100% from 1895 to 1900 driven by a new market of low-cost of ironand steel. The Spanish-American and Boer wars had also increased shipments of grain across the Atlantic and alsoreduced the number of available ships as they had been commandeered by US and British governments. Both theincrease in demand and shortage of ships increased rates and demand in the shipping industry.2 The original estimated cost of purchasing the four shipping lines was: $24M for Red Star Shipping line, $9M forATL, $3.5M for Leyland Shipping ($3.5M), and $24M for the White Star Shipping Line ($24M). The capital structureincluding cash, preferred stock (6%), and common stock was $115M.
Gabriel Bowers, W0755688However, following the acquisitions in July of 1901, the capital structure had increased to $160,000,000mainly as a result of high acquisition costs. If the growth in shipping had continued and a shortage ofavailable ships continued to exist then the IMM may have raised sufficient capital through a publicoffering to pay its debts and grow despite high dividend payments. However, both the Boer andSpanish-American war ended at this time releasing a number of ships devaluing the large shipping fleetthat has been formed through the merger. As well, the US economy reached a trade imbalance leavingmany ships sailing from the US not at full capacity.By the time the merger had formerly been incorporated in October of 1902, the original plans of a publicoffering had been canceled. Both Griscom and the president of the Atlantic Transit Line who hadunderwritten a large portion of the merger had lost the majority of their wealth when the syndicate hadbeen called in. The preferred stock opened at 55% of its expected cost and common stock at 15%.3 J.P.Morgan & Co. lost a total of $2,000,000 in the merger and, more importantly, tarnished their reputationon Wall Street.Warning SignsIn positioning the IMM to control a large portion of available shipping tonnage, Griscom sought toimprove margins through both controlling shipping prices and achieving cost synergies through scale.What J.P. Morgan and Griscom had not anticipated was the negative reaction from the British public inresponse to buying a large portion of their country’s shipping lines. A remaining and much smallercompetitor, the Cunnard Shipping Company, leveraged public sentiment to obtain low-cost bonds toexpand its fleet. As a result, the IMM lost a majority of their British market share to their competitionand was not able to control pricing as originally anticipated due to growing competition.3 See Appendix B outlining that the $160,000,000 capital structure consisted of $50,000,000 in cash, $60,000,000 inpreferred stock, and $60,000,000 in common stock.
Gabriel Bowers, W0755688It is also clear that J.P. Morgan & Co rushed to purchase both of the British shipping companies. Thetotal cost for both was 50% higher than originally planned including a higher level of cash payments thanplanned. Secondly, it is clear that the negotiators representing J.P. Morgan did not carefully researcheither company. It was determined later that the Leyland shipping company held $11,500,000 in debtthat would have to be re-capitalized and that the previous owner of the White Star Shipping Companyhad paid dividends at one-fifth those promised by J.P. Morgan. 4Finally, J.P. Morgan & Co had not considered the possibility of tough times in the future. Whenconsidering the combined net income of the IMM when incorporated in 1902, the sum of interest anddividend payments closely matched the company’s net earnings of $7,000,000. The company thereforecould only survive if the positive outlook continued. Yet the failure to anticipate changes in marketconditions led J.P. Morgan & Co to assume that a high cost of capital was reasonable. Therefore, whileJ.P. Morgan & Co had finished their negotiations in July of 1901, they waited until October of 1902 toincorporate.5 This was equivalent to holding the majority of the shipping industry capital at a high strikeprice for a long period of time and expecting it to go higher.J.P. Morgan’s OrganizationA study of J.P. Morgan’s operations can be used to shed light on the mistakes made during theacquisition. At the turn of the century, the firm had a strong M&A record generally achieving an average4 The White Star Lines had never received a market valuation, therefore, their valuation was determined by theproduct of their net income in 1900 and a 10x price/earnings multiple ($34M). The shareholders were alsoawarded $7.5M in cash disbursements and $20M (20%) of the IMM common stock. After the failed public offeringthe majority of outstanding shares was held by these shareholders who replaced Griscom as president of the IMMwith their previous owner, Thomas Ismay.5 During this time J.P. Morgan appears to have waited for the results of the Hanna Subsidy bill to pass throughcongress. The original bill had supported subsidies for an American shipping fleet. While the bill had passedthrough congress, it was eventually altered in the house to exclude foreign made ships. The loss of these subsidiesraised the overall costs of these ships especially those of the White Star and Leyland that had been subsidized bythe British government.
Gabriel Bowers, W0755688IRR for most ventures of 10%. A large number of these involved US based utility or transportationcompanies. [See Appendix A] In many cases these ventures had high barriers of entry where J.P.Morgan’s team added value through changing management, controlling prices, and cutting operationalexpenses. Therefore, it can be argued that the bankers had assumed prematurely that theirmanagement efforts after the merger would be similar.As well, the bankers assigned to investigate the merger may have suffered from an inability to deal withabstractions. An anchoring bias may have existed where they did not question the underlyingassumptions of future growth and profits proposed by Griscom. It can be argued that a study ininternational economics may have identified an inflection point where such trade growth would notcontinue.It is also conceivable that their team possessed a mental rut where they would have assumed that theshipping industry was similar to that of previous ventures. They may have “Platonized” the shippingindustry assuming it would behave similar to past ventures such as utility or railroads companies. Thiscould explain the key strategic error made in forming the IMM in which neither J.P. Morgan’s team norGriscom realized that the Atlantic Ocean did not provide any barriers to entry allowing for ships to re-locate from one ocean to the other when it was profitable to do so.Finally, the decision making at J.P. Morgan & Co. was also centralized through its 45-members while J.P.Morgan himself often played the role of promoting ventures to potential investors. The firm typicallyassigned one or two junior bankers to investigate a new venture. In such an environment, there waslikely pressure for junior bankers to conform to the wishes of senior members and produce “favorable”results. This may have especially been true given the positive reach that J.P. Morgan had towardsGriscom’s proposal.
Gabriel Bowers, W0755688On reflection, a Devil’s Advocate approach may have identified the warning signs of the IMM venturewhen it was initially proposed by Griscom. A model of the worst and best case scenarios would haveidentified long-term risk that may have shaped both the capital structure of the IMM and the KPIs tomonitor when forming the company. Rules may have been created that would create ceilings forinvestments and provide an exit path in case of poor investments. Such a review would have beenrequired prior to engaging in acquisitions, before finalizing an acquisition, and if possible, prior toincorporation.Conclusion:Dividend payments of the IMM were limited from 1902 to 1912. In 1904, due to poor performance, theshareholders of the White Star Line voted to remove Griscom as president and replaced him with theirprevious owner, Thomas Ismay. As the IMM continued its decline into 1912 nearing insolvency, theIMM was dealt another blow when its new flagship, The Titanic, sunk on its maiden voyage. Theinsurance payments resulting from the Titanic disaster along with impending fear of another war (WorldWar I) further decreased revenues leading to the IMM defaulting on its interest payments in 1914 andclaiming bankruptcy.
Gabriel Bowers, W0755688BibliographyCarroll, P. B., & Mui, C. (2009). Billion Dollar Lessons. New York: Penguin Group.DeLong, J. B. (1991). Did J.P. Morgans Men Add Value? An Economists Perspective on FinancialCapitalism. National Bureau of Economic Research , 45.Irwin, D. A. (2000). HOW DID THE UNITED STATES BECOME A NET EXPORTER OF MANUFACTUREDGOODS? NATIONAL BUREAU OF ECONOMIC RESEARCH , 40.M, F. J. (1932). The International Mercantile Marine Company-An Ill-Conceived Trust. The Journal ofBusiness of the University of Chicago , 268-282.Murphy, A. (2003). Practical Financial Economics: A New Science. Greenwood Publishing Group.Saphire, W. B. (n.d.). The WHITE STAR LINE and THE INTERNATIONAL MERCANTILE MARINE COMPANY.Retrieved from Titanic Historical Society .Sears, M. V., & Navin, T. R. (1954). A Study in Merger: Formation of the International Mercantile MarineCompany. The Business History Review , 291-328.
Gabriel Bowers, W0755688Appendix A – Stock Market Rate of Return on J.P. Morgan’s Companies Figure 1 - PERFORMANCE OF J.P. MORGAN’S FIRM SHOWS A CONTINUED HISTORY OF SUCCESS RELATIVE TO THE STOCKMARKET RETURN. THIS TABLE IDENTIFIES THAT THE IMM WAS CLEARLY J.P. MORGAN’S GREATEST FAILURE. (DeLong, pg 20)
Gabriel Bowers, W0755688Appendix B – Capital Structure of the IMM Figure 2 – Capital structure of the IMM showing proportions of Common Stock, Preferred Stock, and Cash. The cashrequirements had grown to the point that it was funded through collateral trust bonds which were given higher priority over preferred stock. (Sears, pg 22)