I read with some astonishment about the court action taken by shipping company Maersk to overturn Transnet’s decision to award the Durban Container Port tender to Philippine Company International Container Terminal Services Incorporated (ICTS).
The challenge is on the grounds that the tender should have been disqualified because it used its share market value rather than its book value to calculate and report its “solvency ratio”.
It would seem obvious that a borrower is solvent when the value of its assets, should they have to be realised, is expected to exceed the value of debts it has incurred. The closer the ratio of market value to debt, the greater the danger that the company would be forced to wind up.
If the company is listed, its market value is clear and explicit and continuously available. The book value of a private company might be the best initial and readily available estimate of what the assets might realise, assuming the accountants for the firm have following recommended good practice and have been consistently marking the books to market.
At the time of writing, the market value of shipping giant Maersk is $25.9bn, with total debt of $16.7bn (1.6 times), and that of ICTS $15bn with total debt of $4.16bn (3.6 times). The earnings before taxes to interest paid ratio is similar for the two companies — 4.5 times for Maersk and four times for ICTS.
There is a rigorous test of corporate default risk applied to any listed company anywhere — more than 65,000 of them, including Maersk and ICTS. That test is no further away than your nearest Bloomberg terminal. A click or two calling up the company and the DRSK model will give you an immediate probability of default, one that will be closely allied with the conventional ratings provided by the debt ratings agencies.
The Bloomberg model is adapted from the original financial economics of Nobel laureate Robert C Merton and is well known in financial economics. The theory, as adapted by the Bloomberg team in 2021, is elegant and well tested by the evidence that is presented of its predictive power. Science — theory with predictive power for a large sample — is at work here.
The Bloomberg model uses the market value of the assets of a company as the basis of its assets to debt ratio, with an important proviso. The market value of a company is adjusted for the volatility of its share price. The market value is estimated as a “down and out” call on the assets with a maturity date, thus providing a highly realistic estimate of what you might realise the assets for. The more volatility, the less predictable the share price and the less the company may be expected to fetch.
The Bloomberg model gives similar measures for the low probability of either Maersk or ICTS defaulting over the next 12 months. As predicted by Bloomberg, both companies would enjoy a comforting investment grade rating. The market value of ICTS has risen strongly over the past 12 months, while that of Maersk has changed little. The volatility of the two share prices — until recently higher for Maersk — is now similar. Of course, the improved value of ICTS will have much to do with winning the tender. It clearly is a valuable contract worth fighting over.
Underperforming companies raising more debt do not necessarily go broke when the market value of their assets falls below the barrier of debt. They may be rescued by shareholders willing to subscribe additional equity capital. When shareholders prove unwilling to provide support a company will go under. Hence the market value of a highly indebted company that is close to default will always reflect the chances of a rescue. Such a rescue may succeed should the market value of the rescued company rise by more than the additional capital subscribed.
• Kantor is head of the research institute at Investec Wealth & Investment. He writes in his personal capacity.
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