Gabriel Bowers, W0755688

The International Mercantile Marine Company

The White Star Line is most famous today for the sinking of its flag-ship, the RMS Titanic. Another

disaster 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 Marine

Company” (IMM) that in 1902 nearly bankrupted two successful US businessmen and blemished the

record of J.P. Morgan & Co. This paper links the warning signs visible during in the formation of the

IMM 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, the

president of the Red Star Shipping Lines. Griscom sought a merger large enough to dominate the

Eastern US international shipping routes. He argued that the recent upwards trends in shipping and US

exports over the past five years indicated that such a merger would grow in both revenue and profit.1

J.P. Morgan himself was impressed with the prospects of a large US shipping fleet. A plan was made to

acquire controlling interest in three other fleets: the American “Atlantic Transit Line” (ATL) as well as the

British “Leyland Shipping Line” and the “White Star Shipping Line”. The estimated cost in shares and

cash to purchase these lines was $59,500,0002 and the total capital structure of the company was

planned to be $110,000,000.

1 Recent trends in the shipping market supported Griscom’s outlook on future profitability and growth for such a

merger. US trade exports had grown by over 100% from 1895 to 1900 driven by a new market of low-cost of iron and steel. The Spanish-American and Boer wars had also increased shipments of grain across the Atlantic and also reduced the number of available ships as they had been commandeered by US and British governments. Both the increase 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 for

ATL, $3.5M for Leyland Shipping ($3.5M), and $24M for the White Star Shipping Line ($24M). The capital structure including cash, preferred stock (6%), and common stock was $115M.

Gabriel Bowers, W0755688

However, following the acquisitions in July of 1901, the capital structure had increased to $160,000,000

mainly as a result of high acquisition costs. If the growth in shipping had continued and a shortage of

available ships continued to exist then the IMM may have raised sufficient capital through a public

offering to pay its debts and grow despite high dividend payments. However, both the Boer and

Spanish-American war ended at this time releasing a number of ships devaluing the large shipping fleet

that has been formed through the merger. As well, the US economy reached a trade imbalance leaving

many 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 public

offering had been canceled. Both Griscom and the president of the Atlantic Transit Line who had

underwritten a large portion of the merger had lost the majority of their wealth when the syndicate had

been 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 reputation

on Wall Street.

Warning Signs

In positioning the IMM to control a large portion of available shipping tonnage, Griscom sought to

improve 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 in

response to buying a large portion of their country’s shipping lines. A remaining and much smaller

competitor, the Cunnard Shipping Company, leveraged public sentiment to obtain low-cost bonds to

expand its fleet. As a result, the IMM lost a majority of their British market share to their competition

and 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 in

preferred stock, and $60,000,000 in common stock.

Gabriel Bowers, W0755688

It is also clear that J.P. Morgan & Co rushed to purchase both of the British shipping companies. The

total cost for both was 50% higher than originally planned including a higher level of cash payments than

planned. Secondly, it is clear that the negotiators representing J.P. Morgan did not carefully research

either company. It was determined later that the Leyland shipping company held $11,500,000 in debt

that would have to be re-capitalized and that the previous owner of the White Star Shipping Company

had paid dividends at one-fifth those promised by J.P. Morgan. 4

Finally, J.P. Morgan & Co had not considered the possibility of tough times in the future. When

considering the combined net income of the IMM when incorporated in 1902, the sum of interest and

dividend payments closely matched the company’s net earnings of $7,000,000. The company therefore

could only survive if the positive outlook continued. Yet the failure to anticipate changes in market

conditions led J.P. Morgan & Co to assume that a high cost of capital was reasonable. Therefore, while

J.P. Morgan & Co had finished their negotiations in July of 1901, they waited until October of 1902 to

incorporate.5 This was equivalent to holding the majority of the shipping industry capital at a high strike

price for a long period of time and expecting it to go higher.

J.P. Morgan’s Organization

A study of J.P. Morgan’s operations can be used to shed light on the mistakes made during the

acquisition. At the turn of the century, the firm had a strong M&A record generally achieving an average

4 The White Star Lines had never received a market valuation, therefore, their valuation was determined by the

product of their net income in 1900 and a 10x price/earnings multiple ($34M). The shareholders were also awarded $7.5M in cash disbursements and $20M (20%) of the IMM common stock. After the failed public offering the majority of outstanding shares was held by these shareholders who replaced Griscom as president of the IMM with 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 through

congress. The original bill had supported subsidies for an American shipping fleet. While the bill had passed through congress, it was eventually altered in the house to exclude foreign made ships. The loss of these subsidies raised the overall costs of these ships especially those of the White Star and Leyland that had been subsidized by the British government.

Gabriel Bowers, W0755688

IRR for most ventures of 10%. A large number of these involved US based utility or transportation

companies. [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 operational

expenses. Therefore, it can be argued that the bankers had assumed prematurely that their

management efforts after the merger would be similar.

As well, the bankers assigned to investigate the merger may have suffered from an inability to deal with

abstractions. An anchoring bias may have existed where they did not question the underlying

assumptions of future growth and profits proposed by Griscom. It can be argued that a study in

international economics may have identified an inflection point where such trade growth would not

continue.

It is also conceivable that their team possessed a mental rut where they would have assumed that the

shipping industry was similar to that of previous ventures. They may have “Platonized” the shipping

industry assuming it would behave similar to past ventures such as utility or railroads companies. This

could explain the key strategic error made in forming the IMM in which neither J.P. Morgan’s team nor

Griscom 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 typically

assigned one or two junior bankers to investigate a new venture. In such an environment, there was

likely 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 towards

Griscom’s proposal.

Gabriel Bowers, W0755688

On reflection, a Devil’s Advocate approach may have identified the warning signs of the IMM venture

when it was initially proposed by Griscom. A model of the worst and best case scenarios would have

identified long-term risk that may have shaped both the capital structure of the IMM and the KPIs to

monitor when forming the company. Rules may have been created that would create ceilings for

investments and provide an exit path in case of poor investments. Such a review would have been

required prior to engaging in acquisitions, before finalizing an acquisition, and if possible, prior to

incorporation.

Conclusion:

Dividend payments of the IMM were limited from 1902 to 1912. In 1904, due to poor performance, the

shareholders of the White Star Line voted to remove Griscom as president and replaced him with their

previous owner, Thomas Ismay. As the IMM continued its decline into 1912 nearing insolvency, the

IMM was dealt another blow when its new flagship, The Titanic, sunk on its maiden voyage. The

insurance payments resulting from the Titanic disaster along with impending fear of another war (World

War I) further decreased revenues leading to the IMM defaulting on its interest payments in 1914 and

claiming bankruptcy.

Gabriel Bowers, W0755688

Bibliography Carroll, P. B., & Mui, C. (2009). Billion Dollar Lessons. New York: Penguin Group.

DeLong, J. B. (1991). Did J.P. Morgan's Men Add Value? An Economist's Perspective on Financial

Capitalism. National Bureau of Economic Research , 45.

Irwin, D. A. (2000). HOW DID THE UNITED STATES BECOME A NET EXPORTER OF MANUFACTURED

GOODS? NATIONAL BUREAU OF ECONOMIC RESEARCH , 40.

M, F. J. (1932). The International Mercantile Marine Company-An Ill-Conceived Trust. The Journal of

Business 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 Marine

Company. The Business History Review , 291-328.

Gabriel Bowers, W0755688

Appendix 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 STOCK MARKET RETURN. THIS TABLE IDENTIFIES THAT THE IMM WAS CLEARLY J.P. MORGAN’S GREATEST FAILURE. (DeLong, pg 20)

Gabriel Bowers, W0755688

Appendix B – Capital Structure of the IMM

Figure 2 – Capital structure of the IMM showing proportions of Common Stock, Preferred Stock, and Cash. The cash requirements had grown to the point that it was funded through collateral trust bonds which were given higher priority over

preferred stock. (Sears, pg 22)