Nisha Gopalan is a Bloomberg Gadfly columnist covering deals and banking. She previously worked for the Wall Street Journal and Dow Jones as an editor and a reporter.

A bet that China has a bad-debt problem sounds like a no-brainer for investors. Tell that to shareholders of Sino Biopharmaceutical, whose stock plunged 20 percent in Hong Kong on Friday after the company said it's buying a near-5 percent stake in China Cinda Asset Management.

Investor reaction to the 4.9 billion yuan ($747 million) deal is far from illogical. Sino Biopharm is a maker of traditional Chinese medicine and treatments for hepatitis and cardio-cerebral diseases -- not an obvious source of synergy for a financial institution that specializes in managing non-performing assets.

Cinda is one of four asset-management companies created by the Chinese government in the late 1990s as part of a program to clean up banks' balance sheets. The firms buy non-performing loans at a discount and seek to profit by recovering cash, repackaging the debt and selling it on to other investors, or swapping debt into equity.

In 2013, Cinda became the first of the AMCs to be publicly traded in Hong Kong (the second, China Huarong Asset Management, listed last year). Since then, it's hardly been a star performer. Cinda shares have slumped almost 30 percent since their debut, more than the 23 percent decline in the Hang Seng China Enterprises Index, which tracks the performance of China's so-called H shares in Hong Kong.

Sino Biopharm said in a stock-exchange statement on Jan. 7 that buying into Cinda provides a ``reasonable investment opportunity" that will help generate ``attractive returns" for shareholders. The company also said it entered into a strategic cooperation agreement with Cinda to explore business opportunities ``in a wide variety of areas, with a focus on healthcare and life insurance.'' It didn't give more details.

It's hard to see that opportunity right now. Sino Biopharm stock was one of the market's stars, rising 33 percent in the year before Friday's announcement on growing demand for stocks linked to China's healthcare industry. The company signed a deal last week with Johnson & Johnson to develop its hepatitis drug outside China. Annual revenue more than doubled between 2011 and 2014 while net income rose almost fourfold. 

With such strong prospects in its core business, the need for a foray into an unrelated area is hard to see. It's not as if Sino Biopharm was offered a deal it couldn't refuse. The drugmaker agreed to pay 2.58 yuan a share for its Cinda stake. That equated to HK$3.05 as of Friday, or a premium of 16 percent to the closing price of Cinda's H shares on Jan. 7.  As of early this afternoon, the premium had widened to more than 20 percent, with Cinda's shares sinking 3.5 percent to HK$2.52.

Drugs Beat Debt
Sino Biopharm shares have outperformed Cinda

Sino Biopharm is also using up all the net cash -- and more -- on its balance sheet. The company had HK$3.1 billion of net cash as of June 30: It says it intends to finance payment of the full amount using internal financial resources, existing banking facilities and ``banking facilities being arranged.''

Shareholders -- who if they wanted could buy shares in Cinda themselves, and at a better price than Sino Biopharm -- might reasonably ask whether this money would be better spent on developing new drugs or other activities more closely connected with the company's main business. 

Sino Biopharm is now among the top shareholders at the state-controlled firm, ranking only after China's Social Security Fund with 25 percent and Blackrock  on 6.8 percent, according to Bloomberg data. JPMorgan has 4.98 percent of the company

Analysts remain positive on the asset manager, with 14 out of 16 tracked by Bloomberg rating the company a buy. Cinda's shares have been depressed by its purchase of Nanyang Bank, a Hong Kong-based lender put on the block by Bank of China's Hong Kong arm late last year, for which it was the only bidder.

Cinda is forking out $8.8 billion for Nanyang, the largest sum paid for a Hong Kong-based bank. It is also paying a frothy 1.85 times book value, according to Jefferies, for a bank mainly known in the city as a lender for elderly savers, though it has 38 branches in China and a coveted mainland banking license.

Cinda has moved beyond its traditional role. At the end of June, bad loans at banks made up just 9 percent of its total assets, while the business of buying debt companies owe each other (mainly receivables), accounted for 26 percent, according to Barclays analyst Alex Zhou. 

Yet of the four AMCs, Cinda remains the biggest buyer of bad debt from banks. It has purchased between 40 percent and 50 percent of all NPLs sold by banks in recent years, according to Barclays' Zhou. China's soured debt, meanwhile, has surged as the economy has slowed.

Bad Loans Rising
Nonperforming loans at China's banks have been surging in the past couple of years
Source: The People's Bank of China/ Bloomberg Data

More bad loans mean more business for asset managers, and more potential profits for the likes of Cinda and Huarong, other things being equal. The question remains as to whether a drugmaker is the right vehicle to be financing this business opportunity. Without a clearer statement of the strategic logic behind this deal, Sino Biopharm's investment is likely to continue weighing on its stock.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Nisha Gopalan in Hong Kong at ngopalan3@bloomberg.net

To contact the editor responsible for this story:
Matthew Brooker at mbrooker1@bloomberg.net