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China's Yellow Brick Road

Want approval for overseas deals? Stick to Xi Jinping's pet project.
Photograph: iStock/Getty Images

Chinese billionaires who want to buy overseas assets without irking Beijing need to keep their eyes on the road.

China Energy Reserve & Chemicals Group Co., a unit of state oil behemoth China National Petroleum Corp., has bowed out of the consortium that paid a record $5.2 billion for Hong Kong skyscraper The Center, barely four months after the deal was struck, the South China Morning Post reported Tuesday.

Gadfly told you so. Back in November, I alerted readers that China Energy, a Beijing-based specialist in the storage of oil and natural gas, was neither particularly closely connected to its illustrious part-owner (the parent of PetroChina Co.), nor a cash cow. In the first half of 2016, the company generated only 95 million yuan ($15 million) of net income on 2 billion yuan of sales.

No Cash Cow

China Energy's earnings dwindled in 2016, the latest data available, begging the question of how it could afford to buy a Hong Kong office building for more than $5 billion

Source: Jinhong Holdings filings

The Center joins a list of aborted deals by companies from Anbang Insurance Group Co. to HNA Group Co., in an environment where China's government has soured on debt-fueled overseas acquisitions. That hasn't stopped others from trying.

The latest is billionaire Li Shufu, who's paying $9 billion for a stake in Daimler AG. His Geely Group structured the stock purchase through a collar trade, Ruth David, Dinesh Nair and Jonathan Browning of Bloomberg News reported. It's no coincidence that conglomerate HNA used the same tactic to finance its investment in Deutsche Bank AG. 

To be sure, Geely is in better shape than HNA, which is in financial distress after a $45 billion overseas shopping spree that it's now trying to reverse. Instead of buying high-end foreign hotels and real estate, Geely is at least sticking to its core business, seeking a strategic stake in a leading direct competitor.

But being in the same industry is no longer good enough to get Beijing's approval.

Li must be feeling some heat right now, as Chinese media persists in asking how he has managed to pay for the Daimler holding. Since December, Geely has spent more than 10 billion euros ($12 billion) on acquisitions, even though it held only 3 billion yuan of net cash at the end of September, estimates Sanford C. Bernstein analyst Robin Zhu.

Last weekend, Chief Financial Officer Li Donghui went on CCTV, often a platform for populist sentiments, to defend Geely. He said the company had deployed "overseas capital market arrangements" to fund the Daimler purchase. In other words, it wasn't moving money out of China.

 

Short of Fuel

Zhejiang Geely Holding Group Co. doesn't have the cash to pay for a $9 billion stake in Daimler

Source: Bloomberg

Note: 2016 year-end are latest data available.

Still, the acquisition may be less strategic that it first appeared, given the news that Li earlier held talks on potentially taking over Fiat Chrysler Automobiles NV. There are almost no Western carmakers more divergent in their shapes and strategies, as my Gadfly colleague David Fickling writes.

Call me pessimistic, but it's not difficult to imagine that Beijing one day will turn around and accuse Geely of overpaying for Daimler. By any measure, buying shares on the open market isn't a capital-efficient way to accumulate a strategic stake. The more usual and economical route is to negotiate a share placement, often at a discount to the market price. With Daimler rejecting its overtures, Geely should have passed.

In this context, one can see why the company used a collar. While the derivative structure caps gains should Daimler shares soar, it also limits potential writedowns in the event of declines. A large impairment would hurt Geely's net income -- and might draw further scrutiny and censure.

So, to pacify Beijing, overseas acquisitions need to be strategic and cheap while posing no systemic risk to China's banking system.

But there is one loophole. That's to use the auspices of "One Belt, One Road," the pet project of President Xi Jinping, who is now poised to stay in power for life. HNA just announced it will lead two funds that will invest 20 billion yuan in the initiative.

That's one road that doesn't have potholes.

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

    To contact the author of this story:
    Shuli Ren in Hong Kong at sren38@bloomberg.net

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

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