Hostile Raid on China's Biggest Developer Marks New Takeover Eraby
Expect more takeover bids, especially by insurance companies
Capital from shadow banking system is fueling transactions
The long-running hostile raid on China’s biggest real estate developer isn’t short on drama: There’s a swashbuckling, Mount Everest-conquering company chief who courts controversy; a relatively unknown raider using leverage to increase its heft; a white knight; and surprise new potential suitor jumping in.
While the battle for China Vanke Co. isn’t exactly the "Barbarians at the Gate" takeover of RJR Nabisco by private equity firm Kohlberg Kravis Roberts & Co. during the leveraged-buyout boom of the 1980s, the scale and significance may turn out to be equally important in the annals of Chinese business history. As China’s economic growth slows to its lowest level in two and a half decades, organic expansion is increasingly giving way to consolidation. That the largest and one of the most respected companies in its industry is a target heralds a new era for China Inc. in which even the Goliaths are fair game.
Expect an era of many more takeover bids -- hostile or not -- to begin. In fact, it’s already starting.
"China has reached a stage where consolidation is becoming a key and dominant theme, with so much money around in the system, and capital is going to be searching for returns," said Frank Tian, an investment manager at the Hong Kong office of Aberdeen Asset Management Plc. "The Vanke saga signifies that and is going to make history and be one of the milestones of China’s capital market development."
At least 28 property companies have encountered acquisitions of 5 percent or more, the level at which the buyers must notify regulators of the reason for the investment, according to a Ping An Securities report from December. A quarter of these companies were targeted with the purpose of wielding significant influence or seeking control, the report said.
The trend is being fueled by an abundance of cash, much of it from China’s shadow credit system, which makes it possible for investors to use leverage to finance share purchases. Baoneng Group, which Vanke labeled a "hostile" investor, amassed a nearly 24 percent stake in the developer last year by borrowing from brokers and fund managers who raise the money selling private high-yield instruments, known as asset management plans, to wealthy investors who are often bank clients.
AMPs are the fastest-growing segment of China’s shadow banking sector, which is valued at $7.5 trillion by Moody’s Investors Service. The International Monetary Fund estimates that about $2.9 trillion worth of shadow credit products such as AMPs and wealth management products are contributing to "substantial risks" in the financial system.
One acquisitive developer taking advantage of this source of funds is China Evergrande Group. Controlled by billionaire chairman Hui Ka Yan, it became a surprise investor in Vanke in August and now has built up its stake to 6.8 percent. That comes on the heels of an April statement that Guangzhou-based Evergrande would acquire 52.78 percent of fellow developer Calxon Group. In August, it also increased its stake in Langfang Development Co. Ltd. to 15 percent, notifying regulators it had not ruled out taking control.
Evergrande said in filings to the Hong Kong Stock Exchange that both the Vanke and Calxon purchases were financed through "internal resources." The company didn’t respond to written questions from Bloomberg News on its sources of funds or takeover intentions.
Evergrande relies heavily on shadow financing to fill its coffers, according to S&P Global Ratings, which rates the company’s bonds below investment grade.
"You definitely cannot distinguish money used for these stock purchases as coming from internal cash flow, and which is from shadow banking," said Matthew Kong, an S&P director who estimated that Evergrande had at least 111 billion yuan ($17 billion) of shadow loans on its balance sheet at the end of last year -- largely due to trust products and AMPs -- equivalent to 37 percent of its total debt. “For the money they are using to buy Vanke, definitely some of that cash comes from shadow banking."
The insurance industry has also relied heavily on cash from selling short-term investment products to fund equity purchases and potentially launch stealth takeover bids. These policies, which can typically be cashed out after two or three years, offer returns substantially higher than bank deposit rates for millions of Chinese.
"Insurers issuing these products need to look for high-yield investments," said Chen Li, Hong Kong-based Asia strategist at Credit Suisse Group AG. "That’s one of the motivations for uninvited bidders."
Quality property companies carry particular appeal for insurers looking for places to park their cash. They offer stable returns, often trade below the value of their assets and can provide possible opportunities for mortgage-backed securities as well as cross-selling policies to home buyers, according to analysis from Guotai Junan Securities.
Anbang Insurance Group Co. has been particularly active in raising funds through universal insurance products, which soared to 467 billion yuan at the end of 2015 from 65 billion yuan a year earlier, according to Chen of Credit Suisse. Anbang bought a 29.98 percent stake in developer Sino Ocean Land Holding Ltd. for HK$11.1 billion ($1.4 billion) in December, days before it increased its holding in Vanke to 7 percent from 5.7 percent.
Another cash-rich insurer, privately held Funde Sino Life Insurance Co., last year built up a 20 percent stake in Shanghai Pudong Development Bank Co. and holds almost 30 percent of home builder Gemdale Corp., accumulated mostly in 2014. None of these moves, however, met with management resistance.
Not so with Vanke. Since December, the Shenzhen-based company has been embroiled in China’s most high-profile corporate battle, involving a tangled web of state-owned shareholders, competitors, and a hostile predator with unknown motives. Nearly nine months on, there’s still no clear end game. The year so far has been as full of surprises and twists and turns as the takeover of Nabisco by KKR -- though that battle concluded in less than six weeks.
"Remember Barbarians at the Gate?" said Aberdeen’s Tian. "You can almost draw parallel comparisons, though the plot is not exactly the same."
The star of the drama is 65-year-old Wang Shi, who founded Vanke in 1984 when Chinese capitalism was still in the crawling stage. He built it into the country’s largest home builder, with $40 billion in market value, and is a role model for entrepreneurs across China who flock to hear him give motivational speeches and buy his books. His micro blogs have 24 million followers, he’s climbed the highest peaks on seven continents, and he has been featured on the cover of GQ China. Vanke said Wang wasn’t available for an interview and didn’t respond to written questions.
"He’s iconic," said Hao Hong, chief strategist at Bocom International Holdings Co. Ltd. in Hong Kong. "Vanke is one of the best-run companies."
That’s why the attack on Vanke came as such a surprise.
"Here is this long-time blue-chip company, and out of the blue comes a hostile bid," said Fraser Howie, co-author of "Red Capitalism: The Fragile Financial Foundation of China’s Extraordinary Rise." “This should be a wake-up call that there are business groups and entrepreneurs looking to shake up the established order."
Wang has courted plenty of controversy in the past. He has advocated the right of businessmen to weigh in on political issues instead of toeing the party line, told his employees to limit personal donations to survivors of the 2008 Sichuan earthquake to 10 yuan, and called China’s housing market a bubble about to collapse in a 2013 interview with the U.S. television news program "60 Minutes."
Wang was again at the center of media attention in December, after little-known Baoneng Group had built up its stake from the 5 percent it reached in July 2015 to nearly 24 percent, making it Vanke’s largest shareholder. Though he owned just 0.8 percent of the company, China Resources Co. -- the biggest shareholder until then -- had allowed Wang to run Vanke unfettered. With that autonomy suddenly at risk, Vanke President Yu Liang labeled Baoneng’s move a "hostile takeover," and the company obtained a trading halt to give it time to mount a defense.
By March, it looked like Wang had found himself a white knight. He proposed a $6.9 billion asset swap with municipally owned Shenzhen Metro Group that would make the mass transit operator Vanke’s largest shareholder and dilute Baoneng’s stake. But the plan foundered after China Resources voted against it at a board meeting in June, preventing Wang from obtaining the two-thirds majority he needed. With no resolution reached, Vanke’s mainland-listed A-shares resumed trading on July 4. Neither Baoneng nor China Resources responded to written questions about the matter.
The future now looks even more uncertain after the surprise entry of another interloper. In early August, Evergrande said it had amassed an almost 5 percent stake in Vanke. Evergrande has shed little light on its motivation apart from citing Vanke’s "strong" financial performance, and has continued building its stake to 6.82 percent.
On Monday, Vanke’s board secretary, Zhu Xu, said the company wanted to talk with all the parties holding stakes to reach an agreement. The previous day in an earnings statement to the Shenzhen stock exchange, Vanke said the uncertainty has affected operations, with partners in 31 of its projects having asked for changes of terms, suspensions or possible terminations.
On Wednesday, S&P lowered its outlook for Vanke to negative because "the tension between key stakeholders has compromised the company board’s effectiveness and its ability to set long-term strategic initiatives." Vanke’s Shenzhen-traded A shares fell 2.9 percent after the downgrade, closing at 23.99 yuan a share. After resuming trading in early July from their halt in December, Vanke shares initially fell 30 percent to a July 21 low, but had risen 41 percent as of Wednesday’s close.
However the Vanke saga plays out, more corporate raids are likely to follow.
Analysts at SWS Research Co. in Shanghai identified 18 companies as potential acquisition targets for insurers, including Inner Mongolia Yili Industrial Group, Shanghai Yuyuan Tourist Mart Co. and Huafa Industrial Co., by looking at enterprises whose biggest shareholders hold less than 30 percent and various other variables including price-to-equity ratios and market value.
"There are more vulnerable companies out there," said Kristy Hung, an analyst at Bloomberg Intelligence, who said other possible targets include Beijing Capital Land Ltd. and Guangzhou R&F Properties Co., whose diverse ownership structure leave them open. "Whether or not Vanke’s management struggle will be repeated is hard to say."