Last February we described some of the "horror stories" of corporate leverage that emerged as a result of China's unprecedented offshore M&A spree that emerged in 2015 and raged through most of 2016: after all, with nearly $250 billion in foreign acquisitions in 2016 alone...
... the bulk of the funding would inevitably come from debt. These were some of the examples we highlighted:
- Take Zoomlion, a lossmaking Chinese machinery company that is partially state-owned: its total debt stands at 83 times its EBITDA. "Zoomlion’s bid is a desperate attempt to remain relevant,” said Mr Pillay.
- Or how about Fosun, a serial Chinese acquirer that spent $6.5bn on stakes in 18 overseas companies during a six-month period last year, had a a 55.7x total debt/EBITDA in June 2015. "Fosun has bought brand names such as Club Med and Cirque du Soleil as well as a host of other assets including the German private bank Hauck & Aufhaeser."
- Or maybe the highly publicized purchase of China Cosco Holdings of the Greek Piraeus Port Authority for €368.5m. Cosco has promised to invest €500m in the Greek port despite having total debt at 41.5x its EBITDA!
- Or Cofco Corporation, which recently reached an agreement with Noble Group under which its subsidiary, Cofco International, would acquire a stake in Noble Agri for $750m (in the process preventing the insolvency of the biggest Asian commodities trader), has total debt equivalent to 52 times its EBITDA!
- Or how about Bright Food, which bought the breakfast group Weetabix for $1.2bn last year, and has total debt at 24 times EBITDA!
The visual summary was far more stunning, and showed some Chinese foreign acquirers ompanies had levered up as much as 83x.
As we summarized, "what is going on in China's massively overlevered corporate sector, is that virtually every company has become one massive "rollup" a la Valeant, hoping to deflect investors' and analysts attention from their deplorable credit metrics by engaging in a scramble of global M&A at any price, just to buy 1-2 more quarters of silence from skeptics, even as leverage continues to build at multiple turns of EBITDA every single quarter."
The offshore merger spree did not last long: following a recent crackdown by Beijing on offshore (debt-funded) M&A, China's foreign acquisition spree came to a screeching halt earlier this year, when virtually no new Chinese deals have been announced.
And now comes the hangover, because overnight China's regulator finally started a crackdown on the debt-funded mess that emerged in China as a result of this spree.
It started with a report in China's Caixin, which said that the China Banking Regulatory Commission has expressed concerns about "systemic risks" at some big companies, which just happen to be China's most prolific overseas acquirers, and has asked banks to report their exposures to the companies after last year’s unprecedented outbound takeover spree.
Warning companies can transmit risks to upstream and downstream industries and banks, the CBRC added that it will closely track risks when problems occur in big companies. More to the point, the CBRC ordered checks on HNA, Dalian Wanda, Fosun and other prominent foreign buyers and asked banks in mid-June to conduct risk analysis and check loans made to these companies.
As Bloomberg adds, the regulator asked some banks to provide information on overseas loans made to Dalian Wanda Group Co., Anbang Insurance Group Co., HNA Group Co., Fosun International Inc. and the owner of Italian soccer team AC Milan. "The inquiries, which come a week after reports of an investigation into Anbang’s chairman, are likely to put a further chill on China’s outbound takeovers after tighter capital controls cut deal activity this year by 56 percent from the same period in 2016.
Why the crackdown now? By targeting some of the country’s most powerful tycoons, Xi Jinping’s government may be sending a signal of its commitment to cleaning up the financial system before a key Communist Party leadership reshuffle later this year, according to Bloomberg.
“We are now in an environment where preventing financial risks is lifted as the top priority, so I think the regulators are trying to gauge the total exposure,” said Wei Hou, a Hong Kong-based analyst at Sanford C. Bernstein. “Regulators must have seen some red flags.”
The market reaction was prompt, and led to the negative close of the Shanghai Composite noted earlier, despite the solid green start in Chinese trading: as news of the CBRC’s request spread through China’s financial markets on Thursday, shares of companies linked to Wanda and Fosun tumbled and the Shanghai Composite Index erased an early gain. The turbulence came less than 36 hours after MSCI Inc. said China’s domestic equities would join its benchmark indexes, a stark reminder for international money managers of the risks in a market where opaque regulatory decisions are commonplace.
The market impact was swift as shares of billionaire Guo Guangchang’s Fosun and various related companies tumbled in Hong Kong, in line with the plunge of Wanda shares. Fosun fell as much as 9.6%, while Fosun Pharmaceutical Group dropped as much as 7.8%.
The sudden drop dragged down the entire Chinese market.
When asked by Bloomberg to comment on their sharp stock price declines all the named companies denied they had any idea what was going on: Fosun spokesman Chen Bo said “all is normal” at the company, representatives at Anbang and Wanda declined to comment, while HNA didn’t immediately comment. A representative for AC Milan’s owner didn’t return calls seeking comment.
The regulator, however, provided some additional details: Zhiqing Liu, a deputy director at the CBRC, said "we are generally concerned with systemic risks posed by big firms."
The CBRC required banks to provide information on loans related to the five companies’ overseas investments, especially in property, cinemas, hotels, entertainment businesses and sports clubs, people familiar with the matter said. Banks need to submit their assessment of potential risks for such investments and any measures they have in place to deal with risks, the people said.
We have previously profiled the extensive acquisitions undertaken by Chinese companies, but here as a reminder, is the case study of HNA, an "acquisition airline group" as the FT puts it.
HNA has announced more than $30 billion of asset purchases since last year, according to data compiled by Bloomberg, ranging from from stakes in hotel operator Hilton Worldwide Holdings Inc. to asset manager SkyBridge Capital and Deutsche Bank AG.
Wanda has spent more than $10 billion, including the purchase of Hollywood film producer Legendary Entertainment, since 2016.
Fosun, which owns stakes in Club Med and Cirque du Soleil Inc., has also been pursuing billions of dollars of assets overseas.
Anbang’s international holdings include New York’s Waldorf Astoria hotel.
Among the more notable acquisitions by these Chinese companies were AC Milan, Club Med, the Wolverhampton Wanderers Football club, Cirque du Soleil, and real estate in NYC, London, and Sydney, but that period of wanton foreign purchases, many of which led to what was dubbed the "Chinese M&A premium", is now over.
To be sure, as a result of last year's crackdown on capital outflows, today's move was largely expected: as Bloomberg points out, "Chinese policy makers have already made it more difficult for acquirers to move money overseas as the government tries to stem capital outflows and prop up the yuan. The curbs have contributed to a spate of canceled deals, including the $1 billion purchase of Dick Clark Productions Inc. by billionaire Wang Jianlin’s Wanda. This year’s drop in announced deals is the biggest for a comparable period since the depths of the global financial crisis in 2009, according to data compiled by Bloomberg."
Meanwhile, the focus on banks’ exposures to foreign acquisitions comes against a backdrop of tightening financial conditions in China and a regulatory crackdown on risky behavior by banks, shadow-lending institutions and insurers, as well as the detention of the chairman of one of China's most aggressive foreign acquirors: Anbang.
As reported last week, Anbang’s Chairman Wu Xiaohui was detained as part of a probe that includes looking into the sources of funding for Anbang’s overseas acquisitions, possible market manipulation, and “economic crimes." Anbang said last week that Wu was unable to perform his duties for personal reasons.
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Meanwhile, going back to the Chinese stock market which just two days ago was added to the MSCI EM index, the Beijing intervention showed just why anyone rushing to invest in China may want to think twice. “I don’t think it’s the right time to invest or buy into these companies,” said Alex Wong, director at Ample Capital in Hong Kong. “Sometimes this kind of event can accelerate very quickly.”
And while the latest Chinese crackdown is bad news for local stocks, it is good news for US equities where the Chinese potential "merger premium" can now be eliminated, resulting in a fractionally more rational market. As for how far Beijing's attempt to "normalize" its corporate sector will reach, and whether it will lead to even more deflationary outflows from the mainland, jury selection has only just started.