Citic deal sets scene for mainland reform of state firms

Shares in HK flagship soar on the asset injection agreement but a lack of details on pricing and regulatory issues presents risks for investors

PUBLISHED : Friday, 28 March, 2014, 1:40am
UPDATED : Friday, 28 March, 2014, 1:40am


Shares in Citic Pacific surged after the company unveiled a plan to buy almost all of its parent's assets not already under the Hong Kong-listed unit, potentially marking a breakthrough for Beijing's deeper reform for state enterprises, but a lack of details on pricing and regulatory issues presents risks for investors.

Some analysts are concerned whether the deal will have to follow mainland regulations that state assets must not be sold at less than book value.

If so, it would pose a challenge that may require Beijing's special permission since the crown jewel of the assets to be injected by Citic Group - a 61.9 per cent stake in Hong Kong-listed China Citic Bank - is trading at 0.7 times its book value, according to a Morgan Stanley research report.

The stake accounted for 62 per cent of the book value of the assets to be injected.

"The potential transaction is unlikely to be valued at less than [book value] as it involves state-owned assets," the report said.

If such permission is granted, it could potentially open the listing door to many other state-owned firms. This is especially so for banks, which have difficulty getting listed since most listed mainland lenders are trading below their book value.

"For Citic Pacific to pull off the deal, either it has to wait for Citic Bank's shares to rise above its book value, or it has to get special exemption from Beijing," said an analyst who covers Citic Pacific.

A person close to Citic Pacific acknowledged the challenge, but said: "It is not inconceivable that Citic Bank could trade above its book value later."

The steel-to-property conglomerate, also the flagship of Citic Group, said on Wednesday that it had signed an agreement with its parent, the mainland's first overseas investment vehicle, to buy the assets, whose unaudited book value stood at 225 billion yuan (HK$283.6 billion) at the end of last year.

While the acquisition price was undecided, it must not be less than the value to be assessed by a yet-to-be-named independent valuer and must be approved by the Ministry of Finance, Citic Pacific said.

The deal could see Citic Pacific, which had a book value of HK$82 billion at the end of last year and a market capitalisation of HK$46 billion, absorb assets several times its size.

Based on a lower minimum public float of 15 per cent, if Citic Pacific is granted exemption from the normal 25 per cent minimum for a Hong Kong-listed firm, it can partly pay for the assets by issuing up to 6.69 billion new shares to Citic Group. At the issue price of HK$13.48 indicated by Citic Pacific, the shares would be worth HK$90.2 billion.

Given that most of the assets to be injected are traded below their book value, while conglomerate Hutchison Whampoa is trading at 27 per cent below its book value, UBS said it would be reasonable for the assets to be sold at a discount to book value of at least 30 per cent.

The bank said a discount of 40 to 50 per cent would be needed for the deal to be "value-neutral" for existing Citic Pacific shareholders, who will vote on the deal. Citic Pacific and Citic Group are not allowed to vote, given that it is a connected transaction.

Assuming a 40 per cent discount, Citic Pacific would pay HK$169 billion for the assets. After issuing the maximum allowable shares worth HK$90 billion to maintain a public float, the firm would need to pay HK$79 billion in cash. With HK$35 billion in cash at the end of last year, it would need to borrow or issue bonds or shares.

Regulatory issues also need to be addressed. They include whether Citic Pacific will be allowed to own all the assets to be injected - including banking, telecommunications and broadcasting businesses - which are subject to Beijing's shareholding ceilings for non-mainland firms.

In 2002, Citic Pacific was forced to sell to its parent an 80 per cent stake in a telecommunications fibre-optic network after it failed to get a licence from Beijing due to its status as an overseas firm.

Some analysts said that since Citic Group would remain the ultimate majority owner of the assets, Beijing was likely to exempt Citic Pacific from the restrictions. Citic Pacific would not comment.

Shares in Citic Pacific soared as much as 30.6 per cent yesterday before ending 13 per cent higher at HK$14.30.

"While the [asset injection deal] has fuelled investor hopes of a deeper restructuring of the group, the stock has already rallied 13 per cent in the past month prior to the announcement," the Morgan Stanley report said. "We hence believe the near-term upside [is] limited."