Money Matters

Huarong’s HK$12 billion capital mill tells why state firms love listed shells

‘State companies compete for political and financial resources on the size of assets, not profitability’

PUBLISHED : Tuesday, 03 January, 2017, 9:18pm
UPDATED : Tuesday, 03 January, 2017, 11:00pm

Beijing’s tightening of capital outflows is slowing down various overseas investment, but not the interest in acquiring listed investment shells. Indeed, cash rich state-owned enterprises are replacing private entrepreneurs as buyers of these listed entities.

Huarong International Financial Holdings is a telling case of the magic a state company can play with a listed entity.

In March 2015, China Huarong – the country’s largest bad debt manager by asset size – spent about HK$500 million to acquire control of a listed shell, which is then renamed Huarong International.

That was only six months before its own public offering, leaving many to wonder why. The answer didn’t take long to reveal.

Huarong International has become a capital mill.

Riding on the credibility and therefore liquidity provided by the parent, it has loaned out at least HK$12 billion within a year, comparing to its 2015 loan and receivables of HK$912 million.

The operation is not at all complicated.

The parent company, which has been raising bonds at between 2.875 per cent to 4.875 per cent, made a shareholder’s loan of HK$7 billion to Huarong International at an interest rate of 4 to 6 per cent.

The latter then loaned it out at between 4 to 15 per cent. Given Beijing’s tight grip of capital outflows, it is never short of clients.

China Huaxin Group, which claims to be the largest private oil trader in China, is paying 7.5 per cent for a HK$600 million loan to pay off its HK$1.4 billion buying of three floors at the Convention Centre Office Tower in Wanchai.

The help from the parent entity doesn’t always have to be in the form of cash. A show of face will do. Huarong International has raised HK$3 billion in bank loans with letters issued by China Huarong. All were then loaned out at a premium.

How did the bank find any comfort in those letters that offers no guarantee? Why are they lending to a financier which entails a higher risk? Nobody seems to care.

Neither does the details of some lending seems to bother anyone. Huarong International was promised an 11 per cent return in a six month “investment” in a fund that was used to subscribe to some convertible bonds carrying 4.5 per cent interest.

Within a short period of time, Huarong International’s asset book was growing at a rapid clip. By June 2016, it has doubled its assets to HK$8 billion.

That matters a lot for a state companies that compete for political and financial resources on the size of assets, not profitability.

Of course, this could still be done by Huarong Group without the listed shell; but the game would be very different.

Imagine Huarong Group undertook Hong Kong borrowing and lending by itself and then applied for a spin off. It would be unattractive for various reasons.

First, it would take years given the regulatory approvals required. Convincing the regulator that the underlying business can stand alone without the parent’s letter of support is no easy task.

Comparatively, the building of Huarong International has taken less than two years. The price of a listed shell may sound a lot for many. Yet, for state firms, the size is completely within their own jurisdiction.

Second, all state firms are listed as H share companies, and as a result, so would its spin off. These H share companies are subject to more mainland regulation and enjoy much less flexibility than a red chip. The latter has flexible fund raising and genuine share options.

Third, the limited opportunity for personal gain. The acquisition of a listed shell involves much more insider information and therefore more incentive for a state company manager. In contrast, a spin-off is far too heavily regulated to play with.

Unsurprisingly, the price of listed shell has remained firm even as Beijing has pursued a clean-up of its listing application backlog.