China's Highest-Profile Hostile Takeover Ends With the State Stepping In

 | Jun 12, 2017 | 9:18 AM EDT
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The sale by China's largest property developer of a stake in the country's second-biggest homebuilder demonstrates how far hostile takeovers generally get in China. And the answer is, not very far.

China Evergrande Group  (EGRNY) has sold its 14% stake in China Vanke  (CHVKF) for a loss of 7.1 billion yuan (US$1.0 billion), it said in a stock exchange filing.

Evergrande declares that the reason for the disposal at a huge loss is "the strategic development requirement of the company." But since it is selling to a government-owned company, it looks a lot like the "requirement" was necessary if it wanted any future "development" at all.

China Evergrande is now the largest Chinese property developer by sales, having supplanted China Vanke at the top of that ranking with its performance last year. China Evergrande bought into its rival in 2016 during a hostile takeover attempt of Vanke by the insurer the Baoneng Group that began the year before.

The buyer of the Evergrande stake is the Shenzhen Metro Group, the state-owned operator of the subway system in Shenzhen. Shenzhen is China's Silicon Valley, the southern boom town has the highest income in China, and sits just across the border from me here in Hong Kong.

The metro group is effectively the Shenzhen municipal government, and it has emerged as Vanke's white knight. The saga reinforces the fact that China is anything but a free market. The forced sale to a government-owned entity indicates that the Chinese state will step in to take control of companies whenever it sees fit. Even if they just build homes.

Previously little-known, Baoneng's subsidiary Foresea Life Insurance in December 2015 supplemented China Resources as Vanke's largest shareholder. Baoneng has a real-estate arm of its own, as well as around 40 other subsidiaries. But it used Foresea and another insurance affiliate to take a 25% stake in Vanke. That was a bad move; I'll explain later why.

Vanke management called Baoneng's buy-in a "hostile takeover," a highly unusual event in China. Vanke was founded by its chairman, the entrepreneur Wang Shi, but he gave up his ownership stake when the company went public in 1991, deciding to be a professional manager.

That left Vanke open to hostile takeovers, whereas nearly all Chinese property developers are controlled by their founding tycoons. Shi called Baoneng and its founder, Yao Zhenhua, China's fourth-richest man, "barbarians." Vanke's shares were temporarily suspended.

Shi originally introduced Shenzhen Metro in an attempt to dilute Vanke's shares, to ward off Baoneng. But that didn't go down well with the state-owned conglomerate China Resources, which has a 15% stake in Vanke and, despite having its own property arm CR Land (CRBJY) , was previously Vanke's largest shareholder, before Baoneng came along.

So it only made matters more confusing when Evergrande surprised the market when it began buying Vanke shares with a 5% purchase in August last year. It said it was acquiring the shares because of Vanke's "strong" financial performance. 

As he built up his company's stake, market watchers speculated that Evergrande founder Hui Ka-yan, China's 10th-richest man, wanted a strategic investment, as well as potentially gaining board seats and access to Vanke's funding sources.

It's never been entirely clear why Baoneng wants Vanke. But Yao is said to be very ambitious and keen to create an empire that will ultimately go public itself. He may have been inspired by Anbang Insurance, the equally acquisitive and previously unknown insurer that burst on the scene in 2014, when it paid over the odds to acquire the Waldorf Astoria for $1.95 billion.

The confusing situation didn't go down well with China's stock watchdog, the China Securities Regulatory Commission. It reprimanded all of Vanke's shareholders as well as its management last July for ignoring market stability and tarnishing the company's image with their public scuffles.

The CSRC told the different sides to resolve the dispute as quickly as possible. A week prior, Vanke filed with the regulator asking it to investigate Baoneng for alleged misconduct and illegal fundraising via the dodgy "shadow banking" system. 

Although in theory a move unrelated to the Vanke takeover, China's insurance regulator has also got stuck in. That's a problem since Baoneng is backing its buyout with funding from its insurance arm.

The China Insurance Regulatory Commission in December suspended Baoneng's Foresea Life from selling investment-style "universal insurance" until it sorted out problems with risk monitoring and managing customer accounts. It then banned Yao form the insurance industry for 10 years. Foresea later complained to the regulator of potential mass defaults that could lead to social unrest if it and other insurers can't issue new products.

The insurance regulatory body has been cracking down on the insurance industry in general - it imposed a similar suspension on Anbang for aggressive sales tactics. In January it banned insurers from making acquisitions outside their industry that are just financial in nature. 

We are approaching the end point of the Vanke saga, one that will leave China's second-biggest developer in the hands of the state. 

Shenzhen Metro in January acquired the entire 15% stake of Vanke owned by China Resources. Since China Resources is also state-owned, that deal, at a 7% premium to Vanke's price at the time, went down smoothly once the authorities worked out what they wanted to do.

In March, the Shenzhen municipal government said in a post on the social-media chat app WeChat that it had taken direct control of Vanke, which is based in the city. Evergrande said it had given over its voting rights on its stake to Shenzhen Metro, for one year. Now it has sold to the metro company, for good. 

Although it sold at a loss, somehow I doubt Evergrande's generosity to the government will go unnoticed. The government ultimately owns all the land in China, and approves land sales.

What Baoneng does with its Vanke shares now is anyone's guess. But if it, like Evergrande, it fancies having a "strategic development" of any form in the future, it will likely find a sale to the government a "requirement," too.

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