Russia’s invasion of Afghanistan in December 1979 reinvigorated America’s most basic anti-Communist instincts.
But barely six months after the Soviet tanks began rolling towards Kabul, another group of Communists were descending on New York – and their destination was Wall Street of all places.
In the penthouse of a major US bank, senior executives from more than 200 major American firms gathered to exchange views, negotiate deals and even crack jokes with representatives of ‘red’ China.
That pillar of American capitalism David Rockefeller was even on hand to give a glowing welcome to the Chinese guests.
The Chinese contingent – the largest delegation of financial officials that Beijing had ever sent to New York – was led by China International Trust and Investment Corp (Citic). The state-backed firm had only been founded a few months earlier by Rong Yiren, whom Rockefeller described as “the man who would do more to implement his country’s opening to the West than any other”. The highlight of the conference was a pact between Rockefeller’s business organisation and Citic. It would drum up American cash and know-how for China’s new export industries, while Citic would serve as the conduit for establishing these businesses as Sino-foreign joint ventures. The door to China was opening.
Citic became the pioneer as Beijing ushered in a new era of economic reforms. It was the first Chinese bond issuer in an overseas market (launching in 1982 a yen-denominated Japanese Samurai bond). It conducted the first foreign direct investment overseas (buying an Australian aluminium plant from Alcoa in 1985) and it completed the first banking takeover (Hong Kong’s Ka Wah Bank in 1986). It even launched China’s first commercial satellite (AsiaSat 1 in 1990).
Many of these deals were struck in the company’s restaurant – rightly named Window of the World – atop the Beijing Citic Tower (appropriately enough, the restaurant was a joint venture with an overseas partner too). Citic’s 29-floor tower (built in 1980) looked out proudly over the capital, and remained Beijing’s tallest building for a decade after its completion.
Today Citic is seeking to reclaim top spot in the city landscape, planning a 108-storey skyscraper in Beijing’s business hub. But when the Rmb10.4 billion ($1.7 billion) property is completed in 2019, it might not even be home to Citic’s headquarters.
Still the state’s most signficant conglomerate, Citic stunned China watchers late last month with news that it will move all of its assets – and reportedly even its HQ too – to Hong Kong. Investors are wondering how this unprecedented move will play out. Does it signal that Citic is reprising its pioneering role? This time at the vanguard of a push to reform the ownership and governance of China’s giant state-owned firms?
What is Citic today?
Citic has long harboured an overseas listing. “Let me go overseas and I will bring back $10 billion,” Kong Dan, the former chairman, proclaimed in 2010. In December 2011, ahead of a planned Rmb10 billion ($1.61 billion) IPO in Hong Kong, Citic restructured itself into a ‘wholly state-owned company’ known as Citic Group Corp. This holding vehicle, one of only two entities to report directly to the State Council, owns 99.9% of a unit called Citic Limited, with the remainder owned by Citic Limited management. Citic Limited owns a dozen listed firms, including a 57.5% stake in Hong Kong-listed Citic Pacific, as well as a smaller number of unlisted interests. At the end of 2013, net assets of Citic Limited stood at around Rmb225 billion and returned a net profit of Rmb34 billion.
But instead of a conventional IPO, Citic Group announced last week that it has opted for a backdoor listing in which Citic Pacific will acquire its parent Citic Limited. The consideration will consist of a still-to-be-finalised mix of cash and new stock in Citic Pacific to be issued at HK$13.48 per share, or a 6.48% premium to the stock’s trading price immediately prior to the deal’s announcement.
How much Citic Pacific will eventually pay is undecided. But the price tag is going to be significant. The Hong Kong-listed firm’s market capitalisation stood at HK$44 billion ($5.6 billion) on the eve of the deal. After the reverse takeover, the biggest ever in the city, it will have absorbed a portfolio of assets that is six times larger than its current holdings.
A good deal for Citic Pacific?
On the day after the announcement dazzled investors briefly pushed shares in Citic Pacific 31% higher. But the euphoria was fleeting and this week the stock retreated to levels closer to the reference price of HK$13.48. The deal is expected to conclude this year.
The reverse takeover comes at a time when Citic Pacific’s fortunes in Hong Kong have looked increasingly forlorn. An ill-timed expansion into Australian mining in 2006 resulted in repeated production delays and a project that stumbled a costly five times over budget (see WiC220). An earlier debacle over massive currency losses (see WiC10) also sapped investor confidence. The company’s stock has been stuck in the doldrums and among Hang Seng Index constituents is one of the least followed by analysts, and receives the fewest bullish recommendations. “Shareholders have long been counting on a group restructuring to streamline some of Citic Pacific’s overlapping businesses with its parent such as steelmaking and real estate,” a columnist at Ming Pao newspaper in Hong Kong writes. “Then just as investors are about to lose hope, there comes the mother of all restructurings.”
By transforming into something six times larger, Citic Pacific will get investor attention again, says the FT’s Lex Column. It will have to absorb a set of businesses that straddle oil, mining, hydropower equipment and even an ownership stake in Beijing Guoan football club. But up to 84% of the assets that Citic Pacific is about to acquire come from financial services. Is it the best moment to be taking the plunge into China’s financial sector? This will be Citic Pacific’s first exposure to Chinese financial services, Bloomberg notes, at a time when many firms are said to be struggling with mounting bad debt.
Then there is the question of price. Most of Citic Limited’s assets are trading at levels well below their book values. Citic Bank, for example, is the seventh biggest lender in China but is only trading at 0.6 times book, while the price-to-book ratio of Citic Dameng, a Hong Kong-listed firm that invests in manganese mines, stands at 0.5 times. Among all the listed units, only Citic Securities and Citic Telecom International are trading at premiums to their book values.
The problem? The authorities in China have a rule that forbids state assets from being transferred at below-book prices. That means that Citic Pacific’s shareholders will be expected to pay more than market value unless it can get an exemption from the regulations, says 21CN Business Herald.
Why does Citic Group want to do the deal?
The political headwinds in Beijing are favouring a policy that is being termed “mixed ownership”– the idea being that more outside investment in SOEs will dilute the influence of state capitalism (see WiC230). And a key pledge after the Third Plenum last year was that private investors would get more access to industries previously open only to state entities. Citic has rewritten the rulebooks in the past, serving as a testbed for reforms. So it may have been chosen to lead the next phase of restructuring and reinvention that will impact China’s leading state-owned firms.
“Citic is now playing the pioneer again in pushing for mixed ownership reforms,” the China Securities Journal agrees. CBN also believes that the rationale for the Hong Kong listing is to create a vehicle in which the state cedes a larger stake in Citic to private capital and foreign strategic investors.
“We need to change the situation where the state is dominant as the major shareholder, by allowing a fair say from different shareholders,” a senior company official told the newspaper.
Citic Pacific bosses made a similar point, albeit in a more indirect way. “With its established legal framework, high governance standards, international connectivity and strong talent pool, Hong Kong remains the ideal place for the next phase of our development and we are deeply committed to this market,” the company chairman Chang Zhenming said in a statement.
But what about ownership?
Another sensitivity that Citic faces: the bar on foreign majority ownership in strategic industries such as telecoms and banking.
As such, the Economic Observer already thinks it is unlikely that Citic Limited will – as has been rumoured – relocate its domicile to Hong Kong as “such a move would invite unnecessary speculation”. (A domicile change would reclassify it into an ‘overseas’ firm.)
Citing an unnamed “top official” from Citic Limited, CBN reports that the management’s core team will probably move to Hong Kong. “But we’ve never said we will have dual-headquarters or domicile relocation,” the official was quoted as saying.
Much depends on what happens after the reverse takeover is completed. Citic Group in Beijing will retain control of the newly-created company. But Bloomberg reports that the listed vehicle will have to sell about $4 billion of shares to restore its public float to 25% – as required by the Hong Kong stock exchange. This will raise new funds but it will also provide a chance for Citic to attract strategic investors to assist with its plans for global growth. Hong Kong’s Oriental Daily News thinks Citic is already shortlisting strategic shareholders, among which sovereign wealth funds like Temasek are regularly cited as potential buyers.
Li Ka-shing, Hong Kong’s richest man and the owner of the territory’s largest listed conglomerate Hutchison Whampoa, is also getting mentioned in the media. Recently, Li seems to have looked more to Europe for his major deals. But he has history with Citic, having been appointed a board director when Rong Yiren first founded the trust firm in October 1979. He was also a business partner of Rong’s son Larry Yung, when Rong junior orchestrated a series of dazzling deals ahead of the Hong Kong handover to China in 1997, including buying large stakes in two British-controlled businesses, Cathay Pacific and Hongkong Telecom.
What seems clear is that Citic will be looking for strategic investors in three key sectors: property (it has a real estate asset portfolio in China of $31 billion); banking; and telecoms.
But what will happen after that? If the reverse takeover is truly about reform, the real litmus test is whether Beijing will allow its own stake to drift below 50%, says the Hong Kong Economic Times. If that doesn’t happen, the current exercise may end up being regarded as merely an asset reshuffle rather than a sign of genuine change.
Keeping track: last month we reported that Citic Pacific is planning the biggest ever reverse takeover in Hong Kong to allow its state-owned parent Citic Group to go public (see WiC232). It needs the mega fundraising to pay for the huge asset injection and to start showcasing Beijing’s “mixed ownership” reforms, which hope to reduce the influence of state capitalism.
The first of the two objectives is now partially accomplished. Citic Pacific said last week that 15 strategic investors have committed to invest $5.1 billion in new shares, or a combined 11.78% stake in the Hong Kong blue chip. Citic Pacific said it may choose to raise further funds. But given that the public already owns 6.7% in the combined group, and that regulators have allowed it to lower its public float requirement to 15% from 25%, Citic Pacific said the deal is now “half done”.
Citic has picked investors with long-term strategies including three sovereign wealth funds, five insurance firms and five multinational banks.
State-controlled entities will continue to dominate the shareholding mix with China’s National Social Security Fund taking up the biggest slice by agreeing to buy $2.2 billion of shares.
Only five foreign investors are on the list, absorbing about 25% of the offering. They include AIA Group, Qatar Holding and Singapore’s Temasek, while Japanese lenders Tokio Marine and Mizuho Bank will contribute $100 million each. That leaves Citic Group with more than 80% of Citic Pacific, while its new foreign strategic investors control less than 3%. (May 23, 2014)
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