Economy, Talking Point

Change of guard

Are Li Ka-shing and Citic making rival bets on China’s future?

Hutchison Whampoa Chairman Li Ka-shing reacts during a news conference announcing the company's annual results in Hong Kong

Li: the dealmaker’s assets are increasingly in Europe not China

China’s biggest conglomerate has a long and deep relationship with Hong Kong’s richest man. When Citic Ltd was founded in 1979, Li Ka-shing was one of the first directors to be appointed to advise Communist China’s first investment firm. At the time Li had just taken control of Hutchison Whampoa in a dramatic move that broke the British hold over Hong Kong’s leading trading houses. This coup led his compatriots to call him ‘Superman’. By getting Li and his business network on board, Citic – which had been established to spearhead China’s economic reforms – hoped the tycoon would assist with its own dealmaking.

And Li was behind a number of Citic’s key moves, especially in Hong Kong. In 1988 Hutchison lined up with Citic and Cable & Wireless in a joint venture to launch China’s first commercial satellite. Li also partnered with Citic Pacific, the company’s Hong Kong unit (which was headed by Larry Yung, son of Citic’s founder Rong Yiren). Li’s influence was felt on a slew of Citic’s deals prior to Hong Kong’s 1997 handover. These included taking large stakes in blue chips like Hongkong Telecom and Cathay Pacific.

Both Li and Citic have been back in dealmaking mood of late. But the two are no longer working in tandem. In fact, the erstwhile partners have come up with blockbuster transactions that imply different views on the Chinese currency and rival bets on China’s wider wellbeing.

What is Citic’s big punt?

Following its stockmarket debut in Hong Kong last April (via the largest ever reverse takeover the territory had ever witnessed) Citic subsequently arranged a $5 billion share sale to strategic investors. The transaction had been hotly anticipated by analysts, keen to see how Citic would showcase Beijing’s new ‘mixed ownership’ reforms. The deal didn’t excite. It sold less than 3% of its stock to five foreign institutions (including AIA Group, Qatar Holdings and Singapore’s Temasek). But a chunk three times bigger was offloaded to fellow state firms, a strategy that didn’t smack much of mixed ownership (as its name suggests, the policy was supposed to bring in investors from the private sector).

But any lingering disappointment about that sale was reversed last week, when Citic surprised the market by announcing a new alliance with two of Asia’s biggest conglomerates. Japan’s Itochu Corp and Charoen Pokphand Group (CP) of Thailand are to pay $10.4 billion for a combined 20% stake in Citic. The pair will seek loans from Japanese lenders to fund the investment, which will be made via a 50-50 joint venture between the two. The foreign firms will get two directors on Citic’s 14-member board.

At more than $5 billion, Itochu’s financial commitment to the deal exceeds the $4.3 billion in total that Japanese firms invested directly in China last year. Unsurprisingly it’s the largest strategic investment yet by a Japanese company in China.

It would have smashed records in Thailand too, had not CP raised the bar so high by buying 15% of Ping An Insurance for $9 billion from HSBC in 2012.

The trio will now “work together across sectors and countries”, with a strategic cooperation committee set to decide on “joint priorities and evaluate potential areas for collaboration” according to a joint statement.

What’s the rationale?

CP’s chairman Dhanin Chearavanont is a trusted ally of Beijing, with the Wall Street Journal describing the Thai billionaire as “China’s man in Bangkok” after CP sold a stake in its telecom firm True to China Mobile last July, the first major foreign investment in Thailand since the military coup in May.

CP was also the first foreign firm to invest in one of China’s four special economic zones (the most famous of which is Shenzhen) when they were set up in 1979.

In that same year (when Citic was founded too) Itochu became the first Japanese company to open shop in the Chinese capital.

In fact, Itochu was designated as a “friendly trading house” by Beijing’s diplomats in 1972, a few months before relations between China and Japan were normalised.

Itochu and CP have also forged strong bonds with each other. Despite the political uncertainties in Thailand last year, the two agreed to a groundbreaking cross-shareholding in July. The Japanese firm announced a 25% stake in CP’s Hong Kong-listed unit for $850 million, while CP invested $1 billion for a 5% stake in Itochu.

The specifics of how the three-way consolidation is going to advance in the region are yet to be revealed. But CP and Itochu already sit on a powerful food supply chain in the world’s most populous region. Supported by Itochu’s strong presence in Japan (the country’s third-largest trading firm) and in Taiwan (where it’s a key shareholder of food giant Tingyi), the combination is further underpinned by CP’s Southeast Asian agribusiness.

In fact, the heat map of the Itochu-CP presence doesn’t look too dissimilar to the so-called “first island chain”, a term employed by Chinese strategists to describe the potential for an American naval blockade stretching across the western Pacific from Japan through Taiwan to the Philippines.

According to People’s Liberation Army theorists, Chinese President Xi Jinping’s “one belt, one road” idea – i.e. the Silk Road Economic Belt and the 21st century Maritime Silk Road – has been devised to counter such a perceived encirclement.

Or as described less confrontationally by China Securities Journal, China sees “one belt, one road” as a way of building common interests and deepening economic integration with its neighbours.

The Citic-Itochu-CP triumvirate looks to have exactly such an objective. “This partnership will help to stimulate trade and promote investment in Thailand, and across the region. It will also help to create better connectivity between Asia’s economies,” Citic chairman Chang Zhenming said in a statement.

By capitalising on the international exposure of Itochu and CP, Citic could even become “the infantry for the ‘one belt, one road’ strategy”, Securities Times has suggested – primarily by leveraging its strong presence in the financial industry.

“It could occupy the strategic high ground of Asian trade,” the newspaper ventured.

A part of the renminbi’s rise too?

Domestic commentators have been making hopeful noises that the “one belt, one road” initiative will support another objective too: the spread of China’s currency.

In the nineteenth century, Hong Kong’s major trading houses helped promote the British pound as the currency of global commerce. And Securities Times – a publication under the administrative wing of China’s central bank – thinks that Citic and its new partners could offer a similar boost for the renminbi.

Data from Swift, the financial messaging firm, suggests that the trading triumvirate could add momentum to what is already an accelerating trend. Last year China invoiced 25% of its international trade in renminbi (up from just 2% in 2011) and this week Swift announced that the currency is now in the top five for global payments, after leapfrogging both the Canadian dollar and the Australian dollar in its rankings. Also important: earlier this month China announced that it had become a net exporter of capital.

China’s overseas direct investment (ODI) topped $140 billion in 2014, or roughly $20 billion more than the foreign direct investment (FDI) flowing into the country, according to the Ministry of Commerce (MoC). The MoC expects ODI to grow at a faster pace than FDI in future, which is a seismic change likely to shape the next phase of global economic expansion. For instance, as the Financial Times has noted, if China starts to channel more of its investment capital into the trade and infrastructure opportunities of a trans-Asian Silk Road, it will no longer be banking most of its surplus savings in American government bonds.

Barron’s magazine also warned last week that this refocusing could “flood the world with cheap capital,” transforming China from the factory of the world to “the world’s investor”.

Zhang Yechen, the chairman of Citic Capital, Citic’s private equity arm, also told a meeting at Davos last week that the company is setting up an investment fund tailored to projects related to the Silk Road Economic Belt and the Maritime Silk Road concepts.

The multibillion dollar investment into Citic by Itochu and CP is a sign that both companies are buying into this concept, suggests 21CN Business Herald, and by extension that they believe in the ‘rise of the renminbi’ as well.

Why didn’t Li invest in Citic too?

As a long term ally, why wasn’t Li Ka-shing’s conglomerate part of deal? Well, it would seem he has taken a different view of the world, as well as the future of the Chinese currency. Much of Li’s recent activity has lessened his exposure to the renminbi, including the overhaul of his listed companies two weeks ago. The upshot of the restructuring is that he has significantly reduced his direct exposure to Hong Kong real estate while raising his stake in the group’s global operations.

Combined with a switch in the incorporation of his main holdings to the Cayman Islands, the speculation has been intense that the tycoon’s confidence in China is waning.

“The restructuring has released a dangerous signal: that the value of renminbi-denominated assets are poised to take a plunge,” a forex investor wrote in his 21CN column.

Hong Kong’s newspapers have been suggesting for a while that Li has been shifting focus away from Greater China towards Europe. But lately, Li has been doing it at a quicker pace and on a wider scale. Last week CK Hutchison announced a £2.5 billion takeover of British trainmaker Eversholt Rail, for instance. And a few days later it said it was in talks to acquire UK telecom firm O2 for about £10 billion. If 02 can be merged with Li’s Three brand, the purchase will create Britain’s largest mobile operator, with 31 million subscribers. Li is already the leading foreign investor in the UK, with the Daily Mail describing him last week as “the frugal billionaire buying up Britain”.

In fact, Li has a liking for the European continent in general. Just look at the numbers. By the end of 2013, Europe accounted for 41% of Hutchison’s revenues (based on data released prior to this month’s restructuring announcement). Of this sum, Britain contributed 17%, compared with just 12% from mainland China (and this disparity would further widen upon completion of the two latest UK purchases).

Since 2010, Li has raised $20 billion through sales of assets in Hong Kong and China. In Europe his companies have launched acquisitions with a combined value of $40 billion (including the ongoing deals).

Hutchison had about HK$858 billion ($110 billion) in total assets by the end of June last year. But this ‘Chinese’ conglomerate had only 9.5% of its assets in mainland China and 14% in its home base of Hong Kong (in the early 1990s, it had more than 80% of its assets in Hong Kong and mainland China).

As of the same date its European assets were worth $47 billion, or 43% of the group’s total (and the percentage would probably be closer to 60%, WiC thinks, if financial assets such as euro-denominated bonds are included).

Moreover Hutchison’s asset weighting will skew further towards Europe when its group restructuring is completed, with the planned acquisitions in Britain beefing up its European assets by more than a third. By contrast the contribution from renminbi-denominated assets is likely to dwindle to less than 5% of the total – and may soon be deemed too insignificant to even break out separately in the company’s financial statements.

Li’s European strategy sets him apart from other Hong Kong property tycoons, most of whom have been growing their exposure to the China market. Perhaps the most telling example is Wharf Holdings, a property conglomerate with roots similar to Hutchison as a nineteeth century British trading house before being taken over by shipping magnate YK Pao in 1979.

Traditionally the biggest commercial landlord in Hong Kong, Wharf has been upping its holdings of Chinese real estate. “The Group is building a new tomorrow in China and aims to have 50% of its total assets in the mainland in five years,” it declared in 2007. Wharf hasn’t met that goal: by June last year mainland China accounted for 39% of its total assets, up from 23% in 2007. (But that percentage would be higher were it not for the fact that the valuation of Wharf’s prime Hong Kong properties has more than doubled in the last five years. Its assets include some of the territory’s busiest shopping malls – such as Harbour City – which have boomed thanks to the purchases of mainland tourists.)

Movements in the forex market this year may vindicate Li’s currency choices, at least for the time being. The renminbi fell on Monday to its weakest level in seven months, and the potential for a devaluation of the currency has been a recurring topic in the Chinese media. The rumours have been so insistent that the overseas edition of the People’s Daily even ran a lengthy article this week denying that the renminbi faces a “free-fall devaluation risk” (akin to what has occurred to the rouble).

“The yuan remains a strong currency against Europe, Japan and emerging markets,” the newspaper declared, adding that the renminbi has just reached its highest point against the euro since 2001.

That may say more about weaker confidence in the Eurozone rather than anything particularly positive about the Chinese redback. But for Li Ka-shing – now 86 ­– fluctuations in the renminbi’s worth will have a lot less bearing on the value of his asset portfolio. Why? Because it’s now predominantly exposed to sterling, euros and US dollars (his assets in Hong Kong dollars are pegged to the greenback).

For those that like to follow the smart money, it’s worth noting.

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