Going underground

Found new investor: Wang Shi

In the 1970s the Japanese were keen to export their railway expertise. A consortium led by Mitsubishi signed an agreement to build a metro system in Hong Kong for HK$5 billion (an amount then equivalent to $975 million in US dollar terms). The deal eventually collapsed as the colonial government refused to guarantee the financing in the event the project ran into deficit. Instead the British went for a Plan B: devising a railway-plus-property model. The Mass Transit Railway Corp (MTRC) was set up in 1975 and it sold land adjacent to or above railway stations to real estate developers. Property income was used to subsidise its capital-intensive – and lossmaking – railway operations.

Hong Kong has since built arguably the world’s best subway system. The MTRC’s market value stands at $28 billion, a level similar to the market capitalisations of some of the city’s leading property developers.

More recently the MTRC has tried to duplicate its business formula in Shenzhen. Progress has been slower partly because it doesn’t enjoy the same level of policy support in mainland China it does at home (the Hong Kong government owns 77% of MTRC). But that hasn’t stopped Vanke, China’s most respected homebuilder, from trying to copy the railway-plus-property model. Indeed, the Shenzhen-based developer has just announced a groundbreaking deal with state-owned Shenzhen Metro Group (SZMC).

As WiC reported in its first issue of 2016, Vanke and its founding chairman Wang Shi have been fighting off a hostile takeover from Baoneng, a privately-held financial conglomerate that has amassed a 24% stake (see WiC308). Vanke’s shares have been suspended from trading since last December pending an announcement on a business restructuring. The media had speculated that Wang might bring in a new shareholder to boost his position and dilute Baoneng’s influence. According to CBN, there has been no shortage of suitors: the chance to buy into China’s biggest developer (in terms of residential sales) doesn’t come often, and Vanke has just reported a 15% climb in 2015 net profit to Rmb18 billion ($11.6 billion), with revenues up by a third to nearly Rmb200 billion.

Wang finally revealed his hand on Sunday and said he has picked SZMC, the operator of Shenzhen’s inner city metro, as his new partner.

In a preliminary accord signed by the two parties, Vanke says it will acquire SZMC’s property projects, mostly atop subway stations in Shenzhen. Vanke will fund the asset injection by issuing new shares to SZMC worth up to Rmb60 billion. That equates to 24% of Vanke’s pre-deal market value. When completed, the deal will give SZMC about 13% of Vanke’s enlarged capital. Baoneng’s stake will be diluted as a result.

In welcoming state-owned SZMC as a new investor Wang is taking Vanke back to its roots, as it started out with shareholders including Shenzhen’s municipal government.

The dealmaking also reinforces Wang’s vision for how Vanke should be run. He and his management team don’t have a controlling share in the company, but they have maintained effective control over its day-to-day decisionmaking. The outcome is a ‘mixed ownership’ structure – a buzz word in Chinese politics that seeks to blend state shareholdings with more efficient private sector involvement.

“Our positioning is very clear. And it is a mixed ownership. We don’t want a single controlling shareholder,” Wang told the company’s house magazine.

Wang will still have to negotiate hard with SZMC. For instance, there is no final conclusion on the value of the property projects it is bringing to the deal. Shenzhen’s home prices have climbed more than 50% in the past year, which may make it harder to agreed on a figure.

It was initially thought by media that adding up the shareholdings of parties friendly to Wang would lead to a block of over 40% of Vanke’s shares (Wang’s own stake and that of Vanke’s management, plus SZMC and China Resources – a property conglomerate and long-term shareholder).

But the takeover battle may not be over yet. In an unexpected twist on Thursday, China Resources has voiced its dissatisfaction over Vanke’s proposed share sale to SZMC. According to CBN, China Resources is irked the the deal was announced before Vanke’s board of directors including representatives from China Resources had the chance to discuss it. Vanke’s management, however, told Beijing Youth Daily that it had already informed China Resources of the dealmaking.

Trading in Vanke’s shares in Shenzhen will remain suspended until June – with Vanke telling public shareholders yesterday it needs more time to finalise its business restructuring.

Industry observers view a railway-plus-property model as positive for both Vanke and SZMC. The latter’s current land bank in Shenzhen is mostly in prime locations. But Shenzhen’s metro is expected to triple its number of stations to 371 by 2030. With more than 30 years of experience in the city, Vanke has the expertise to unlock the full value of this property portfolio. It is also betting that the rail network may extend to new financial districts such as Qianhai.

Sun Jia, Vanke vice-president, expressed his confidence in the new venture this week, highlighting the “enormous opportunities” for rail transit in Chinese cities. Company sources said that Shenzhen’s rail network, which bears 28% of public transport in the city, could be expanded to shoulder 91% of the load, matching Tokyo.

Back in Hong Kong the MTRC has found it harder going in another of its flagship projects – an express rail link that will carry passengers between Guangzhou, Shenzhen and Hong Kong in less than an hour. Engineering challenges have led to lengthy delays and huge cost overruns for the new bullet line. Requests for further funding from the Hong Kong government have encountered stiff political resistance and filibustering (see WiC307).

But the proposal for further finance was controversially approved by lawmakers last week. The new railway isn’t set to open till late 2018 at the earliest.

© ChinTell Ltd. All rights reserved.

Sponsored by HSBC.

The Week in China website and the weekly magazine publications are owned and maintained by ChinTell Limited, Hong Kong. Neither HSBC nor any member of the HSBC group of companies ("HSBC") endorses the contents and/or is involved in selecting, creating or editing the contents of the Week in China website or the Week in China magazine. The views expressed in these publications are solely the views of ChinTell Limited and do not necessarily reflect the views or investment ideas of HSBC. No responsibility will therefore be assumed by HSBC for the contents of these publications or for the errors or omissions therein.