M&A, Talking Point

The vision thing

Different directions for two of China’s most acquisitive companies


Live and let fly: Chen Feng wants HNA to own assets wherever its aircraft fly

When Jia Yueting, LeEco’s flamboyant founder, unveiled a model of his firm’s first driverless car in April, he described it as another step ahead in his “crazy dream”. Perhaps investors should have taken closer note of the language being used.

Never short on confidence, Jia thinks his businesses will trump Netflix and Tesla. Apple is also in his sights and he has taken potshots at the Californian icon as a “dusk empire” (see WiC325).

Jia’s tech firm is one of the brasher demonstrations of China’s outward investment push, which is prompting an unprecedented wave of merger and acquisition activities from Chinese firms.

Another company in dealmaking overdrive is HNA Group, which has just announced the latest in a series of global power plays with a bid for 25% of the Hilton hotel chain.

But last week, LeEco’s investment drive seemed to come to a shuddering halt when Jia announced that his company was dangerously low on cash.

The Hainan-based HNA, which is much lower profile, shows no sign of relenting in its global push. So who is behind these two companies and what can be said about their investment approach?

LeEco slams on the brakes, HNA accelerates…

LeEco made headlines earlier this month as the share price of its Shenzhen-listed unit Leshi plunged on speculation that the group is struggling to repay up to Rmb15 billion ($2.2 billion) worth of debts.

Jia’s seemingly scattergun strategy has seen LeEco most recently expanding into real estate, with a factory-cum-theme park in Zhejiang where it was promising another $2 billion of investment (see WiC339). The company’s commitment to transforming its business has been bold, including the high-profile launch of its LeSee electric car in San Francisco last month. But the debut disappointed when Jia told the crowd that the latest concept car wasn’t available. The only model was in London for the filming of the latest instalment of the Transformers film franchise, he explained, before introducing an older version.

He caused even more drama a few days later, however, when he penned a lengthy letter to his employees warning that LeEco was entering a perilous period. “No company has had such an experience, a simultaneous time in ice and fire,” he explained in his missive.

Jia said that the company was bleeding cash and part of the reason was the foray into the car business, where spending had already surpassed Rmb10 billion, leaving less capital for LeEco’s other units.

“We blindly sped ahead and our cash demand ballooned. We got over-extended in our global strategy. At the same time, our capital and resources were in fact limited,” he acknowledged.

Meanwhile, HNA Group has invested heavily in real estate and international hotel chains, including the $6.5 billion investment in Hilton.

Over the past two years the company has announced deals worth more than $33 billion, with half the proceeds invested outside China, says data provider Dealogic.

Earlier this year HNA bought the Dublin-based aircraft lessor Avolon for $7.6 billion and it has offered $10 billion for CIT Group, another aircraft leasing firm. A $6 billion bid for Ingram Micro – a logistics provider – is awaiting final approval.

Why has HNA been expanding so aggressively?

Founded by Chen Feng in 1993 with just two aircraft, Hainan Airlines has grown into the HNA Group, a much larger and diverse conglomerate. Often described as privately-owned, the label isn’t completely convincing because Hainan’s provincial government is a key backer. HNA has emerged as the country’s fourth-largest aviation group with interests in more than a dozen airlines, jostling for position with Air China, China Eastern and China Southern, whose central government ownership gives them a special status.

Chen says that means that his own airlines are kept away from the most lucrative routes.

“Xinjiang… Inner Mongolia are all ours”, he once complained to Yingcai, a magazine for entrepreneurs. “We own the flights to places where even rabbits don’t shit,” he added, colourfully.

In response HNA has been expanding its geographical reach by buying into airlines in Brazil, Portugal and Australia, and looking for code-share arrangements that help its home base in Haikou, the capital of Hainan province, to become more of a hub.

The airline business now accounts for about a fifth of the group’s income, although HNA has also turned towards more profitable sectors of the aviation world by investing in aircraft leasing and taking stakes in ancillary businesses like Swissport, a ground handler at airports, and Gategroup, an airline caterer.

The investment in the hotel chains indicates that it wants to build a vertically integrated business. That’s the reverse of European and North American airlines, which have sold down their stakes in non-core units and focused on efficiencies in their main operations. However, they don’t have the capital that seems to be at HNA’s disposal, nor can they count on the tidal wave of new passengers that are anticipated in the Chinese market. Conceptually, at least, the HNA plan makes sense in bulking up across the travel and tourism industry and then selling services to millions of customers at airports, on flights and in hotels.

What has LeEco being trying to achieve?

LeEco’s breakthrough began with a pioneering video streaming service. Since then it has widened its horizons, with the clue in the company’s name – ‘Le’ meaning ‘happy’ in Chinese and Eco a short form for ecosystem.

HNA plans to capture millions of tourists with an end-to-end travel experience but LeEco wants to corral its customers into a walled-off world of content. It is spending heavily on movies and television (The Great Wall, starring Matt Damon and produced by its film division, will be released next month in China) and it plans to deliver them by flooding the market with its own televisions, smartphones and virtual reality headsets. Hence the $2-billion bid for the television maker Vizio in August, as well the investment in Faraday Future, a US-based manufacturer of self-driving cars.

Faraday first grabbed headlines with a concept vehicle that drew comparisons with the Batmobile (see WiC309) and LeEco’s dream is that these ‘smart’ cars will be sold at giveaway prices, with customers paying for content as they are being driven along.

Sobbing proudly through the unveiling of his first supercar in Beijing earlier this year, Jia outlined that this was how he would surpass Tesla. “We consider the car a smart device on four wheels – essentially no different to a cellphone or a tablet,” he explained to Reuters (see WiC325).

Both firms are responding to deeper trends?

China’s bolder companies are investing overseas while the economy’s growth rate is slowing at home. The government wants them to adopt more of a global profile and there was more than a hint of patriotism-for-profit from HNA’s Chen at Harvard earlier this year, when he told students that he was going to buy thousands of new aircraft, forcing Boeing and Airbus to give him a better deal.

“For over a hundred years when did the Chinese have the power to decide anything?” he asked his audience. “Now, finally, I have the opportunity to decide.”

HNA’s strategy is backed by its expectations that China will ‘export’ millions of tourists, and not just investment capital. But like other dealmakers, it wants to take advantage of the cheap financing on offer, says David Fickling at Bloomberg

One of its recent bond prospectuses indicates that by the end of last year its total assets were worth as much as Rmb469 billion, up 45% from 2014. However, its net asset value stood at only Rmb22.5 billion.

But HNA paid just Rmb247 million in interest on Rmb264 billion in average debt last year. And like other Chinese buyers, it’s keen to do deals now in case the yuan weakens further against the dollar. If the yuan dips, it’ll be easier to pay down the yuan-denominated debt.

What are the dangers in the spending spree?

One concern is that cashed-up companies often overpay for their acquisitions. Analysts say that HNA bid almost a third more than Ingram Micro’s pre-deal price, for instance, despite sparse evidence of cost savings from the takeover. And it has paid more than book value for the aircraft-leasing firms at a time when the sector has been trading at discounted levels.

This month Hainan’s flagship firm stunned Hong Kong’s property analysts when it paid $1.1 billion – almost twice the sum expected – for a plot of land at the city’s old airport. “I am completely shocked. The market is crazy, we have to be careful,” Joseph Tsang, the managing director of JLL Hong Kong, told the South China Morning Post. “I really don’t understand why the winning buyer paid such a high price.”

How a residential project in Hong Kong fits into the aviation strategy isn’t immediately apparent (apart from its historic link to Kai Tak airport) and HNA has just paid another record price for an office block in Minneapolis, a city that is home to Carlson Hotels, which it also acquired in April.

It splashed out another $137 million on 10 golf courses in Seattle this month too, postulating that rich Chinese tourists will be keen to get out their clubs.

But as LeEco’s Jia is now discovering, integrating such a diverse mix of assets can be challenging. In the past Jia defended his business model by saying that complexity made it harder for rivals to copy. Now he has had a change of heart, complaining about “an apparent lack of momentum” in some of the businesses under his control, and highlighting that LeEco is suffering from “Big Company disease” in terms of organisational effectiveness.

HNA and LeEco have also faced criticism that their operating cash flows are nowhere near sufficient to cover their investments. Both firms have had to raise money and in some cases, the sources of the finance aren’t always apparent.

“We don’t understand where HNA’s money is coming from,” one foreign banker complained to the Financial Times recently. “They are spending a lot and investing in a lot of things. But it’s too much leverage. When we don’t understand something we don’t lend.”

China’s banks show fewer concerns. Earlier this year HNA counted more than 150 domestic lenders as “stable, long-term partners”. China Construction Bank committed another Rmb30 billion of new loans in May, for instance, and a statement from HNA at the time mentioned that it had access to credit of over Rmb530 billion.

The company dismisses concerns that it is under financial pressure, saying that the banks scrutinise each of its investments, and that they have been lending it more every year. “It points to the fact that HNA’s financial performance is sound and our credit is good. We always meet our interest payments on time,” a corporate insider told Economic Daily this week.

The banks look likely to feature as the main source of finance for the foreseeable future, including debt taken on by the group’s listed entities. HNA says it is reducing its leverage, however, and Economic Daily agrees that there has been an effort to shift some of the funding away from bank loans, with a total of Rmb82 billion in new equity raised by HNA’s listed firms since last year.

Collateral damage for LeEco?

LeEco’s financing options look more constrained and it doesn’t enjoy the patronage of a provincial government as a backstop. That led to jitters when Jia went missing two years ago, amid rumours that he had been collared by anti-graft investigators.

He returned to the public eye a few months later, citing a period of illness (see WiC268). But Leshi’s market value plummeted in his absence and questions started to be asked about how he was financing his firm’s growth.

Jia has been borrowing against his equity in Leshi, LeEco’s only profitable entity. By the end of last year he had pledged the large majority of his stake as collateral and channelled the proceeds into other ventures, according to Leshi’s annual report. He has admitted to media that Leshi’s directors disagree with him on most of the new initiatives, so he puts his own money behind them instead. He has worked hard to convince investors too, bringing in billions more yuan for LeEco’s other ventures.

Jia had a lot more wriggle room when Leshi’s shares were soaring during last year’s stock market boom. When prices slumped the boss was forced to sell more than Rmb2 billion in stock and lend the proceeds back to the video site.

The downward trend has continued, with the stock dropping by a third since the whispers about LeEco’s financial condition grew louder, and the share price fell sharply again after his letter to employees. Shares in Coolpad, a Hong Kong-listed smartphone maker controlled by LeEco, plunged even further as investors ran for cover.

Questions about LeEco’s financial resources are also coming to the fore at the Faraday plant in Las Vegas as well, where Jia has promised to create a high-tech manufacturing hub. A steady stream of senior executives has already departed, including the finance director, and the lead contractor in the plant’s construction has called a halt after Faraday fell behind on payments.

The Las Vegas Review Journal reports that Jia invested $300 million in Faraday and put up even more in stock as collateral for hundreds of millions of dollars of tax credits and subsidies for the project from the state of Nevada.

But Dan Schwartz, the state treasurer, has been a long-standing opponent of Jia’s plans. “If I were to sum it up: it’s the emperor’s new clothes,” he told the Los Angeles Business Journal in February. “If you look at the financials, [Jia] isn’t making any money. He certainly isn’t making any money to fund a billion-dollar car facility.”

Now Schwartz is ramping up his critique that Faraday doesn’t have the funds to get the plant into production and he is demanding to know the identities of the other investors that LeEco promised to bring to the deal. “The question this has raised is there is potentially massive financial fraud here. We’re increasingly more concerned than we were before,” he warned the Las Vegas Review Journal

What happens next?

The future of both firms comes down to how successfully they can deliver on their strategic visions: vertical integration in travel and tourism at HNA, and the ecosystem of entertainment at LeEco.

Of the two, the industrial logic looks more compelling in HNA’s approach, especially as the Chinese start to travel in record numbers.

LeEco’s plan seems like more of a stretch, not only in delivering on its hardware-and-content combination, but also in competing for customers in markets where its brands aren’t well known.

HNA has experienced stumbles: it diversified into shipping following the September 11 attacks, but when the maritime sector suffered a slowdown of its own, company bosses sold off their ships. But they still ran into legal trouble as creditors chased them for payment and a cruise liner was impounded in South Korea in one bruising case (see WiC210).

Jia’s letter to LeEco’s loyalists makes clear that he has to retrench, stirring speculation that he may not close the deal for the television maker Vizio and that the dreams for the car plant in Nevada might dissolve in the desert air.

“Now, our ecosystem strategy must enter a second stage quickly, moving away from cash-burning,” he explained in his letter.

But he insists that last week’s warning was designed to demonstrate his determination to carry on with his vision despite the difficulties ahead. Cutting his own salary to just one yuan, Jia says he will focus on making his businesses work rather than investing in new ones. He is also trying to put a brave face on the cash crisis.

On Tuesday he announced $600 million in emergency funding from former business school classmates, and last weekend he was spotted in Hong Kong’s banking district, posting confidently on his weibo account that LeEco’s cash crunch would be “completely solved in the near future”.

With his flare for drama, Jia felt the need to wonder aloud if his firm would be swallowed up in the “giant waves” of its cash crisis or whether it would “boil the ocean” with the intensity of his new strategy. In his letter, he took a stab at answering the question. “We’ll be progressing in disruption and pain,” he promised his staff – with commendable honesty. But will such a downbeat message motivate his troops? Remember that even when things looked dire in 1940, Churchill balanced his bleak analysis with the promise of sunlit uplands ahead.


Keeping track: LeEco’s Shenzhen-listed unit Leshi Internet Information is one of the private-sector tech firms that might be hoping for a boost from the new Shenzhen trading scheme, as international investors add the counter to their portfolio.

But at the time being investors seem more concerned about a liquidity crisis for Jia Yueting’s ambitious firm.

Leshi shares plunged another 7.85% on Tuesday, a day after the Shenzhen Connect’s commencement. On Wednesday trading in the internet TV operator was suspended altogether. Several Chinese newspapers cited gossip that Jia has been forced to pledge another large chunk of his Leshi stake as collateral for a loan. However, the company’s share price has dipped 40% since July, triggering margin calls and the trading suspension.

According to WIND, a financial data and analysis company, LeEco’s founder and his brother pledged more than 84% of their holdings in Leshi as collateral for more than Rmb10 billion of loans. Meanwhile, another acquisitive Chinese firm we flagged in issue 346 may be wrestling with a potential cash crunch as well. Hong Kong’s Apple Daily says that the aviation conglomerate HNA Group has also pledged stakes in four of its listed units as collateral for loans.

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