“Know the enemy and know yourself,” advised Sun-tzu in his classic text The Art of War. Follow this maxim and “in a hundred battles you’ll never be in peril,” he added. Investors in Sunac China will be hoping the company’s founder Sun Hongbin, takes the motto to heart after he surprised the market last week by ploughing Rmb15 billion ($2.18 billion) into cash-strapped Leshi Information and Technology Company, as well as some of the associated companies of its troubled parent LeEco.
Sun hails from Linyi in Shanxi where construction workers unearthed the oldest surviving manuscripts of Sun-tzu’s military strategies. His origins are fitting, given that he has tried to style himself as China’s white knight, initiating (but subsequently dropping) deals to help ailing companies ranging from property developers Kaisa and Greentown to food firm Yurun.
The Leshi deal is subject to board approval at Sunac, but investors have already responded with a resounding thumbs-down. Sunac’s Hong Kong-listed shares dropped 8.1% the day after the announcement (Shenzhen-listed Leshi’s went up 10%). Agricultural Bank of China’s international unit described the bid as a “negative surprise” and CICC said that “side effects” including worsened financing conditions for Sunac and an unclear picture for Leshi led to concerns “over Sunac’s short-term stability and results.”
Other analysts pointed out that Sunac has been clinging onto its B+ rating with a negative outlook from Standard & Poor’s (Moody’s downgraded Sunac to B2 last October). S&P described the acquisition as “credit negative” but said it wouldn’t immediately effect the rating since Sunac’s “strong sales in 2016” should help to “absorb the impact of the transaction without materially affecting financial leverage”.
Not everyone agrees. CICC believes Sunac could end up with a net gearing ratio of over 200% by the end of the 2016 financial year and analysts have also queried what synergies Sunac hopes to derive from an investment in a tech conglomerate (LeEco) with a reputation for “blind expansion” (to quote its own founder, Jia Yueting).
Part of the answer appears to be the internet-of-things, which Sunac wants to integrate into the smart housing projects it is planning to build. LeEco already has a Californian site where it intends to showcase its technology prowess in respect to ‘smart cities’ (it also has a Rmb20 billion eco-park in Zhejiang, see WiC339).
Also by way of explanation, Beijing News says all three of Leshi’s companies are becoming more profitable. The Shenzhen listed entity recorded Rmb493 million net profit in the third quarter, up 30.75% year-on-year (it is a leading player in video streaming entertainment, and is sometimes compared to Netflix). Unlisted Leshi Pictures made Rmb136 million of profit in 2015 and Leshi Zhixin (a smart TV maker) may also have turned a corner (Rmb56.78 million net profit in the first half of 2016 compared to an Rmb731 million loss in 2015).
The newspaper then outlined how Sunac will exert control over Leshi, particularly by stopping cash being siphoned off from profitable bits of the group into funding for Jia’s new ventures. Sunac gets two out of five board seats in the Shenzhen-listed entity and the articles of association have been changed so that board decisions need a two-thirds majority to proceed.
Sunac will put its own finance managers into Leshi Zhixin and Leshi Pictures, which the group has promised to inject into the listed vehicle by 2019. But the investment comes at lower valuations than recent fundraising rounds. A total of Rmb6.04 billion goes to Leshi Internet for an 8.6% stake, valuing it at Rmb70.16 billion. A further Rmb9.75 billion goes to Leshi Zhixin for a 33.5% stake (now valued Rmb6 billion lower at Rmb23.73 billion). And Rmb1.05 billion goes to Leshi Pictures for a 15% stake (valued at Rmb7 billion).
Sunac has set itself a Rmb210 billion sales target in the property sector this year, compared to Rmb150.6 billion in revenues in 2016. But analysts believe it needs to scale down its M&A activity after spending Rmb107 billion in 2016 (almost what it made in contracted property sales). Mind you, the indications are that Sun isn’t taking their advice. On January 9, he invested a further Rmb2.6 billion in a 6.25% stake in online real estate agency Homelink.
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