Property, Talking Point

A model restructuring?

Lessons from the bailout of a troubled real estate baron in Henan province

Hu Baosen-w

Tycoon Hu Baosen with diehard fans of the football team that till recently was named after his company

You could infer pretty much everything about the dramatic changes that Chinese football and the beleaguered property sector have undergone recently from the Chinese Super League’s (CSL) opener last week, with Henan Songshan Longmen drawing 2-2 with Dalian Professionals.

Until 2021 the former team was known as Henan Jianye, the same name as that of the real estate developer which had been its owner since 1994. It was the only CSL team which had not changed its name until an order by the Chinese government last year instructed all clubs to drop references to sponsors or owners in their names.

Dalian Pro was previously known as Dalian Wanda. The property heavyweight of the same name was the pioneer that came up with the winning strategy of investing aggressively in a football club in return for brand awareness and influence.

Both teams have a strong fanbase but many supporters have been disenchanted not only by the name changes but also by the recent takeovers of their clubs by state-owned entities in their respective home provinces. Indeed, SOEs have become an increasingly influential force within the CSL.

About half of the 16 teams are still backed by property developers but most of them have been struggling financially. This is not only a concern for football fans. Off the field, investors are now also wondering if the CSL’s gradual ‘nationalisation’ is set to spill over into the stock market and bring changes in control at some of the biggest listed property firms.

What has happened to Henan Jianye FC?

If you ask diehard supporters of Manchester United – many of whom still protest at the takeover of one of Britain’s most famous clubs by American billionaire Malcolm Glazer in 2005 – you’ll know a new team owner is not always welcomed by fans.

After the China Football Association (CFA) announced a directive in late 2020 to “regionalise and decommercialise” professional football clubs, Henan Jianye introduced two SOEs controlled by the local government of Zhengzhou (the capital city of Henan) and Luoyang (one of China’s ancient capitals). The latter company also operates the tourist facilities at the popular attraction the Longmen Caves. Yet when the club proposed to change its name to Luoyang Longmen (in Chinese longmen sounds exactly the same as the word ‘goal’), most fans were unhappy. Many of them protested outside the team’s home stadium. Some wrote complaint letters to the CFA, arguing that, as the oldest CSL brand, the 26 year-old club was the closest thing to the CFA’s goal of building “professional and international clubs that could last 100 years”.

Unlike Dalian Wanda and Guangzhou Evergrande, Henan Jianye has never won a CSL title. It was never a so-called tuhao club that ‘bought’ success either. Similar to the business philosophy of its parent firm, Henan Jianye always looked modest but stable. This explains why, unlike many of its more successful rivals, it rarely ran into financial trouble over the past three decades.

Henan Jianye and its founder Hu Baosen, who grew his property empire by focusing on his native Henan province, is said to have burnt through more than Rmb5 billion in spending on the club as part of his commitment to investing in Henan. “How could there be no representative from we Henanese in the most popular sport?” Hu once explained to Chinese media on the rationale for continuing to invest in football for more than two decades.

In a video clip widely shared by fans last year, Hu made known his own feelings about the CFA’s drastic reforms. “The CFA has announced such rules. You have raised the club for so many years. Make no mistake you need to keep raising it, although the club can no longer bear your name,” Hu said stoically.

Henan Jianye was eventually allowed a partial compromise: it kept half of its name (the non-commercial ‘Henan’ bit). But the remainder now references two famous tourist attractions (Songshan is where the Shaolin Temple is based) that are overseen by its SOE shareholders, which claimed in a recent statement that the club is the first Chinese football franchise to complete a ‘mixed ownership reform’.

The extent of that ‘mixed ownership’ could be the subject of debate though. There is no public information on the club’s new shareholding structure. Reports from Chinese sports media last week revealed that Hu is prepared to sell his remaining stake in the club to the SOE shareholders after a state-led bailout of his real estate firm (the football team’s parent).

How about Henan Jianye the property firm?

Unlike football fans, shareholders of Henan Jianye are likely to have cheered when the partial nationalisation of the property group was announced last week.

Since the Chinese government unveiled the so-called ‘three red lines’ policy in late 2020, which prevents highly leveraged property firms from raising more debt, the group’s Hong Kong-listed flagship Central China has dropped more than 80% in market value.

All private sector firms in the property market have since suffered from a liquidity crunch while being hit by a double whammy: a constriction in homebuying demand triggered by the Covid-19 pandemic, plus subsequent waves of city lockdowns. The Henan-focused firm then experienced a rare triple whammy when in 2021 the inland province suffered the worst flood in recent memory.

Last September a letter from Hu to the Henan provincial government began making the rounds on social media, in which the property tycoon confessed that his group had suffered “economic losses” to the tune of Rmb5 billion in a year as he issued a plea for help.

Something very similar happened a year earlier to China Evergrande, which was more famously founded in Guangdong by Xu Jiayin, another Henan native. A petition from the company to the Guangdong government somehow got into the public domain via social media revealing that ‘the world’s most indebted developer’ was also desperately soliciting state support, warning darkly that its own cash crisis would unleash systemic risks in the financial sector.

While Evergrande’s debt crisis has worsened and a state-led task force has been sent to the company to oversee an imminent restructuring, the Henan government has just come to Hu and Jianye’s rescue.

On June 1, his listed vehicle Central China announced in a stock exchange circular that it will raise about HK$688 million by selling 29% of its enlarged capital to Henan Railway Construction & Investment Group (HRCI), a company wholly owned by the government of its home province. The share price of Central China rebounded strongly as the deal has valued the stock at a 23% premium to its last trading price before the good news was made public.

Moreover, HRCI will invest another HK$708 million by buying convertible notes issued by Central China with a coupon rate of 5% (equating to a 9% yield if held to maturity and fully repaid). However, if fully converted to shares instead the Henan government will add a 16% stake in the Hong Kong-listed firm, which means the provincial authorities could end up being its biggest shareholder with more than 40%.

Prior to the bailout, Central China’s bonds were downgraded by foreign credit rating agencies to junk levels. After bringing on HRCI as a strategic investor, the group’s creditworthiness has now effectively been back-stopped by the Henan government, CBN newspaper suggested. This puts the private sector firm in blue chip territory in the domestic capital market.

The terms set out by HRCI are not especially harsh. A 5% coupon rate is a borrowing cost that bond investors expect from a triple-A property blue chip. Nor is the rescue just cherry-picking some of Jianye’s best assets and forcing it to sell others at distressed values. HRCI is not taking control of the firm outright either. The Henan government is effectively helping Hu to buy time for his firm while waiting for a turnaround in homebuying demand and a possible relaxation in property market regulations. If these eventualities occur, Jianye’s local government will enjoy a handsome capital gain; if not, it can still take control of the province’s biggest developer at a reasonable price.

In fact, the Henan government had earlier offered strong support for the property group. Besides taking a stake in its CSL franchise, the two provincial SOEs have invested an undisclosed amount to take a majority stake in two ‘cultural-tourism real estate’ projects in the Jianye portfolio, including a ‘movie town’ co-developed with the financially troubled Huayi Brothers. This move was to prevent the massive developments from turning into ugly “rotten-tail properties”, Chinese media noted.

Will other local governments offer similar rescues?

Nationalisation, or “dyeing red” as Leju Finance, a property market-focused magazine, has put it, is often an option for tycoons like Hu and Xu when they run into difficulties.

Vanke, one of China’s biggest homebuilders, brought in a railway SOE controlled by the Shenzhen government as a major shareholder to fend off an unsolicited takeover attempt by Evergrande in 2015; in the same year, the financially distressed Greentown China (which previously owned a CSL team too) also switched to ‘mixed ownership’ mode by selling a large chunk of its shares to China Communication Construction, another SOE. The Zhuhai government, meanwhile, invested at least Rmb3 billion last year for a stake in Wanda’s property management unit which is reportedly seeking a Hong Kong listing that could value the company at more than Rmb100 billion.

The trend has gathered pace going into 2022. In March, China Fortune Land (another erstwhile CSL club sponsor) successfully restructured half of its debts with the assistance of SOEs from the Jing-Jin-Ji area (aka Beijing, Tianjin and Hebei). A month later Kaisa, which sits on a valuable land bank in Shenzhen, signed a strategic cooperation agreement with China Merchants, an SOE with immense influence in Shenzhen, to co-develop a number of urban renewal projects.

The most-watched developer – Evergrande – has set up a ‘risk management committee’ with representatives from several SOEs including the Guangzhou government’s property unit Yuexiu. However, creditors are still waiting for how things might turn out in what promises to be a gargantuan state-led restructuring.

The situation in Henan has prompted Chinese media outlets to compare Evergrande and Jianye, and ponder whether investors should also expect a similar rescue act at Evergrande.

The problem is that the two situations are not comparable. The sheer size of Evergrande’s debt, which is believed to be at least 10 times that of Jianye, could turn out to be too large even for the vast Guangdong government to handle.

Another important difference, Leju Finance pointed out, is that Hu and Jianye have been focusing on Henan for more than two decades, while contributing to the midwestern province’s economic growth. The group was still the third biggest taxpayer in Henan last year. Hu also resisted the temptation to expand nationwide like many other developers. Indeed, the group is so deeply invested in Henan it has projects in all of the 122 cities or counties in its home province. Even during the worst days of its cash crunch, Jianye was the first to make a sizeable donation to relief efforts amid the 2021 flood too. “Jianye is a flag of Henan. When ‘Old Hu of Henan’ is in trouble, the local government won’t stand idly by and let him drown,” Leju Finance said.

Evergrande seems to be an entirely different proposition. The company started out as ‘Guangzhou Evergrande’ but it has since built up the biggest national land reserve of all property firms. With less loyalty to its home city it switched its new headquarters to Shenzhen and dropped Guangzhou from its name to rebrand as ‘China Evergrande’.

Back to the CSL…

Jianye’s Hu and Wanda’s Wang are good friends. In April Wang even lent a helping hand to Hu and signed off on a cash-generative Rmb700 million deal for the right to manage Jianye’s commercial properties for 10 years, reported Jiemian, a news portal.

Wanda was the first property heavyweight to go into deleveraging mode following a regulatory crackdown on overseas investment in 2017. It has since sold off an enormous commercial property portfolio and focused on property management – the most high-growth segment of the real estate industry. As such, Wang is now widely dubbed as ‘the happiest property boss in China’.

His friend Hu now has the luxury of a little more time to recover. Perhaps illustrating the group’s renewed vigour after its partial nationalisation, Henan Songshan Longmen thrashed reigning champions Shandong Taishan 4-1 on Wednesday…

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