Will Chem China Get its Money?

We’ve been doing some work recently on the proposed Chem China acquisition of Syngenta. The documents submitted so far are woefully inadequate, forcing investors to rely on press reports from Caixin Magazine in Beijing. That has left many investors scratching their heads figuring out if the financing is solid. As they note, “ChemChina intends to finance the Offers with funds borrowed through credit facilities entered into with HSBC Bank plc, as facility agent, and China Citic Bank Corporation Limited, respectively. “ More important, the offer is not subject to last minute “financing conditions.”

The phrase that is most striking in the press reports is “underscoring the government’s lack of enthusiasm is the fact that none of the four largest state-owned banks has joined” the lenders.

Caixin, an independent magazine in Beijing, is generally quite reliable (admittedly I am biased as my daughter worked there two years ago). But they are short-staffed and don’t always cover business thoroughly. And sometimes they are motivated by their political backers who reach into the highest levels of government (I can’t say in print who they are…) . Are they reliable here? My gut tells me no – but it doesn’t mean the magazine is correct in assuming that there is no support for the deal. Let me explain.

It is true that a large loan commitment from the state banks generally would be a sign of approval from higher channels, primarily the State Council that pulls the strings on the more sensitive, and expensive, decisions. However, I also know from recent meetings with bankers in Beijing in October that there is increasing reluctance among the state banks to lend to state-owned corporations, even large ones. The banks have been used as a channel for many of China’s investment plans, and they are getting concerned that they will be forced to absorb losses from defaulting state firms – which the banks would prefer to push them back to the central bank, the Ministry of Finance, or local governments. Some banks even have an informal quota for loans to key sectors such as rail because of excessive investment abroad by China Rail and other state firms. So lack of support from these banks per se doesn’t indicate lack of political support generally.

My estimation, after carefully reading the documents, is that there is tacit permission from the leadership for the deal – but no one will commit unless it is confirmed. It’s too risky to attach one’s name to a transaction of such size, global importance, and cost, that could fail. What seems clear is that, having completed 100 acquisitions, Chem China Chairman Ren Jiang is known as a guy who can get deals done. But he’s also known as a person who often stretches his connections and financing to the limit.

Can he complete the financing for the Syngenta transaction? The center of the financing is China Citic Bank in Beijing. China Citic Bank has signed an undertaking for the majority of the financing, around $30 billion, with plans to offload at least $15 billion to others. But there are some red flags here. First, Citic’s own balance sheet is becoming riskier. Property investment jumped to 27.4% of corporate loans in 1H 2016 from 24.2% in 1H 2015. This is a sector that is on shaky ground due to an exploding property bubble. Elsewhere, although interbank placements fell a marginal 4.7% YoY, the short-term portion (under one month) jumped 27.6%, suggesting growing nervousness in the interbank market.

The biggest issue is how and if Citic offloads the $15 billion into the private sector through the shadow banking market. They would do this by selling pieces of the loan to private investors in the form of China’s famous “Wealth Management Products” (WMPs). These are….well…more or less anything the buyer will accept. Citic could bundle them with other products, or sell them directly as part of the Chem China deal. They are supposed to be transparent but the banks have been skirting these rules.

What would a batch of WMPs mean for the deal?

1. First, there would be a lot of interested parties holding pieces of Chem China in the form of a non-fungible equity investments. Exiting may not be easy for them and they may become a political force with unknown consequences.

2. Second, Citic would have to offer a relatively high interest rate to convince buyers to acquire these WMPs, putting pressure on Citic’s balance sheet, and in turn, on the Syngenta deal itself.

3. Third, at this stage it looks like these investments would be channeled through six SPVs that are being established offshore. It’s doubtful Citic could raise this capital offshore from the private market. There’s little appetite for dubious WMPs among offshore investors. There is the possibility of institutional investors coming in but it seems more likely they would buy shares in Syngenta directly. If this capital is sourced from Chinese investors on the mainland, how would they get the capital offshore? Citic would not be able to convince the PBOC/SAFE to allow this much money to move into a speculative offshore investment, particularly since SAFE is clamping down on all international transactions. It would be up to the individual investors to arrange the currency conversion – possible but increasingly difficult.

We still think the transaction will be financed and approved. But there are complications that have to be conquered before completion.