by Ying Staton, Global Counsel Head of Asia
The term ‘grey rhino’ was coined by American economist Michelle Wucker as a metaphor for looming, high probability events with potentially catastrophic consequences, prefaced by clear signs which people tend to ignore.
In China, the term (which usually refers to events) has been adapted as a label for a number of large, privately-owned companies, such as Anbang, which have gone on a debt-fuelled foreign spending spree in recent years.
Anbang was recently taken into administration by China’s Insurance Regulatory Commission. The insurance regulator cited “illegal operations may have seriously endangered the company’s solvency”.
There have been signs along the way – last year, Anbang Chairman Wu Xiaohui had been detained by the authorities, and as early as 2016 negative signals from the authorities had led Anbang to step back from high profile deals including a US$14 billion bid for Starwood Hotels.
Beijing had to step in to avoid this grey rhino from causing a catastrophe. The case of Anbang highlights three problems posed by China’s grey rhinos, the largest of which include Fosun, Wanda, Ping An and HNA, but behind which stand many lower profile cousins.
The first is leverage. In conjunction with the RMB4 trillion (US$635 billion) stimulus package the Chinese Government launched in the wake of the financial crisis, Beijing also issued a directive to banks to extend credit.
Over the following two years, lending by the four largest state-owned banks increased by RMB7 trillion (US$1 trillion). Private enterprises rode the wave of cheap money, to fuel international expansion and to leverage up with additional off-shore loans from international banks.
As a result, total bank credit to the private non-financial sector in China has soared to 157% of GDP (the G20 average is 89%).
Now, as the government tries to deleverage the economy, some grey rhinos are struggling to stay afloat.
HNA has been engaged in a frantic attempt to shore up its credit-worthiness ever since state lender CITIC openly questioned the company’s financial position at the end of last year, recently announcing US$16 billion of asset sales.
In the case of Anbang, the critical risk posed by the company’s debts was exacerbated by the fact that the savings of millions of ordinary Chinese were tied up in the insurer’s balance sheet.
The second is poor deal-making. In their approach to foreign acquisitions, grey rhinos have tended to be unstrategic, imprudent and short-termist.
They have taken aim at trophy assets and companies totally unrelated to their core business and to which they are unable to add value: Anbang bought the Waldorf-Astoria; Fosun the Wolverhampton Wanderers, a second-tier British football club. They are insensitive to price and indifferent to returns: industry insiders say Wanda overpaid by around US$1 billion when it acquired Hollywood studio Legendary Entertainment for US$3.5 billion in 2016.
Whilst investment bankers may be delighted, investors from other parts of the world are left to contend with inflated asset prices and a distorted market.
Rather than a strategy to add value over the long-term, many acquisitions seem to be motivated by a short-term desire to move cash out of China, hardly surprising in the feverish atmosphere of the ‘make hay while the sun shines’ mindset that prevails amongst many grey rhinos.
Acquisition targets and co-investors are increasingly wary of getting into bed with a partner that is unlikely to stick around for more than two or three years, as changing political tides mean that assets which are bought one year are sold the next.
Finally, the surge of Chinese outbound investment is provoking a reaction in the West.
Earlier this year, the attempt by Ant Financial (part of Alibaba Group) to purchase US transfer company Moneygram was blocked by the Committee on Foreign Investment in the United States, which has ramped up scrutiny of Chinese acquisitions.
In Europe too, several member states – including France, Germany and Britain – are tightening their FDI screening processes, conscious that right now – unlike Beijing – they have relatively few policy levers to pull to protect themselves from grey rhinos.
In 2016, the acquisition of chipmaker Aixtron by the Fujian Grand Chip Investment Fund fell through after the German Government (under US pressure) withdrew its approval. To justify a higher degree of intervention, European governments are expanding the definition of ‘national security’ and in a way that blurs the line between defending security and competitiveness; in this way, ‘critical infrastructure’ can cover not only the defence sector but utilities, information technology, and financial services.
European policymakers want to protect, not just national security, but also high-value jobs and R&D, and to have a say over where headquarters are located. These new hurdles will challenge even more seasoned and sophisticated foreign investors.
Decades of rapid economic growth, a high savings rate, strict use of capital controls and the unleashing of credit in the aftermath of the financial crisis have built up an immense reservoir of capital in China that is trying to find a way out. This growing pressure will shape global FDI flows for the foreseeable future, and poses a systemic risk both within China and in the countries where the capital wants to flow.
Policymakers are right to keep a close eye on these grey rhinos.
Article published by the The Straits Times on 7 March 2018.