Red chip Citic Pacific has agreed to buy Citic Ltd for Rmb227 billion ($36 billion) from its state-owned parent Citic Group in a complex deal that promises to make a new behemoth in Hong Kong's stock market.
Citic Pacific – a Hong Kong-listed, China-focused company specialising in iron ore mining, property development, and specialty steels – will fund the acquisition of highly diversified Citic Ltd with cash and via a massive Rmb177 billion ($28.4 billion) new share issue to Citic Group.
These shares to Citic Group will be priced at HK$13.48 per share, representing a 25.8% premium to the 60-day average closing price of Citic Pacific but a 5.7% discount to its HK$14.30 close on Wednesday, following a sharp recent rally in the stock.
To help fund the acquisition, Citic Pacific also plans to raise Rmb50 billion through a new share placement with institutional investors. The minimum price will be whichever is highest on the last trading day prior to the placing agreement: HK$13.48 or 80% of Citic Pacific's closing share price.
At a press briefing in Hong Kong, Citic Pacific chairman Chang Zhenming told reporters that the company is already in talks with domestic and international investors about the share placement. Chang is also chairman of Citic Ltd.
The newly merged entity, to be called Citic Ltd, will have a free float equal to 15%-25% of the total outstanding shares, leaving Citic Group to hold the remainder.
The reorganisation of Citic's assets is happening at a time when China's government is reining in its state-owned enterprises (SOEs) and pushing them to be more transparent and market-driven. "This is one of the reasons or targets of us going to Hong Kong, to conduct SOE reform," Chang said at the briefing.
The deal will bring Citic Ltd -- whose highly diversified businesses are mostly onshore -- in line with international governance standards, and will add a heavyweight stock to the Hong Kong exchange -- at a time when Chinese internet giant Alibaba looks set to list elsewhere.
“We think it is a good move. Citic Ltd will be subject to the corporate governance norms of the Hong Kong exchange and Hong Kong’s bourse will gain a much bigger listed entity with mainland assets,” said Carson Wen, a China M&A partner at legal firm Jones Day.
It will also leave Citic Pacific with a stronger balance sheet. Citic Pacific, rated BB by S&P and Ba2 by Moody’s has long enjoyed a halo effect from its parent. But there have been concerns over its credit rating and debt levels on a standalone basis. The company's iron ore project in Australia, in particular, has dragged on its business.
One banker previously dubbed the company the “stuff of credit officers’ nightmares."
According to a company presentation, the newly merged entity's credit rating is likely to be on a par with Citic Group's, which is currently rated Baa2/BBB+ (Moody’s/S&P), meaning it should gain access to cheaper funding.
Citic Ltd has a broad range of major assets including a 67% stakes in Citic Bank and a 20% stake in Citic Securities, which are both listed. It also has stakes in Citic Telecom, Citic Resources and Citic Heavy Industries.
The new entity will have combined revenues of HK$410 billion and assets of HK$5,322 billion – the largest among the conglomerates in China and exceeding Li Ka-shing-controlled Hutchison Whampoa.
The deal is still subject to majority approval by Citic Pacific's independent shareholders, regulator and government approval but is expected to complete on or before August 29, the company said.
Unusually, for a deal of its size, there was no involvement from foreign banks. Citic Securities and CSCI were financial advisers to Citic Pacific.
China clean-up opportunities
The market is closely monitoring the deal because it is one of the first big tests of China’s SOE reforms after the country's political leadership pledged to shake up the ownership shareholder structure of SOEs at the third plenum of the 18th Central Committee in November.
The central government hopes to let market forces play a more important role in SOEs, which are relatively inefficient and lack proper corporate governance. Many Chinese SOEs are also currently faced with overcapacity in their industries and declining profitability, especially in sectors like oil and gas, iron and steel, energy and power generation.
Some are already moving to draw in greater private investment. Sinopec, China's biggest oil refiner, is planning to sell up to 30% of its retail assets to private investors for $30 billion, potentially the largest asset sale by a Chinese SOE, according to company statements and media reports.
But that is just the tip of the iceberg, potentially generating many more opportunities for banks. According to Chinese Ministry of Finance data, the total assets held by SOEs (wholly or majority owned by either central or local governments) reached Rmb91 trillion last year.
The combination of Citic Pacific and Citic Ltd promises to provide the SOE with better access to international capital markets and strengthen its capital base for future growth. The new company will be headquartered in Hong Kong and will comply with Hong Kong’s laws and regulations, which are widely regarded as more mature than in the onshore market.
Bringing in global and local institutional investors and other strategic partners will also help the company to improve its management and corporate governance, Chang Zhenming, chairman of Citic Group, said.
Even so, the extent to which private capital will play a bigger role shaping China's SOEs remains to be seen, analysts and economists say.
“It’s hard for the private sector to gain power to make overall change in the SOEs,” Chen Zhiwu, a member on the international advisory board of the China Securities Regulatory Commission, told FinanceAsia at the Boao Forum for Asia.
Without any supervision of state power within the SOEs, the companies may continue to make the same mistakes by targeting expansion rather than greater efficiency, fostering corruption and creating unfair competition, according to Chen, who is also a professor of finance at school of management with Yale University.