How HNA’s house of cards unravelled

An acquisitive Chinese conglomerate is paying price of biting off more than it could chew. Here's how it got there.

When HNA merged its Hong Kong-based financing arm, HNA Innovation Finance, into its bigger HNA Logistics unit, it cited "streamlining its operations and boosting efficiency" as its rationale.

But that's only half the story. In fact HNA Group has been frantically offloading expensively acquired assets as it seeks to ease its financial distress. 

But how did the company, which started as a modest airline in the island province of Hainan, find itself in this situation? A look into its background offers clues.

Private equity firms are generally in the business of taking over companies using some of their own money but also money they’ve borrowed – the more the merrier. It is a debt-fuelled growth strategy embraced by Chen Feng, founder of the famously opaque HNA, when he started his aviation venture two decades ago.

In 1993, Chen, a former assistant to Hainan’s governor, received a budget of Rmb10 million ($1.6 million) from the Hainan government to fund an airline to help boost tourist traffic into the region. Chen knew the seed capital was nowhere near enough for what was required to build a business with critical mass, so he reached out to his government connections.

Leveraging that political capital, Chen managed to raise Rmb250 million from private investors in China and secured another Rmb600 million from state-owned lenders. Without any obvious leveraged-buyout experience, the Shanxi native first purchased two 737 aircraft from Boeing using his seed money, and then pledged the new planes as collateral to purchase another two 737 jets.

Hainan Airlines made its maiden flight in April of 1993, flying between Haikou, the capital city of China's most southerly province, and Beijing. It was the start of something big – arguably too big and unfocused.

“In the case of HNA, the ego of the company’s CEO has surpassed its real needs to service its aviation business,” said Veronique Lafon-Vinais, a finance professor at Hong Kong University of Science and Technology, told FinanceAsia.

Chen’s method of financing was almost unheard of at the time in China, when even capital markets were incipient as the Shanghai Stock Exchange had only launched two years earlier, but it allowed him to recoup his initial investment and maintain ownership of his newly acquired assets.

Spurred by the initial success, HNA repeated the formula again and again to quickly gain control of other businesses. Trouble is, as everybody knows, aggressive debt funding can go horribly wrong if the assets used as collateral turn bad, making it harder to repay those debts; it can push a company to the brink of default.

This has happened with highly leveraged private equity-owned companies through the years such as the failures of Toys ‘R’ Us, Caesar's Entertainment, Claire’s Stores and Energy Future Holdings show. Private equity firms structurally protect themselves from a bankruptcy among their portfolio companies. HNA has not built in that same distance.

Short of bankruptcy, leaning heavily on financial leverage to acquire multiple businesses can be costly, placing pressure on the acquirer to ensure everything, from post-merger integrations to a business’s day-to-day operations, run smoothly.

To shed light on HNA’s liquidity problem, the group has Rmb140 billion of bank deposits as of June last year, less than its Rmb181 million short-term debt for the same period, according to its interim report.

Its total debt stood at Rmb590 billion, or almost 28 times its half-yearly earnings before interest and tax, making it one of the most leveraged company globally.

Amid concerns about its liquidity, HNA in December last year said it has unused credit of Rmb310 billion from eight lenders, including China Development Bank and Import-Export Bank of China.

This has not appeased authorities in China. HNA spent more than $50 billion between 2015 and 2017, scooping up stakes in Deutsche Bank and hotel operator Hilton Worldwide Holdings, as well as trophy office towers in lower Manhattan. But about a year ago, HNA started to feel the heat from regulators and creditors.

With Chinese President Xi Jinping keen to stem the onerous levels of debt in the Chinese economy, the once-acquisitive conglomerate realised that it would be nearly impossible to continue accumulating assets with borrowed money at the same furious pace, while maintaining a huge pile of debt.

So since the start of 2018, HNA has sold more than $13 billion-worth of property projects in Hong Kong, Australia, and New York and trimmed its stakes in Deutsche Bank and Hilton Worldwide.

With more than $100 billion in outstanding debt – about 25% of it falling due this year – it is perhaps just as well.


HNA's turbulent times


With a culture of leveraged financing from the start, HNA has tended to fund acquisitions by pledging shares in itself or its affiliates as collateral for debt finance. Typically, HNA lends a stake in an affiliate to a bank in exchange for funding in a so-called equity collar facility, which allows the Chinese company to hold ownership of the company on paper but in fact no longer own the shares, bankers told FinanceAsia.

In practice, HNA firstly proposes an injection of assets such as a parcel of land into one of its listed companies, immediately boosting the value of the shares. After the capital injection, HNA then pledges the shares of the listed company as collateral to borrow funds that it can use to make other acquisitions. It has done this in a number of ways.

“HNA has utilised every type of instrument [from complex derivatives to expensive bridge loans for acquisitions] in the capital markets, many of which are highly leveraged,” said Lafon-Vinais. “The leveraged model can be lucrative, but it is also risky.”

According to stock-exchange data reviewed by FinanceAsia, HNA was involved in more than 800 transactions using share-pledge financing in the past three years.


In one recent example, HNA pledged a 41% stake in its subsidiary Hong Kong International Construction Investment Management Group (HKICIMG) to private-equity firm PAG for an undisclosed loan in March.

In December of last year, HNA pledged 919.3 million Hong Kong-traded shares in Postal Savings Bank of China to an undisclosed investor, the company said in a filing to Hong Kong stock exchange.

The share pledge allowed HNA to get fresh funding without reducing its stake at the Chinese bank.

An HNA spokesman told FinanceAsia that the security-based lending reflects the company’s innovative approach to its corporate finance.

“In the period of rising asset prices, the securities-based financing helped HNA expand quickly in a short period. But it also forces the company to sell fast when the asset prices fall, or its growth of debt is faster than its repayment ability,” said Lafon-Vinais, a former StanChart and Credit Agricole banker.

HNA generated about $110 billion in revenues in 2017, mostly from companies it acquired outside of the country. It has $237 billion of assets, according to its website.


HNA doesn’t have a credit rating from one of the three largest global credit rating agencies, allowing it to avoid disclosure of its financial statements to them and a label on the credit worthiness of its debt. As a result it is forced to borrow at relatively more expensive rates.

In November of 2017 HNA sold a 363-day bond paying a coupon of 8.875%, the highest interest rate ever paid by a Chinese issuer. The debt offering underscored the group’s desperation as pricing was punitive For single B-rated Chinese property developers, typical coupon rates at the time varied from 5% to 7%.

Conservative investors such as insurance companies and pension funds are required to buy a rated bond because of their more stringent investment mandates.  At the same time, unrated bonds also tend to be smaller and less liquid than rated bonds.

“Many investors are restricted from buying unrated bonds and most prefer the transparency that a rating confers,” said a Singapore-based debt investor, who declined to be named because he is not authorised to speak to the press.

HNA’s interest payments doubled to Rmb15.6 billion during the first half of 2017 versus the same period a year earlier. Its short-term debt surged to Rmb185.2 billion, more than its cash and cash equivalent, according to HNA debt filing last year. Even onshore credit investors, which usually have higher risk tolerance for higher returns, were worried about its prospects. So much so that Hainan Airlines, a HNA affiliate listed in Shanghai, scrapped plans in December to sell Rmb1 billion of perpetual bonds in China’s local market to repay maturing debt.

“[Beijing’s] deleveraging campaign is causing a negative spillover to HNA,” Victor Shih, professor of political economy at the University of California San Diego, told FinanceAsia. “The top question here is HNA has never explained why it needs to borrow in such a large scale.”

Overall loans and bonds surged to Rmb637.5 billion ($101 billion) by November 2017, up from Rmb441.4 billion in December 2016, according to its bond prospectus last year.

For Chinese policymakers, HNA’s debt mountain presents a dilemma because, as independent research group Bond Critics put it last year:  “HNA has grown so huge it has become a national interest.”

Christopher Lee, managing director of corporate ratings for Greater China Standard & Poor’s estimates that assuming HNA had a CCC+ rating then the probability of default among Chinese corproates for the past 17 years, that HNA has a default probability of 35%. S&P has not officially rated HNA.


HNA’s buying spree really started to take off in late 2012, when Xi took political power.

Its opaque corporate structure attracted scrutiny from overseas regulators, who often questioned the motives behind the deals and the role played possibly by the Chinese government.

In an unusual move, the company unveiled its ownership structure in July when more than half of HNA’s shares were handed over to its domestic and international charities. This came about after Guo Wengui, a fugitive Chinese billionaire living in the United States, accused HNA of being connected to Wang Qishan, China's anti-graft tsar during Xi’s first term. HNA vigorously denied that accusation.

The Swiss Takeover Board in November then rapped HNA for providing it with inaccurate information and failing to disclose how its co-founders controlled a dominant stake during the company's earlier takeover of Zurich-based airline caterer Gategroup. This was followed in December by the blocking of HNA’s bid to acquire a vehicle finance firm in New Zealand after the country’s regulator claimed it was unable to work out the true ownership of HNA.

“HNA started to emerge as a global powerhouse in 2012, when Wang Qishan became a Standing Committee member,” said Professor Shih, a former principal for The Carlyle Group, a US private equity firm. “HNA has enjoyed a high level of patronage,” he said, referring to the company’s strong support from state-owned lenders.

To be fair, it is notoriously difficult to distinguish between genuine investment interest and government motivation, given Beijing’s invisible hand in every single industry.


There is little evidence to suggest HNA is improving the performance of the companies it acquires or achieving a valuation greater than the sum of its parts.

For instance, it quickly sold three pieces of land in Hong Kong’s Kai Tak Airport, in which its chairman Chen Feng once promised to build affordable flats for its local staff.

In a little over two years, HNA has sold Hilton shares in stages..

For investments realized in 2015, the average holding period was 5.5 years, according to data provider Preqin.

“HNA has no problem getting loans to finance its deals, but it didn’t get much from buying the Hilton shares in terms of brand building and the knowledge base to run a hotel chain,” a Singapore-based private-equity investor told FinanceAsia. He declined to be named because his company bought hotel stakes from HNA recently.

That’s not exactly how a professional private equity firm is supposed to do it.

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