How long before the first major default of a Chinese corporate or of one of their expensively assembled acquisitions?
Those questions must linger unpleasantly in the minds of bankers as a succession of mainland Chinese companies come to market with debt-reliant M&A bids for international companies.
The latest was Zoomlion, which on Wednesday confirmed that in January it had made a $3.3 billion tilt at US crane maker Terex, in an unsolicited effort to muscle in on the company’s merger discussions with Konecranes of Finland. Zoomlion said it would use bank debt to fund 60% of its proposed bid, which values Terex at $30 a share -- a 100% premium to the value of its shares before the offer.
That’s a hefty slice of debt to add to the book. While Zoomlion has cash – around $2.3 billion, according to the Financial Times – it also has a debt-to-Ebitda ratio of 43 times.
It’s far from the first debt-laden Chinese company to decide to pile more red onto to the balance sheet to make offshore purchases. China National Chemical Corporation (ChemChina) has made a $43 billion bid for Switzerland’s Syngenta that will be supported by huge amounts of debt, including huge acquisition financing lines from HSBC and China Citic Bank.
The New York Times estimated that ChemChina could throw nearly $16 billion onto Syngenta’s balance sheet, so it would need to find a further $28 billion itself to finance the deal. That’s punchy for a company that had Rmb232 billion ($35.5 billion) in debt and cash of Rmb29.8 billion at the end of September.
The amount of debt being clamoured for by acquisition-hungry companies looks set to rise a lot further.
All-told Chinese companies announced 598 outbound deals worth $112 billion in 2015, according to Thomson Reuters. This year the tally of announced M&A already stands at $55 billion, as more companies respond to Beijing’s desire to acquire more technology, expertise, and products to help upscale the country’s manufacturing capabilities and improve local consumerism.
According to the Financial Times, complaints are emerging that the levels of debt support underpinning some of these deals are emanating largely from local banks with an apparently fathomless level of risk appetite. That offers the companies an artificial advantage over international rivals that utilise far shallower levels of leverage.
At the same time, concerns are mounting about the state of China's banking industry as the world's second-largest economy slows and non-performing loans rise.
The China Banking Regulatory Commission said on Monday that 1.67% of commercial bank loans in China last year were non-performing, while 'special mention loans’, which many consider to include effective bad debt, hit 3.79% at the end of December. All-told, official NPLs in the banking sector totalled Rmb1.22 trillion in 2015 versus the Rmb1.59 trillion in profits collectively made, according to the CBRC.
The official NPL figure is probably also a major underestimate of the true scale of the problem. Hedge fund manager Kyle Bass of Hayman Capital Management has said his firm is betting against the renminbi, arguing the country's banking system cannot have grown "1,000% in 10 years and not have a loss cycle."
UBS economist Tai Wang disputes such doomsday scenarios but even she takes a 10% NPL level as a worst-case scenario, notably higher than the official rate reported today.
Bad debt drain
China’s banks are accelerating their lending too, to help offset slowing economic growth. In January the banks lent Rmb2.51 trillion of new loans, a record monthly high and far more than anticipated. McKinsey Global Institute reported this month that Chinese indebtedness quadrupled from 2007 to 2014, from $7 trillion to $28 trillion, taking total debt to 282% of GDP.
That offers a concerning mismatch.
Chinese companies are using piles of debt on sometimes already leveraged balance sheets to support M&A bids, even as the banks offering them the money see bad debts mount and their balance sheets become more stretched.
The assumption among most M&A targets, their investors, and the shareholders of all the Chinese companies making these bids is that the Chinese government is the ultimate backstop to this debt. After all, it’s in large part due to its urgings that companies are heading out to buy assets and in the process putting additional pressure on their balance sheets.
President Xi Jinping told Reuters in a written interview in October that China overseas investment would reach $1.25 trillion in the coming years in the coming decade. "The Chinese government supports Chinese companies in going global," he said.
But that doesn’t mean all risk is shed. Instead it heightens the danger that some of China’s major companies, able to lean on seemingly limitless credit lines, overbid for assets and then struggle to make them work.
That could in turn force NPLs in the banking sector to continue upwards as the companies borrowing opt to renegotiate the payments on these debts and the state banks feel unable to foreclose on companies that buy in line with Beijing’s urgings and to which they have enormous exposure.
At a bare minimum it suggests more bank balance sheets could get loaded with the overseas debt of large companies, reducing their capacity to lend onshore. That, in turn, could crimp efforts to improve local liquidity.
China’s companies don’t possess a particularly good track record when it comes to acquisitions either, in part because so many were expensive resources-focused purchases and the commodities markets have since slumped. One example is oil and gas major Cnooc, which conducted an $15.1 billion acquisition of Canada's Nexen.
The purchase, which was funded through $4 billion in bonds as well as cash, has been a very expensive flop. It was conducted when oil was valued at $100 a barrel. It's now nearer $30 a barrel, so the company faces an uphill struggle to execute oil-sands projects.
China’s banks and company investors had best hope the country’s latest round of acquisitions are conducted with more strategic sense and sensible valuations. But given the juicy premium being offered by Zoomlion, the latter at least might be a forlorn hope.