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By Denny Thomas and Umesh Desai
HONG KONG, June 3 Minority shareholders of Hong
Kong-listed CITIC Pacific Ltd are gathering on Tuesday
to vote on a landmark deal to acquire $36 billion of assets from
its state-owned parent CITIC Group Corp, China's biggest and
oldest financial conglomerate.
They are expected to give the go-ahead to the deal to buy
practically all of the conglomerate's assets. In doing so, they
will be endorsing not just China's ambition to reform its
state-owned enterprises. They will also be backing a plan to
give CITIC Pacific direct exposure to the mainland's banking
sector - and along with that, the country's bad loans problems.
How CITIC Pacific plans to chart a safe and rewarding
journey through China's banking sector remains unclear. Some
analysts are also concerned about CITIC Pacific's ability to
manage a diversified conglomerate that would include financial
services alongside its current steel and property businesses.
The deal centres on the acquisition of CITIC Ltd, the chief
operating arm of CITIC Group. CITIC Ltd has a number
of businesses, ranging from real estate and natural resources to
manufacturing and engineering. But it derives its income mainly
from financial services, which accounted for 87.3 percent of
total pre-tax profit in 2013.
Driving the bulk of the segment's earnings is China CITIC
Bank Corp. While CITIC Bank is profitable, the bank,
like other Chinese lenders, is exposed to a rising tide of
souring loans as China's economy slows.
"Investors may take a cautious note on their increased
exposure to China's banking sector amid prevailing concerns
about the slowing Chinese economy and potential increase in bad
debts," said Ben Kwong, KGI Asia's head of research. "This will
be a real challenge for CITIC Pacific, and only time will tell
whether they could navigate out of this situation successfully."
CITIC Ltd, as a whole, has also expanded into riskier,
higher-yielding offerings including wealth management products.
Its so-called "maximum loss exposure" to higher-yielding
investments jumped 36 times to 322 billion yuan ($51.5 billion)
at the end of 2013 from 8.97 billion yuan in 2011, according to
a disclosure by CITIC Pacific to its shareholders in April.
Chinese banks, one of the conduits of such products, earn
fees by offering retail investors high-yielding investment
products often backed by loans to borrowers that are struggling
to access normal lending channels. Such borrowers include
property developers, local governments and firms in sectors hit
by overcapacity in a slower economy.
While such products usually don't carry a formal guarantee
from banks that create and distribute them, banks may face
pressure to protect retail investors from losses in order to
safeguard their own reputations.
Analysts widely expect minority shareholders to approve the
deal, after some of them - including Temasek Holdings,
Qatar Holding and AIA Group Ltd - agreed to help
finance the acquisition.
"CITIC Pacific will become a diversified conglomerate
offering an opportunity to engage directly in China's next round
of development," an external spokesman for CITIC Pacific told
Reuters. "Under the continued leadership of Chairman Chang
Zhenming, the enlarged group will maintain its high level of
corporate governance through CITIC Pacific's established Hong
Analysts say CITIC Pacific has to show it has the management
prowess to sail through all this with confidence. Four of the
seven analysts covering CITIC Pacific have a sell rating on the
stock, two have a hold rating, while Jefferies is the only stock
broker with a buy rating, according to Thomson Reuters data.
Confidence is a scarcer commodity these days after the
company miscalculated the huge cost of developing a mine in
Western Australia in recent years. CITIC Pacific said
inexperience was one of the factors for busting its budget. The
company has also made wrong-way bets on the Australian dollar
while hedging currency risks linked to its mining investment.
"The company has a disappointing track record, which is a
big worry when investors look at the current situation," KGI
Asia's Kwong said. "The key challenge is to hire top quality
managers and make them responsible for their actions."
CITIC Pacific has attracted the attention of short sellers,
with the shares currently ranking No.1 on the short-selling list
in Hong Kong. Nearly 72 percent of CITIC Pacific shares that can
be borrowed by short-sellers are out on loan, the most among the
companies listed on the bourse, according to financial data
company Markit. Short-sellers sell borrowed stock with the
intention of buying back the shares at a cheaper price.
THE NEW CITIC
The sense of caution is countered by the prospect of
improving financials. The combined CITIC entity is estimated to
be more profitable, with return of equity (ROE) forecast to rise
four basis points to 13 percent, Jefferies estimates.
In comparison, Hong Kong tycoon Li Ka-shing's conglomerate
Hutchison Whampoa Ltd generates 7.6 percent ROE,
while Swire Pacific Ltd has 6.2 percent ROE, according
to Thomson Reuters data.
"We continue to view the "New Citic" to be a good proxy for
the Chinese economy," Jefferies analyst Christie Ju wrote in a
note. "We expect minority shareholders to support the
acquisition, and expect "New Citic" to become the largest (in
revenue, asset and market cap) and potentially the most
profitable Chinese conglomerate in the Hong Kong market."
The deal, first unveiled in March, was hailed as the biggest
SOE reform in China. It would change CITIC Pacific's business
mix considerably, with financial services set to bring in more
than a third of the new CITIC Pacific's revenue and resource and
energy accounting for just over a fifth, according to Jefferies.
"It is positive from a credit point of view as now the
company is one level closer to government, owns more assets and
its strategic importance is enhanced with the inclusion of an
asset like CITIC Bank," said Moody's analyst Gary Lau, who has
put the company's Ba2 rating on review for an upgrade.
Its bonds due 2020 have rallied 15 points to
trade at 110 cents on the dollar since the announcement, with
the yield dropping 240 basis points to 4.6 percent. Its bonds
maturing in 2023 and 2018 have
also rallied, indicating investors' increasing comfort from the
strong support of CITIC Group, which is wholly owned by the
Chinese State Council, or Cabinet.
($1 = 6.2473 Chinese Yuan Renminbi)
(Additional reporting by Nishant Kumar in HONG KONG; Editing by