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.
Sell rating
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 <0013.HK> generates 7.6 percent ROE, while Swire Pacific Ltd <0019.HK> 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 2020have 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.
Source: Reuters
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.
Sell rating
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 <0013.HK> generates 7.6 percent ROE, while Swire Pacific Ltd <0019.HK> 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
