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China Cracks Down On its Conglomerates

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In nature, crocodiles are apex predators. They sit at the top of the food chain. As adults, they’re not preyed upon by any other species in the wild.

China’s “financial crocodiles” similarly sit atop their respective financial market food chain.

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These large Chinese conglomerates are headed by high-profile billionaires like Wang Jianlin of Wanda Group (net worth estimated at US$28.7 billion), Wu Xiaohui (over US$1.1 billion) of Anbang Insurance Group, Guo Guangchang (US$7.3 billion) of Fosun International Limited, and Cheng Feng (undisclosed, but lots…) of HNA Group Co. Ltd.

These crocodiles are well known outside of China for their large-scale and aggressive overseas acquisition and investment sprees over the past couple of years.

And make no mistake, these crocodiles have been feasting…

Billions of dollars in deals

For example, Dalian Wanda paid US$3.5 billion for Legendary Entertainment Group, the producer of some 50 feature films (including The Dark Knight, The Hangover, and Godzilla) last year.

Meanwhile, HNA Group paid US$6.5 billion for 25 percent of hospitality group Hilton Worldwide.

Fosun purchased Club Méditerranée (the group behind the Club Med resort chain) for US$1.1 billion, and paid US$1.5 billion for the Cirque du Soleil entertainment company.

And Anbang bought Strategic Hotels & Resorts (a hospitality REIT) for US$6.5 billion. And notably in 2014, it bought New York’s landmark Waldorf Astoria for US$1.95 billion.

These four companies alone have executed over US$55 billion of outbound deals in the past five years, according to Dealogic. And of the US$221 billion in overseas acquisitions out of China in 2016, US$24 billion came from these four crocodiles.

But whilst these companies may be top predators, that doesn’t mean they’re invulnerable.

The crackdown on these crocodiles

In nature, the hippopotamus, weighing up to one-and-a-half tons with a huge yawning mouth and large tusks, can easily kill a crocodile. They may be herbivorous, but they can be unexpectedly aggressive.

Chinese President Xi Jinping is the hippo. And this year he has been reminding these crocodiles who’s really in charge.

Last month, China’s banking regulator (the China Banking Regulatory Commission) issued an order for domestic banks to investigate the potential “systemic risk” that these crocodiles pose to the domestic financial system. And Anbang’s Wu Xiaohui was detained by authorities, probing whether or not he was involved in any kind of “economic crimes” in his role at Anbang.

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(It’s not the first time a big conglomerate chairman has been asked to assist with certain investigations (which, one would imagine, is something of a Godfather-esque offer you can’t refuse). In 2015, Fosun’s Guo Guangchang went AWOL for a few days to help financial law enforcement.)

The narrative from up high is that these companies have possibly overleveraged themselves through domestic lending to fund their overseas acquisition sprees, which could put stress on the financial system should one of these crocodiles run into trouble and find themselves unable to pay back their debt.

Or as central bank governor Zhou Xiaochuan put it, “The experience of the global financial crisis tells us that the first priority is to keep financial institutions healthy so that financial crises could be prevented. We cannot tolerate phenomena such as heavy leverage, low capital and non-performing loans.”

But there are reasons beyond keeping these companies healthy for Xi Jinping to make his presence felt.

First, it’s a simple reminder to visible tycoons of multibillion-dollar conglomerates of who’s in charge. Nobody is bigger than the party. And making an example of wealthy tycoons could rein in overly aggressive acquisitions.

Second, whilst China wants to see its domestic enterprises go forth and acquire, it needs to be done at a sensible pace. As the chart below shows, outbound merger and acquisition volume out of China had been increasing steadily until it exploded in 2016 from US$100 billion to over US$200 billion in outflows. This represents a nearly four-fold increase compared to 2011.

This kind of outflow is not sustainable. And what’s more, it’s potentially destabilising for the renminbi currency. Big capital outflows often necessitate selling local currency to buy the acquisition asset currency, typically euros or dollars. This can put excessive downward pressure on the renminbi and complicate efforts by authorities to maintain a stable currency. There’s also a risk that the broader public views such outflows as capital flight, which in turn can exacerbate renminbi selling pressure as others look to join the crocodiles in taking money offshore.

The final reason is political. These tycoons made their fortunes well before Xi’s ascent to the throne in 2012. Therefore, they have closer ties with the old political guard, not the new administration.

In the cutthroat house of cards that is Beijing politics, you keep your friends close. And your enemies of dubious political loyalty? Well, you purge them as best you can.

This autumn sees the 19th National Congress of the Communist Party of China, an event that elects new leadership within the ranks of the party. There’s little doubt that Xi will be elected as General Secretary (the top leadership position within the party). But thus far Xi’s ability to consolidate power has been striking, especially through his anti-corruption campaign that cleared out a lot of political opposition.

What does this mean for Chinese stocks?

For financial markets, these periodic crackdowns bring about intermittent bouts of volatility. But beyond that they don’t fundamentally alter our bullish view on Chinese stocks.

And it’s important to note that these clampdowns, messy as they are sometimes, do ultimately encourage stability. So expect to see the trend of billionaire tycoons taking out big loans for high (or over-) priced overseas asset purchases diminish in the short term.

Good investing,


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