In the space of just 12 months, Chinese airline-to-finance conglomerate HNA has morphed from a symbol of the ambition and wealth of China Inc into a cautionary tale of corporate indebtedness.

Its $146bn in global assets range from airports to trucking companies, shipping groups and stakes in Deutsche Bank and the Hilton hotel chain. But it is the company’s stretched finances, and questions over its ultimate ownership, that have brought it to international attention in recent months. The case illustrates how a particularly Chinese mix of debt and politics can affect markets far from its shores.

“There was this environment where the Chinese government said ‘Go West! Go forth and conquer!’ and they started doing that,” says Veronique Lafon-Vinais, of the school of business and management at Hong Kong University of Science and Technology. “If you build conglomerates with leverage, sooner or later it catches up with you.”

About $20bn in US dollar-denominated bonds issued by HNA and its subsidiaries are due to mature in 2018 or 2019. The yields on three of those dollar bonds issued by HNA’s main Hong Kong subsidiary have spiked, doubling this month to more than 18 per cent.

There are also signs of a cash crunch rippling through the group’s complex structure, which includes 16 listed entities and many layers of shell companies and crossholdings. Several have raised debt from Chinese banks and HNA has also turned to high-interest peer-to-peer loans, making its renminbi-denominated debt harder to quantify.

HNA charts

The powerful China Development Bank has Rmb50bn ($7.9bn) in outstanding loans but has pledged its backing. HNA has said the company has Rmb300bn in unused credit from Chinese banks, of a total Rmb800bn credit lines.

On Friday HNA sold an Australian office block to US buyout group Blackstone for A$205m ($166m) in an attempt to boost cash reserves.

Debt-fuelled expansion is a common strategy in Asia, tripping up companies from South Korea to Thailand and Indonesia when the Asian financial crisis hit in 1997 and creating worries about systemic risk in China today. The goal is to build influence through size, while securing assets, especially land, that will later appreciate in value. The risk lies in the debt pile exceeding an ability to service it, especially during a downturn or in a less favourable political climate.

For three years, HNA had international asset managers salivating as it gobbled up global assets in a $40bn shopping spree. Last February Blackstone, which frequently sells to Chinese buyers, hosted HNA co-founder Wang Jian in a charity fundraiser in New York, featuring glitzy gold masks of Mr Wang’s face. Two months later HNA inked one of its highest-profile deals, with the purchase of a 9.9 per cent stake in Deutsche Bank, Germany’s biggest lender.

Yet HNA now looks like an example of how rapid expansion can backfire, especially when political shifts suddenly leave a group’s debt level too large to handle. It may offer a lesson for foreign banks, hedge funds and other investors as China turns to the markets to finance its next round of infrastructure and its Belt and Road investments in Eurasia and Africa.

HNA investments

Swissport

The largest cargo handler in the world, HNA subsidiary Swissport is looking to raise cash via a public listing in 2017

Deutsche Bank

HNA bought a 9.9 per cent stake in Deutsche Bank, Germany’s biggest lender, in April using funding from UBS

In late 2016, regulators concerned at the rapid capital outflows from China managed to convince President Xi Jinping that financial risk was a matter of national security. But even as regulators began to clamp down on the outflows, HNA and other large, politically connected companies appeared to be able to carry on as normal, completing purchases such as the Deutsche Bank stake using offshore financing.

Then HNA was swept up in the a factional tussle ahead of Mr Xi’s second five-year term. At issue was the future role of Wang Qishan, Wall Street’s primary contact among the Chinese elite and the man leading Mr Xi’s anti-corruption purge, who some hoped would stay in post beyond retirement age.

A self-exiled businessman, Guo Wengui emerged as an unlikely internet star when he railed against Mr Wang and alleged ties between the politician’s in-laws and HNA. Mr Wang has never commented on the claim. In the summer regulators ordered credit checks on HNA and three other well-connected conglomerates with extensive overseas investments which had often raised money via China’s shadow financing market. Mr Wang retired from his seat on the elite Politburo Standing Committee in October. The questions raised by Mr Guo, however, continue to haunt HNA by turning a spotlight on the ownership of the group.

“Now is our time of the oligarchs,” says one private executive of a Chinese company, likening the Xi clampdown to Russian president Vladimir Putin’s purge of billionaire businessmen.

To counter the perception that China’s ruling Communist party is hostile to business, officials have reassured international visitors that Beijing respects private assets. At the World Economic Forum in Davos last week, Mr Xi’s closest financial adviser, Liu He, was at pains to assure the elite crowd that Beijing supports “economic globalisation” while warning against high debt and asset bubbles in international financial markets.

Politburo Standing Committee member Wang Qishan attends the opening session of China's 19th Party Congress at the Great Hall of the People in Beijing, Wednesday, Oct. 18, 2017. Chinese President Xi Jinping on Wednesday urged a reinvigorated Communist Party to take on a more forceful role in society and economic development to better address "grim" challenges facing the country as he opened a twice-a-decade national congress. (AP Photo/Mark Schiefelbein)
Wang Qishan © AP

In the fourth quarter of 2017, HNA was forced to begin rolling over loans and delaying payments at various subsidiaries. Executives insist its liquidity woes are a temporary byproduct of the year-end cash crunch that many Chinese companies face as domestic banks’ lending quotas expire. Board member Zhao Quan said in December that cash flow from its tourism and aviation businesses was “healthy”.

The scrutiny on HNA’s finances has not let up. Investors are waiting to see how, or whether, the conglomerate will extricate itself. Normally, indebted companies can sell assets to raise cash. A Financial Times review of HNA’s acquisitions, however, shows that solution may not be as simple as it seems.

The problem is that HNA’s debt levels make it hard to realise the full value of some of its assets. Many are already heavily leveraged, and shares of the listed companies have often been pledged to banks as collateral. Two months after chief executive Adam Tan pledged to sell assets, it has announced only one big sale, the Australian property deal.

As a result, HNA’s finances are creaking under the weight of debt. Its main Hong Kong-listed unit has $800m in US dollar-denominated bonds due this year and a further $5.3bn by 2019.

HNA charts

The group has suspended trading in the shares of seven of its 16 listed subsidiaries, citing an upcoming asset restructuring that one subsidiary called “wide-ranging, large-scale and involving many discussions and negotiations”. It has pledged most of its shares in those subsidiaries to banks as collateral for loans, according to stock market filings.

Some of the company’s assets, including its Chinese airports, are state infrastructure that cannot be easily divested. Others would be attractive prizes, but many of its international assets were purchased using shares in the target company as collateral. “In and of itself, there’s nothing wrong with that. This is what private equity and leveraged buyout firms have done for decades,” Ms Lafon-Vinais says. “But it makes it very complicated to unravel.”

If HNA were to try to sell assets purchased in this way, a large portion of any sale revenue would end up back with the lender in that transaction, not HNA. “The net amount it releases isn’t as much as the gross amount of the shareholding would imply,” says Nigel Stevenson, an analyst at Hong Kong consultancy GMT Research. “And you don’t want to announce to the world that you are doing it.”

Late last week Swissport, HNA’s Swiss aviation services subsidiary, said it was looking to raise cash through an initial public offering this year. But four bond market investors told the FT that they thought the proposed IPO would be challenging given the aviation services company’s more than €1bn of leveraged loans and junk bonds, and its relationship with its parent. Swissport has made a series of short-term loans to HNA affiliates in the past four months.

“I don’t see how this IPO is going to happen,” says one investor. “Swissport is still more than six-times leveraged and who will want to be a minority shareholder alongside HNA?” Swissport said it could not comment on the investor’s opinion.

HNA investments

Hilton

HNA spent $6.5bn on a 25 per cent stake in Hilton Hotels in 2016 — part of a push into leisure and hospitality

Avolon

The aircraft leasing company, bought in 2015, is controlled by Bohai Capital — HNA’s main domestic financing arm

On the domestic front, the use of share pledges by HNA to get bank loans would similarly complicate any sale. The practice is common among Asian private companies and can be useful in periods of growth, like those seen in most Asian markets in recent decades.

Pledging shares in a rising market lifts the value of the collateral. But downturns tend to be sudden and vicious, because as shares lose value they trigger calls from banks for repayment or additional collateral. This can snowball as share prices drop, triggering margin calls on other unrelated companies. “It’s a typical inverted structure which increases systemic risk,” says Michael Pettis, a professor of finance at the Guanghua School of Management at Peking University.

HNA’s liquidity woes could ultimately turn into another kind of political test — this time of China’s legal system. International investors have lost money before on bonds issued by Chinese companies, and discovered they had little ability to make claims in mainland China. In a 2013 debt dispute, a Chinese creditor had to turn to a South Korean court to seize a cruise ship operated by an HNA subsidiary.

The conglomerate now has many more operations, opening the possibility of competing claims lodged against assets in multiple jurisdictions.

Roger King of CreditSight in New York says investments such as the HNA stakes in Deutsche Bank and Hilton are shielded from cross-financing that might complicate any asset sale. But bonds issued by HNA’s Avolon aircraft leasing subsidiary “have very little protection against upstreaming money into Bohai Capital [HNA’s main domestic financing arm]”, he says.

Equity analysts say HNA’s risk weighs primarily on its overseas subsidiaries. The group’s domestically listed companies “are healthier than [HNA’s] financial companies”, Citic Securities said in a research note in December.

Goldman Sachs chimed in this month, saying the group has “strong cash generating assets” but warned over debt and cash flow mismatches among some of the subsidiaries. The core airline and tourism business generates cash, although HNA has already pledged the revenue from some of its air routes to a Chinese trust company.

There is some optimism too in China’s plan to allow airlines to raise prices on well-served domestic routes this year — but that benefits HNA less than its three state-owned competitors, which dominate the major routes.

For HNA, that’s part of the problem. Beijing’s bias towards state-owned groups forces private rivals to over-expand to compete. The conglomerate, which started life as Hainan Airlines with a single plane in 1993, has survived turbulence before. However, the ride this time threatens to be far more bumpy.

Additional reporting by Archie Zhang in Beijing, Kiran Stacey in Hong Kong and Robert Smith in London

Dealmaking: Ownership question dogs HNA expansion

In this July 25, 2017, photo, White House communications director Anthony Scaramucci walks back to the West Wing of the White House in Washington. Scaramucci is out as White House communications director after just 11 days on the job. A person close to Scaramucci confirmed the staffing change just hours after President Donald Trump’s new chief of staff, John Kelly, was sworn into office. (AP Photo/Pablo Martinez Monsivais)
Anthony Scaramucci © AP

Hedge fund investor Anthony Scaramucci sold his firm, SkyBridge Capital, to HNA Group to smooth his path to joining the Trump White House. A year later the deal is still awaiting approval from the Committee on Foreign Investment in the US (Cfius), which vets sensitive foreign purchases. Mr Scaramucci has long since left the administration.

The main stumbling block to completing the SkyBridge deal is uncertainty over HNA’s ultimate ownership, according to a lengthy US lawsuit filed after a separate HNA deal fell through this autumn.

Exiled Chinese businessman Guo Wengui created a stir last year when he claimed that the family of Wang Qishan, until October the head of China’s anti-corruption purge, benefited from ties to HNA. Mr Wang has not commented on the claim. The FT has not been able to verify it. Company executives subsequently revealed that 29 per cent of HNA shares — held overseas by Indian-American businessman Bharat Bhise and a Beijing spa owner, Guan Jun — in fact belonged to HNA insiders.

The group’s chief executive Adam Tan told the FT last summer that a small group of HNA shareholders, including himself, would inject that 29 per cent stake into the New York-based Hainan Cihang Charity Foundation. The foundation is seeking accreditation as a charity in order to become HNA’s major shareholder but has given conflicting answers on the progress of its application to the Internal Revenue Service for 501(3)(c) status, allowing donations to be made tax-free.

Regulators in at least six countries are now scrutinising HNA deals — including some that have already been approved — to identify who owns the company. As a result one deal In New Zealand has been blocked and HNA has been forced to cancel another.

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