China's Gray Rhinos and Why They're Running Scared
By John Bostwick, Managing Editor, Radius
I’m approaching my five-year work anniversary at Radius, and over that time I’ve done a fair amount of reading and writing about global economic issues. God knows I’m still no authority on the subject, but I’ve learned this much: Things change.
This isn't news, I know, especially in the wake of the 2008 global financial crisis. But it’s worth remembering — or, rather, it’s nearly impossible to overlook — that laws governing tax, immigration and employer benefits never stand still, no matter what the jurisdiction. Moreover, we’re consistently confronted by the fact that the sometimes-murky forces shaping economies — such as collateralized debt obligations that helped create the sub-prime mortgage crisis — can be hard to control and understand, and can have unpredictable effects. Those sometimes catastrophic effects are the so-called “black swans” we heard so much about during and after the financial crisis.
Just last year, I wrote a brief piece about how Anbang Insurance Group Co. had offered nearly $13 billion to purchase Starwood, a US-based hotelier. While Anbang’s bid was ultimately unsuccessful, it was part of a pattern of privately-owned Chinese companies offering and often paying huge sums of money in cross-border deals. The Wall Street Journal reported at the time that from January to mid-March of last year alone, private Chinese companies had already agreed to over $100 billion in foreign deals. It added, remarkably, that “the private sector’s share of overseas spending shot up from barely above zero about a decade ago to nearly half of China’s total overseas investments in 2016.” In addition to Anbang, other prominent Chinese M&A players in recent years have included the Dalian Wanda Group, HNA Group, Fosun and Rossoneri Sport Investment Lux.
These companies have dramatically and abruptly changed the global M&A landscape, particularly in the real estate, sports and entertainment, and hospitality industries. Variety reports, for example, that Wanda has “its sights set on Tinseltown glory,” and has closed four cross-border entertainment deals, including the $3.5 billion purchase of Legendary Entertainment in 2016. (Legendary has produced dozens of blockbusters including The Dark Knight, Inception and Jurassic World.) The Wall Street Journal says that “in Hollywood, industry insiders widely believed [Wanda] paid too much.” Chinese regulators agreed, according to Forbes, and they “opined that Wanda had vastly overpaid” to acquire Legendary. There are other examples. After the Starwood bid, for instance, Chinese authorities “expressed displeasure … believing that Anbang had offered too much.”
These freewheeling Chinese companies and their respective leaders are lately referred to in China as “gray rhinos,” a play on “black swans” meant to emphasize that, in the case of the rhinos, economic forces aren’t murky or easily overlooked but plain to see. The New York Times explains that this “herd of Chinese tycoons … [has] feasted on cheap debt provided by state banks, spending lavishly to build their empires.”
The Times adds that Chinese authorities initially encouraged the gray rhinos’ cross-border acquisitions, and state banks supported them with huge loans, all in an effort to bolster China’s economy after the 2008 crisis. A US-based academic quoted by the Times says: “The Chinese government played the role of an indispensable enabler. … If you look at how [these companies] got so big, it’s all through taking on debt.” Now, the gray rhinos are inextricably “enmeshed” in the Chinese economy. And as they have taken on debt, so has China. The Times reports that six years ago, “total credit extended to private, nonfinancial companies was about 120 percent of economic output in China, [and it] is now 166 percent.”
It should come as no surprise that the Communist Party isn’t thrilled about this mounting debt and the increasing influence of privately-owned Chinese companies on the nation’s economy. The Times says that in December, Chinese regulators warned about the risks of “irrational” cross-border deals, and that more recently “the political and regulatory environment [in China] has quickly shifted.” Basically, Party leaders have gone from stoking cross-border investments by private companies to trying to contain them.
As the Journal explains, Party leaders in Beijing — with President Xi Jinping’s “previously unreported approval” — have prohibited state-owned banks from lending money to Wanda as part of a wider effort to rein in the gray rhinos. Authorities have told banks to “scrutinize loans” made to Anbang, HNA and other “high fliers.” A Beijing-based lawyer specializing in M&A told the Journal that the recent government clampdown on China’s privately-owned behemoths “feels like an avalanche. … This is sending a shock wave through the business community.”
The Journal adds that some believe the moves will make it more difficult for private Chinese companies of all sizes to get loans, “which would help shift financial clout further in favor of big state-owned enterprises.” The Journal indicates that the regulatory shift should not affect privately-owned Chinese companies involved in President Xi’s global One Belt One Road initiative. And a Shanghai-based economist tells Bloomberg that China will still support “‘reasonable’ offshore and local investments as long as they contribute to the domestic economy and don’t rely on excessive bank borrowing.” Nevertheless, according to the Journal Beijing’s policy shift does represent “a watershed moment in the Communist government’s relations with a private sector it has never been comfortable with.”
The shift will have effects that extend beyond China’s borders, and will affect operations much smaller than Starwood and Legendary Entertainment. The Forbes article quoted above observes that the change in policy “has cut deeply into the earnings prospects of numerous investment bankers, lenders, attorneys and finance industry professionals who had come to depend upon the loose-spending ways of major players in the PRC.” Another Forbes piece notes that Beijing’s clampdown on lending may even have already affected the housing markets in Toronto and Vancouver.
So, again: Things change.