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BFCSA: Era of Chinese exuberance over as Beijing brings dealmakers into line

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Era of Chinese exuberance over as Beijing brings dealmakers into line

Australian Financial Review Aug 11 2017 11:00 PM

Lisa Murray, Angus Grigg

 

Just 10 minutes after looking over an industrial site in the inner Sydney suburb of Erskineville, Chinese billionaire Feng Di was ready to make an offer.

Over coffee at a nearby cafe, Feng put his opening bid down on paper, or on the back of a napkin to be more precise.

"He didn't speak much English so he just wrote the number down and let me tell you it had a lot of zeros on the end," said one person familiar with the event.

That opening offer in late 2014 would eventually lead to a $380 million signed contract by Feng's Golden Horse Group for what was then the largest urban land deal in Australian history.

Over the next few years, a spate of deal-making by cashed-up Chinese investors spawned hundreds of similar anecdotes, injecting price tension into sales processes for everything from apartment blocks, office towers, mines, ports, cattle stations, dairy farms and vitamin companies.

Australia's real estate sector was transformed. In early 2015, Wang Jianlin, who was then China's richest man, set his sites on Gold Fields House in Circular Quay. His Dalian Wanda Group paid $415 million for the landmark Sydney property, adding to its portfolio, which already included plans for a $900 million resort on the Gold Coast.

Two years on, the Wanda deal is still remembered as a high water mark for Chinese exuberance and the offshore investment frenzy sparked by Beijing's encouragement for its firms to go overseas. But this week, Wanda, under pressure from Beijing to crimp its offshore expansion and reduce financial risk, restructured its Australian assets in what many believe is the first step toward a sale. The group's Hong Kong-listed entity announced it was selling a 60 per cent interest in both the Gold Coast and Sydney projects to a related private company controlled by Wang.

The deal is a worrying signal for Australia, which has received $US90 billion in Chinese investment since 2007, putting it second only to United States, according to KPMG.

Containing risk

In a series of sharply worded edicts from authorities, Beijing appears to have called time on this era of overseas deal making and begun reining in the private and state-owned companies that propagated it.

Containing financial risk is the Communist Party leadership's new priority and that includes flashy overseas acquisitions. There is concern this new direction could lead to a spate of sales.

At the very least, Fraser Howie, an expert on Chinese regulation and co-author of "Red Capitalism", says the days of the Chinese bidder coming into a sales process and paying top dollar with scant due diligence are over.

"We're not going to see the splurge over the next few years that we've seen over the last few years," he says.

Deals are "going to be smaller, more concentrated and more focused".

The reason China policymakers are taking such radical action is due to the scare they received last year when capital started flowing out of the country in record amounts.

Foreign reserves, which had long been a source of pride for China and a handy war chest in times of economic turmoil, tumbled from just under $US4 trillion in June 2014, to slightly less than $US3 trillion in January. They have since bounced back above that important comfort level but it was a wake-up call in Beijing and authorities responded by strengthening capital controls and increasing oversight of foreign exchange transactions.

It warned potential acquirers against buying "non-core" assets overseas – a de facto ban on the purchase of football teams and iconic hotels – and demanded state-owned companies explain valuations and financing arrangements for any potential deal.

Competitive tension

The tighter reins had an immediate impact. Total outbound investment dropped nearly 46 per cent to $US48.19 billion in the first half of the year, according to the Chinese Ministry of Commerce. Offshore property investment plunged 82 per cent over the same period.

However, Beijing's biggest surprise came two months ago. With the Communist Party waging a war against financial risk, the China Banking Regulatory Commission directed lenders to review their exposures to the country's most aggressive corporate players.

Those targeted included Wanda, Anbang Insurance, which bought New York's Waldorf Astoria in 2014, HNA, which holds a 13 per cent stake in Virgin Australia and Fosun Group, which has made a string of European acquisitions and is developing apartments in Brisbane and Sydney.

These companies are all headed up by executives with high-level connections in Beijing and have spearheaded China's push overseas. Their targeting by authorities has reverberated across deal rooms around the world.

With Beijing's blessing and as China's economy began to slow, giants such as Wanda had moved their investment focus offshore. Australia, with its shared time zone and being a popular destination for Chinese tourists and students, became a favoured market.

One investment banker in Sydney said that in the infrastructure space Chinese buyers had added between 20 and 30 per cent to the price of assets.

"When you are in a process, the sense that the Chinese are there drives your client harder," says the banker, who has been involved in many of Australia's major infrastructure deals.

He says record prices have been paid for Australian infrastructure assets in recent years, partly due to the Chinese adding competitive tension to the bidding process.

'A return to more sensible valuations'

There is now a fear deals will dry up amid rigorous scrutiny from Chinese authorities and limited access to funding for big overseas transactions.

KPMG's Doug Ferguson, who compiles an annual report on Chinese investment in conjunction with Sydney University, says it has been a noticeably slow start to the year for Chinese deal-making in Australia.

He says commercial real estate investment has fallen away considerably, as has the appetite of Chinese buyers to own agricultural land outright.

"Maybe we will see a return to more sensible valuations [in commercial property] driven by strong local players," he says.

"I think, however, if you are in branded food, health services or renewable energy then there will still be a strong appetite for deals from Chinese buyers."

But these deals are expected to take longer to complete and the number of Chinese buyers sniffing out opportunities in Australia is likely to be far smaller.

Andrew Lumsden, a Sydney-based partner at Corrs Chambers Westgarth says the State Administration of Foreign Exchange (SAFE) has become the most important approval for Chinese deal makers. Traditionally, the important sign off has been the one from China's top economic planning agency, the National Development Reform Commission, or the Ministry of Commerce. The elevation of SAFE's role is an indication of how capital controls have moved up Beijing's priority list.

"The year 2016 was a big year in terms of M&A activity," says Lumsden. "We're continuing to see pretty good flows but not quite in the same way. There is more caution, more deals involve syndicates and it is important to have a good understanding of the SAFE approval process."

Impact on real estate

The new capital controls will not just affect the big M&A deals in the infrastructure and real estate sectors. They will also have a significant impact on the residential property market.

China was the largest foreign buyer of Australian real estate in the 2016 financial year, according to a recent report by Morgan Stanley, investing about $32 billion, almost four times more than the next largest buyer, the United States.

"We estimate $20 billion of residential transactions related to Chinese investors, hence the impact of slowing Chinese demand on residential will be the most significant," Morgan Stanley said in its report.

As part of Beijing's campaign to curb capital outflows, China's regulators are more strictly enforcing the foreign exchange quota for individuals of $US50,000 a year and closely monitoring transactions.

"Capital controls on individuals and corporations should affect demand and pricing," Morgan Stanley says.

Within commercial real estate, it said the office sector would be most affected as Chinese buyers accounted for between 12 and 25 per cent of transaction value over the last two to three years.

Despite attracting some criticism for increasing state control over the economy, Beijing's capital controls appear to be working as flows have stabilised. Foreign reserves have risen for six straight months, standing at $US3.08 trillion in July, the highest level since October.

 

Optimists note this more comfortable situation may ease the pressure on foreign deals. However, Chinese policymakers have been helped along by a weaker US dollar. Any reversal of that trend could result in further tightening of the capital controls and more glum news for offshore deal making.

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