What happens to prices when the biggest, reckless buyer walks away?
China’s State Council has issued guidelines on what Chinese companies can and cannot acquire overseas. The purpose is to “promote healthy growth of overseas investment and prevent risks.” These risks would be that the $18 trillion of Chinese corporate debt will balloon further, though much of this debt is already going bad, and that it will blow up, triggering a spectacular financial crisis. This is to be avoided.
So Chinese companies have been given priorities, and their efforts to invest in overseas commercial real estate – such as office towers and apartment buildings – in hotels, and in Hollywood will be axed.
The guideline intends to drive the output of China’s products, technology and services, and deepen cooperation with countries involved in the Belt and Road Initiative.
The government will support “eligible” Chinese companies “to make overseas investment and join in the construction of projects in the Belt and Road Initiative.”
These enterprises should take the lead to export China’s superior technology and equipment, upgrade the nation’s research and manufacturing ability, and make up the shortage of energy and resources through prudent cooperation in oil, gas and other resources.
Other investments will be “restricted,” particularly those “against the peaceful development, win-win cooperation, and China’s macro control policies.” These policies are now being implemented to dodge this spectacular financial crisis.
Among those outbound investments and acquisitions that will be “restricted” and that directly impact US markets and valuations are:
- “Real estate”
There have already been examples of big deals in the US in these three categories that got scuttled – or that succeeded and the Chinese acquirer is now being pushed to unload the property – because Chinese authorities have been putting pressure on their state-owned banks to curtail lending to fund these overseas acquisition binges at peak prices by Chinese conglomerates. Here are just a few:
Real Estate: In April 2016, LeEco, a Chinese company that had surged out of nowhere, bought Yahoo’s 49 acres of land in Santa Clara, Silicon Valley, for $250 million. LeEco was going to build its global headquarters on it and hire 12,000 people. Earlier this year, LeEco scuttled those plans and pulled back from the US, after China’s state-owned banks had refused to lend it more money. It is now trying to unload assets, including this property.
Hotels: Anbang efforts in September 2016 to acquire Starwood Hotels & Resorts Worldwide fell apart. In June this year, its chairman was detained by the Chinse government.
Entertainment: In March this year, Eldridge Industries said that it had terminated its agreement, made in November, to sell its Dick Clark Productions – the company behind the Golden Globes telecast – to China’s Dalian Wanda Group for $1 billion because Wanda had “failed to honor its contractual obligations.” The state-owned banks had turned off the spigot. This comes after Wanda had bought movie producer Legendary Entertainment for white-hot price of $3.5 billion. Wanda, under pressure from Chinese authorities, has since been unloading a number of it Chinese properties.
China outbound M&A targeting US companies has plunged 65% so far this year, compared to the same period last year, according to Dealogic, “amid growing regulatory scrutiny.” Last year, Chinese companies made $65.2 billion in acquisitions in the US, including HNA’s acquisition of 25% of Hilton Worldwide.
“Since then, regulatory agencies have been reviewing and rejecting an increasing number of transactions,” Dealogic said. This is “an effort to stem capital flight and depreciation of the yuan.” There was also more intense scrutiny in the US, particularly by the Committee on Foreign Investment, which is concerned that Chinese investments may threaten national security.
How big of a deal is this Chinese crackdown on outbound investments for the US?
Chinese firms have acquired $17 billion of just commercial real estate – such as office and apartment towers – over the past two years in the US. And it was concentrated in just a few trophy cities.
In Manhattan, Chinese entities accounted for half of the commercial real estate purchases in the second quarter. This includes the $2.2 billion purchase in May of the 45-story office tower at 245 Park Avenue.
In terms of funding new real estate projects, China ranked Number 1 among foreign investors in US commercial real estate in 2016, according to Cushman & Wakefield. In 2016 alone, China invested $19 billion in commercial real estate projects, with the top three targets being: Manhattan, the San Francisco Bay Area, and Los Angeles.
Chinese money is “transforming LA’s skyline, revitalizing neighborhoods, and inspiring additional investment,” the report gushed in March, concerning LA Downtown’s super high-end condo towers Metropolis, the forthcoming Oceanwide Plaza, and other skyscraper mega-projects funded with Chinese money that have been announced, including a complex with three towers by Shanghai-based development firm ShengLong Group. One of the towers will be among the tallest in the city.
Rumors have been swirling for months about how Chinese authorities are strangling the credit flow to the big conglomerates to curtail their growth and reckless borrowing and speculation, and perhaps force them to shrink. One of the big issues was that these companies were borrowing heavily to buy at the peak of the market, after asset prices have run up into the stratosphere for the past eight years. Chinese authorities are worried about the debt, and a financial crisis, and they’re taking steps to get a grip on the risks.
Now we have the official pronouncements, instead of rumors.
For valuations in the US, this is a killer. China has been a big buyer and a big developer, and prices didn’t matter – the higher, the better, it seemed, on the principle that this is just borrowed money. As the money flow from China is succumbing to strangulation by Chinese authorities, other big reckless buyers supported by reckless state-owned banks may not readily materialize. And then the music stops.
Chinese authorities have a lot of tools to keep their debt construct propped up. The upside is fake stability. The downside is too ugly to contemplate. Read… So When Will China’s Debt Bubble Finally Blow Up?
Would you like to be notified via email when WOLF STREET publishes a new article? Sign up here.