Investors are losing money on a number of private investments in Chinese companies, as projections that seemed like sure winners three or four years ago run into trouble.
These investors purchased traditional bonds and bonds convertible into stock ahead of expected initial public offerings and rich stock-market valuations.
The market for private offerings of high-risk, high-yield debt and convertible bonds in Asia took off in 2006 and 2007, backed by strong demand from hedge funds. Deal watchers say the reasons behind the stumbles vary, but together they show that investments in China and other parts of Asia might be riskier than default figures suggest.
Losses can be tough to track because many such deals aren’t reported and involve investors that generally keep their cards close to their vests, such as hedge funds and private-equity firms.
Liquidator firm Borrelli Walsh says more than half of 11 Chinese companies listed in Singapore that sold convertible bonds from 2005 to 2008 are now unable to repay their debts. Their ranks include China Milk Products Group Ltd., Delong Holdings Ltd. and Celestial NutriFoods Ltd., which have all disclosed their problems to Singapore Exchange officials.
The troubled companies together issued at least $700 million in convertible debt, according to Dealogic.
Investors aren’t willing to convert bonds into stock because the current share price is below the conversion price for the bonds and would saddle them with a loss. Some of those companies are involved in payment talks with bondholders.
Another example is China Sun Bio-Chem Technology Group Co., which was delisted by the Singapore Exchange this year after PricewaterhouseCoopers couldn’t verify the existence of bank and trade-receivable balances worth 929 million yuan ($137 million at current exchange rates). The company has since been trying to repay investors in its $100 million convertible bond, which was handled by J.P. Morgan Chase in 2006.
Asia’s default rate on public, speculative-grade corporate bonds was 5.9% last year, according to Standard & Poor’s, lower than the 9.2% global rate and the 10.9% rate for the U.S. But deal watchers say the figure would be higher if the region’s private placements were included.
The number of companies unable to pay their debts prompted the Securities Investors Association of Singapore to ask the Chinese government to discipline some companies, because Singapore doesn’t have the authority to do so. The association has been talking to Beijing authorities this year, though it’s unclear which companies they are discussing or what the disciplinary measures could be.
‘In China, the number of ways a deal can go wrong is very broad and very high,’ said David Patrick Eich, a partner at law firm Kirkland & Ellis in Hong Kong. Problems can range from lower customer demand for products to problems with founders to overoptimistic projections. ‘I’ve never seen a deal fail for the same reason in China,’ he said.
A number of the stricken companies are smaller to midsize firms that don’t have the financial backing enjoyed by larger firms.
In one pre-IPO deal gone awry, Hunan Taizinai Group, a Chinese dairy products producer with backing from U.K. private-equity firm ActisMorgan Stanley and Goldman Sachs Group Inc., went into liquidation this year. Morgan Stanley, for one, has written off its US$15 million investment. The company also owes creditors including Royal Bank of Scotland Group PLC, Singapore’s DBS Group Holdings and Citigroup Inc. at least 300 million yuan.
Market watchers anticipate additional pain brewing in some parts of the Chinese real-estate business, which is getting cut off from bank lending as part of government efforts to clamp down on rampant growth in the sector. Loans from Chinese banks last year saved a number of real-estate deals from default, noted Joel Rothstein, a partner at Paul Hastings in Beijing.
For now, lenders are choosing to ‘extend and pretend,’ preferring to give companies anywhere from six to 12 months more time to try to ‘cure’ the default, say Mr. Rothstein and others.
Creditors in China are particularly vulnerable. Chinese companies are limited from providing collateral to offshore debts, so creditors don’t have much in the way of guarantees.
The specter of Asia Aluminum Holdings Ltd. looms large. The company tried and failed to buy back its debt at pennies on the dollar before going into liquidation. Creditors that included hedge fund Stark Investments, Bank of America Merrill Lynch and Och-Ziff Capital Management Group LLC, already unhappy with what they would have gotten from the company buyback, ended up with even less.
‘Default is valuable only if by putting an issuer into default you get something,’ said Mr. Eich.