Saturday, March 14, 2015

In China, a Building Frenzy’s Fault Lines (Kaisa)

New York Times


MARCH 13, 2015

As the real estate market in the United States was collapsing in the mid-2000s, Wall Street went in search of new terrain, and found it in China. All across the country, from Beijing to Shenzhen, sprawling housing developments and business districts were popping up, seemingly overnight. Real estate prices were soaring. Western banks, hedge funds, private equity firms and other investors wanted a piece of the action.

Billions poured into Chinese real estate, and big foreign financial firms hunted for the next hit — the small bet that investors could ride to great heights. One of those firms, Credit Suisse, scoured the landscape and in 2007 discovered Kaisa, a relatively small property developer in Shenzhen that mostly bought and rehabilitated distressed properties. Credit Suisse brokered a $300 million investment deal for Kaisa, and two years later, it went public. Its chairman, Guo Yingcheng, posed for photographs on the floor of the Hong Kong Stock Exchange holding a statue of a bull, which seemed to signify hopes for his company’s coming bull run. His colleagues poured Champagne into an ice sculpture of the company’s stock code: 1638.

With the $450 million raised in the initial public offering, Kaisa embarked on an aggressive expansion into 20 more cities. It formed a partnership with Marriott hotels and announced plans to build one of the world’s tallest buildings. Kaisa shares skyrocketed, helping lift the fortunes of its Western patrons, including the Carlyle Group, an American private equity firm.

Then came the fall.

The real estate market slumped, dragging down the rest of the Chinese economy. Developers, in particular, were under pressure, as foreign investment dried up.

And in this market tumult, reports surfaced late last year that Kaisa’s chairman was being questioned in a corruption case. With little explanation, in December, Shenzhen authorities blocked Kaisa from selling homes at several major residential developments.

Soon after, Mr. Guo, the chairman, resigned “due to health reasons.” A string of resignations followed that wiped out virtually the entire senior management team, including the chief executive, chief financial officer and the head of investor relations.

The chairman’s family bailed out of the company in February, agreeing to sell its 49 percent stake to a Chinese developer for $580 million, a small fraction of its value just months earlier.

Stock investors got burned as Kaisa’s share price fell 55 percent in just a few months. The developer had also tapped the debt markets, selling $2.5 billion worth of bonds overseas to big fund management companies like BlackRock and Fidelity Investments.

Kaisa is now pushing such bondholders to accept roughly 50 percent of the value of their holdings, or risk getting pennies on the dollar if the company goes bankrupt.

“We’ve seen problems with other developers, but nothing like this,” said Peter Churchouse, a property consultant in Hong Kong and a former executive with Morgan Stanley. “There’s a deep mystery here.”

The Kaisa story offers an unusual window into what can go wrong when investors rush headlong into China. In a country where the profits have been so tempting, the warning signs — the complex corporate structures, the opaque deals, the political influence — often go unheeded. Investors, even sophisticated investors, either miss them or ignore them.

The Chinese authorities have offered no reason for their decision to freeze sales at Kaisa properties. And the company’s executives are not talking. But there were hints. Reports of bribery. Insider deals involving more than a dozen of the chairman’s relatives. An increasingly complex network of affiliated companies. And a land development project tied to a former Chinese security chief and Politburo member, Zhou Yongkang, who was arrested and expelled from the Communist Party last year in one of the biggest graft cases in decades.

The most striking details about Kaisa were public. Court documents from a 2010 corruption trial in southern China show that the chairman, Mr. Guo, confessed to paying a $130,000 bribe to a high-ranking judicial official in Guangzhou to gain favorable treatment in a Kaisa property deal. And while the company has never acknowledged the case in public filings, the details are available in the court’s verdict.

“Many investors are shocked at what happened,” says Neil McDonald, a lawyer in Hong Kong for Kirkland & Ellis, which is advising some of Kaisa’s bondholders. “It’s troubling that in a market as sophisticated as this, no one knew what was going on.”

A Murky Past

Kaisa’s 2009 initial public offering prospectus is a mind-numbing 837 pages of data. It includes a corporate history and a compendium of regulations, risks, financial covenants, options plans and term loan facilities. It also contains a breakdown of Kaisa assets, a corporate chart with 90 affiliates, and mailing addresses for the directors.

But a search for the most basic biographical information about the company’s chairman and co-founders, usually standard fare in offering documents, will end in disappointment. The prospectus says nothing about Guo Yingcheng’s education or work history before he founded Kaisa, at 35. Nor does it include the work histories of other important players, including his brother, the vice chairman.

How Mr. Guo, 50, made his early fortune is a mystery, even to research analysts who have covered Kaisa for years. “There’s a history of Kaisa, but not too much on how the founders made their money,” says Franco Leung, an analyst at Moody’s Investors Service.

Mr. Guo is from Chaoshan, a region of southern China that is the birthplace of some of the country’s most dynamic entrepreneurs. He grew up in a poor village, called Tieshanyang, dotted with ancestral temples and clay-tiled homes. Residents say that Mr. Guo is the son of a local shopkeeper and that he left home at 16 to join his uncles on Hainan Island, where he sold fish and traded in imported goods.

“He went to Hainan after the opening and reform,” says Guo Wenxiong, a resident of the village. “He just sold some household goods, at that time, whatever you could sell. Later, his business picked up, and he brought his brothers to Hainan.”

After that, his story has major gaps. Corporate records suggest that he and his brothers worked in property construction or the import and export business.

What is known is that by 1999, Mr. Guo had amassed enough money to start Kaisa, in China’s fast-growing manufacturing center Shenzhen. From the outset, the company focused on redeveloping distressed properties near one of Shenzhen’s biggest industrial parks.

When Credit Suisse found Kaisa, the company had completed only a handful of residential developments, hardly noteworthy for their architecture or amenities. But given the property boom, the bank saw the potential, as did investors. The Carlyle Group, the Singapore investment fund Temasek Holdings and other investors bought a 12 percent stake in Kaisa in 2007 for $300 million. [Note: Temasek sold its shares before the collapse in May 2011.] That deal helped attract investments from a group of Hong Kong tycoons, including the billionaires Cheng Yu-tung and Lee Shau-kee.

Energized with money from major backers, Kaisa underwent a rapid transformation. The developer started building residential communities with aspirational names like Lake View Place and Monarch Residences, and built more than a dozen hotels, including the Jinsha Bay Kaisa Marriott Hotel in Shenzhen. 

Kaisa then went in search of more money, this time tapping global bond investors. Citigroup, JPMorgan Chase and Credit Suisse lined up to win a share of the fat fees from selling the bonds. Mutual funds and other major investors were attracted by the high interest rates, up to 13 percent. In all, Kaisa sold about $2.5 billion in bonds.

“They were a turnaround story,” said Wee Liat Lee, a property analyst at BNP Paribas. “They had started out with bad-quality land and then got better land and hired good people.”

Carlyle, which sold the last of its stake in Kaisa in 2012 at a decent profit, declined to comment. Citigroup, Credit Suisse and JPMorgan Chase also declined to comment.

As the money poured in, Kaisa’s deals started to look increasingly risky, fraught with potential conflicts of interest. Company disclosure became less transparent.

Corporate records filed with the Chinese authorities show that more than a dozen of the chairman’s relatives have been involved in Kaisa property deals, including his father, brothers, cousins and in-laws. One affiliate was set up by the spouse of a Kaisa senior executive. Another was registered by two low-level Kaisa employees who, until recently, were cooks at the company’s headquarters, according to interviews with employees.

Regulators often require detailed disclosures on deals with affiliates. The risk is that such parties could siphon off money from the company or allow senior executives to make deals with favorable terms to friends and relatives, at the expense of the company.

As Kaisa grew, it also became entangled in power politics.

According to corporate documents, Mr. Guo and several Kaisa affiliates last year acquired a large stake in National Trust, a midsize financial services firm based in Beijing that has long had connections with the relatives of the former prime minister Wen Jiabao. In 2004, the prime minister’s daughter, Wen Ruchun, held a stake in National Trust through a network of shell companies using an alias, Lily Chang. Mr. Guo and the Kaisa affiliates bought the position from companies controlled by the Hong Kong businessman Zheng Jianyuan, a longtime partner of the Wen family.

A National Trust spokeswoman denies such a sale took place and says the privately held firm had no relationship to Kaisa.

Kaisa may have also stepped into a political minefield by acquiring land in the city of Chengdu with a company partly controlled by the relatives of the former Politburo member Zhou Yongkang. Mr. Zhou’s downfall last year set off political fallout that has rippled through the business community. A group of Communist Party officials who worked with Mr. Zhou were arrested, while business executives who were in partnerships with his family have also been detained or imprisoned.

Battle for the Tower

The Sinopec Tower is one of Kaisa’s flagship properties. The building, in Guangzhou, one of southern China’s biggest cities, consists of two 51-story office towers and a six-story shopping arcade. One of the shops is a Chaoshan-style restaurant that cooks food from Mr. Guo’s hometown.

But Kaisa took control of Sinopec Tower in a controversial deal, tainted by bribery and corruption.

Sinopec Tower was originally developed by a Chinese businessman named Zhong Hua in the early 1990s. His vision was to build an office and shopping complex that would anchor the city’s newest commercial corridor. He called it Zhongcheng Plaza.

But in 1996, as the complex was nearing completion, work was halted by a court order. A state-owned company had demanded payment for debts it said were owed by one of the building’s partners. The court case dragged on for years, and the project languished.

In 2004, a proposed sale fell apart when the buyer was accused of fraud. That is when Kaisa stepped in. Kaisa, with court approval, acquired Zhongcheng Plaza in 2006 for about $118 million, according to state-run media. Soon after, Kaisa sold one of the plaza’s two office towers to Sinopec for $160 million. Kaisa kept the other tower and shopping mall, valuing those three years later, in its I.P.O. prospectus, at more than $200 million. It was an extremely profitable investment.

Two years later, however, a case against a high-ranking judicial official at the Guangdong High People’s Court cast a shadow on Kaisa’s deal. The judicial official, Yang Xiancai, was arrested on corruption charges.

At his trial, Mr. Yang confessed to receiving many payoffs, including a $130,000 bribe from Kaisa’s chairman, Mr. Guo, for help acquiring Zhongcheng Plaza. Mr. Yang is now serving a life sentence. During the trial, Mr. Guo confessed to making the bribe payment, according to the court verdict. He escaped punishment.

In a recent interview, Mr. Zhong, the original developer of the site, said that the judicial officer, Mr. Yang, had pressured him to sell at a below-market price.

“They were working together,” Mr. Zhong said about Mr. Yang and Kaisa’s chairman, Mr. Guo, who both grew up in the Chaoshan area. “I got trapped by this Chaoshan group.”

While he refused to go along, the court approved the sale to Kaisa anyway. Mr. Zhong said he never received a penny.

Neither Kaisa nor Mr. Guo ever publicly commented on the case or discussed it in regulatory filings.

But it was no secret. In 2010, accounts of the trial, and the battle for control of what became known as the Sinopec Tower, were published in major Chinese publications.

A publication affiliated with Xinhua, the official government news agency, even described the Sinopec Tower deal with Kaisa as a miscarriage of justice by a “manipulated judiciary.”

It did not register outside China. Analysts called the stock a “preferred name” and a “top pick.” Kaisa’s stock price soared, and global bond investors snapped up billions of dollars of offshore debt.

None of them reached out to Mr. Zhong, the original developer, or the lead lawyer in the trial of the judicial officer.

“No, one ever called about that,” said Yang Wenlong, Yang Xiancai’s lawyer. “We didn’t hear from any Kaisa investors.”

Reversal of Fortune

Kaisa, the champion of redeveloping distressed property in Shenzhen, is now a distressed asset.

After sales of its Shenzhen properties were blocked by the authorities last December, the bad news piled up. In January, the company missed a payment on a $50 million loan from the British bank HSBC. Analysts began speculating about whether the developer would file for bankruptcy.

Adding to the worries, Kaisa announced in February that its debt was valued at $10.4 billion, twice earlier projections. Several analysts said that it appeared the company had been borrowing through off-the-books affiliates, perhaps making its balance sheet look stronger than it was.

A lot of these Chinese developers are leveraged to the teeth,” says Anne Stevenson-Yang, an analyst at J Capital Research.

Now investors, creditors and banks are fighting over its assets. Sunac, the Chinese developer, has agreed to pay $580 million to acquire 49 percent of the company’s stock from the Guo family.

With billions of dollars at stake, Chinese state banks and creditors have asked the courts to freeze Kaisa’s assets to ensure they can recover money they lent it. Most likely, global investors, who bought billions in offshore bonds from Kaisa, will take a huge loss. A restructuring, announced by Kaisa on Monday, outlined plans to cut the interest rates on bonds and defer payments on them, essentially cutting their value in half. Bondholders are pushing for better terms. If they do not come to a deal, offshore bondholders will not have much recourse, because they have little claim on the underlying assets. Kaisa says they may get only 2.4 cents on the dollar.

Whether politics played a role in Kaisa’s downfall is unclear, though there has been speculation that the company’s connection to the family of the former security chief Zhou Yongkang was a factor. Bloomberg News has reported that the company may have been undone by its ties to Jiang Zunyu, a high-ranking Communist Party official in Shenzhen who was detained last October on suspicion of corruption and later found to have 42 homes and $32 million in unexplained cash.

But analysts say Kaisa may also have been suffering from financial stress in the property slump. Chinese government restrictions on borrowing for land purchases had also made it more difficult to finance developments. While other Chinese property firms have run into serious trouble, few have prompted such a fallout among Western investors.

Whatever the case, the situation was dire enough that the Guo brothers sold their entire stake in Kaisa. Several lawyers in the case say that Guo Yingcheng is in Hong Kong, which is under a separate legal system, and refuses to return to mainland China. In early February, a young woman at the luxurious Residence Bel-Air, a complex where he has an apartment, came to the door. She said Mr. Guo was home and then went to consult with him. She came back several minutes later with a message from the chairman: “Please go away!”

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