HNA Shuffle Heralds Start of the Great China Bailout

(Bloomberg Gadfly) -- HNA Group Co.'s long-awaited restructuring may finally be taking shape.

CCOOP Group Co., an HNA unit and hitherto obscure manager of mainland department stores, will sell new shares in itself to fund a purchase of group assets, according to a statement to the Shenzhen stock exchange.

There's scant detail of the amount of assets to be bought or cash to be raised, but as a model for digging HNA out of its 434 billion yuan ($68 billion) net debt hole, it's well-timed.

After all, canny Chinese investors will now be on the lookout for alternatives to their existing investments. The blended forward 12-month price-earnings ratio of the CSI 300 Index hit 14.5 times on Tuesday, its highest level since the bubble madness of mid-2015. If the 8.7 percent gain in the index since the start of the year is maintained for another week, January 2018 will prove to be one of the best months for that gauge in the past decade.

Investors who have done well may want to realize some of their gains to buy new stocks and diversify exposure. As a result, current circumstances are near-perfect for anyone looking to exchange equity for cash.

That's frequently a losing bet for the buy-side of these trades. There's a long-standing negative correlation between equity index valuations and the returns from new share sales: When P/E ratios are high, owners can offload any old rubbish to investors hungry for novelty; when they're low, only the most attractive prospects will get a bite. Luckily for HNA, it's firmly on the sell-side of this trade.

Still, this shouldn't be considered an easy route out of danger.

For one thing, even investors addled by rich valuations are able to discriminate in the assets they purchase. As Gadfly's Shuli Ren has pointed out, the Beautiful 50 index of large, mostly state-owned companies on the Shanghai exchange has handsomely outperformed wider measures over the past year, in line with the better returns on equity of its member stocks.

For another, the rising valuations of 2017 have failed to translate into more capital raisings so far. The of such share sales last year came to just 719 billion yuan, about a quarter of the 2015 total and the lowest figure since 2013, according to data compiled by Bloomberg.

That's in part due to the leaden process of getting government approval for new IPOs. The queue of companies awaiting sign-off for mainland listings was more than 600-strong last month, according to the official China Daily -- equivalent to almost one-sixth of companies on the Shanghai and Shenzhen exchanges.

Getting away equity sales on existing listings like the squad of obscure HNA-linked stocks trading on mainland and Hong Kong exchanges is in one sense easier, since it usually only requires exchange approval. In another sense, though, it may be harder, because without a neat IPO narrative to sell to investors, it looks much more like a bailout.

For all the problems inherent in the process, tapping Chinese investors' current bullish mood for cash isn't the worst expedient available for deal-hungry mainland conglomerates. While the likes of HNA may have been overpaying for underperforming businesses in recent years, they've ended up acquiring real assets that retain real . Even after stripping out goodwill, the of HNA's net assets last June just about exceeded net debt.

A well-managed garage sale could be just enough to keep this show on the road.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

David Fickling is a Bloomberg Gadfly columnist covering commodities, as well as industrial and consumer companies. He has been a reporter for Bloomberg News, Dow Jones, the Wall Street Journal, the Financial Times and the Guardian.

To contact the author of this story: David Fickling in Sydney at dfickling@bloomberg.net.

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