One of the hottest news in the capital markets recently has to be the proposed acquisition of Chinese property developer SOHO China by the American private equity investment company Blackstone Group. In this fascinating development, Blackstone is proposing to privatise SOHO in a deal worth US$4 billion (S$5.6 billion). At the same time, Blackstone would also be responsible for SOHO’s US$4.7 billion debt.
It is worth noting that Blackstone is in exclusive talks with SOHO and its offer per share is double that of SOHO’s share price. Blackstone is determined to deter would-be investors and acquire SOHO.
Even though the details of the deal would only be finalised in the coming weeks, there is no doubt that Blackstone would be successful with its bid for the property company founded by prominent couple, Pan Shiyi and Zhang Xin. (Please see Note.)
Dubbed the top private equity company in the world, Blackstone Group is also one of the most popular investment funds in global capital markets. Its businesses include private equity funds, real estate funds and mezzanine funds. According to its financial statements, revenue for 2019 was US$3.512 billion, with a net profit of US$1.694 billion, a stunning performance by any measure.
SOHO China, which is listed on the Hong Kong Stock Exchange, is the biggest property developer in Beijing. It is a Chinese company that focuses on the development and sales of commercial properties in Beijing’s central business district.
The courting ritual between two astute market entities has culminated in a win-win blockbuster deal that is testament to the market insights and business wisdom of both parties.
Due to the Covid-19 pandemic, the Chinese property market is facing the coldest winter in its history and is almost at a standstill.
Market bloodbaths produce investment opportunities and Blackstone has sufficient firepower for the Asia Pacific property market. Since it can only profit by investing the funds it raised, Blackstone will not pass up the chance when it has a good catch like SOHO in its sights.
Blackstone is buying SOHO because of the company’s intrinsic value and the bright prospects of the commercial property market in China. Due to the Covid-19 pandemic, the Chinese property market is facing the coldest winter in its history and is almost at a standstill. It is definitely an opportune time to go bottom fishing for Chinese properties especially since the Chinese government is expected to loosen its reins on the property sector after the pandemic to satisfy pent-up demand. In the second half of this year, the Chinese property market is likely to experience a new round of explosive growth and the losses caused by the stagnant market in the first half of the year would be mitigated.
By then, SOHO’s brand value and its performance may improve as the property market recovers. Blackstone is confident of adding value to turn this hot potato in Pan Shiyi’s hand into a goose that lays golden eggs.
At present, the financing cost for US companies is about 1%. On 3 March, the Federal Reserve announced an emergency rate cut of 50 basis points to between 1% and 1.25%, reducing the financing cost to 0% immediately. The actual financing cost for a Chinese company is 4%. Theoretically, if one were to raise US dollars in the US to invest in China, one can earn 3% through arbitrage in a year. With 10 times leverage, the amount earned through arbitrage can rise to 30%.
Looking at the global real estate market, this round of interest rates reduction by the Federal Reserve means that it is possible for top property companies to double their values in 2021. That is why Blackstone is willing to pay a 100% premium to acquire SOHO. Blackstone is accountable to its investors and would have done its homework in advance before doing SOHO this favour.
SOHO has been clamouring to sell.
A closer look at Blackstone’s investment history shows that its tactic of having a long investment time horizon is its key to staying ahead. This would also have been the guiding principle behind its acquisition of SOHO.
SOHO China’s size suggests that only a few in the mergers and acquisitions market have the capacity to take over it. Blackstone with its means could turn out to the biggest investor to do so.
In future, Blackstone would apply its investment strategy for the European and American markets of buy-improve-sell to China. It will purchase attractively-priced assets (its valuation of SOHO is still relatively low despite the premium) before deploying asset-management companies to resolve structural and operational problems so that valuations of the assets rise. The company would then sell the assets to reap profits when the time is ripe.
SOHO has seen better days. In 2003, it paid the second highest taxes in the industry. Its chairman, Pan Shiyi, together with other property moguls Ren Zhiqiang and Wang Shi were the first few property magnates in China. However, after the Chinese government rolled out a series of policies to put pressure on the real estate industry, the future became gloomier for the industry which once enjoyed handsome profits.
With no way out, SOHO has been clamouring to sell. From 2014 to 2019, Pan Shiyi sold company assets worth tens of billions of renminbi.
SOHO disposed of its assets cheaply because its rental returns were below expectations. For example, its rental returns in Beijing were below 3%, lower than the 4.4% interest it needed to pay to service its bank loans. The significant disparity meant that the company was operating at a loss. The frequent disposal of assets caused SOHO’s performance to continue deteriorating even after its transformation. From 2012 to 2018, its revenue plummeted from 16.143 billion RMB (S$3.26 billion) to RMB$1.721 billion, and the net profits attributable to shareholders of the parent company decreased from 10.585 billion RMB to 1.925 billion RMB.
As of the end of June 2019, SOHO's total assets amounted to 68.898 billion RMB, with debts due within a year reaching 2.053 billion RMB. During the same period, its cash and equivalents were only 1.15 billion RMB$, a shortfall of 903 million RMB. Coupled with its long-term debts, SOHO’s cumulative debts came up to 32.68 billion RMB. Under such circumstances, Pan Shiyi has to sell to pay debts and exit the real estate industry. This lifeline from Blackstone will allow him to do so and cash out, so he has no reason to turn it down.
Capital markets have also reacted enthusiastically to the deal. On 10 March, SOHO’s share price rose 37.58% to reach HKD$4.1, making it a rare bright spot among property counters that were battered. (NB: SOHO's share price stands at HKD$3.7 as of 20 March 2020.)
Now it is up to Blackstone to work its magic.
Pan Shiyi and his wife Zhang Xin are a legendary couple in China. They have been described by The Times of London as "China’s most visible and flamboyant property tycoons".
Known as an unconventional, astute, and dynamic businessman, Pan was born in a village in Gansu, north central China. Gansu is traditionally a region of poverty and Pan's parents were poor. Pan graduated from university and went to work at the former Ministry of Petroleum Industry. He quit in 1988 and headed to Shenzhen and Hainan to embark on a career in real estate. He was successful and co-founded property firm Beijing Vantone in 1992. He met his wife Zhang during this time.
Zhang’s parents were Chinese immigrants in Burma (now Myanmar) who later returned to Beijing in the 1950s. Zhang took on various jobs to pay for her education. In her teens, she worked in a garment factory and electronics plant in Hong Kong. A determined and strong woman, Zhang managed to study in the UK and got a master's degree in development economics from Cambridge University. She was working as an investment banker for Goldman Sachs and Travelers Group when the two met.
According to news reports, Pan proposed to Zhang four days after their first meeting in a whirlwind romance. And three days later, Zhang said yes. She was quoted in various interviews saying: "Within 10 days of meeting Pan Shiyi in 1994, I decided to marry him, even though he was divorced twice, was from the village, neither rich nor tall, and was balding."
They founded SOHO China in 1995. The dynamism and creative energy of the couple are seen through their many exciting projects in China, especially in the 2000s. They hired high-profile foreign architects such as Zaha Hadid, Yung Ho Chang, Bjarke Ingels, Kengo Kuma, and Kazuyo Sejima to design their buildings. They introduced the small office/home office (Soho) concept into the Chinese real estate market, and came up with ingenious concepts such as Commune by the Great Wall, described as "a private collection of contemporary architecture designed by 12 architects". The project won the Venice Biennial Special Prize in 2002.
Pan and Zhang complement each other at work. Pan once said that his wife was in charge of building houses while he was good at selling them. The couple is also slick at promoting themselves on traditional media as well as the various internet and social media platforms.
The high-profile couple have seen their fair share of controversy. They went through difficult times in 2012 when Pan had an affair and was reported to have fathered a love-child outside marriage. In 2014, they donated US$10 million to Yale University and US$15 million to Harvard University. Chinese netizens were unhappy with their decisions and there were even internet rumblings of the two being US spies. Later in 2017, Chinese businessman Guo Wengui who is on self-imposed exile in the US, claimed that Zhang was having an affair with former US ambassador to China, Gary Locke. The couple disputed the allegation.