Corporate Governance
• 8 minute read

The Future of Vanke After New SOE Alliance

Chinese real estate giant fights off takeover bid with support of a government controlled company, but will this be a good thing in the long run?

By An Ran, PhD Candidate, School of Accountancy, CUHK Business School

Wang Shi resigned as chairman of Chinese real estate giant China Vanke in June 2017 – only months after winning arguably China’s biggest-profile takeover battle.

The move means he has handed over control of the Shenzhen company he founded and had run for the past three decades to its president, Yu Liang.

The 18-month-long, increasingly bitter power struggle for control of Vanke was unprecedented in China’s corporate history and attracted the attention of the government’s top regulators.

It began in October 2015 after the insurance and real estate conglomerate Baoneng began slowly buying up Vanke shares. Within two months Baoneng had become Vanke’s largest shareholder with a 25.5 per cent stake – overtaking the 15.31 per cent stake held by China Resources, a state-owned enterprise (SOE) and long-time ally and investor in the real estate giant.

Then another developer, China Evergrande, also got involved in the power struggle; by November 2016 it had slowly acquired a 14.07 per cent stake. However, the following month saw an end to the takeover battle when investigators punished both Baoneng and Evergrande for the way they had tried to carry out their leveraged buyouts.

On January 13, 2017 a Vanke supporter, Shenzhen Metro – the Shenzhen subway operator controlled by the Shenzhen government – agreed to buy all of China Resources’ shares. Then, on June 9, Shenzhen Metro became Vanke’s biggest shareholder after acquiring Evergrande’s shares, giving it a total stake of 29.38 per cent.

The start of a break-up

The end of Vanke’s 16-year partnership with its one-time ally and staunch supporter China Resources was not unexpected.

The beginning of the end came once China Resources – last year ranked 91st and this year 86th in Fortune magazine’s list of the world’s 500 biggest companies by revenue – was replaced by Baoneng as Vanke’s largest shareholder in December 2015. Vanke shares were then suspended after Wang said Baoneng’s move was not welcome.

Wang, who once had praised China Resources for its ‘tacit support’ to Vanke’s board, looked for its backing once again as he found his position under threat. In March 2016, he decided to seek protection with the help of a second state-controlled company.

He hoped to get support from China Resources to use Shenzhen Metro as a so-called “white knight” investor by initiating an asset restructuring plan that would dilute the shares held by the hostile Baoneng.

However, China Resources was among the major Vanke shareholders that rejected this move at a board meeting in June that year – sparking suspicions that now the SOE was backing Baoneng in the power struggle. Later that same month Vanke’s board successfully rejected Baoneng’s motion to remove them.

However, the bitter power struggle had caught the eye of China’s financial regulators, who looked into the source of the insurance funds used to fund the share purchases of both Baoneng and Evergrande.

As part of efforts to clamp down on leveraged buyouts in the stock market, the China Insurance Regulatory Commission sent inspection teams to the insurance units of Evergrande and Baoneng to check if there had been any non-compliance activities.

Then in December 2016, Liu Shiyu, chairman of the China Securities Regulatory Commission, denounced companies that had used unauthorised funds to finance their leverage buyouts as “barbarians,” “robbers’ and “ghouls”.

Within days the Vanke power struggle was over after regulators suspended Baoneng’s Foresea Life Insurance unit from selling “universal life” products and banned Evergrande’s insurance arm, Evergrande Life, from trading in stocks.

Since April this year, Xiang Junbo, chairman of the China Insurance Regulatory Commission, has been under investigation for violating party discipline.

What does the future hold for Vanke?

Yu has seen the company he now controls bid farewell to its alliance with one SOE, China Resources – its former major shareholder – only to team up with another SOE as its major shareholder, Shenzhen Metro. It was Vanke’s close ties with Shenzhen Metro that gave it the protection to defeat the hostile takeover.

When Wang first established Vanke in 1988, the government owned the majority of its shares. But a series of structural reforms saw the proportion of state-owned shares in Vanke decrease, first from 60 per cent to 40 per cent, and then later to 25.5 per cent.

These changes in Vanke’s structure were all part of broad economic reforms that have been sweeping through China since 1978. Wang once said: “We are people with a vested interest in China’s economic reform.”

“During the economic transition, the Chinese government has been able to retain a great deal of power and influence through its state-owned enterprises. Inevitability there can be advantages for those non-state-owned companies that have closely allied themselves with an SOE, compared with other firms that remain privately owned, because governments can provide protection for property rights of allied partners” says Prof. Zhang Tianyu, Director of Center for Institutions and Governance at the Chinese University of Hong Kong (CUHK) Business School.

“The government often keeps a close eye on important entrepreneurs as their influence on the Chinese economy, public opinion and social issues increases,” he says.

Wang saw the benefits of having China Resources as Vanke’s largest shareholder at first hand in 2000, when it was trying to resist a takeover as a real estate boom was taking place in mainland China.

He also realized that if Vanke wanted to grow into a major company then having an SOE as its largest shareholder would offer it not only protection, but also help to ease any government concerns about its expansion and increasing influence in the real estate industry.

“To strike a balance and achieve a win-win business model, entrepreneurs need to know how to deal with the state that stands behind SOEs and political institutions where their business is embedded.” – Prof. Zhang Tianyu

There is no such thing as a ‘free lunch’

However, as the saying goes: “There is no such thing as a ‘free lunch’.” So, when Chinese entrepreneurs seek protection and benefits for their companies from close ties with SOEs, there will also be some disadvantages.

Since all SOEs are owned and controlled by the state, the way they behave is influenced not only by economic concerns, but also by the government’s will.

In the case of Vanke and China Resources, insiders reported that in the past Wang had enjoyed the close support of the SOE’s chairman, Song Lin, for at least a decade. This might have explained why Vanke enjoyed a relatively long period of untroubled expansion.

Yet things changed after Song was detained by Chinese authorities in 2014 – then held for more than two years without being charged. In December 2016, Song was charged with abusing his position at China Resources between 2003 and 2013 and illegally obtaining funds totaling 9.74 million yuan (US$1.4 million).

In February 2017, Song pleaded guilty to corruption and the embezzlement of more than 33 million yuan during a one-day hearing at Guangzhou Intermediate People’s Court.

Once Song was placed under investigation by the anti-corruption authorities, China Resources’ position towards Vanke changed. The SOE wanted greater control over Vanke – even to include the real estate giant under its own governance and management – rather than being only a “financial sponsor”, as before.

Therefore, it is not difficult to understand why China Resources sided with Baoneng against Vanke’s proposed restructuring plan. By doing so, it could stop the arrival of a major new Vanke shareholder and also seize control of the real estate giant.

Did pressure force China Resources to pull out?

So why did China Resources retreat completely from Vanke? This move might be linked to pressure from the special commission responsible for managing SOEs, called the State-owned Assets Supervision and Administration Commission of the State Council (SASAC).

According to a report by Caixin, the financial and business media group, SASAC held the view that “the central SOE should not compete for benefits with local enterprises” and it required China Resources to cooperate with the Shenzhen government. Such pressure from Beijing reportedly led China Resources to sell its Vanke shares to Shenzhen Metro.

For now, it is clear that Shenzhen Metro is fully backing Vanke’s management team. But what should be kept in mind is that it is still just another SOE. Who knows whether Vanke’s break-up with China Resources will not repeat itself between the real estate giant and Shenzhen Metro somewhere down the line?

Yet more importantly, there is a lesson to be learned from Vanke’s bitter power struggle – one that not only Yu, Vanke’s new boss, but also other Chinese entrepreneurs must learn and remember.

“Joint ownership with the state in a business might well be one way to protect the enterprise to help it grow smoothly in China’s transitional market, but a SOE shareholder is certainly not a panacea,” Prof. Zhang says.

“To strike a balance and achieve a “win-win” business model, entrepreneurs need to know how to deal with the state that stands behind SOEs and political institutions where their business is embedded,” he says.

Related article: The Battle of Ownership in Chinese Enterprises: The Case of Vanke


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