Global bondholders caught in China's cement consolidation push

[SINGAPORE/HONG KONG] A push by authorities in China to shrink the nation's cement industry has caught global bond investors in the middle.

China Tianrui Group Cement Co last month increased its stake in China Shanshui Cement Group Ltd to 28.16 per cent, more than Shanshui founder Zhang Caikui. Fitch Ratings Ltd deemed the move a change of control, and downgraded Shanshui to BB-, three levels below investment grade. A change of control also allows some of the company's dollar bondholders to demand immediate repayment.

Cement makers in Asia's biggest economy are under pressure to clean up their act after Premier Li Keqiang said in March a key priority this year is to enforce new environmental protection laws.

Cement makers' heavy pollution is mainly because of a reliance on coal power. Shanshui Cement, which reported a profit last year about one third of what it achieved in 2013, has embarked on a strategy of selling minority stakes to various companies to raise money in an increasingly competitive environment.

"The Chinese authorities' approach to the sector is clear - they want consolidation," said Kalai Pillay, a senior director at Fitch Ratings in Singapore. In the case of Tianrui's part acquisition of Shanshui Cement, "we don't know the intention of Tianrui and we don't know how local lenders will react to the change of control."

An investor relations official at Shanshui declined to comment. Tianrui officials didn't immediately reply to two phone calls and an e-mail seeking comment.

The ratings company isn't the only one puzzled by Tianrui's share buying. Credit analysts and bond investors alike are also in the dark because Tianrui didn't disclose its intention behind the purchase in the secondary market. Shanshui has also yet to outline any relationship plans with Tianrui.

Shanshui's US$500 million of 7.5 per cent 2020 bonds sold in March, the most liquid of its notes, fell 2 cents to 98 cents on the dollar in the three business days after its April 16 exchange filing about the stake purchase. They've since rebounded to 99.7 cents, still off their pre-Tianrui 101.7 cent- peak.

"While consolidation is good in the sense that cement players become bigger and it reduces overcapacity, what's negative for bondholders includes potential changes in management strategy after the Tianrui takeover," said Raymond Chia, the head of credit research for Asia ex-Japan in Singapore at Schroder Investment Management Ltd.

"Tianrui has made three to four attempts to tap the offshore bond market but all were pulled, which shows investors' reception to the company. With this acquisition, concern about Tianrui may spill over to Shanshui." Schroder managed $474.3 billion as of March 31, including Chinese company debt.

Tianrui's stock acquisition has also pushed the free float of Shanshui shares to under 9 per cent, well below the 25 per cent minimum the Hong Kong stock exchange requires in order for companies to maintain their listing status. Shanshui has been suspended at HK$6.29 since April 16 as the board assesses the effect of Tianrui's increased holding, including its impact on any contractual obligations. Its stock is up 69.1 per cent this year.

Shanshui's new controlling shareholder and how Shanshui might react has led analysts to wonder what the deal could mean for bondholders.

"We believe the free float issue and the fight for control may not be resolved any time soon," Shirley Han, a credit analyst at UBS Group AG in Hong Kong, wrote in an April 17 note. That may weigh on the company's dollar bonds, she said.

Change of Control Shanshui's other shareholders include a company associated with founder Zhang - China Shanshui Investment Company Ltd. - which holds 25.09 per cent, Taiwan's Asia Cement Corp with 20.09 per cent, and state-owned China National Building Material Co. with 16.67 per cent, according to an April 16 Shanshui filing. China National Building Material completed buying its stake in November, according to data compiled by Bloomberg, and its purchase was mutually agreed upon.

Tianrui amassing an interest in Shanshui could trigger a change of control clause on Shanshui's US$400 million of 8.5 per cent 2016 notes, according to the securities' sale document. A change of control is defined as occurring when any person or group's total voting stock of the company exceeds that held by founder Zhang and his family and affiliates. Should bondholders demand action, Shanshui would have to make an offer to purchase the bonds at 101 cents on the dollar not later than 30 days following the change of control, the prospectus shows.

Shanshui had earlier indicated it plans to buy back the bonds on or after their May 25 call date at 102.125 cents on the dollar. Tianrui buying has created some uncertainty as to whether Shanshui will follow through with that plan.

The stake acquisition "could also lead to a delay in calling the 2016s, though we expect holders to be paid later this year in line with company's earlier intentions," Eric Ha, an analyst at Deutsche Bank AG wrote in an April 24 research note. The debentures in question were trading slightly above their put price of 101 cents at 101.7 cents as of Tuesday.

Based on Shanshui's cash position of 1.15 billion yuan (US$185 million) as at the end of 2014 and proceeds from its 2 billion yuan onshore note issuance last month, the company has sufficient cash to redeem the US$400 million bonds. More of a concern is the 2020 notes, money managers say.

"The 2020s, while offering attractive yields, may see some volatility in the short term," said Raymond Lee, a portfolio manager in Sydney at Kapstream Capital Pty, which manages the equivalent of about US$7 billion. "Despite Shanshui's ability to tap the local market for funding, we expect the company's financial profile to weaken post the 2017, and potentially 2016, notes buyback."

Shanshui redeemed US$400 million of 10.5 per cent 2017 notes last month, according to an April 27 exchange announcement. The notes were redeemed at a price equal to 105.25 per cent of the principal, meaning Shanshui spent $442 million, including accrued and unpaid interest.

Compounding the financial pressures on Shanshui from its bonds is China's cooling property market.

New-home prices dropped in March from a month earlier in 49 of the 70 cities tracked by the government, the National Bureau of Statistics said April 18, while the average price fell for an 11th consecutive month, bringing the decline from a year earlier to 6.1 per cent, the steepest on record, according to Bloomberg calculations. The slump in housing demand is hurting cement makers, resulting in several either closing or being sold.

Deutsche Bank expects property-related cement demand will contract by 10 per cent in China this year. Demand linked to infrastructure projects however may increase by 12 per cent, boosted by China's silk road project.

"There's a push to phase out low quality cement and older production facilities that aren't energy efficient," Fitch's Mr Pillay said. "The execution of the strategy to improve efficiency has been a lot more serious in this industry than others."

BLOOMBERG