HONG KONG (Reuters Breakingviews) - Evergrande's M&A boldness has backfired. China's second biggest property developer has spent 36.3 billion yuan ($5.2 billion) building a stake of more than 14 percent in larger rival Vanke. With the regulator cracking down on capital market "savages" and Evergrande itself now ruling out a takeover, the bet is 13 percent out of the money - and things could get worse.
Vanke was already embroiled in a high-profile power struggle, involving financial conglomerate Baoneng, China Resources, and Shenzhen's metro operator. On Dec. 18 Vanke dropped a controversial deal with Shenzhen Metro that would have made the group its top shareholder. Evergrande's intentions in wading into this battle were not clear.
In any case, Vanke's Shenzhen-traded stock has dropped 24 percent in the past month, as the country's securities and insurance watchdogs have made it clear they are not fans of corporate raids by insurers and other money managers.
That leaves Evergrande sitting on paper losses of nearly $700 million, a Breakingviews calculation suggests based on the opening share price on Dec. 22. It is not clear how the company financed its purchases, or if it hedged any risk.
While Vanke's future is still murky, its share price is unlikely to recover any time soon. A takeover at a premium seems out of the question, and its other big shareholders are unlikely to buy Evergrande's stake.
In fact, the stock is likely to fall further. Vanke’s A-shares still trade at a premium, at 1.74 times book value for the next twelve months, based on forecasts compiled by Eikon. The mean for its mainland listed peers, including Poly Real Estate, is just 0.83 times. And the average analyst's price target for the company's mainland shares is 18.36 yuan, Eikon data shows.
Vanke share’s started trading at 20.30 yuan on Wednesday. If they were to fall to match the price target, Evergrande would be nursing a $1 billion-plus loss. Officially, the highly leveraged company has called the stake purchases simply an "investment". If so, it looks like a bad miscalculation.
Reuters Breakingviews is the world's leading source of agenda-setting financial insight. As the Reuters brand for financial commentary, we dissect the big business and economic stories as they break around the world every day. A global team of about 30 correspondents in New York, London, Hong Kong and other major cities provides expert analysis in real time.
Sign up for a free trial of our full service at https://www.breakingviews.com/trial and follow us on Twitter @Breakingviews and at www.breakingviews.com. All opinions expressed are those of the authors.