China’s train makers are raising vast amounts of money at the worst possible time. Have they gone off the rail?
Slowing growth? Tick. Jittery markets? Tick. Infrastructure overcapacity? Tick. Excessive leverage? Tick.
Compile a short checklist of indicators on the financial prospects of China’s infrastructure companies and a message seems to appear in bright red: don’t go there. So it was somewhat surprising over the past 10 days to see the country’s largest developers tap offshore markets to raise unprecedented amounts of convertible debt. And even more puzzling is the warm reception investors gave them.
On 18 January China Railway Construction Corporation (CRCC) blew the starting whistle. The world’s second-largest engineering and construction business issued $500 million worth of convertible bonds on the Hong Kong Stock Exchange. That vastly surpassed its previous effort at raising equity, which saw it raise CNY1.242 billion (€173 million; $189 million) onshore in 2014.
Just a week later China Railway Rolling Stock Corporation (CRRC), the world’s largest rolling stock manufacturer, collected $600 million via a similar transaction. It was the company’s first issuance since its creation from the merger of two high-speed trains companies a year ago.
The offerings had an almost identical structure. Both bonds were zero-coupon, offered no yield and had a five-year tenor. The only difference lies in the conversion premium – a gauge of a convertible security’s perceived riskiness – with CRRC’s securities issued comparatively cheaper because the company is unrated by international agencies. Still, investors snapped up both bonds with seemingly equal enthusiasm. The offerings are said to have been twice oversubscribed.
There is a reason why such transactions are more likely to happen now than before. Last September, Beijing unveiled a revised set of rules for debt issuance that made it much easier for domestic companies to tap offshore markets. The complicated and lengthy process they had to go through previously meant they seldom did it; a revised registration process means offshore convertible bond sales can now be approved by the regulator in a matter of days.
That still doesn’t quite explain why investors – especially offshore ones – would be happy to bet their money on Chinese railways. However, taking a closer look at who the issuers were is instructive: both are state-backed companies with useful connections and an implicit anti-failure guarantee (CRRC, for instance, is rated A3 by Moody’s). As advisers we spoke to suggest, convertible debt offerings by investment-grade Chinese companies are a rare commodity.
Still, being state-backed doesn’t mean an infrastructure company can’t stagnate. Investors wouldn’t bet on one without trusting the business plan for the years ahead. And therein lies the main clue to understand why Chinese rolling-stock equity is currently a hot ticket.
In 2013, Chinese President Xi Jinping announced the “One Belt One Road” initiative (OBOR), which involves injecting billions of dollars into the infrastructure that links mainland China and its Eurasian neighbours. About 65 countries are covered by the plan, for which a total investment of $240 billion is expected to be needed. Some of this will come via a $40 billion Silk Road Fund, which China established in 2014, as well as from the $100 billion Asian Infrastructure Investment Bank it was instrumental in founding last year. Another big chunk will probably be provided by companies as well, which in return stand to vastly benefit from the increase in business activity the plan will generate for them.
Chinese developers such as CRRC and CRCC will play a central role in this effort. Their ability to raise offshore convertible debt shows investors reckon the dollars they’re lending will soon be spent to lucrative effects. More plainly, it also indicates that lenders believe the OBOR programme has solid traction. But OBOR remains an inherently political affair. More cautious travellers probably won’t come on board until the first projects really gets in motion.
A version of this post was first published on InfrastructureInvestor.com
Photo by KYODO