China Hongqiao Gets Bailout as Firm Struggles Under Multiple Pressure Points

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You don’t come from near obscurity to become the largest aluminium producer in the world, seemingly overnight, without courting some controversy — but China Hongqiao Group seems to have garnered more than its fair share.

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The company is mired in allegations of misreporting profits, underreporting power costs and saddled with massive debts built up as the company went on a spending spree opening new smelters and buying rivals, the company. According to the South China Morning Post, net debt has surged to 62 billion yuan (U.S. $9.3 billion) at the end of last year, or 137% of Hongqiao’s shareholders’ equity. That is up from 97% two years earlier.

Unable to raise more capital on the markets following the suspension of shares earlier this year, the firm has had to turn to Citic Group, founded in 1979 to handle China’s overseas investments and run directly by the central government.

Hongqiao has enjoyed Citic’s support for some years as the investment conglomerate has funded previous acquisitions for the group. China Hongqiao Group will get a HK$8 billion (U.S. $1.02 billion) financial lifeline from Citic Group to repay bank loans, following its agreement to sell 806.6 million new shares and U.S. $320 million of convertible bonds to Citic and the conglomerate’s unit CNCB (Hong Kong) Investment. If they are fully converted into shares this could give Citic up to 13.3% of Hongqiao, making the conglomerate the smelter’s second-largest shareholder, the South China Morning Post reports.

The Fast Rise and Criticism

China Hongqiao Group’s rise has been dramatic.

With an installed capacity of 6.46 million tons, the firm has overtaken domestic rival Chalco and Rusal to become the world No. 1.

But the achievement is not without its critics.

Hongqiao had to suspend its own shares earlier this year when allegations by short seller Emerson Analytics that the firm “fabricated” profits that vastly exceed those of its peers via “underreported costs and subsidies” from “connected parties disguised as independent third parties,” according to the South China Morning Post and others.

To add further fuel to the fire, the firm has been unable to complete and file its 2016 accounts, followed by the resignation of its auditors E&Y, followed by their replacement Baker Tilly, HK, only for them to be fired and yet a third firm, Shinewing (HK), to be appointed.

Shinewing may be a perfectly respectable firm, but the impression among some foreign investors will be Hongqiao has appointed a Chinese auditor it can influence more readily than a foreign firm. Accounts have still not been filed and the shares remain suspended for now.

While state-owned rival Chalco is expanding production, cash flow will not be helped by the fact Hongqiao has been forced to close 2.68 million metric tons of capacity — equivalent to 4.5% of global output last year — as part of Beijing’s drive to close “illegal” smelter capacity (meaning smelters that do not meet or hold all the required environmental permits and clearances). The announcement sent shockwaves through the global aluminium market and has contributed to supply-side concerns that have driven prices higher this past month.

Hongqiao is unlikely to implode under these myriad pressure points. The firm remains financially supported by Citic and is probably deemed too big to fail, but it is not exactly a poster child for China’s aluminium sector.

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Not all allegations are necessarily fully justified. But, by the same token, there is no smoke without fire. Hongqiao’s corporate structure, past dealings, accounting practices and environmental compliance leave a lot to be desired.

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