How Tengzhong won by losing the Hummer deal

BEIJING (Caixin Online) — The proposed sale of General Motors Co.’s struggling Hummer subsidiary to China’s privately owned Sichuan Tengzhong Heavy Machinery Co. never seemed to make much sense. So few were surprised Feb. 25 when Tengzhong officially abandoned the proposal after failing to receive critical support from Chinese government regulators.

The estimated $150 million buyout was scheduled to close by China’s Lantern Festival in late February, almost nine months after Tengzhong and GM signed a memorandum of understanding in June 2009.

At one point during the process, which was constantly shadowed by doubts over regulator and funding support, Tengzhong introduced a plan that bordered on comic desperation: It offered to salvage the deal by creating an offshore company in hopes of sidestepping the tricky Chinese government approval process. But the joke fell flat.

Now, GM plans to shutter the Hummer line of military-inspired SUVs. And Sichuan Province-based Tengzhong, which builds heavy equipment, is moving on.

In retrospect, failing to buy Hummer may have been the best possible outcome for Tengzhong.

Heavy doubts

Tengzhong has never built an automobile, so skeptics rose in force as soon as the Hummer plan surfaced. Many questioned the Chinese company’s motivation and doubted its ability to raise the $150 million GM sought. Moreover, many said Tengzhong would not be able to run a multinational operation.

Apparently reflecting these doubts was a slow, sometimes hard-to-trace handling of the Hummer buyout application by government regulators scattered across three agencies.

Chinese law says overseas investment transactions exceeding $100 million must be approved by the National Development and Reform Commission (NDRC), Ministry of Commerce (MOC), and State Administration of Foreign Exchange (SAFE). So after the Hummer memorandum was signed, NDRC’s Foreign Investment Department became the first to process the application.

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NDRC officials said July 15 they received Tengzhong’s application to acquire Hummer. That was about six weeks after the companies had signed their memorandum.

Then on Aug. 27, more than a month later, NDRC announced that “the acquisition of Hummer does not involve localization” and so “does not fall within the NDRC’s approval scope.” Instead, the agency suggested MOC consider the application.

After NDRC’s withdrawal from the procedure, an MOC source responsible for foreign investment projects later said, a Tengzhong representative and a deputy mayor from the Sichuan city of Deyang visited MOC offices in Beijing to discuss the transaction. Nevertheless, the source said, the company never submitted a formal application to MOC.

Indeed, on Feb. 24 — the day before Tengzhong formally cancelled the transaction — Assistant Minister of Commerce Wang Chao told reporters at a press conference that MOC had never received Tengzhong’s application. Wang also discounted claims that the application had been “rejected.”

But sources familiar with the government approval process say various government approval bodies sometimes “play football” with an overseas transaction application. When that happens, it’s a signal that a deal is in trouble.

An NDRC source told Caixin that, in recent years, NDRC has denied approvals for large-scale transactions that don’t fit national industrial-policy goals, such as saving energy and reducing emissions. Hummers are widely known as gas-guzzlers and therefore inconsistent with energy-saving.

The source also said that, although the government has been encouraging industry pacesetters to grow through acquisitions, unsuccessful acquisitions can hurt government goals. Thus, NDRC has not supported cross-industry acquisitions.

For example, NDRC previously rejected Blue Star Group’s proposed acquisition of South Korea’s Ssangyong Motor Co.
noting that Blue Star’s main business is chemicals, and that the company had no previous experience with the automotive sector.

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The NDRC source said after Blue Star withdrew the application, China’s largest auto maker SAIC (600104) successfully acquired a Ssangyong stake. But the merger stumbled after the two auto companies failed to integrate, which in turn made the government more cautious about overseas automotive transactions. For this reason alone, Tengzhong’s proposal was greeted with caution at NDRC.

Fudgy funding

Even if Tengzhong had received government approval, though, the company would have had to overcome doubts about its fund-raising and operational capabilities.

After signing the memorandum with GM, Tengzhong claimed it had financial support from a domestic bank. But an investment-industry source said Tengzhong’s funds for buying Hummer actually came from another source.

That real financial source was never publicly revealed. But it may have been connected to Tengzhong’s behind-the-scenes leader, Suolang Duoji, who has particularly close relations with the business community in Sichuan. He also has close ties to the military in the province, as evidenced by the two-car motorcade he uses for traveling. He rides in one of the military-licensed cars, while his bodyguards ride in the other.

The industry source said Suolang had obtained preliminary purchase orders for Tengzhong-made Hummers for military use by leveraging his military connections. Then, with stamped order papers in hand, he had sought out investors to finance the acquisition.

Domestic banks including Bank of China (3988)(601988)
refused to support the financing plan mapped out by Suolang. Tengzhong later sought but failed to obtain funding from foreign banks.

Even while Tengzhong scrambled for financing, the deal was facing financial trouble and regulatory resistance. A backup plan to establish an offshore company to skirt government approval procedures was drafted, but it faced two major obstacles.

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The first obstacle was that MOC approval is needed whenever a Chinese company wants to establish any offshore company. And SAFE backing is required if the proposed company’s investment source is inside China.

A lawyer with the Dacheng Law Firm familiar with the process told Caixin that MOC officials treat offshore company proposals very carefully.

But even an offshore investment company established without Chinese capital needs Chinese government approval if the controlling shareholder is a Chinese company. Based on these restrictions, the lawyer said, Tengzhong’s attempts to set up an offshore company for the acquisition were basically untenable.

And Tengzhong never explained its funding source.

All for the best

Tengzhong spent a significant amount of time and money on the proposed Hummer deal. But its pullout was not necessarily bad.

Some in the industry say operating Hummer would have been a disaster for the Chinese company, and that walking away from the altar was the right decision. Many have noted that Tengzhong signed with GM only because no one else wanted to bid for Hummer.

And while Tengzhong insisted it was serious about the bid, market observers smelled a publicity campaign.

Two weeks after the memorandum was announced, a company called Lumena Resources (67), in which Suolang owns a controlling stake, listed on the Hong Kong Stock Exchange. The stock rose 19% on opening day to 2.38 Hong Kong dollars (30.7 U.S. cents).

On Feb. 25, as Tengzhong announced the end of the Hummer deal, Lumena’s share price rose as much as 8%, even while the market index fell, apparently reflecting market backing for Tengzhong’s nonsensical and risky interest in Hummer. See this story on Caixin Online.

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