CITIC’s $41 bln mega-merger needs fancy footwork

March 27, 2014

By Una Galani

The author is a Reuters Breakingviews columnist. The opinions expressed are her own.

CITIC’s $41 billion mega-merger will need some fancy footwork. The Chinese state-owned conglomerate wants to reverse most of its assets, which include stakes in banks, brokerages and resources, into Hong-Kong listed subsidiary CITIC Pacific. There’s something in it for both sides, but the deal will require creativity to ensure it looks good financially for both the Chinese state, and CITIC Pacific’s minority shareholders.

The plan is that CITIC Pacific will acquire its parent’s main operating arm for cash and new shares, issued at a premium to the previous closing share price. If it were funded entirely by stock, CITIC Pacific would emerge with 15 percent of the combined group based on its 12 percent relative share just before the deal, according to a Breakingviews calculation, suggesting a modest premium. The shares rose as much as 30 percent on March 27.

Strategically, there’s something in it for both sides. CITIC Group will get the prestige of a long-coveted public listing. It also gives the government an option to reduce its shareholding further down the line. Shareholders in industrial-focused CITIC Pacific will get massive exposure to China’s fragile financial sector that they didn’t have before, but it will also more closely align the interests of the listed company with its parent.

There are two challenges. One is that in order to keep a minimum free float that’s acceptable to the Hong Kong stock exchange, CITIC Pacific will have to pay for part of the deal in cash, or issue some new shares to the public. Since CITIC already owns 58 percent of the listed company’s shares, it would otherwise end up with more than 90 percent of the new company.

The other is that the government won’t want to look like it is selling state assets on the cheap. A deal must be done at or above an independently assessed fair value. Some of the conglomerate’s biggest assets, such as CITIC Bank, trade at below their book value. Yet minority shareholders of CITIC Pacific have the right to approve the tie-up. The strategic logic is appealing, but the tough bit will be persuading both sides that they’re getting the better end of the deal.

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