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Foreign Hedge Funds Take Another Run at Kaisa in a Changed China

They meet again. 

Hedge funds that profited from the debt restructuring of Kaisa Group Holdings in 2015 are back, circling the Shenzhen-based real estate developer that is once again trying to dig out from under a mountain of debt. This time, the stakes are even bigger. About $12 billion of dollar-denominated debt is at risk versus only $2.5 billion back then. 

A group of bondholders advised by Lazard Ltd. has offered about $2 billion of new financing to Kaisa, which was the first Chinese developer to default on dollar-denominated debt. The Shenzhen-based firm, which was already late on repaying a $400 million note, was labeled a defaulter, along with China Evergrande Group, by Fitch Ratings last week. 

One mover behind the new consortium — as it was in 2015 -- is San Francisco-based Farallon Capital Management, according to investors. Back then, the hedge fund, which has a history of investing in distressed emerging markets from Argentina to Indonesia, along with BFAM Partners Hong Kong Ltd., led a group of creditors that initially proposed taking an equity stake in Kaisa in the restructuring. 

Even though the offer was roundly rejected amid nasty negotiations and squabbles among investors, Farallon came out quite nicely after holding out in its confrontation with Kaisa. Following the January 2015 default, an initial proposal in March from the company that offered sharp cuts to coupon rates would have amounted to more than a 40% haircut, Debtwire reported at the time. But the final deal sweetened by Kaisa a year later to prevent a drawn-out court battle, promised a recovery of about 80%. As Kaisa resumed apartment sales, the eventual payouts were even better. In about 1 1/2 years, Kaisa’s 8.875% coupon note due in March 2018 had climbed to the high 80s from 33 cents.

So it’s no wonder that investors are tempted to give Kaisa another go. They’ve pitched several fundraising strategies, including Kaisa selling equity or convertible bonds, that have echoes of the past.

But China has changed — the political and economic environment portend a more hazardous road ahead for foreign capital.

For one, international creditors benefited in 2015 from a tussle for control of Kaisa between chairman Kwok Ying Shing and Sunac China Holdings, a rival developer that had sought to buy out Kwok’s stake shortly after Kaisa’s default. In May 2015, Sunac dropped out, after Kwok hinted that he would offer a much improved deal to offshore bondholders.  

This time, no bidding war is on the horizon. Private property developers that have withstood China’s heavy-handed crackdown on their financing this year will be too shaken to try a big acquisition. Meanwhile, state-owned white knights are never in the mood for boardroom games and typically can’t be pushed around or squeezed out, as Sunac was. 

These are early days but here’s one likely scenario: With much of the real estate industry fighting for solvency, the inevitable consolidation that follows will be spearheaded by state-owned enterprises. As private enterprise recedes, the property sector will become easier for the government to control.

A late November presentation by Lazard suggests the overseas bond investors are holding out hope that China’s real estate industry will be driven mainly by market forces. For instance, one of their seven fundraising strategies would provide up to $2 billion in financing for urban-redevelopment projects. Kaisa owns about $4 billion of development rights to rebuild old towns, villages and factories into modern abodes around Shenzhen. The “true economic value [is] well in excess of this,” noted the presentation.

But rules can change. In October, the nearby city of Guangzhou launched an investigation into urban-renewal projects that local districts had approved — to protect the city’s cultural heritage and prevent overdevelopment, said the government. A similar move by Shenzhen would decimate the value of Kaisa’s development rights. 

Unlike China Evergrande Group, which built ghost towns across China, Kaisa’s real estate portfolio is prime. So distressed asset funds are rightly tempted again. However, applying the same old mindset is a misguided approach, because the incentives in China have changed. The likes of Farallon need to build a good government relations team this time, bearing in mind that in Chinese, the word crisis is written with two characters: one, danger and the other, opportunity. 

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This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Shuli Ren is a Bloomberg Opinion columnist covering Asian markets. She previously wrote on markets for Barron’s, following a career as an investment banker, and is a CFA charterholder.

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