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Fighting a hostile takeover is taking its toll on China Vanke

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A resident walks through Vanke Harbor City in Tianjin, China.   © Reuters

HONG KONG In the midst of China's housing market boom, the country's largest property developer, China Vanke, is preoccupied not with maximizing sales but fending off contentious bidders.

"Workforce stability is our top priority now -- the first time in 32 years," said Zhu Xu, Vanke's company secretary, who chaired a briefing on the company's first-half results from which founder and Chairman Wang Shi and President Yu Liang were both absent. "Yu is in the thick of sorting out our shareholder conflict," Zhu explained.

The "conflict" Zhu was referring to began last December when a consortium led by little-known conglomerate Baoneng aggressively built up its stake in the Shenzhen-based homebuilder to 24.26% from just 5% in July 2014. The consortium, which includes Shenzhen Jushenghua Industrial Development and Foresea Life Insurance, subsequently threatened to dissolve Vanke's board of directors.

The move displaced Hong Kong-based state-owned conglomerate China Resources as Vanke's largest shareholder. China Resources was enlisted in 2000 by Wang -- who is also a nonexecutive director of its property arm -- as a strategic partner to prevent Vanke from being divvied up by speculators, or, in his words, "financial barbarians."

Despite being the founder of Vanke, which was re-formed as a joint-stock operation in 1988, Wang did not own any interest in the company until the recent introduction of an employee share option scheme. But the company's ownership structure remained extremely loose, making it vulnerable to hostile takeover bids.

Soon after welcoming Anbang Insurance, the deep-pocketed suitor of Starwood Hotels & Resorts earlier this year, as an ally in December, Vanke sought to cement its defenses by proposing to buy two projects from Shenzhen Metro Group, a state-owned urban rail transit manager, via a rights issue. Swapping 2.87 billion A-shares at 15.88 yuan apiece with railway assets would ultimately make Shenzhen Metro Group the largest shareholder, with a 21% stake in Vanke, and dilute those of Baoneng and China Resources to 19% and 12%, respectively.

Baoneng and China Resources -- which Vanke's independent director Hua Sheng claims have been working together behind the scenes -- staunchly opposed the 45.6 billion yuan deal, even though it would boost Vanke's land bank by 1.8 million sq. meters at a time when land auctions in China are fetching exorbitant prices.

The dispute took a fresh twist in August when rival China Evergrande emerged as Vanke's third-largest shareholder after hurriedly upping its stake to 6.82% through the A-share market. Cheng Kar-shun, chairman of Hong Kong real estate conglomerate New World Development, and Cheung Chung-kiu, chairman of Hong Kong-listed C C Land Holdings -- both friends of Evergrande Chairman Xu Jiayin -- bought Vanke's H-shares at the same time. Their shareholdings now total 0.14% and 0.94%, respectively, of the current total outstanding shares.

"We've been asking them about their motive in buying our shares, but they have never replied," said Wang Wenjin, Vanke's director, who indicated he was puzzled by Evergrande's entrance into the fray.

Evergrande has remained tight-lipped to date, except to indicate that the company is using its own resources generated from property sales to seize a stake in Vanke, according to its, CEO Xia Haijun, who is trying to brush off the speculation that Evergrande Chairman Xu was on a "political" mission to buy Vanke's shares.

"It's a sensitive issue," Xia said of Evergrande's maneuver against Vanke. He emphasized that the company prefers to disclose its actions related to Vanke through corporate filings.

But he stressed that takeovers among Chinese developers will only become more common as consolidation of the industry gathers pace. "It's in a state of big fish cannibalizing small fish," said Xia.

"Vanke got listed in the '80s; Evergrande started its first real estate projects in 1996. But we're now considered on par. Evergrande's success is obvious," Xia said, adding that both companies will "see pleasant growth for the simple reason of deepening market concentration."

Even though the power struggle has yet to become a full-blown crisis, Vanke is already facing disruptions to its operations.

"Certain business partners were concerned that the company is losing its brand recognition, management and financing advantage, and therefore proposed to alter the terms of cooperation. Some even made requests to terminate their contracts with us," said Zhu, the company secretary. According to her, 31 out of 70 contracted projects came under such threats between the end of June and early August, with five projects under negotiation being suspended.

Zhu also said banks had raised their lending requirements and that the company is losing employees to rivals due to growing concerns about its long-term prospects.

DECEPTIVELY POSITIVE In spite of the tempestuous proxy battle, Vanke achieved stellar results for the first half of 2016. Its contracted sales hit a record 190.08 billion yuan for the period, up 69.9% from a year earlier, with new construction starts meeting 75.7% of the full-year target. Its market share also rose, climbing 0.9 percentage point to 3.9% over the six months. The results have not yet included a total area of 24.04 million sq. meters that has been sold but not yet booked, which could translate into contracted sales of around 297.71 billion yuan.

In terms of financial health, the company saw its net gearing ratio improve to 15% from 20% at the end of last year. Distribution expenses as a proportion of sales ticked down 0.33 percentage point to 1.08%.

But analysts are not impressed by the performance, as the company was merely booking results from presales made a year ago. That means repercussions from the current turmoil are not expected to show up on Vanke's financial statements until at least 2017.

"Although Vanke's [first-half] results were in line with our expectations, adverse impacts from the shareholding dispute are emerging," Jason Ching, a Deutsche Bank analyst, wrote in a report. "As acquisition plans, business partnerships and employee stability have all suffered various degrees of disruption in the past 12 months, we think Vanke's competitiveness will be impaired and eventually affect financial results."

Following Vanke's latest earnings report, credit rating agencies Moody's and S&P Global both downgraded their outlooks for the company to "negative" from "stable."

"The power tussle has lasted longer than we anticipated," said S&P Global. "China Vanke could face downward rating pressure if the senior management team is replaced and a more aggressive shareholder takes control of the company. In such a scenario, we believe the company's good reputation, track record of steady execution, strong profitability and good financial discipline could weaken."

This assessment is particularly alarming in light of the intensifying competition among China's property developers. With fewer and fewer partners willing to collaborate with Vanke through mergers -- a key means for accessing prime land in top-tier cities -- the company runs the risk of losing its market share to strong rivals such as state-owned China Overseas Land & Investment or China Resources Land.

Upbeat on the market boom, many developers have not only raised their full-year sales targets to new records, but also busy replenishing their stock of land. "We purchased 180 land parcels in the first half of the year. Striking a land deal almost every day, we may possibly acquire more than 360 parcels this year," said Mo Bin, president of Country Garden. The midtier developer has been looking to expand its footprint in China's largest cities since last year and has spent about 40 billion yuan on land purchases so far this year.

Guangzhou-based R&F Properties, which has reached only 57% of its sales target for this year, is expanding its staff in Shenzhen to snap up more land in the city. Shenzhen, a Vanke stronghold, saw the highest growth in housing prices among all mainland cities this year. Vanke booked 40.23% of its net profits in the first-half from business in the Guangshen region, which includes Shenzhen and Guangzhou.

"The city is benefiting from government policies such as support for innovative technology," said Li Sze-Lim, chairman of R&F Properties. Li said Shenzhen, whose stock market is home to many tech startups, has been at the forefront of China's economic reforms since 1978, which makes it far more competitive than most mainland cities in attracting talented people.

Evergrande is also making the young city its prime focus. "Shenzhen is our most important ground for strategic development among all tier-one cities," Xia said. "We now have 22 projects in Shenzhen, with a land bank of 10 million sq. meters."

Nikkei staff writersYu Nakamura in Guangzhou andJennifer Lo in Hong Kong contributedto this report.

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