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China debt crunch

Tsinghua Unigroup's bond default: Five things to know

Chinese chipmaker's financial problems send shock waves in corporate debt market

Tsinghua Unigroup has been aiming to establish itself as a leader in China's memory-chip industry since 2015 but has been facing investor skepticism over its finances.   © AP

HONG KONG -- The liquidity crisis at Chinese chipmaker Tsinghua Unigroup, a crown jewel of President Xi Jinping's grand "Made in China 2025" plan, deepened this week after the company said it would default on more bonds.

The company, majority-owned by the prestigious Tsinghua University in Beijing, Xi's alma mater, said a subsidiary failed to meet a deadline to repay a $450 million Eurobond and noted that the credit delinquency "will constitute a cross-default." That means three U.S.-dollar denominated bonds issued by the unit in January 2018, with a total face value of $2 billion, will also be considered in default.

The chipmaker -- which last month defaulted on a 1.3 billion yuan ($198.6 million) onshore bond, sending shock waves across the corporate debt market -- on Thursday also revealed that it had failed to meet a 260 million yuan interest payment for another onshore bond.

The company in a statement this week to the Shanghai Stock Exchange, where the bond is listed, said its "liquidity is strained," and it was "proactively raising funds through multiple channels" to come up with the cash.

For a while now, investors have wondered where the company would find the funds to fulfill its ambitions. While the company counts government-backed venture capital funds and a credit line from China Development Bank, the university does not have the wherewithal to deploy the billions of dollars necessary for chip market dominance.

Here are five things you need to know about Unigroup's current woes:

What is Tsinghua Unigroup?

Majority-owned by Tsinghua University's Tsinghua Holdings, Unigroup was established in 1988. The company employed nearly 40,000 globally and had consolidated total assets of 270 billion yuan as of 2018, according to its website. Unigroup says it is the world's third-largest designer of commercially available mobile phone chips and controls a fifth of the global SIM card market.

The investment vehicle of Zhao Weiguo, Unigroup's chairman and a Tsinghua University alumnus himself, owns 49% of the company, while the university holds the other 51%.

The company, which has been aiming to establish itself as a leader in China's memory-chip industry since 2015, has for more than a year faced investor skepticism over its finances. Its U.S. dollar bond due in 2023 tumbled late last year and yields soared past 10%, forcing it to hastily arrange a call to reassure investors that its finances were healthy.

Now, investors' fears have materialized. The company's free cash flow for the first half of this year was negative 11.57 billion yuan, deteriorating from negative 1.89 billion yuan a year ago. Its capital-to-asset ratio at the end of June was just above 30%, with the company itself admitting the level of liabilities was "relatively large" in its disclosure to bondholders in August.

Its interest-bearing debt was 156.69 billion yuan, with over half facing redemption within a year, as of June. It had only 51.56 billion yuan in cash at that point.

What happens to the company now?

After a default, a company usually goes through a restructuring process, typically with a creditors' meeting to disclose its financial and cash flow positions. An independent liquidator may also be appointed to oversee the whole process.

Some common outcomes include liquidating assets, issuing new debt with a new, more remote maturity date, or a "haircut" on existing debt where creditors receive a percentage of what they are actually owed. Sometimes new shares could be issued.

"The whole restructuring process may last for a few months or even years," said Jackson Chan, a fixed income analyst at BondSupermart. "Most of the time, [a] company can continue to run in order to keep generating profits."

Unigroup has told bondholders that it has formed a joint group with government officials to assess the path ahead and ways to ease the debt burden. This may involve bringing in new investors, according to a bondholder.

The company's national importance means new investors should be Chinese. In addition, Beijing will need to ensure the entity putting in the money is not under U.S. sanctions. As many as 35 Chinese companies, including its largest chipmaker, Semiconductor Manufacturing International Corp., have been added to a blacklist of companies with alleged Chinese military ties in a move that could prevent U.S. investors from buying the companies' shares and bonds.

Given the complexity and the size of a bailout, any resolution will take some months, investors and analysts say.

Tsinghua Unigroup Chairman Zhao Weiguo is an alumnus of Tsinghua University. His investment vehicle owns 49% of the company, while the university holds the other 51%.   © Reuters

Is there any impact on the company's chip business?

There are signs that trouble is surfacing at the core chip business. As Nikkei Asia has reported previously, two very high profile projects -- a 3D NAND flash memory factory in Chengdu and a DRAM memory chip factory in Chongqing -- have hit significant delays due to the cash shortage.

These projects were originally announced with great fanfare, as they were considered to be part of Xi's "Made in China 2025" program to make China self-sufficient in terms of chips and other key high-tech products, against the backdrop of heightening tensions with the U.S.

The company seems to have been feeling the pinch. In a disclosure to bondholders in late August, the company admitted that it may "not sufficiently be able to capture the strategic opportunity of industry development." It also hinted at a possible reduction in government subsidies, which have helped it financially over the years, as an important risk factor.

The company has not responded to requests from Nikkei for comment on how the latest credit crunch has affected its core chip business.

Will Xi's link to the group save it?

It is always extremely difficult to tell how strong connections are to the Chinese Communist Party for any given company or individual, including Unigroup and Zhao, its chairman.

Wu Xiaohui, a former head of once acquisitive Anbang Insurance Group, makes for a good case study. When Wu was shopping the globe for various assets, he was thought of as "safe" due to his former marriage with former paramount leader Deng Xiaoping's granddaughter. However, Wu is now behind bars, sentenced in May 2018 to 18 years for fraud and embezzlement.

As for Unigroup and Zhao, some say their party and state connections may not be so reliable. Alex Payette, the founder and CEO at Cercius Group, a Montreal-based research firm specializing in analyses of Chinese companies' political connections, points out that Zhao is a "personal friend" of Hu Haifeng, the son of former top party and state leader Hu Jintao. For Xi, Zhao may not be the one to save. Payette thinks "bailing Unigroup is likely not a priority right now" for Xi.

Tsinghua Holdings, the parent that owns 51% of Unigroup, is a different story. The holding company, fully owned by Tsinghua University, is a major vehicle for a so-called "New Tsinghua Gang," a Xi clique organized by affiliates of the university. "Tsinghua Holdings probably would not be allowed to fail," Payette told Nikkei in a written reply.

Will the company's troubles lead to a financial system crisis?

Fund managers and analysts say no. Nevertheless, a spate of defaults in recent months by notable state-owned enterprises, including Huachen Automotive Group and Yongcheng Coal & Electricity Holding Group, have called into question the implicit government guarantee on debt issued by these companies.

While domestic defaults have climbed, offshore defaults have been rare. This default will force investors to reassess the creditworthiness of weaker state-linked companies. China corporate bond yields are already rising.

However, there was little immediate impact on the nation's $50 trillion financial markets, which will be reassuring to authorities aiming to clean up leveraged state-backed corporates without wider contagion. Ratings agency Fitch expects the number of state-owned entity defaults to rise marginally in 2021, with tighter funding conditions than in early 2020. Investor appetite for debt from weaker SOEs would ebb, it said.

Some $21 billion of offshore debt issued by local government financing vehicles is due in 2021, more than double the amount this year, while onshore bond maturities for SOE's will marginally fall to 677 billion yuan next year from 686 billion yuan, the ratings agency estimated.

"We need to view these defaults in the context that China is trying to introduce more capital market discipline to weed the system of companies that really should restructure and to also remind onshore China investors that there is no blanket sovereign put," said Jonathan Liang, senior fixed-income investment strategist at Alliance Bernstein.

"At the same time, the central government does have levers to pull to prevent any snowballing effect that might turn cause contagion ... we do not believe we will see a systemic crisis," he said.

The Royal Bank of Canada's head of Asia foreign-exchange strategy noted: "Beijing is showing its determination to squelch the assumptions about a state guarantee of SOE debt with the troubled Tsinghua Unigroup Co. defaulting on more bonds [Thursday]."

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