Ping An Celebrates a High-Stakes Bank Deal

飞雪寒冰

Seven passengers stepped off a private jet at Shanghai Pudong Airport on a day in March, climbed into cars and sped off to a secret meeting at Ping An Group's Zhangjiang office center.

The travelers represented U.S. private equity firm TPG and its Asian subsidiary Newbridge, and Zhangjiang was the chosen venue for a huge deal that left Ping An with a controlling stake in Shenzhen Development Bank (SDB).

Before the deal, TPG held the largest stake in SDB -- 17.89 percent – which it bought in 2004 with a five-year lock-up period expiring in 2009. The latest agreement means that, if regulators agree, Ping An will take over the controlling interest and get a major bank that it's long sought, eventually securing a nearly 30 percent stake.

Negotiations were tough at Zhangjiang, headquarters for Ping An's insurance, banking, assets management and investment businesses. The company's financial advisor, Goldman Sachs, used cute nicknames to mask the players in the confidential negotiations: Ping An was called "Dove," TPG was "Nightingale," and SDB's name was "Tigger." But the charm disappeared behind closed doors.

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Perfect Exit

Among those celebrating the agreement nailed down at Zhangjiang was Shan Weijian, a TPG partner who played a lead role during the days of non-stop talks. He shared the credit for his fund's handsome profit and future options in selling SDB, and with relief flew to Hong Kong for his daughter's high school graduation a few hours before the public announcement.

According to the contract, Newbridge would receive 11.45 billion yuan from Ping An for the 520 million SDB shares, or 22 yuan per share. It also would have a chance to exchange 299 million Ping An H shares. Based on Ping An's share price in the last 30 days prior to June 8, when trading in the stock was suspended, that stake equals 26 yuan per H share.

In 2004, Newbridge originally spent 1.24 billion yuan for the SDB shares in 2004. Over the following years, it injected 1 billion yuan into the bank which, following several new share issues, brought its stake to 16.8 percent. The latest sale price represents a more than 412 percent return for Newbridge. After factoring in currency exchange rates, Newbridge's initial investment of US$ 150 million pulled in US$ 1.67 billion.

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The deal also gives Newbridge an opportunity to become a Ping An stakeholder and benefit from the group's fast development.

For Shan and his team at Newbridge, it was a perfect way to end the SDB engagement.

Shan joined Newbridge in 1998 after working as head of JP Morgan's China office in the mid-1990s. He also spent six years as a Wharton School professor at the University of Pennsylvania.

Shan cut his teeth for the landmark 2004 deal with SDB by leading a team to acquire the former Korea First Bank – a deal signed after 15 months of negotiations.

But the effort to buy an SDB stake was even more intense than swallowing South Korea's largest nationwide bank. During more than two years of talks, negotiations between Newbridge and SDB broke down several times. At one point, the two sides went to court.

And SDB has hit turbulence several times since settling with Newbridge. For example, ex-chairman Zhou Lin was arrested for issuing illegal loans. The bank endured a long dispute with shareholders during China's shareholder reform period. Banking regulators often ordered the bank to pump up capital adequacy ratios. And the bank has undergone a number of major personnel changes.

Anyone watching Newbridge as it worked with SDB through those bumpy years would have been keenly interested in the investor's exit strategy.     

"Newbridge came (to SDB) at a time when many outside were most pessimistic about China's banking sector," said Fred Hu, an economist at Goldman Sachs. "Opportunities abounded. Any institution could take SDB."

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"But people were worried and scaled back," Hu said. "Newbridge was rewarded for its far-sightedness."

Lin Yong, manager for Haitong Securities Hong Kong, said more than 10 institutions showed interest in buying SDB shares from Newbridge in 2005 and '06. Newbridge carefully weighed the candidates. Suitors were even knocking at the door while Newbridge and Ping An negotiated. For example, insurance giant China Life expressed its interest in a stake by faxing a letter to SDB on June 11.

Why did Newbridge choose Ping An? Shan and Hu, among others, agreed that a domestic buyer would be the best choice. One reason was that the financial crisis prompted several international investors to sell their stakes in Chinese banks.

"My instinct was that we should find a domestic investor," said Hu.

But Hu was not interested in finding a buyer from among major Chinese industrial companies, since a marriage between industry and banks can raise conflicts of interest.

And other major Chinese banks were not interested. "Big banks don't need SDB," Hu said. "No bank of similar size was particularly suitable, since an overlapping of networks and services would be inevitable.

"Considering all these factors, Ping An was an ideal candidate," said Hu.

Shan said Newbridge undertook "a thorough investigation" of Ping An before choosing it as the favorite buyer. "We took into account their investment value, strategy, management team and experience with running a bank," Shan said. "The result is we have no conflicts in culture or management philosophy."

Moreover, Shan said TPG and Newbridge may exercise their option to invest in Ping An. "We are actually eyeing the 4.1 percent stake," he said.

But the U.S. fund is ready to exit SDB. "Newbridge made valuable contributions, and on its way to the exit door, it was very responsible in finding a strategic partner for SDB, to build a larger platform," Hu said

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Dove Tales

Newbridge and Ping An had contemplated an SDB deal for up to three years. All along, Ping An was cautious.

"Unless there is financial investment value, we will not acquire Shenzhen Development Bank," said Ping An Chairman Ma Mingzhe in a Caijing interview June 14. "But of course, strategy is more important than finance."

Ping An has wanted a nationwide bank since snapping up regional Fujian Asia Bank in 2003. A year later, it bid for Guangdong Development Bank but dropped out amid fierce competition.

The market first learned about Ping An's interest in SDB in 2006, when the bank's stock was trading at 16 yuan per share, and SDB needed extra capital to pay for the share-reform required by the securities regulator. Ping An nailed a deal to buy shares of SDB and signed a contract to buy a stake from Newbridge as soon as the lock-up period expired. But Newbridge ditched the plan and footed the bill for SDB share reform by itself.

After failing to acquire the SDB stake, it turned to buy Shenzhen Commercial Bank and merged the two banks under its umbrella to form the Ping An Bank. But the banking arm never grew to Ma's expectations.

"For now, insurance is still our core business, as it represents 80 percent of the group's business," Ma said. "Banking and asset management account for 10 percent.

"We hope to spend about five years encouraging non-insurance businesses to grow faster," he said. "Our goal is to see the insurance and non-insurance businesses contribute 50-50 to the group's profits."

SDB was Ping An's last chance at a big bank. Other nationwide commercial banks either have a stable shareholder structure, or previously invited enough strategic investors. So talks with Newbridge resumed this past spring.

"The negotiations were very professional, very tough," said Hu. The bottom line for Newbridge was 22 yuan per share. Finally, both sides agreed that one Ping An H share could be exchanged 1.74 shares of SDB.

In fact, the price of SDB's new private placement -- 18.26 yuan per share -- was agreed upon just one hour before the June 12 board meeting. This was an average of SDB's market price over the previous 20 trading days, above an industry norm that usually offers a 10 percent discount.

Despite the higher price, Ping An wasn't upset. It helped that the buyer was Ping An's subsidiary Ping An Life, not the parent group, which was troubled by heavy write-downs resulting from a recent investment loss in the European financial group Fortis.

Ping An General Manager Louis Cheung said money is not a problem since the group "has disposable cash of around 24 billion yuan, and can meet the solvency standards for our subsidiaries. Even if Newbridge chooses cash, it would be no more than 11.45 billion yuan."

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Regulatory Obstacles

Taking over the Shenzhen bank and its 500 billion yuan in assets would expand Ping An's opportunities for potential insurance clients by incorporating 80 percent of insurance clients into its banking system, up from the current 15.7 percent. Nevertheless, the firm faces challenges tied to financial holding regulations.

According to Chinese rules, any deal involving the purchase of more than a 5 percent stake in a commercial bank requires the investor to be profitable in the preceding three years. Ping An Life reported a 2.1 billion yuan net loss in 2008 due to write-offs on its Fortis holdings.

When asked about the regulatory rules, Ping An spokesperson Sheng Ruisheng told Caijing the deal would be conducted in accord with relevant regulations.

Huang Huamin, a Citic Securities analyst, told Caijing: "It is common for insurers to have losses on stock market investments, and they should not be banned from future investments simply because of their past losses."

Caijing learned SDB plans to file an application with the China Banking Regulatory Commission (CBRC) soon. It will also need securities regulator approval. Ping An shareholders will vote on the deal at a meeting scheduled for August.

Moreover, the national insurance regulator needs to decide if an insurance company can invest in a bank, and whether Ping An can use its life insurance reserves to buy equities. But industry analysts think Ping An's previous investment in banks has already paved the way.

On the securities side, Ping An's eventual 33 percent stake in SDB would break a regulatory cap of 30 percent, triggering a tender offer. Ping An hopes the securities regulator can make an exception, but if not the firm may sell a small stake to meet this requirement.

"Ping An Bank and Shenzhen Development Bank are still two banks with separate operations and management," said Ping An Vice Chairman Sun Jianyi. "Ping An can allow Shenzhen Development to share client and network resources with Ping An Insurance in areas that Ping An Bank does not reach."

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SDB's Choice

The capital injection is welcome by SDB. The bank will "benefit from the new shareholder in several aspects, and the primary one is a rise in its capital base," the bank's Chairman Frank Newman told Caijing.

Shares in Ping An and SDB resumed trading June 15, three days after the public announcement. Although the former saw mixed price movement, the latter's stock price soared.

The private placement will boost SDB's capital pool by between 6.7 billion and 10.7 billion yuan, raising its core capital adequacy ratio as high as 8.8 percent, and its capital adequacy ratio to a range of 10.7 to 12 percent, more than 10 percent above the regulatory threshold.  

Over the past five years, SDB's development was hampered by a capital shortage. Newbridge's Shan said the problem led to inadequate investments in some key areas, including efforts to expand SDB's network and upgrade the IT infrastructure.

First on Newbridge's agenda after becoming a SDB shareholder was to beef up the capital pool. "It looked like the capital ratio was 2.3 percent at that time, but many hidden toxic assets made the actual capital ratio even lower," Shan said.

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But Newbridge faced a funding dilemma. China's banking rules say a foreign investor cannot hold a bank stake greater than 20 percent, which gave Newbridge little room for additional investment in SDB. The rules also limit any combination of foreign investors to less than 25 percent. And Newbridge feared adding Chinese investors would jeopardize its role as largest shareholder.

Several efforts to inject extra capital into SDB failed. General Electric signed a contract with SDB in 2005 to infuse US$ 100 million by buying the latter's new issue. But nationwide shareholder reform delayed the issue for two years, during which SDB's share price rose to more than 30 yuan from 5 yuan. GE's investment was declared dead in October 2007.

A month later, SDB said it would sell 120 million shares to Chinese steelmaker Baosteel for 4.2 billion yuan. But regulators rejected the idea of an industrial firm's capital moving into banks, so the plan was abandoned in 2008.

SDB had another capital-raising option – subprime bonds. But capital adequacy ratio rules affected the plan. A total 9.5 billion yuan worth of bonds sold in three tranches, but even that was not enough to pump up the capital pool significantly.

The bank can't rely on the capital market, Shan said, but there has to be a "permanent, stable source of capital" for SDB's development.

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Remaining Uncertainties

Ping An has a long way to go before incorporating SDB into its financial empire. Market analysts think that, sooner or later, SDB will acquire Ping An Bank, raising Ping An's stake in SDB to more than 50 percent.

Most of Ping An's subsidiaries are wholly owned, which lets the parent consolidate financial reports, improve synergy and avoid business duplication. It now holds 90 percent of Ping An Bank, and market insiders think the same thing will happen to SDB.

Ping An's Sun said the two banks will operate separately for now while sharing a back office. In the future, it can choose from several business models, including full merger, but Sun said it's too soon to consider such details.

Hu has proposed a sweeping deal in which Ping An would give a tender offer to all SDB shareholders, allowing them to choose between cash and Ping An's share. "After that," he said, "an incorporation of Ping An Bank and SDB would be very smooth."

Such a scheme would face no legal barriers in China, but precedents are rare. In addition, the size of the latest deal, Ping An's dual listing status on the Hong Kong and Shanghai bourses, as well as Newbridge's role as a foreign investor, would certainly invite controversy and prolonged regulatory review.

These realities prompted Newbridge and Ping An to compromise and choose the current takeover plan. SDB shareholders approved the private placement plan June 29.