Last year, we saw the incoming of the Hainan Provincial Government to take control of HNA Group Company Limited (HNA) and the potential sell-off HNA’s airline assets as spread positive for SANYPH 10/21s. The bonds rose to the high 70s before coming down to the high 40s in May on a series of negative headlines such as HNA Technology’s default on a USD4bn loan from Agricultural Bank of China to finance the USD6bn buyout of Ingram Micro in 2016. (HNA agreed to sell Ingram Micro to Platinum Equity, a US private equity firm, last December for USD7.2bn.)
Asset sales have slowed due to a COVID-19 impact on the valuation of travel-related assets but the effort was on-going with financial support from Chinese banks, especially China Development Bank. The bankruptcy notice on 29-Jan proved that asset sales, credit facilities, and new management set up by the provincial government are simply not sufficient to keep HNA afloat. Both SANYPH 10/21s and HONAIR Perp fell about 10 points on the bankruptcy news.
The most important piece of recent news on HNA is the CNY109bn embezzlement (and hidden debt guarantee) figure which appears to us as the tip of the iceberg. COVID-19 and the corporate governance issues will make it difficult to conclude on HNA’s recovery value on its bonds. Hence, even at 30c on the dollar, we cannot recommend buying HNA-related bonds including both SANYPH 10/21s and HONAIR Perp.
The Hainan Provincial Higher People’s Court’s bankruptcy notice to HNA on 29-Jan makes it official that HNA is in a bankruptcy procedure. The event is still a surprise to us despite what HNA has been through since late 2017. We believe last year’s administration of HNA by the Chinese authorities is a step in the right direction but we believe the following factors have led to the bankruptcy court filing:
1. Lingering economic impact of COVID-19 is proving to be too much for the Chinese authorities to handle.
2. The bankruptcy court filing leads us to believe that the asset sales, new management since last Feb, as well as the credit facility lifeline from Chinese banks, particularly China Development Bank are not sufficient to service HNA’s debt.
3. As we have pointed out in our previous reports on HNA, HNA’s major problem is in its liquidity position and the difficulty of moving money around its complex corporate structure.
The eventual bankruptcy 2 weeks ago only confirms that the group will likely be broken up, in our view, and that does not mean HNA will be in liquidation any time soon, but we expect HNA to be a much leaner company with perhaps more focus on its root in the aviation industry. We understand HNA’s aviation business will remain state-owned after the restructuring while the non-aviation business will be put into a trust where creditors will have an opportunity to swap debt into equity holdings of the trust. We note that, in the event of a bankruptcy, bondholders at the holding company level are at structural subordination to bonds issued by operating subsidiaries. In short, we understand the Chinese authorities are looking to restructure HNA and, at the same time, continue to sell the company’s non-aviation assets.
The bankruptcy under normal circumstances should be the beginning of the end of negative news flow for HNA. But here are the factors which point to asymmetric downside risk for all HNA-related debt, in our view:
1. Asset Sales: HNA has undergone asset disposal since 2018. We are of the opinion that COVID-19 will depress the valuation of travel-related assets as well as properties that HNA is trying to sell now.
2. Embezzlement: Worse than the depressed valuation is the 1-Feb and 10-Feb news (from Bloomberg) that Hainan Airlines Holding (HAH), HNA Infrastructure Investment Group (HIIG), and CCOOP Group (CCOOP) reported that they failed to disclose CNY46bn in debt guarantees and that their shareholders and affiliates misappropriated at least CNY63bn of funds in separate exchange filings on 30-Jan. To rectify the situation, HAH will transfer interest-bearing debt of at least CNY72.5bn back to HNA and HNA Aviation Group. HIIG and CCOOP will convert their reserves into new shares. The embezzlement confirms the market suspicion of HNA’s corporate governance. In our view, this event obviously eliminates trust in HNA’s financial figures.
3. Complicated corporate structure: This problem is not new to HNA nor anyone who is looking to invest in HNA. The complicated corporate structure, especially of shareholders of HNA, makes it more time-consuming to undertake due diligence on HNA and its consolidated subsidiaries, in our view.
4. Complicated financing structure: HNA embarked in non-traditional ways to finance its acquisitions. As a result, we believe HNA’s total leverage exceeds what was on the group’s balance sheet. We understand many shareholders of HNA’s subsidiaries have pledged shares as collateral to borrow at the shareholders’ and/or affiliates’ level to acquire target companies. Those stock loans were not consolidated on HNA’s balance sheet.
These four factors will make it very difficult to sell assets at attractive valuations, or to even find private investors to inject equity into the non-aviation trust or even the new aviation entity. Simply speaking, the recovery value of HNA-related bonds have become uncertain with asymmetric downside risk to all HNA-related debt, let alone SANYPH 10/21s and HONAIR Perp, in our judgment.
EXHIBIT 1 & 2 show price performance of HNA’s SANYPH 10/21s and Hong Kong Airlines’ HONAIR Perp. Both SANYPH 10/21 and HONAIR Perp prices (ask) were at 30 cents on the dollar at the time of this review. We do not believe both bonds are liquid and investors may not be able to find bonds even if one believes HNA’s recovery rate will exceed 30 cents on a dollar. In our view, HNA’s involvement with embezzlement leads us to believe it is impossible to gauge potential liabilities of the group at this point in time. Hence, we cannot recommend investors to buy both bonds.