S&P: China Vanke Outlook Revised To Negative On Increased Uncertainty Due To Ongoing Tussle; 'BBB+' Rating Affirmed
We also revised our outlook on Vanke Real Estate (Hong Kong) Co. Ltd. (Vanke HK) to negative from stable. At the same time, we affirmed our 'BBB+' long-term corporate credit rating and 'cnA+' long-term Greater China regional scale rating on the company, which is a wholly owned subsidiary of China Vanke. We affirmed our 'BBB' long-term issue rating and 'cnA' Greater China regional scale rating on notes guaranteed by Vanke HK.
We revised the outlook on China Vanke to reflect the increasing likelihood that the tension among the key shareholders and the management team could ultimately weaken the company's steady business execution and good financial discipline. The power tussle has lasted longer than we anticipated. In our view, there is no clear path to a resolution that could satisfy all stakeholders. We believe the emergence of a rival developer, China Evergrande Group, as a meaningful shareholder increases the complexity of the evolving situation and creates additional uncertainty over the stability of the senior management team.
Since the disagreement between China Vanke's senior management and its largest shareholder, Baoneng Group, emerged in December 2015, the tussle for control of the company has become more public and hostile, in our view. China Vanke's longstanding and second-largest shareholder, China Resources Holdings Ltd. (CRH), also took a more active role in rejecting management's plan to acquire property assets from Shenzhen Metro through a share issuance transaction. Until December 2015, CRH was the largest but passive shareholder in the company. We note that CRH has not commented on the transaction in recent times.
In our view, the tussle has compromised the China Vanke board's effectiveness and its ability to set the company's long-term strategic agenda. The decision on the Shenzhen Metro transaction at the company's board of directors meeting in June was interpreted differently by various parties due to opposition from CRH, which has a 15.3% stake. The schedule for the second board meeting and general shareholder meeting is still uncertain, based on our knowledge.
In our view, the future strategic direction of China Vanke is increasingly uncertain and senior management stability has been weakened. We believe that the existing gridlock could weaken China Vanke's competitiveness and strong reputation in the current volatile and tough property market in China. For these reasons, we have lowered the management and government score for the company to fair from strong, although this has not directly affected the rating.
The board re-election in March 2017 is a near-term risk event in that China Vanke's major shareholders could try to influence the company beyond the role of a pure financial investor. The current board of directors comprises three representatives from CRH, three representatives from senior management, and five other directors, of which four are independent. Baoneng's requisition to remove each director and supervisor of the board in June 2016 raises the likelihood that the board composition would change following the re-election.
We believe 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.
China Vanke has said that the situation has started to negatively affect its operations. The company disclosed that new land acquisition and joint ventures with business partners have slowed and certain overseas funds and banks have held back project co-operation and banking facilities in some instances. Nonetheless, the company's contracted sales are showing strong year-on-year growth, in line with the industry's robust sales so far this year. We also expect margins to remain relatively stable. However, we believe the negative impact on the company's business and financial operations could increase if the open dispute further escalates.
We affirmed the rating on China Vanke based on the company's sound financial position and solid contracted sales growth. The company's financial leverage sits steadily for the current rating level with a debt-to-EBITDA ratio of about 2.1x as of June 30, 2016. We also affirmed the rating on Vanke HK because we believe the company will remain a core subsidiary of China Vanke.
The negative outlook on China Vanke indicates the disagreements among major shareholders and management could weaken the company's steady business execution and good financial discipline. The board re-election in March 2017 is a near-term risk event in that new directors could change the management team, strategy, and business directions. In such a scenario, the company could adopt a more aggressive strategy or reduce the effectiveness of execution and operations, leading to weakened business prospects and financial position.
The outlook and rating on Vanke HK reflect that on parent China Vanke.
We could downgrade China Vanke and Vanke HK if China Vanke's strategy becomes more aggressive such that we believe it would lead to a decline in business performance or weakened financial leverage over the next two to three years. A significant change in the senior management team could signal increased potential of such a shift. We could also lower the ratings if China Vanke's market position, reputation, and access to funding weakens. This could be indicated by a higher funding cost, more restrictive terms, or a material decline in the company's ability to participate or control joint-venture projects.
We could revise the outlook to stable if the power tussle between key stakeholders is resolved satisfactorily. This would mean that in our assessment, China Vanke's competitive position, strategic direction, operational capability, and financial discipline would remain unchanged. In addition, we would expect the senior management and shareholders to find a balance of power such that the possibility of further dispute is minimized.