Thursday, 13 November 2008
Parent Company Bails Out CITIC Pacific
CITIC Group has agreed to provide CITIC Pacific with a US$1.5 billion standby loan facility to be substituted by a convertible bond issued to CITIC Group. Meanwhile, the parent group will assist CITIC Pacific to reorganize its AUD leveraged foreign exchange contracts, potentially incurring a loss of USD19bn.
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Parent Company Bails Out CITIC Pacific
Leanne Wang, Hong Kong
13 November 2008
CITIC Group has agreed to provide CITIC Pacific with a US$1.5 billion standby loan facility to be substituted by a convertible bond issued to CITIC Group. Meanwhile, the parent group will assist CITIC Pacific to reorganize its AUD leveraged foreign exchange contracts, potentially incurring a loss of USD19bn.
Under the agreement, the convertible bonds of the same value of the standby loan facility will be automatically converted into equity at HK$8 per share, which will make CITIC Group the majority shareholder in CITIC Pacific, with a stake of 57.6%. The conversion price represents a premium of about 32% over CITIC Pacific’s last closing price at HK$6.06 before it was suspended from trading on October 31.
In CITIC Pacific’s filing to the Hong Kong Stock Exchange yesterday, the parent group will “economically assume the liabilities and benefits” of the leveraged foreign exchange contracts and CITIC Pacific “would no longer have to account for such losses and profits.”
CITIC Pacific bought leveraged currency contracts to fund an A$1.6 billion ($1 billion) iron-ore mine in Australia but mistakenly bet that the Australian dollar would rise, incurring losses after the currency tumbled 30 percent against USD from a 25-year high reached in July.
Under the leveraged foreign exchange contracts , which have clear upside limits but no downside limits, CITIC Pacific is obligated to buy Australian dollars at the price of A$1:US$0.87
Under the agreement between CITIC Pacific and its group parent, the target AUD-USD exchange rate is set at around USD 0.70. With the AUD trading at USD 0.64, the parent is taking a big risk by taking over part of the contracts.
Regarding the leveraged foreign exchange contracts, the Board of CITIC Pacific has established a committee, chaired by Chang Zhenming, the president of CITIC Group, who said that he believed the agreement would help restore confidence in the company so that it can “move forward and continue developing its businesses.”
It has puzzled investors why the company jumped for over A$9bn while the total capital needed for the mining project was only A$1.6bn, an act called by industrial insiders an “over hedge”.
The joint statement issued yesterday stating that “the AUD leveraged foreign exchange contracts within CITIC Pacific will be used for its Australian iron ore business” and that the parent group will take on the rest of the contracts can be interpreted as a silent admission that CITIC Pacific had been engaged in speculation through derivative transactions.
CITIC Group and CITIC Pacific have worked out another derivative-looking arrangement to justify the credit relationship which benefits all parties. The parent will assume the troubled contracts under a name of the creditor and in the meantime will become the majority shareholder of CITIC Pacific. CITIC Pacific will defuse the “time bomb” with its parent’s “critical financial support” and then will be able to continue its operations with an appropriate level of debt.
However, key questions about its internal control and risk management have as yet received no answer.
CITIC Pacific has been heavily criticized for the six-week delay in disclosing the unauthorized trades. Investors also suspect the company profited from insider trading during the six weeks its share turnover skyrocketed.
But yesterday’s statement mentioned only that “PricewaterhouseCoopers undertook an initial review of CITIC Pacific’s treasury systems ahead of the company’s announcement on 20 October 2008, and is currently conducting a more detailed review of internal controls.”
Hong Kong’s Securities and Futures Commission has started an investigation into CITIC Pacific and the results are pending.
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