Two critical steps in liquidizing state-owned assets

By Wang Jihong and Miao Juan, Zhong Lun Law Firm
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Public-private partnerships (PPPs) remained a popular funding model in 2016, and central enterprises, especially those with a construction licence, captured the spotlight in the PPP market by acting as the investor as well as the general contractor. In the meantime, however, a thorny problem is looming – as more PPP projects start to break ground, massive financing and investments are sending debt-to-asset ratios at central enterprises to hefty levels that approach the warning lines set by the State-owned Assets Supervision and Administration Commission of the State Council (SASAC).

Wang Jihong, Zhong Lun Law Firm
Wang Jihong
Zhong Lun Law Firm

So how can central enterprises secure a project’s construction contract through investment without making its financial report look bad? Some central enterprises join hands with financial investors to bid for the project through a consortium, within which the central enterprise would be responsible for building the project and the financial investors
would be responsible for raising money for the construction.

Some enterprises choose to take action after the bidding result is announced. After they are awarded the project, they seek to fund it by selling outstanding shares, issuing new shares, transferring their own shares, or launching asset securitization programmes. The authors worked on an expressway equity transfer project worth more than RMB10 billion (US$1.45 billion), in which a central enterprise adopted the latter approach. The transaction also touched upon two critical steps of the sale of state-owned stake – appraisal and listing.

The appraisal

Asset appraisal is a critical step but often ignored in the sale of state-owned assets. The result of asset appraisal determines the value of the assets, and sometimes decides whether a sale is successful or not. There are stringent regulations in place governing the scope of appraisal, the selection of appraisal agencies, as well as appraisal approaches, results and procedures. According to state-owned asset regulations, unless otherwise specified, state-owned assets cannot be sold before their value is properly appraised.

According to the Instructions on the Selection of Appraisal Agencies by Central Enterprises, the SASAC requires central enterprises and their subsidiaries to select an appraisal agency from their own database through a competitive mechanism. If the asset sale is an abrupt decision and the agency cannot be selected from that database, it must be selected from the SASAC’s database, and the result should be reported to the SASAC.

Price is the core consideration for both the buyer and seller of state-owned assets. According to general commercial practice, in a big deal involving an asset sale the seller and buyer must have already reached a preliminary agreement about the price of the deal, pending the result of the appraisal. However, according to the SASAC’s notice about strengthening the management of state asset appraisals, when an asset appraisal is carried out under the going-concern principle, the appraisal agency should adopt at least two appraisal approaches and choose one to estimate the value of assets to be sold.

In practice, the present earning value method and replacement cost method are commonly used to appraise asset value. Appraisal agencies are generally inclined to use the approach pointing to a higher appraised asset value. If the appraisal result is beyond expectations of the two sides, the deal might fail to materialize.

In addition, the seller and buyer must obtain regulatory approvals before the deal is completed, and register the deal after it’s completed. Generally speaking, it can take several months from when the appraisal process begins until the appraisal result is announced.

Miao Juan, Zhong Lun Law Firm
Miao Juan
Zhong Lun Law Firm

The listing

The SASAC and Ministry of Finance in 2016 released the Regulatory Measures on Transactions of State-owned Assets of Enterprises. The decree, considered to be a powerful weapon to oversee the sales of state-owned assets, has rolled out a string of stringent conditions on state asset sales. In principle, state assets must be publicly auctioned on the equity exchange market. Exceptions are: (1) when the transaction concerns the reorganization or integration of key enterprises whose main business is crucial to national security or economic safety, concerns special requirements on the assignees, concerns equity that must be transferred among state-owned or state-controlled enterprises, and is approved by the state-asset management authority; and (2) when the asset sale is among the state-owned enterprises and its subsidiaries or enterprises controlled by itself due to internal reorganization or consolidation, and consent is made by the state-owned enterprises. Such regulation has led to a result that even though the central enterprise and prospective buyer may have reached consensus in private, it still has to go through a full set of procedures to publicly list the assets on the equity exchange market.

In order to take PPP projects out of their balance sheets, central enterprises have to transfer control of the projects as they sell shares to financial investors. Under that circumstance, in addition to 20 business days of information disclosure, they must make pre-disclosures of no less than 20 business days within 10 business days of the transaction being approved. The disclosures have further extended the process of equity transactions.

Deal payment is also a sticking point in the listing stage. PPP projects involve big sums of money, and most buyers prefer instalment payments to buy the assets. But the down payment must be no less than 30% of the total. The buyer must also provide a legitimate and valid guarantee against the remaining payment, and pay interest expenses based on the corresponding bank lending rates for instalment payments. The entire payment must be settled in one year. The buyer should take into account guarantees against the instalment payment and interest expenses when planning on the means of payment.

With growing calls to liquidize remnant assets and cut corporate debt, more and more central enterprises are expected to put their PPP projects on the block, and asset appraisal and listing should be given thorough considerations in the sale process.

Wang Jihong is a partner and Miao Juan is an associate at the Beijing office of Zhong Lun Law Firm

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