Last October, troubled insurance company Genworth (GNW) announced that it would be acquired by China Oceanwide, a private Chinese company that had thus far limited its US investment to real estate. “Limited,” however, may be the wrong word.
The company and its majority shareholder, Lu Zhiqiang, have already invested in a large project in Los Angeles that will have a new luxury Park Hyatt, a skyscraper in San Francisco, and an “unusually large collection of mansions”—as well as a $41 million ranch in Sonoma County, according to the Wall Street Journal. Though relatively unknown in the US, Zhiqiang, a former Communist Party secretary, is among the top 10 richest people in China.
For Genworth, the timing of the sale to China Oceanwide couldn’t have been better, and this week shareholders voted to approve the acquisition.
But a source with extensive experience in Chinese business, who has reviewed the deal, says the transaction reflects Americans’ lack of understanding of Chinese business and changing US-Sino relations. The source tells Yahoo Finance the deal is unlikely to happen.
Why Genworth is selling
Originally the Life Insurance Company of Virginia, Genworth went through a series of acquisitions, first by what is now Aon (AON) and then by General Electric’s GE Capital in 1995. In 2003, some of the GE insurance properties were renamed “Genworth,” and the following year GE spun them off in a $2.83 billion IPO. The company sold its remaining stake in Genworth in 2006 for $2.8 billion.
A decade after the largest IPO of 2004, things have not been smooth for Genworth. With its clients living longer and requiring more payouts from policies than expected, Genworth needed money it didn’t have to cover debt maturing in 2018. As a result, credit ratings for numerous Genworth businesses, which had already been beset by a series of downgrades, plummeted even more in February 2016, and then again last October.
In February of 2016, S&P downgraded Genworth from “BB-” to “B,” skipping “B+.” AM Best, which specializes in insurance company credit ratings, downgraded Genworth from “bb+,” the lowest “investment grade” rating to “bb-,” which the firm categorizes as “non-investment” grade, after the sale announcement in October.
Selling portions of its business raised some capital to cover debt, but the company explored more options, and engaged in talks with several companies over the sale of its life and annuity and long-term care businesses. Though one company walked away without explanation after performing due diligence, talks with another company yielded progress. Genworth moved towards completing negotiations to sell its life and annuity businesses, a move that would give Genworth more cash to pay its debts maturing in 2018.
But Genworth sidelined that deal when concurrent talks with China Oceanwide culminated in an agreement. The Chinese company offered to buy the whole business for $2.7 billion, and provide $1.125 billion more in capital to keep Genworth’s maturing debt from defaulting and boost its life insurance business.
The deal hasn’t been without major hiccups. At the end of September, meetings between China Oceanwide and Genworth top brass deteriorated when Genworth’s chairman of the board urged China Oceanwide representatives to up its proposed price. In response China Oceanwide said no and was considering dropping the deal and re-evaluating later. According to our source who has reviewed the deal, both sides have been trying to play each other.
High likelihood of China killing this deal
The deal’s likelihood of actually happening may be far less than the market anticipates—which may not be that high considering shares have fallen 20% following the acquisition announcement. The problem? Americans’ poor understanding of Chinese business practices.
According to our source familiar with China policies who has reviewed the deal, getting the money out of China may prove to be impossible for China Oceanwide, thanks to China’s new policies regarding outflows of cash. It’s unlikely China Oceanwide has already expatriated the requisite cash to complete the transaction should that outflow be denied, through SEC filings show a reverse termination fee of $210 million is currently safe in a Citibank escrow account, payable to Genworth should China’s State Administration of Foreign Exchange kill the deal.
Announced in November, China’s policy requires that deals involving more than $1 billion leaving the country are subject to Chinese regulatory approval if the deal is unrelated to the investor’s business. So far, China has been hesitant to provide this approval, and over $75 billion in deals have been cancelled, something that’s hit Hollywood hard, ruining potential acquisitions of Dick Clark productions and MGM by Chinese companies.
Already, at least four deals have been shot down by this $1 billion policy, and many companies have worked hard to stay under that threshold, according to a source with knowledge of the matter.
With so many individuals and companies wishing to move money out of the country, China—and the US—has been strongly scrutinizing why Chinese companies are buying assets. Without any insurance experience or related business, the question of why China Oceanwide wants to buy the struggling Genworth looms large. If there is no better answer than simply to get money out of China, the deal could die.
Another set of hurdles in the U.S.
For U.S. regulators, another possible issue is where the money comes from, a question that scuttled a $14 billion purchase of Starwood Hotels (HOT) by Chinese insurance company Anbang when people began asking for details on its byzantine and opaque ownership structure, where the money came from, and the identities of the owners. Additionally, Anbang’s attempts to buy life insurer Fidelity & Guaranty Life have been delayed numerous times, as US regulators ask questions about who owns Anbang, according to the Wall Street Journal. However, the Journal noted the China Oceanwide was far more accommodating with appeasing regulators.
Both Anbang and China Oceanwide are major investors in Minsheng Bank, but only Anbang has experience in the insurance industry, a notoriously complex and difficult business as Genworth’s plight illustrates.
This complex nature of insurance also means that many, many regulators will be involved, including the Committee on Foreign Investment in the United States (CFRIUS), which has the power to stop a deal if it has the potential to affect national security. More specifically, the Committee sends the deal to the president to be reviewed.
For any deal involving China, this is bad news, as the current president is Donald Trump, who has expressed a distaste for China, accusing the country of manipulating its currency multiple times during the election. Since the deal was brokered and announced when Hillary Clinton was expected to win, the new landscape could be another problem for the deal.
Trump isn’t alone in anti-Chinese investment feelings. A bipartisan effort in Congress led by Sen. Chuck Schumer (D-NY) and Sen. John Cornyn (R-TX) has emerged to make CFIUS more powerful and scrutinize Chinese investments in the US, which have tripled in the past year to $46 billion.
On the state level, regulators will likely scrutinize the deal due to China Oceanwide’s lack of experience in the insurance business. In 2015, during the talks with another unnamed non-insurance company, Genworth expressed concern about how that inexperience would appear to regulators.
For its part, the Genworth board has noted that conversations with Delaware regulators in October have shown it could be amenable to the deal, SEC filings show. According to SEC filings, China Oceanwide’s strategy is keeping Genworth’s management team together, simply owning it wholly, intact, and retaining its expertise. In an email to Yahoo Finance, a Genworth spokesperson declined to discuss sale specifics as a matter of policy, but noted the company has filed all its applications with regulators (each state Genworth does business in must sign off, as well as federal regulators). Both companies have been engaged in discussions with regulators, the spokesperson said.
Keeping the pilots who know how to fly in the pilot’s seat is a smart move, and many analysts estimate the odds tipping towards the deal closing. In January, BTIG analyst Mike Palmer wrote that the likelihood of the deal going through regulators was 60%, thanks apparently to the considerable capital China Oceanwide agreed to put up. But perhaps it should be put another way. At the very best, this deal is a coin flip. At worse, there won’t even be a coin to flip.