Kerry and the Credit Juggernaut

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Robert Kuok Hock-nien didn’t become one of Asia’s richest men by gambling on financial derivatives. A conservative investment philosophy combined with close attention to relations with governments has been more his style. But the reportedly ailing 85-year old Malaysia-born Hong Kong resident tycoon may have been losing his grip on an empire which has been growing at a faster than usual pace – too fast for the current conditions.

Reports that the extensive Kuok family’s holding company, privately held Kerry Holdings, has lost as much as HK$1 billion on currency derivatives is bad news too for the group’s two main listed companies, Shangri-la Asia and Kerry Properties. These Hong Kong-listed vehicles are respectively owned 49.5 percent and 53 percent by Kerry Holdings. (The Malaysian and Philippine listed companies are subsidiaries of Shangri-la Asia.). Concerns about any such losses may well have contributed to the sharp fall in share prices of both the main vehicles. Shangri-la is down to HK$9.40 from a year high of HK$26.30 – having been down to HK$7.80 – and Kerry Properties has crashed dramatically from HK$70.70 to HK$14.60. Thus this supposedly conservative group has massively underperformed a very weak market.

Any big losses by the private holding company come at a particularly awkward time when the traditionally under-leveraged group is in the middle of huge expansion with many billions in development commitments just at a time when cash flow from existing operations is probably plummeting.

Shangri-la Asia owns 44 hotels and operates 42 of them. It also operates another under its brand names. At first glance it seems to have good spread. But in practice its two hotels in Hong Kong, which have far higher room rates than any others, account for 29 percent of its profit. That is set to take a beating. The group’s 22 hotels in China generated just 22 percent of its profits last year and in the first half of 2008 saw their occupancy rates sink to 59 percent. Growing China might seem a reasonably secure if moderate profit source. But the group is currently building another 20 hotels in China, and just three elsewhere. “Too far, too fast” might be a reasonable comment.

Shangri-la made 36 percent of its profit last year from managing hotels which carry its brand names but are owned by others. But these revenues also look under threat as the investment bankers who once viewed a five-star Shangri-la as an acceptable hostelry are now looking for jobs.

Long-term China expansion that might make sense for a group which Kuok, dubbed a Chinese racist by one of his non-Chinese relatives, has made a home from home for rich Chinese businessmen. But for now at least this sudden expansion of a group which has been in the hotel business for nearly 40 years is a huge burden. According to its last annual report, capital commitments increased during 2007 from US$1.4 billion to US$2.2 billion. Since then it has also taken on a new commitment of RMB7.6 billion in partnership with Kerry Properties for its huge Jingan development in Shanghai and another in Nanchang.

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In principle this should be no big problem for a group whose mid-2008 debt was only 25 percent of equity of HK$53 billion. But in addition to the strains on its finances created by plunging operating profits — down 20 percent even in the first half of 2008 before the financial tsunami hit — and escalating commitment payments, it may also face problems with mainland partners who themselves may need to be supported through the crisis.

But the problems of Shangri-la in this as in other aspects may be small compared with those of Kerry Properties. The latter again had an apparently quite low debt-to-equity ratio at end-2007 -- 20 percent and rising to 26 percent by mid-2008. The group revalues its properties on a regular basis and this has been a major contributor to profits, and puts the debt/equity ratio in a favorable light. Last year for instance revaluations accounted for HK$3.93 billion out of profit attributable to shareholders of HK$6.56 billion. For the first half of 2008 they were HK$948 million out of a total HK$2.48 billion.

Those valuations look likely to have to go sharply into reverse when the accounts for end 2008 and mid-2009 are drawn up, greatly reducing the net worth of the company which at June 30 stood at HK$52 billion.

In addition it will likely face declines in income from its mostly residential Hong Kong residential property portfolio — 63 percent of operating profit last year — as well as cash calls in respect of its various mainland developments. Properties under development were in the books at HK$24 billion at June 30, an increase of HK$6 billion over the year. Capital commitments rose sharply in 2007 and may have since increased further.

None of the above spells disaster for the Kuok empire. It is likely to be in a far stronger position than the many small developers, and some of the big ones, on the mainland and may well be in a position at some future date to expand by picking up casualties. But if the Kuoks — the patriarch has eight children — really have lost heavily on derivatives they are likely to focus on preservation of capital as they join the list of mega-rich finding out the hard way that China is not a sure thing, and that profits based on asset price gains are usually illusory.

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