End of an era with arrest of HNA Group chairman

In his heyday less than a decade ago, Chen Feng seemed like an unstoppable man on a mission to conquer the world.

HNA Group Co., the sprawling conglomerate Chen and his late partner Wang Jian helped start as Hainan Airlines in 1993, became the standard-bearer for a cabal of companies that snapped up trophy assets from the U.S. to Europe. Their wave of acquisitions symbolized the arrival of China Inc. on the world stage. Courted by Wall Street, the globe-trotting tycoon also hobnobbed with powerful leaders including President Xi Jinping and David Cameron, the former British prime minister.

Then, it all collapsed under one of the world’s largest mountains of corporate debt. The pandemic was the death knell for HNA, which had already been scrambling to sell off assets as its liabilities loomed. Effectively seized in February, 2020 by the government of China’s Hainan island, where it’s based, the group’s aviation and tourism businesses were paralyzed by the shutdown in travel, and it’s now being restructured.

Already sidelined as officials moved in, Chen, 68, has come to the end of the line. The chairman was detained along with HNA’s chief executive officer Tan Xiangdong for unspecified crimes, the company said late Friday, caught up in Beijing’s sweeping corporate crackdown. It also comes as another heavily indebted conglomerate, China Evergrande Group, faces a financial reckoning that’s coursing through global markets and raising questions about whether Beijing will step in.

Critical Industries

Chen and his group were among the myriad of billionaires and business empires spawned in China’s decades of liberalization since the death of Mao Zedong. While the state often dangled favorable policies and used companies to advance the country’s foothold in critical industries, the Communist Party remains leery of the power wielded by business and its potential threat to financial stability. It’s a wariness now playing out in its reining in of Alibaba Group Holding Ltd., Didi Global Inc. and others.

But unlike the technology giants — whose success and control of big data have made them a target — HNA grabbed the government’s attention for a different reason. Under the leadership of Chen and Wang, the group took advantage of the easy credit that swirled in China in the twenty-teens to fund a raft of overseas acquisitions. Deals worth more than $40 billion included significant stakes in Deutsche Bank AG and Hilton Worldwide Holdings Inc., luxury properties such as golf courses, landmark hotels across six continents and the 648-foot skyscraper 245 Park Avenue in Manhattan.

When Beijing became aware of the risks of such capital flight and leverage, it started to clamp down on the big acquirers. The high-flying Anbang Insurance Group, owner of New York’s Waldorf Astoria hotel, was seized by the government in 2018. HNA’s slow-motion unraveling began soon after, with it shedding assets as debt repayments loomed. The group still faces at least $63 billion in claims from creditors.

“Chen shared the same strategy of many business people with political connections — they used their connections to borrow as much money as possible from state-owned financial institutions,” Victor Shih, an associate professor who specializes in Chinese financial policies and elite politics at the University of California San Diego, said in an interview before Chen’s detainment. “The way that these conglomerates used leverage to over-pay for overseas assets rapidly was not sustainable and resulted in catastrophic deleveraging.”

Debt was the foundation stone for Chen and Wang’s ambitions. Both devout Buddhists, they set their sights on HNA becoming one of the top companies in the Fortune 500. Credit-fueled expansion helped the conglomerate rise 183 spots to 170th by 2017, but also sealed its fate within months as debt ballooned to more than $93 billion the following year.

Born in China’s coal mining hub of Shanxi, Chen grew up in Beijing and graduated from the Lufthansa College of Air Transport Management in Germany. He held positions at the Civil Aviation Administration of China and the National Air Regulations Bureau before venturing into the private sector. Around 1990, he helped establish a company that later became HNA’s flagship Hainan Airlines Holding Co. while serving as the aviation business adviser to Hainan’s governor.

During the early days of its growth, HNA managed to secure billionaire George Soros as an investor, which was a coup for a small regional airline with just 10 million yuan ($1.5 million) of government backing at the time. Chen quickly became the toast of China’s nascent business community, cultivating a dynamic and accessible image in interviews. He’d serve drinks and snacks on Hainan Air flights, posing for the cameras.

Chen was an “incredibly effective speaker and an effective salesman for HNA and its aspirations,” said William Kirby, a Harvard Business School professor who has known Chen for years and invited him to speak at several of his classes.

Collar Strategy

HNA’s ambitions to go beyond aviation — and the confines of China — began in 2007, when it bought SA Sode Hotel in Belgium, one of its first overseas assets. More deals followed, including the investment in Deutsche Bank AG that made it the German lender’s biggest shareholder at the time. The stake deployed a “collar” strategy popular with leveraged-up Chinese acquirers then, and saw HNA own the bulk of its holding through derivative contracts known as put options.

Chen was unfazed by the piling debt. In an interview with state broadcaster China Central Television in 2004, he famously likened leverage to lice. When you have so many, “you don’t feel itchy any more. When you’ve borrowed so much, you can fall asleep at night.”

The conglomerate’s financial struggles began to emerge in the middle of 2017. HNA, Anbang and others began selling off their assets, unwinding some of their biggest buys to pay back debt. Though people familiar with discussions in 2018 said China’s top leaders had agreed to help HNA raise funds, providing a safety net, that didn’t materialize.

Too Fast

“HNA was expanding faster than the expertise of the management,” said Warut Promboon, managing partner at Hong Kong-based credit research firm Bondcritic Ltd. “The government used HNA to expand the influence of China, but it had to go hand in hand with the health of the company.”

The turmoil deepened in July 2018, when Wang died while vacationing in southern France. He was 57. Local police said HNA’s co-chairman fell from a height of 15 meters (49 feet) while having his photograph taken in the village of Bonnieux. Months later, French daily Liberation reported the incident was suicide.

Wang’s death provided an extra layer of intrigue around HNA, which was facing a rising drumbeat of questions about its ownership structure, and its alleged financial links to Communist Party leaders. The perceived connection to power gave some bond investors a sense of security that Beijing would come to HNA’s rescue if it ever got in trouble with its debt.

Soon those investors would find out their optimism was misplaced. Since the authorities took charge of HNA and plowed it into restructuring, allegations of financial mismanagement under the original regime have surfaced.

In exchange filings in February, three HNA units alleged that some shareholders and affiliates misappropriated at least 63 billion yuan ($9.7 billion) of funds and that they failed to disclose about 46 billion yuan in debt guarantees. On Saturday, the day after Chen’s detainment was revealed, the Chinese magazine Caixin reported scores of related-party transactions, some of them linked to HNA’s overseas acquisitions, weren’t fully disclosed to regulators.

A study of the company’s filings and interviews with multiple former and current executives, found that Chen, along with Wang and several senior executives, owned companies that were controlled or invested in by family members that conducted business with HNA, Caixin said. The complex network of related-party dealing meant HNA might have paid as much as 50% more than competitors for aviation materials and 10% more for aircraft, a former HNA executive who wasn’t identified was quoted by Caixin as saying.

Representatives for HNA declined to comment.

Sitting Buddha

With Chen now in police custody with Tan — a U.S. citizen, according to filings to the Securities and Exchange Commission — HNA is firmly in government hands. Its Hainan headquarters, whose famous shape is often compared to a sitting Buddha by the local media, is now thronged by officials, who negotiated the sale of stakes in its airline and airport businesses earlier this month and plan to restructure the group into four independent business units.

While his son Chen Xiaofeng remains a member of the board, the elder Chen’s detainment severs him from HNA. His treatment bears similarities to that of Anbang’s former chairman, Wu Xiaohui, who was sentenced to 18 years in prison in 2018 for fraud and embezzlement.

More companies that are highly leveraged could meet HNA’s fate, said Bondcritic’s Warut.

“Without explicit guarantee, the government should not have been expected to come in to bail out the company,” he said. HNA “sets the precedence that companies can undergo restructuring, so investors know these things could happen to a lot of companies in China.”