Sunday, December 15, 2013

Cargolux: The Deal with HNCA

Sunset, a reciprocal image. Photo ET

Cargolux: The Deal with HNCA

Earlier in 2013, no one in Luxembourg would have known the name HNCA. The Acronym stands for Henan Civil Aviation Development & Investment Co., Ltd, created in June of 2012. HNCA has three shareholders: Henan Coal Chemical Industry Group, Henan Transport Investment Group and Zhengzhou City Real Estate Group. Citing from a speech translated into neo-Chinese English: "Zhang Mingchao, Chairman of HNCA, spoke that the HNCA had the glorious mission of developing the civil aviation of Henan province. The Company will keep learning, innovating, optimizing operation, and make more contribution to the construction of Zhengzhou Airport Economic Comprehensive Experimental Zone and Henan Province."

I had a look at the "Commercial Cooperation Agreement" between HNCA and Cargolux in the form of the "Updated draft of 30 September 2013, changes as per meeting HNCA Cargolux 10 December 2013". It has 13 pages, cover page included, and 5 pages of attachments !

The fact that such a short, poor document saw little improvement over the last 10 weeks, is reason enough that I would be embarrassed to bring such a document to a meeting.

Apart from the very little remediation to the text, my analysis fills me with doubt about the negotiation skills of those who did this, the poverty of the language which allows for many questions and opens the door for conflicts in the future, and to open legal questions, which I would ask my lawyer. I have to believe and hope that CV's lawyers saw those considerable questions, which they didn't want to detail publicly?

1. Negotiation 101

HNCA exists since mid 2012. Its mission is to focus on the " Zhengzhou Airport Economic Comprehensive Experimental Zone and Henan Province." Did you read "Experimental"? It says further that "The Company will keep learning, innovating...". 

No one at this stage can say that the parties don't negotiate in good faith. There is an exciting project: creating an airport, now encroached by several towns, expand it from 1 to 4 runways, create a JV with CV for another all cargo airline in Zhengzhou, together with all the infrastructure on the ground, including maintenance and pilot training. Nothing of these exists today. As a young adventurer, not risking my own money, I would go for it in a minute. And as a broker, I would sell it as a nice story for a nice fee to anyone who would listen.

But does this accomplish the "glorious mission" to guarantee CV's future? No one knows from this Agreement exactly what was agreed to. But essentially, not much has changed when it comes to CV's extremely low valuation. It was essentially pre-determined by the undervalued and unfortunate Qatar Airways deal. Now, for the neutral outside observer, there is maybe a very stupid seller, and a sophisticated buyer. But it doesn't impede the next steps, if both sides are happy with the price. The very impatient seller, the Luxembourg government, seems very happy. The only problem there is, it isn't the seller's money, it is the tax payer's money.

As for the rest, CV will be a strategic asset for HNCA in the grandiose adventure of creating a market, an airport with 4 runways, with infrastructure, a new airline with its own maintenance and pilot school, and other unnamed JVs. If that is the exciting project where we want to see CV's future, and where HNCA sees CV as a strategic asset, the overwhelming question is, why didn't CV become a shareholder of HNCA? There was enough valuation in CV (the real value of CV) to get a reciprocal share for CV in HNCA, for no money down. But the opportunity to get reciprocity and a fair valuation for CV was missed. Who negotiated this? A pertinent question, as there was and is no real urgency.

2. The "Commercial Cooperation Agreement" is barely an Executive Summary.

If you buy or sell a one family home in an Anglo-Saxon jurisdiction, the contract can easily have 180 pages. Selling 35% of CV, I understand, can be done in 18 pages, cover page included. It is indeed much easier to read. As I'm not a lawyer, I appreciate that fact, but I would ask my lawyer, if I hadn't fired him yet for such a disappointing performance, the following questions:
Page 2: Define in more detail voting rights and mandatorily convertible bonds
Page 4: Is import + export cargo 30,000 tons or 60,000 tons?
Page 5: If cargo volume through CGO doesn't reach 200,000 tons after 36 months, what happens?
Page 5: With so many JVs considered, why isn't there cross ownership CV-HNCA?
Page 5: There is much uncertainty as the Luxembourg government deals with a non-sovereign Provincial government. What if rules change, CAAC doesn't cooperate or the Chinese government comes out as bad cop undoing what the good cop Henan Province seemed allowed to do?
Page 6: Are 4 flights binding? Who covers the losses? CV is a commercial venture, not a government agency. Page six actually overflows with dictates of a planned economy for a venture that has to care for the bottom-line in a market economy: increase flights, additional "traffic rights", scaling up flights, subsidies and their guarantee over time, etc. But: CV has no veto right, as again, reciprocity would have demanded.
Page 7: 3.7. The Dual Hub Strategy Fund needs "Unanimous decisions". Good luck.
Page 7: 3.8. "Reasonable cooperation" means "best efforts" only?
Page 7. 4.1. "Reputable international consulting firm". What can that be? At what cost?
Page 8. 5. CV could have had cross ownership in HNCA, at no other cost than the value of 35% of CV. Or at least get a better price.
Page 9: 9 is boiler plate language. Just mentioning that there was no excruciating effort in that paragraph.
Page 10: This agreement is under the laws of England and Wales. Future JV's under Chinese laws. Dispute resolution will be through arbitration in Hong Kong (HKIAC), a place not known for its strong pro-Luxembourg bias. It is not impartial territory.
Page 11: 11. Waiver of Sovereign Immunity. But of course: the good cop - bad cop plays out. Luxembourg and the Province of Henan waive their rights. Beijing does not. It is not involved for now. Later it will.
Page 12: 12. Just standard clerical discipline: Fill in the following missing address for HNCA:
HNCA: No.8 Shangwuwaihuan Road, 
Zhengzhou City, Henan Province, China
Zip Code

Phone: 0371-87519086
Page 12: 13.1. We are talking millions in fees, legal etc. Does any third party get commissions? How much? Are those commensurate with service levels provided? Not to a politically exposed person?  Beware of international and Chinese anti bribery laws. CV doesn’t need new fines, jailed managers, if not executed ones.

3. Conclusion. Manage risk. Start over again.

All in all, the Agreement is a poorly written document, barely a draft Executive Summary maybe, and an ill-conceived, -negotiated, and poorly defined undertaking. I guess Shearman & Sterling, which is a sterling law firm, was only minimally involved in the production of this document, and even worse, was not involved in advising what the deal could be and should be. They would certainly love to answer my  questions from a lay man and they have many more of their own.

There is also some more intangible political risk, as was the case with Qatar. We are not partnering with a Swiss or German entity. In this case we partner with one of a newly assertive super power, which leaves the political risk at the level of politics, preferences, and pragmatic choices for Luxembourg. Locally in Zhengzhou, CV will be associated with a project that will cover probably about 30km2 or more, going from the present one runway small airport to a multiple of four. It will have an important impact on zoning, and encroaching populations will have to be displaced, villages razed. This displacement may not become a major political issue though, as the local culture provides for a more docile acceptance for general interest projects, than it would in Luxembourg.

Maybe it is not too late to make corrections and fill in the blanks in the hollow Agreement, blanks about which I hope there is at least a consensus between both sides over answers, that there are common assumptions and verbal commitments at this stage. HNCA has shown a positive approach, and will be glad to learn and understand. In particular, that there is no mention, no declaration, no formal guarantee to alleviate the rightful concerns of the Luxembourg employees, tax payers and other stakeholders when it comes to their future.

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