Johnson Controls is looking at alternative funding strategies for its China operations. The People’s Bank of China (PBoC) policy of tightly controlling liquidity in its financial system presents some unique challenges for the US’ largest auto-parts supplier.
“The biggest volatility that we have seen is in terms of liquidity in the market – our ability to raise capital in China,” said Marc Vandiepenbeeck, Asia Pacific and Middle East corporate treasurer at Johnson Controls to Asiamoney PLUS in an interview on May 21. “It comes and goes very fast, it’s tight and strictly controlled.”
“We have been very smart about managing our liquidity in China. We haven’t been building up too much cash in the past, which has been extremely beneficial for the company because we manage to redeploy that cash somewhere else [for investments and acquisitions],” he added. “But that also means that today, we need to borrow and we have been looking a lot at our banking partners and other joint-venture possibilities."
As a result, the company has looking into several alternative funding strategies, particularly third-party entrustment loans. Since direct borrowing and lending between two commercial entities is strictly forbidden under China's regulations, entrusted loans have been considered a solution to the problem of trapped cash.
Entrusted loans are a form of intercompany lending that enables these entities to redeploy funds from a cash-making subsidiary to another in need of financing at a minimum cost. There are two types of entrusted loans: intra-group and third-party entrusted loan.
Johnson Controls has opted to use the latter as an alternative financing source.
“We are looking into borrowing from other corporates that are cash rich,” said Vandiepenbeeck. “Some of them are sitting on a large amount of cash and the return that they are making from that cash is much less.”
“What we are offering to them is a deal – we are going to enhance your return and you are going to get a fairly good risk as Johnson Controls is a highly-rated investment grade company. The advantage for us is that we are going to borrow at a cost that is less than what we borrow from the banks,” he added.
Vandiepenbeeck highlights that Johnson Control’s potential savings could be as high as 100 basis points (bp) as oppose to borrowing directly from a domestic banks. Meanwhile, its corporate lender will be able to reap a higher investment yield of around 100bp-250bp more.
The transaction is also positive for Johnston Controls financial advisers as entrustments loans are administered by banks according to target borrowers, usage purpose, amount, duration and rate. These financial institutions, which act as intermediaries of entrusted loans from a depositor or principal, collect handling charges and will not take on any loan risk.
“If we are a bank, for example, it is a win-win-win situation for all as they are not lending their own money, but they just get some commission income,” said Steve Wong, Asia Pacific and Middle East director for corporate treasury at Johnson Controls in the interview.
However, the challenge remains in securing a partnership with a cash-rich corporate, but Johnson Controls believes that this would be a minor obstacle that can be easily overcome.
“Some of the companies have very strict investment guidelines with their cash,” said Vandiepenbeeck. “But, we are looking at short-term borrowings because our investment creates very high return in a short period of time, which means that the payback is extremely fast.”
Johnson Controls, the world’s largest producer of automobile batteries, is looking into expanding its presence in China. For example, the company plans to increase its production of automotive batteries as many as 30 million annually in China by 2015 amid growing demand in that country. It will also build four additional plants in China to meet production needs.
Seeing that there is a need for Johnson Controls to tap financing amid its aggressive investment plans, the company has also considered other forms of funding, including plans to issue a dim sum bond.
However, given current market conditions, the company has put this plan on hold for the time being and is actively monitoring the market for good opportunities. Vandiepenbeeck realises that investors are now demanding for higher yield given the fact that the potential for renminbi appreciation has declined.
“We don’t want to be exposed to anything and try to keep a balanced portfolio, and not rely on one source of funding,” declared Vandiepenbeeck. “That’s one of the reasons why we would be ready to do a CNH bond, but not at the pricing that it is today. As that market reshapes itself, we are standing back a little bit to monitor it.”
“[By issuing a dim sum bond], we get to create a new investor base that we can rely on and not being only dependent on the American or European investors,” he added.
The average yield of dim sum bonds tracked by a Deutsche Bank index was 3.7% at the beginning of March, up from 1.5% a year ago.
In addition to the potential issuance of dim sum bonds, Johnson Controls has also looked into factoring, or accounts receivables factoring. This would mean the company outsourcings its receivables collection process to another party.
The factoring company (factor) pays the business a percentage of the value of the accounts receivable and deducts a fee for the cost of collection. The factor then collects the receivables.
“Just like a lot of other manufacturing companies, we are exposed to those bank drafts that we don’t always like because of practicality of receiving those bank drafts and then passing them onto our supplier base,” said Vandiepenbeeck. “It’s not good for the long term, and then the health of your supplier wouldn’t be good.”
While Johnson Controls believes this is generally effective, the lack of transparency in China, however, is one of its major concerns.
“We have been discounting some of those bank drafts with some of our partners. They like that business because it returns a good yield. We like that business because sometimes prices within the cost of the credit lines,” said Vandiepenbeeck. “Cost wise it is volatile also because the banking sector in China is not extremely transparent.”
Johnson Controls had a 2.5% increase in revenue to US$364 million in the second quarter of 2012 as the company's 2011 acquisitions began aiding net income. The company manufactures automotive interior systems and batteries, and provides facility management systems, controls and services.