When Singapore’s richest property family invested in a Chinese real estate group, the deal was touted as “game-changing” for its expansion in Asia’s largest economy. Almost a year later, it has instead become a cautionary tale for firms looking to invest in Chinese developers.

In a case of a dream turning into a burden, City Developments Ltd. last month revealed a $1.78 billion write-down on Chongqing-based Sincere Property Group that led the Singapore firm to suffer a record annual loss.

The impairment constituted almost all of CDL’s $1.9 billion investment in Sincere, which more than doubled from its initial outlay as its partner’s finances deteriorated. Now CDL has had enough, saying it will no longer inject funds until the Chinese company returns to health. Cash-strapped Sincere has dragged their rift into the open after missing a bond repayment.

See: CDL plans bond issue as Sincere Property defaults, and blame game begins and Lack of reaction from CDL's price implies Sincere's bond default is factored in

CDL’s wager in a Chinese developer with liquidity issues quickly unravelled when Beijing imposed checks on fresh fund-raising by highly indebted builders that breached its “three red lines.” For others seeking to expand in China, its predicament is a warning: Investing in the world’s second-largest economy may be seductive but also comes with hidden risks.

“It’s a tightly regulated sector and swift change in policies can quickly turn the table against an investor,” said Bloomberg Intelligence analyst Kristy Hung. “In Sincere’s case, the three red lines rule heightened the refinancing difficulties of smaller-scale developers with high leverage.”

Conducting due diligence when investing in China may not reveal the true extent of debts, profitability or potential of a company, said corporate governance expert Mak Yuen Teen, an associate professor of accounting at the National University of Singapore.

“Due diligence is more challenging and differences in legal system, rule of law, business practices and corporate governance are all risks that are greater in China than, say, in other more developed markets,” Mak said.

While CDL declined to comment for this story, Chief Executive Officer Sherman Kwek said at the company’s earnings briefing on Feb 26 that Sincere’s debt restructuring turned out to be “far more difficult, challenging and complex than we expected.”

To scrutinize Sincere before clinching the April 2020 deal, CDL hired one of the big-four accounting firms, along with HSBC Holdings Plc as its financial adviser and China-based Fangda Partners on legal matters. Representatives for Fangda and HSBC declined to comment.

CDL conducted thorough due diligence, said Zhao Dongmei, chief financial officer of Sincere Holding Group, the second-largest shareholder in the Chinese builder. “We opened hundreds of accounts to them, our entire situation,” Zhao said in an interview.

Sincere faced debt issues even before CDL took it over. At the end of 2019, its liabilities made up 68% of assets excluding advance proceeds from projects sold on contract, according to calculations based on its financial report. That’s close to the 70% ceiling later imposed by authorities -- one of the red lines -- as a condition for refinancing.

The Chinese developer had almost 16 billion yuan ($3.3 billion) of short-term interest-bearing liabilities as of June 2020, versus about 2.6 billion yuan of cash on hand, its semiannual report showed. It has around 3 billion yuan in bonds coming due this year through September, including 444.5 million yuan on a note that matured on March 9.

Sincere paid interest on that bond two days after it matured, though investors are still waiting for a principal payment, according to two bondholders.

Blame Game

Then the blame game began. After missing the repayment, Sincere released a statement saying delays in decision-making by CDL “severely affected” its ability to use fundraising and asset disposals to improve operations and cashflows.

CDL replied by saying that Sincere’s message contained incorrect information which could mislead people to believe it should take primary responsibility. While CDL has a 51% joint controlling stake, the Singapore developer said it doesn’t have majority control of Sincere’s board decisions.

At last month’s earnings briefing, chairman and family patriarch Kwek Leng Beng said CDL needed the consent of Sincere’s founder and chairman Wu Xu to monetize its numerous portfolio assets. “He has a different view from us,” Kwek said, adding that he was hopeful that Wu would cooperate.

To be sure, the firms have faced headwinds beyond their control. On top of the crackdown on leverage, the real estate industry has been roiled by the pandemic, which slowed demand for residential and commercial assets. Yet CDL renegotiated the deal after Covid-19 struck, describing the new terms as “significantly improved” over original ones announced in May 2019.

“CDL could have overestimated the easiness of cashing out on Sincere’s heavy assets post-pandemic, and underestimated its refinancing difficulties,” said Hung. “Then things quickly went downhill when the three red lines rule was introduced in August.”

Shares of CDL rose 0.7% on Monday morning in Singapore. The stock has gained less than 1% since the Sincere deal was announced 11 months ago, while the benchmark Straits Times Index is up 19%.

Chairman Kwek has signalled his optimism that the Chinese firm might still attract investors. But with fellow local developers busy repairing their own balance sheets to comply with the stricter rules, that could be wishful thinking, according to Hung. With Sincere unable to repay its bond on time, “any white knight coming in could be investing at a distressed price given its serious liquidity problem,” she said.

“The cautionary tale for other companies is, venturing out to diversify is great, but you need to take a step back and see where your true competitive advantage lies and whether you’re truly gaining from the acquisition,” Justin Tang, head of Asian research at United First Partners in Singapore. “Not everything that glitters is gold.”