ASIAVIEW: Unclean hands

After a protracted separation, one of the messiest divorces in private equity real estate finally has reached a conclusion.

Via a delicately-brokered asset swap and management spin-out, the three chief protagonists involved in Winnington Capital’s $1 billion Trophy Property Development fund can begin to look forwards – even if one side is nursing a bruised reputation, another a bruised reputation and bottom line and the third a bruised reputation, a battered bottom line and, most likely, permanent exile from the sector.

An autopsy of the one-time largest China-focused property development fund doesn’t reveal many positives for any side, nor should it. Indeed, being part of this fund has meant a litany of mistakes that should not be repeated.

In the first place, Kenneth Hung and Winnington Capital, his hedge fund-cum-private equity real estate business, had no business corralling 150 LPs worth of equity for a property development program that came with so much uncertainty. Those investors, including some of the most sophisticated US institutions and fund of funds, had no business backing a seven-year vehicle managed by what was effectively a start-up, especially one partnering with a developer best-known for projects lasting far longer than seven years. Lastly, the developer, Hong Kong stalwart Shui On Land, had no business partnering with limited-life capital on projects that were at such an early stage that it could not suitably predict exits.

As one of Trophy Property’s investors told PERE: “There’s no party involved here with clean hands.” Even now, when an agreement between the three sides has been successfully brokered and a new-look fund and management team has arisen to take the (now written-down) investment forward, Winnington’s chief protagonists should learn from their experience.

Let’s remind ourselves of the facts: Winnington, a hedge fund manager, fancied a shot at property development. Its founder, Hung, emphasized family ties (through marriage not blood) to convince investors to back a vehicle wrapped around investments in minority stakes in five mixed-use developments in Shanghai, Wuhan and Chongqing by Shui On Land, which is run by his brother-in-law, property tycoon Vincent Lo. In 2008, about 150 investors committed capital, ranging from large US pension plans to individuals from Goldman Sachs. They had been dazzled by the prospect of outsized returns from China’s growth story and Shui On’s ongoing regeneration of an area of Shanghai called Xintiandi into one of the city’s most popular destinations.

After two ‘honeymoon years’, tensions arose between the partners. First, they disagreed about how to develop the assets. Tensions escalated when it became apparent that relocating the sites’ inhabitants would be more costly and take longer than originally forecasted. When it became clear exits were unlikely (let alone distributions) and more than the $815 million invested by the fund would be required to keep the fund’s stakes at the same size, accusations started flying and advisors were appointed by all sides. By the time a solution was brokered this summer, the fund’s debt to Shui On, which had continued to fund the developments on its own, had grown to RMB2 billion (€244 million; $326 million).

Last month, an agreement to swap the fund’s minority stakes in the five developments for a majority share in one residential-heavy project called Taipingqiao 116 in Shanghai’s Xintiandi was approved. As a stipulation, Hung withdrew his involvement completely, and today the fund is managed by a spin-out from Winnington called Venator Real Estate.

PERE obtained a ‘parting note’ from Hung to Trophy Property’s LPs (see page 26) expressing remorse for what happened (while firing shots at Shui On Land for its part). The vehicle had become “the majority of Winnington’s business” he wrote, indicating the heavy price he paid for swapping familiar hedge strategies for unfamiliar property development.

Shui On’s mistake was in underestimating the importance of aligned interests. Just as GPs must seek alignment with their operating partners, there also is an onus on operating partners to understand the parameters of the capital with which it is working. Additional capital calls for private equity funds are not as formulaic as public company rights issues. Another note seen by PERE stated that “Shui On had no obligation to meet the fund’s life since they were not aware of what it was.” Shui On was naïve to consider its partner would be able to cope with further costs and delays.

Some of Trophy Property’s investors insist that they backed the fund in spite of the family connection between Hung and Lo. They also noted that there were few other investable options in China in 2008. Even so, how they got comfortable with minority stakes in nascent developments, over which their manager had no control, is anyone’s guess.

Only the advisors have emerged from the debacle with any credit. PERE understands that TAN-EU Capital, general partner of another China development fund alongside Shui On sister company SOCAM Development, played a pivotal role in brokering the swap solution and management spin-out. It is telling that TAN-EU and SOCAM share GP responsibility for their fund. Undoubtedly, the Winnington experience informed Shui On’s second private equity real estate venture.

Meanwhile, it would be an interesting statistic to see how many of the 150 LPs in Trophy Property have returned to China development strategies. For Hung, however, it’s hard to see any way back.