There is something tragic yet inevitable about Evergrande’s staggered demise. The debt-laden Chinese property developer’s chances of surviving in its current shape are receding rapidly.
Just this week, it hired two restructuring advisers and warned the Hong Kong Stock Exchange that monthly sales halved between June and August, to Rmb38.1 billion ($5.9 billion). Furious shareholders marched on its headquarters in Shenzhen, demanding compensation on Rmb40 billion in wealth management products.
In a desperate attempt to reduce its $89 billion debt pile, Evergrande is seeking to sell non-core assets, including an electric vehicle unit, and trying to get irate investors to accept properties at steep discounts in lieu of cash repayments.
If you think you know what the market will be like in China in two, five or 10 years’ time, you are deluding yourself
There are shards of good news. None of the firm’s $14 billion worth of offshore debt is due this year. But that’s as good as it gets.
Evergrande’s 2022 debt is trading at 30 cents on the dollar, unsettling markets and raising fears of instability in offshore bond markets, and widening fissures in China’s financial system.
At close of trading on September 16, its Hong Kong-listed shares were trading at HK$2.63 ($0.34) apiece, down 50% in a month and 81% this year.
Management’s next big date with destiny is September 23, when the firm is scheduled to meet interest payments of $125.4 million.
Contradictions
How did this happen? How is it possible for China’s second-largest private property group to be teetering on the precipice of default? Why did it choose to build an empire on the back of so much debt, or for its strategists and advisers to decide that making electric vehicles was a good idea?
“The sector has been red hot for 25 years, with the cards firmly stacked in its favour, yet it is the world’s most indebted property developer,” says Fraser Howie, author of Privatising China. “That tells you a lot about how the company is run, how Chinese business manages itself.”
And therein lies the rub. It is easy to look at Evergrande and tut, but other big real-estate firms are also financially hobbled. Last year, Beijing introduced a ‘three red lines’ policy aimed at cutting excess industry leverage, by limiting firms’ ability to borrow.
It had some effect: new-build house price rises slowed for the third month in a row in August, according to the National Bureau of Statistics. But the spooked reaction to Evergrande’s downward spiral is telling. The Hong Kong shares of Country Garden and Sunac China, two more big property firms, fell 7.23% and 11.25% respectively on Thursday (September 16).
Underlying all of this is the great and seemingly intractable contradiction of China.
The country is both the greatest economic story of the age and an investor’s nightmare.
Too little is known about how many of its biggest companies are governed, be they private firms or state-owned enterprises.
In its latest report, published May 2021, the Asian Corporate Governance Association ranked China 10th in the region for corporate governance, unchanged from two years earlier. Only India and the Philippines ranked lower.
In the ‘government and public governance’ category, China ranked last.
This matters. Global institutional investors have spent decades trying to figure China out. If most are honest with themselves, they aren’t any closer to the truth.
Each decade, at least one huge vehicle goes suddenly and very spectacularly bust. In 1998, state investment firm Guangdong International Trust and Investment Corp failed, leaving foreign investors on the hook for its debts.
Xinjiang-based D’Long folded in 2004 after buying a slew of distressed European firms.
More recently, there was the implosion of Anbang and Tomorrow Group, once-mighty conglomerates slowly dismantled by regulators. Now Evergrande, at least in the eyes of investors and, increasingly, the ruling Party, faces the same fate.
Mistakes
“It is over” for them, says Alicia García-Herrero, Asia chief economist at Natixis. “Evergrande has already fallen. The question is whether it will go through bankruptcy.”
She believes China will find a way to stop a corporate crisis from metastasising, but describes the scale of the challenge ahead as enormous.
Does China learn? There’s no sign of that happening.
Every president since Jiang Zemin has made the same basic mistake: in the pursuit of economic growth and jobs, they let entire sectors get out of control before frantically reining in the more bothersome or systemically dangerous corporate constituents.
Even these efforts can be ham-fisted and self-damaging. Xi Jinping’s current ‘common prosperity’ doctrine is a laudable and even noble cause. It aims to force business and entrepreneurs to close the stubborn wealth gap.
The president is busy checking powerful private technology platforms and crushing prices to make everything from education to healthcare more affordable.
Fair enough.
Yet the way his administration is going about reducing social inequality brings to mind former British prime minister Gordon Brown’s ‘clunking fist’.
Xi’s crackdown on fintech, then real estate and education technology, with healthcare tipped to be next, has left investors struggling to see what sector comes after that.
This is why analysts at Goldman Sachs wrote in July that the word “uninvestable” had come up about China so often in recent discussions with investors. And it is why during a round table on September 14, Julius Baer’s Asia Pacific head of research Mark Matthews said he could “understand” why foreign investors would be “reluctant to invest in China because it has changed”.
He added: “This is the biggest change I’ve ever seen in my career, which is 30 years.”
The S&P US-listed China 50 index, which tracks the performance of the largest New York-listed mainland firms by market cap, has been on a downward path since February. Matthews said that value is “gone and I don’t think it is coming back”.
Delusions
So why would you put your hard-earned dollars, euros, pounds, francs and yen to work in Chinese-owned assets and securities? At least, as long as prices and valuations are determined not by market forces, but by top-down political policy.
Beijing has spent the last few years opening at an unprecedented rate its financial sector to commercial and investment banks, asset managers and private equity firms.
Yet if China is simultaneously cracking down arbitrarily on this sector, then that sector, what are investors supposed to think?
A good rule of thumb is to remember that in the eyes of the Party, its own needs will always come first.
“Beijing doesn’t care about share prices,” says a senior Hong Kong-based investment banker. “They care about political stability, yes. But they care about their capital markets a lot less than you or I would like to believe.”
If you think you know what the market situation and climate will be like in China in two, five or 10 years’ time, which companies will be on the rise, which ones on the wane or chopped at the knees, you are deluding yourself.
