Whats The Big Deal With Evergrande

It’s October 2007 and I’m on a week’s study leave.

On the second morning, I awake to learn the Dow Jones has tanked. Every stock market indicator is flashing dark red like the dashboard on my first car.

Overnight, news has broken that Lehman Bros, the 174-year-old investment bank, is on the brink of collapse due to the sub-prime lending crisis.

And Wall St is freaking out about the contagion effect.

But analysts are quick to allay any fears, “…this is an isolated incident, the banks are too big to fail, just calm your farm”.

The next night the Dow Jones rockets back up and the dashboard is dark green again.

And then a few months later…Bear Sterns, American Home Mortgage, Lehman Bros, and a few other banks fall like dominos. Buried in debt.

And now opinion is divided over whether Evergrande is another Lehman Bros.

It goes like this…

Evergrande is the most indebted company in the world.

It’s also the second largest property developer in China.

The problem is, Evergrande is on the brink of collapsing. It’s about to bury itself under $US300 billion ($A400 billion) of debt.

Here’s one example why…

Last Thursday, Evergrande defaulted on an interest payment of $83m for an offshore loan of $2b.

Meaning, they couldn’t even meet the repayments on a loan that makes up less than 1% of its total debt position.

That would be like you not being able to service 1% of your mortgage.

Meanwhile, Evergrande has approximately 1,200 projects across 230 cities totaling 1,600,000 units waiting to be completed.

The problem is these units are already pre-sold and Evergrande has used the money for other debt obligations and can’t finish the developments.

They’ve pinched from Peter to pay Paul.

So, by now you’re probably wondering how Evergrande ended up in this position?

Simple. For the past 25 years, China has had a growth at all cost mentality.

Hence our mining boom. Remember our two-speed economy during the naughties (2000 – 2010)?

But recently, the Chinese govt. has become concerned about the amount of debt being racked up by developers.

Consequently, as of August last year, they banned the largest developers from borrowing any more money. Period.

Simultaneously, the Central Govt. also imposed borrowing restrictions on home buyers and investors to curb one of the most expensive property markets in the world.

As a result, Evergrande has been sandwiched.

They can’t borrow any more money to finish their projects while they struggle to sell existing stock.

Put simply, the money has dried up and they’re now illiquid. Hence the reason they defaulted last Thursday.

And then there’s this curve ball…

In preparation for the Beijing winter Olympics next year, Xi Jinping, has put restrictions on steel production and coal fired power stations to reduce the amount of air pollution.

I.e. factories can only operate 3 days per week instead of 5. BTW…they’re not told in advance what days they can work either.

Xi Jinping has even banned the use of streetlights at night!

It’s oppressive. Economically and socially.

In a video to our clients last weekend, I analogized Evergrande’s situation with a python and a cobra.

When a business is heavily laden with debt, it slowly chokes itself to death (python).

But when it becomes illiquid, it’s death is sudden (cobra).

For the past 12 months, Evergrande has been wrestling with a whopping big python wrapped around its neck.

And now it’s staring at a Cobra, close enough to kiss it on the lips.

Only one question remains.

How many other Chinese property developers are about to be kissed on the lips as well?

Have a great weekend!

Adam

Back paddock – granddaughter to grandfather

Granddaughter: Grandpa, if I tell you who sleeps with Granma when you’re not here will you give me $1?

Grandpa: I’ll give you $2 for that!

Granddaughter: Me.