Posted by Evergrande… you may have seen the name in the news, but do you know who they are, and why they keep hitting the headlines?
The short answer is, they’re what the Guardian in the UK described as ‘the ‘runaway’ developer that could become a wrecking ball for China’s economy’. The longer answer is a bit more complicated than that, so let’s delve in and take a look.
Who are the Evergrande group?
The China Evergrande Group is the second largest property developer in China. It was originally called the Hongda Group, and was founded in 1996 in the southern city of Guangzhou, during a period of mass urbanisation in China.
It grew rapidly in its core residential property development business in the 2000s and 2010s. By the late 2010s, it was one of China’s largest real estate developers with over 1,300 projects across 280 cities.
However, Hui Ka Yan (Evergrande’s founder) had grander ambitions and wanted to diversify the company into a major conglomerate spanning multiple industries. So Evergrande invested heavily across many new sectors even as it continued its aggressive real estate expansion.
Some key Evergrande diversification efforts included electric vehicles, sports, mineral water and tourism, but while real estate consistently delivered profits, most of these diversification bets struggled with poor results, becoming money pits.
Despite this, Hui Ka Yan continued to plow in cash in pursuit of his conglomerate dream. This further weakened Evergrande’s financial stability when its core business model ran into issues after years of excess.
What went wrong?
Evergrande’s business model of rapid expansion required taking on massive loans to acquire development land and fund the construction of hundreds of parallel projects. As Evergrande grew into one of China’s largest developers, the debt started to spiral out of control.
A major factor driving Evergrande’s unchecked borrowing was intense political pressure. Local governments demanded aggressive expansion to stimulate growth, taxes, and jobs. With property and related industries accounting for around 30% of China’s GDP, companies like Evergrande were expected to be the engines of economic development. Communist Party officials had significant influence over business leaders, and there were fears of serious consequences for missing growth targets. Evergrande itself was responsible for nearly 20% of the real estate sector’s expansion in key provinces.
This combination of a growth-obsessed business model and political pressure created an internal corporate culture that turned a blind eye to risk management. Hui Ka Yan set increasingly ambitious annual development goals that were passed on to subsidiary heads across China. Meeting these goals took priority over all else – enabled by easy access to loans from state-linked banks. There were few mechanisms in place to control debt as this crazy expansion carried on. Of course, without reining in borrowing, Evergrande had no chance of avoiding disaster when things eventually came crashing down.
Heading for trouble
Evergrande’s reckless expansion hit a wall in 2021 as a tightening of government policies finally cooled China’s property market. With buyer confidence collapsing, Evergrande’s sales and revenue went into freefall. This was devastating for a company that was dependent on pre-selling unfinished apartments in order to raise vital working capital to pay for construction.
Projects stalled across Evergrande’s empire as they struggled to pay suppliers and contractors. At the same time, the company moved closer to default as interest payments on its unparalleled $300 billion debt pile came due. Years of questionable risk management were laid bare as an ugly liquidity crunch crippled Evergrande’s business almost overnight. This cashflow crisis caused such immense damage that even China’s highest political leaders couldn’t co-ordinate an easy rescue.
Instead, Evergrande was forced into a desperate fight for survival – attempting to sell anything it could to raise capital while fending off angry creditors in court. It was a monumental fall from grace for a company that just a few years earlier had claimed to sell one out of every 30 residential properties built in China annually.
What’s happened now?
After nearly two years of this uncertainty in which Evergrande had repeatedly failed to come up with a plan to restructure those unbelievable debts, this week a judge ordered Evergrande to liquidate, meaning that liquidators will be brought in to look at Evergrande’s overall financial position, identify any ways it could restructure, and take over general management of the company. They’ll be looking for more assets to sell off, so that the proceeds can be used to repay creditors.
However, this process could take months or even years, and overseas creditors aren’t likely to see any money before creditors in China and Hong Kong, putting them at risk of bankruptcy if they can’t recoup their losses. Would-be homeowners, meanwhile, could be left with nothing after paying deposits on property that hadn’t been built.
What does this mean for the markets?
The liquidation order has sent shockwaves through China’s financial markets and shares in Evergrande fell by more than 20% in Hong Kong after the announcement. The Chinese economy is already seen to be struggling, with weak demand, rising unemployment and falling confidence creating challenges for the Government.
We could see a credit crunch – the collapse of Evergrande could mean banks and other lenders may be forced to lend less, meaning companies will struggle to borrow money at attractive (or affordable) rates, which in turn could stall companies growing.
However, that doesn’t necessarily mean there’s a Lehman-style global meltdown on the cards. Experts say that would be almost impossible, due to the tight control the Chinese Government maintain over the wider financial system, and the fact that investors had already started to lose confidence in putting their money into China.
Either way, the Evergrande sage is a cautionary against a ‘growth at all costs’ business strategy and improper risk management. I’ve talked about Evergrande on the podcast and will no doubt be talking about this latest development soon, so if you’re not already, make sure you’re subscribed to Behind the Façade, wherever you get your podcasts!
Image: Reuters