Chinese real estate giant Evergrande on the verge of collapse: should the Dutch investor be worried?

1. What kind of company is Evergrande?

Evergrande is a Chinese real estate company that was founded in 1996. In those 25 years, thanks to the large population migration to the cities, it quickly grew into the second largest real estate developer in the country. It now owns more than 1,300 real estate projects in 280 Chinese cities.

At the end of last year, more than 123,000 people worked at the company, which sold real estate contracts in 2020 with a total value of 100 billion dollars (85 billion euros). But today the real estate giant does much more: it develops its own electric cars, sells mineral water, owns amusement parks, a music label and since 2010 even its own professional football club.

So far, so good, you would think. Until it turns out that the Chinese owner Hui Ka Yan, whose wealth is estimated by business magazine Forbes at more than 9.5 billion euros, has taken quite a bit of risk in building his empire.

2. Why are they in trouble?

Evergrande’s aggressive growth strategy is based on borrowing a lot of money from state banks, and then speculating with it on the basis of local governments. That has been going well for years: the Chinese economy is growing exceptionally fast and the demand for real estate is enormous. Not only because people moved from the countryside to fast-growing cities, but also because real estate appears to be an attractive investment.

Although things almost went wrong during the financial crisis of 2008. Evergrande hardly gets any projects sold, but with the help of new loans from investment banks and especially the rousing IPO in Hong Kong a year later (yield 722 million dollars), the company is happily rumbling on.

Until the Chinese government tightened the reins last summer. In order to slow down the exploded real estate prices, developers are no longer allowed to borrow endlessly. They also have to report their debts to the government. What seems? Evergrande has a mountain of debt of more than 250 billion euros and immediately receives ‘code red’.

When Chinese house prices also fall, the company will run into further problems this year. Especially if it turns out that it has difficulty paying the sky-high interest on loans from lenders. If investors get wind of this, a merciless price decline sets in.

This year, the share has plummeted by more than 83 percent. In addition, today it emerged that Evergrande missed the first deadline of its interest payment of more than 71 million euros to bondholders, raising fears of collapse.

3. Does the Dutch investor notice anything of this?

According to experts, that’s okay. “If you look purely at how many international investors invest in China at all, that is not much in percentage,” says investment strategist Lukas Daalder of asset manager BlackRock. “Even if you own Chinese stocks, the chances are small that they are specific to this company, because in the Netherlands it often concerns baskets of shares. The direct exposure is very limited in that sense.”

The Evergrande debacle does affect the global economy in the longer term, says asset manager CornĂ© van Zeijl of Actiam. “There is a clear impact on the housing market in China, where house prices have entered a negative spiral.”

The demand for raw materials, such as concrete and steel, is also falling, according to Van Zeijl. “Look at the steel price that has plummeted. And Dutch companies like AkzoNobel that have paint stores in China will sell less paint.”

It does not leave the financial markets outside China completely unaffected, Daalder also thinks: “Last week you saw that the fear was reasonable in the market due to the headlines about Evergrande and the so-called ‘fear of heights’ among investors on the record-breaking stock exchanges.”

Although the latter is a bad argument, he says. “You always need incidents for a downward movement. That incident could be Evergrande. But if the stock markets sink because of this, many parties will see that as a reason to get in.”

But to compare Evergrande to the US investment bank Lehman Brothers, which fell in September 2008, as has been suggested here and there, the two asset managers think it is an exaggeration.

Van Zeijl: “At the time, Lehman caused an enormous implosion of the system because commercial banks started to mistrust each other, which heralded the credit crisis. Evergrande mainly borrowed money from state banks.”

4. How will this debacle continue?

Such an implosion of Evergrande would cast China in a very bad light and drive many investors away. The expectation among economists and credit rating agencies is that the Chinese government will not let it get that far. Not least because Evergrande is considered to be too big to fail: The company’s debt amounts to 2 percent of China’s gross domestic product.

One possibility is that Evergrande will be cut up and sold in parts with the help of local governments. In the best case, the ailing projects can then be taken over and completed.

“The Chinese authorities will take the lead,” says Daalder. “The government also has that power and will not allow Evergrande to fall because they are afraid of ripple effects across the rest of the world. Although that does not solve the problem overnight.”

Because shareholders, bond investors and customers of Evergrande will certainly not come out of this any better. While a large number of jobs are also at risk. Van Zeijl does not feel sorry for the Dutch investors who are suffering. “For ten years there have been stories that Evergrande has a lot of debt. Then you should have known: this will go wrong. The question is always when.”

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