China's Real Estate Disaster - Company Forensics | Sidebean

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1:01This episode is brought to you by Google Chrome. You think you know a browser, but Gemini and Chrome? That's new. It can help you with practically anything on the web, like restoring a vintage motorcycle from a 50-page restoration block or finally break down that long article you've had open for weeks. Gemini and Chrome is here for it. Ready to make anything online makes sense? There's no place like Chrome. Chrome responses set up require compatibility and availability, very 16 plus. It's 2021 and the world has come to a halt. A giant boat is blocking this Swiss canal and wait, no, that's evergreen. That's a Taiwanese company. It's a different country. And that's how you upset a billion people in the first five seconds of the video. Alright, so let's start. It's December 7th, 2021. Evergrande, the second largest real estate company in China has missed a payment. And that triggers panic in China and in the rest of the world. This is about China's real estate sector. Huge change in the Chinese economy. $48 million to overseas countries. Thousands of investors have lost money.

2:02Thousands of ordinary Chinese citizens who've made investments in the company and bought its homes. This could be China's big short moment. This is like the end of capitalism. The bill was $82.5 million due as interest on the over $300 billion in debt that this company has. For the past few decades, Evergrande has been a pillar of China's real estate boom, of China's economic boom. The year before, alone, it built the equivalent of 300 empire state buildings of housing across China. And then that time, it pulled a rabbit out of a hat and saved itself, but fast forward to August 2023. And this time, it looks like they're out of luck. Evergrande filed for US. Chapter 15 back for China. Evergrande has filed for Chapter 15 for the President's Income Crisis. A world-murged indebted property. You know, the $300 billion in liability since 2021. In this particular piece, could very well trigger a domino effect and detonate China's biggest economic and social unrest in decades. I bet you're going to be hearing a lot about Evergrande in the coming week.

3:03So here's a timeline on the rice and fall of Evergrande. It's 1996. Born in poverty, a former steel factory worker, Shiu Gian, found what will become Evergrande. China's 90s were not like our 90s in the West. This was a time of transformation where hundreds of millions of people are moving from rural China to the cities. From 388 million people living in cities in 96 to over double that amount as of last year. In 1997, the company scored its first property and borrowed its first money from the bank to build a JinBi garden. And they sold it below cost. Now, we need to zoom out. Sorry. Now, before we go on, we need to zoom out of the timeline for a moment. For today's explainer time. As a real estate developer business, the big challenge is cash. You need a lot of money to create something very valuable.

4:05And companies usually don't have it or don't want to risk all of their own cash in the bank. So, of course, what you do is you borrow money against an asset. And then in a balance sheet, that loan would look something like this. What you can also do is pre-sale the apartments you're about to build. And this is a common practice everywhere, but particularly in China, where demand is so high and people aren't generally allowed to invest in other stuff like in the stock market. So buying houses is just a obvious investment for a lot of people in China. As the company begins construction, they have to spend cash to pay the developers and the materials. But, as that plot of land transforms from just an empty plot into a building, they can assume that those assets are now worth more, as long as it's finished. And then, to that, you can also stack up the fact that all real estate prices are growing in the country. So these unfinished projects, they're still owned by Evergrand, because they aren't finished. But now, they can appreciate them in the books. They can assume that they are worth more.

5:06And they can go get another loan on the bank on this new added value, and then rinse and repeat. So you can use accounting to show that the value is there, but you need some liquid cash to actually realize that value by paying the developer to actually finish the apartments that you started. And this has always been Evergrand's game. And it looks somewhat familiar. In 2008, it bit them in the ass for the first time. The global financial crisis caused by some degenerate gambling on the other side of the world. I never hung out with these idiots after work. Ever, I had fashion friends. Down 1.7% here, loss of 37. And then the plans that Evergrand had to raise money to pay some of their debt were scrapped. And you had to use this charm to raise at a sort of emergency $500 million investment slash bailout round. And this is where it becomes clear that shoe was in the empire business. In 2010, they purchased the Guangzhou soccer club with great success.

6:12And then they jumped into CPG and into plastic surgery with this premium ice water that they announced that year, but they had to give up on it like three years later. And all through this time, the leveraging didn't stop on the contrary. But in 2017, they were looking at $178 billion in liabilities. This was kind of allowed to happen because of how charming and how well connected shoe was essentially buying favors with the Chinese government through charity and to just being the spearhead of China's real estate. Enough to get his loans approved or for the government to help him crush anyone who dared question him. And then another big issue that's particularly hard to track here is how many deals and how many contracts Evergrande had that are not reflected in the books or in those public filings. They're not illegal per se, but they're these verbal agreements, some of which probably stack up their liabilities. But the diversification of businesses kept going. It's soccer school and oil company dairy pig farming. In 2018, they announced they were getting into high tech.

7:13They were leveraging the middle of the trade war with Trump. And in 2019, they announced that they were getting into EVs. At this point, I've lost track of all the subsidiaries. I didn't want the research to take too long and I didn't want the video last 40 minutes. When you need to build up your team to handle the growing chaos at work, use Indeed sponsor jobs. It gives your job post the boost it needs to be seen and helps reach people with the right skills, certifications, and more. Spend less time searching and more time actually interviewing candidates who check all your boxes. Partners of this show will get a $75 sponsor job credit at Indeed.com slash podcast. That's Indeed.com slash podcast, terms and conditions apply. Need a hiring hero? This is a job for Indeed sponsor jobs. This episode is brought to you by Paul Molliv. Family time isn't just the big moments. It's weeknight dinners, sitting around the table, everyone talking all at once. So when the plates are empty and the sink is full, use Paul Molliv ultra. Paul Molliv's most powerful formula removes up to 99.9% of grease, leaving your dishes

8:16sparkling clean, and the new convenient pump makes cleaning even easier so you can spend less time tackling dishes and more time together. Shop now at PaulMolliv.com. So here's a list. Someone could make the argument that all of these strategies and diversified companies were just a patch to save this real estate company in a market that's actually slowing down. Someone could argue that all of this capital raised is meant to just keep some cash flowing to finish those construction projects and maybe realize the value that they're declaring for those assets. The problem with these paper valuations is that sometimes they cause economic recessions.

9:20We made a whole thing about that. Now the key word that you want to remember whenever you want to sound cool on this topic is contagious. If a company or a bank that is too big fails, it triggers other companies and other banks to fail. Maybe because of how much exposure they had. Maybe because a lot of people panic. Now the Chinese government of course knows this and as much of a friend of theirs shoe might be, well they implemented a policy that started the company's downfall. The three-rowed line system requires companies to meet three rules in order to borrow any more money. Liabilities should not exceed 70% of assets evergrans was 82%. Number two net debt ratio. That's net debt divided by total equity. That should not be greater than 100%. That means that the money reserves that they have to cash needs to be at least one X or 100% of their short term debt. Evergrans was 200%. And then rule three, a cash to short term debt ratio of at least one dollar. That means that there's enough cash in the bank to cover all short term debt.

10:23Which sounds obvious, but Evergrans was 0.4. And this is the beginning of the end. Even after they write a letter to the Guangdong provincial government begging for help to restructure the company because they just don't have the cash and they can't borrow anymore. The letter leaks and it gives everyone a glimpse into how desperate the company is. They're unable to borrow more money and then they begin selling everything they can. The companies and the subsidiaries, apartments that it still owns sold for a massive discount. Projects get halted all over including their mostly vanity stadium. And then by September, the world economic forum calls it. A default by the company is possible. Now you can run any math you want to calculate or inflate your assets. You make invents investors to keep pouring money. But the moment you actually fail to pay your lenders, people panic and they start looking more closely. And so the world did 1.4 million unfinished houses.

11:23Evergrant becomes China's first financial concern because 30% of the country's GDP is real estate. 41% of the banking assets are tied to real estate and if Evergrant crashes and causes contagion in real contagion, it could cripple their entire economy. And so the Chinese government faces this same question the US government did in 2009 with and with Silicon Valley Bank recently. Does it intervene to save the economy at the cost of setting a precedent that this recklessness will get bailed out? And the PR mess is here. The world knows what's happening but the Chinese bank says no, it's poor management and reckless expansion. 2022 and 2023 have just been just pouring water out of a sinking ship. Stock trading was halted a couple times. They were ordered to demolish some of their projects which is basically assuming that they'll never get completed. Stock price, nose diving, post-COVID economy, actually shrinking home values in China means that there's no escape from this.

12:23With 1800 projects under construction and abandoned stadium Evergrant filed for bankruptcy in China, chapter 15 bankruptcy protection in New York City. Even though there are Chinese companies, they need protection against potential lawsuits from their lenders in the US and the rest of the world. And then comes Contagion. Evergrant is or was the second largest real estate company in China. The first one, it's called Country Garden, reported losses of $6 billion in the first half of this year. Stock is down 30%. Seen ocean, a state-backed real estate developer and the Zhang Hao International Trust Company, both missed payments on their interests. On our side of the world, UBS, Blackbrook and Ashmore, they all have over $300 million each invested in Evergrant. That's how a house of cards starts falling apart. But as always, it's the regular people who suffer. That's 1.4 million families that paid for a unit to Evergrant and now have no idea if they might get their house or their money back or if they'll get anything at all.

13:25It's not over. There's a difference between going bankrupt and filing for bankruptcy protection. A bailout by the government is unlikely but still possible and other companies might come to the rescue and just buy parts of it of what's left. If you want to understand the difference between those two and how that bankruptcy process works, you should check out our bankruptcy explanation using Monopoly. We also made a video on the three largest financial crises in history, including our very own 2008 bubble. I'll link both of those here. Make sure to hit that subscribe button and we'll see you next week. Fall has never looked or tasted this good. Sweet Greens' Fall Harvest Menu is back with seasonal favorites dressed to impress and made to be devoured. Warm roasted sweet potatoes. Crisp apples. Maple glazed Brussels. And crave worthy flavors. In the autumn harvest bowl, Maple Glazed salmon plate and roasted bacon Brussels side. The season's most desirable menu has returned to sweet green.

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