China’s Evergrande has long held the title of the world’s most-indebted property developer, but in the last few days its reputation has shifted from bloated to doomed.
On Monday, Evergrande’s stock price dropped 10.2% in Hong Kong, the latest blow for the Chinese property giant that has been on a downward spiral for months. Since the beginning of this year, Evergrande’s stock price in Hong Kong has dropped from 14.1 HKD ($1.81) to 2.3 HKD ($0.3), sinking the company’s valuation from $24 billion to $5 billion. The selloff Monday reflects investors’ growing worry that Evergrande will default on part of its $300 billion debt this week—$120 million in interest on two bond notes that’s due on Thursday. The bonds have a 30-day grace period, but the company’s sinking bond prices suggest investors think default is the most likely outcome.
Analysts Fortune interviewed Monday say investors are right to fear Evergrande’s demise, but they aren’t betting on a total, uncontrolled collapse.
Turning point
Founded by Hui Ka Yan in 1996, Evergrande built a massive property empire in China by capitalizing on the country’s booming real estate market and rapidly urbanizing infrastructure, often selling out entire buildings before they broke ground.
But the company founded its business on debt. It borrowed to develop property and fund acquisitions but then struggled to service the debt. Beyond real estate, Evergrande expanded into sectors like electric vehicles, bottled water, and tourism, none of which proved particularly profitable.
Nigel Stevenson, an analyst at GMT Research in Hong Kong, says that Evergrande has been “teetering on the edge” for years. But now the company’s debt is coming due as it struggles to offload unsold properties and runs headlong into Beijing’s new anti-borrowing campaign that’s made it harder to raise cash.
“We are pretty skeptical about the quality of the assets on its balance sheet… It’s not able to just grow out of its problems anymore,” says Stevenson.
Bruce Pang, head of macro and strategy research at China Renaissance Securities, says a turning point for Evergrande’s problems were ratings downgrades from Moody’s and Fitch earlier this month. The downgrades stemmed from Evergrande’s legitimate liquidity crisis, but they prompted a flood of negative media coverage of the company in China and internationally, which helped spark protests at Evergrande offices. Customers showed up to demand repayment of their investments.
Bo Zhuang, China economist at Loomis Sayles points to an even earlier event—reports in August that Evergrande was trying to sell the building that houses its Hong Kong office—as a turning point. The news sparked panic among investors since it seemed to signal just how desperate the one-time giant had become.
Collapse?
But even with the office protests and the market selloff, analysts are skeptical that Evergrande is headed for freefall. They tell Fortune that the chances of Evergrande’s complete demise are thin, given the systemic risk it would pose to the larger Chinese economy. The most likely outcome, they say, is a sort of managed collapse in which the government allows the firm to restructure some of its debt and carry out fire-sales to raise capital.
“I think the government will eventually step in to bail it out,” allowing Evergrande to sell off its assets to a combination of private developers, state-owned firms, and other corporations, Pang says.
Zhuang puts the chances of an unstructured Evergrande collapse at 5-10% but says that each day of government inaction raises the possibility of default as investors, customers, and employees lose faith in the firm.
Even with a cushioned collapse, there is a real risk that Evergrande’s problems become Beijing’s problems.
Zhuang estimates that 70-80% of Chinese household wealth is tied up in the property market. Real estate has long been the safest investment in China and one of the only avenues for Chinese citizens to build wealth.
He says that a central question will be whether Evergrande’s crisis will shake public faith in real estate investments.
Evergrande is only the most troubled player in a real estate sector that’s highly-leveraged.
“Evergrande is obviously on the extreme end of things and the amount of Evergrande’s completed [but unsold] properties is much larger than the other firms, but they are all doing it,” says Stevenson.
Shares of other property giants like Country Garden and Vanke are down 20% and 13% this year, respectively, amid concerns that they may be plagued by similar problems.
“You might get a real property price correction… it’s potentially a game changing factor in moving Chinese household wealth,” Zhuang says.
