Key points:
- The CFO and CEO of China Evergrande have both just left
- There was debt diversion within the group
- This makes an refinancing, reconstruction, much more difficult
China Evergrande (OTCPK:EGRNF) (OTCPK:EGRNY) stock is being smothered under the company's $300 billion and change debt burden. If there's to be any future for China Evergrande then that debt burden needs to be resolved in a restructuring. For it's not an amount that can be traded out of, not even in China's economy. One thing about debt restructurings though. It has to be possible for those willing to take the haircut, the hit, to know that this is it. They've been told everything, there are no more stones unturned with nasty things beneath them. That's the part of the story that China Evergrande probably doesn't want to hear emphasised right now.
For the CEO and CFO of China Evergrande have just resigned. Not over their more general stewardship of the group, but over the manner in which certain debt was diverted within the group. Some debt was raised for the Hong Kong listed Evergrande Property Services unit. Well, that's OK, there would be security over the assets of that company and so on. But that cash was then whisked away into the parent group and there used for “general operations”. The ” ” there indicating that we all probably think it was used to patch up leaks in the cashflow elsewhere in the larger company.
China Evergrande, the parent company, might be able to find the money to pay that back, might not. But even if it did then the Hong Kong listed company is only an unsecured creditor – there's an awful lot of senior and secured debt ahead of that bill being paid. Paradoxically, right on its own, that increases the value of the debt owed by the senior company – there's more available to pay secured creditors of course. But that's not the end of the story.
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The underlying problem here is that China's real estate market has been in a massive boom for decades. As ever massive booms conceal who is getting into trouble but can conceal it as a result of the boom. If everything keeps rising then mere baubles like debt ratios don't matter, do they? Until everything does stop rising and then suddenly debt repayment becomes quite the order of the day.
Given that this is China the final outcome will owe more than a little bit to politics. The debts come in three – and three large – flavours. There's debt to Chinese state owned banks and if push comes to shove those can be hidden or sidelined. There're deposits and prepayments made by house and flat buyers and as the bank issue in Henan is currently showing even in China there would be considerable political pressure to make sure they don't lose out. Which leaves the foreign and bond money plus the equity. Guess who is going to take the hit?
But the one thing that makes all of this vastly more complex is if the debt position isn't clear. If money has been routed around within China Evergrande and ending up where it wasn't quite supposed to be. Which is exactly the thing the departing CEO and CFO are said to have done.
It's difficult to see a happy ending at China Evergrande.