The Beginning of Evergrande's Downfall
Evergrande Group (恒大集团), the second-largest property developer in China, has been in the news for the past month due to its inability to pay back its enormous pile of debt reaching over $300 billion. This has negatively affected the Chinese property market, with a decline of 16.9% in sales in September following a 19.7% loss in August. Similarly, other developers like Fantasia and Sinic have suffered from their stock price drop, struggling to pay back their recent bond payments.
These troubles highlight the fragility of the Chinese property development market due to being ravaged by debt: debt from inefficient allocation of their investments in building, ghost cities, unsuccessful diversified activities such as wealth management & technology products and keeping zombie companies alive. In addition, the People’s Bank of China has been unwilling to bail them out by calling the situation “controllable” , while urging the developer to pay back the bondholders through "market-oriented and the rule of law principles". This is despite the PBOC's recent policies in loosening credit to stabilize the sector, cutting the bank's reserve requirement ratio and keeping interest rates low until mid-2022.
Hence, Evergrande has been holding talks in Greater China with investment banks, law firms and creditors to restructure and sell its assets to curb the burden of its massive debt. They include Houlihan Lokey and Admiralty Harbour Capital as financial advisers to find the best solution against bankruptcy, especially since it has defaulted three times on debt to its offshore investors to prioritize its onshore ones. Therefore, a rival of Evergrande, Hopson Development Holdings (合生创展集团有限公司) has announced its interest in buying 51% of Evergrande property management division. The bid is a way to take advantage of its rival's woes in meeting its obligations while allowing Hopson to increase its property development activities around China. The deal to acquire Evergrande’s majority share of the property unit would be more than HK$40 billion ($5 billion), which is a good deal for Hopson since it is ranked 336th in the 2021 Fortune China 500 in comparison to Evergrande being at 18th in terms of assets.
Hopson Development is a medium to large high-end residential property development company established in 1992 by Zhu Mengyi. Hopson, a company originally from Guangdong province just like Evergrande, is part of the five most prominent real estate companies from the most populated province in China. It also develops properties in other large Chinese cities such as Beijing, Tianjin, Shanghai, and Chengdu. Via these development successes, it has accumulated cash and bank deposits of HK$42.9 billion and a liability to asset ratio of around 67%.Therefore, acquiring the Evergrande Property unit would be an accessible investment, especially after Evergrande's market cap dropping by 70% in 2021, reaching HK$55.4 billion this month. , and it’s stock prices shrinking from HK$18.90 to HK$5.12, a decrease of around 72% within the first week of October.
The potentiality success of this deal would be huge since Hopson is ranked as the 77th largest developer in China, reaching HK$300 billion in contract sales in 2020, which has led them to want to internationalize its business. Its international ambitions have led them to acquire in 2019 a project in Manhattan in New York for $113.5 million to develop residential and commercial markets worldwide. The acquisition of Evergrande property services would make it a unit of Hopson less than a year after being IPOed on the Hong Kong Stock exchange. An IPO raising around $1.8 billion, with a value of $12.3 billion; however, it has dropped its value to the fears of its parent company's inability to pay back its debt. Therefore, for Hopson, that would be a once of a lifetime opportunity to continue its plan to expand its operations around the world while also acquiring at a discount a majority stake of the activities from the second-largest property developer in China.
For Evergrande, it is about limiting the negative sentiment around the company while being able to repay the bondholders. It has recently sold its 20% stake in the Shengjing Bank for HK$10 billion to a state-sponsored asset management company to raise funds to repay the domestic lenders. Evergrande is also in the process of disbanding or selling its energy car and healthcare business to repay its different rounds of domestic and offshore bond payments. For bondholders, the investment bank Moelis & Co and the law firms Kirkland & Ellis will represent the bondholders, with another deadline being at the end of the month.
However, not all companies are rushing to buy Evergrande businesses. The recent proposal to acquire Evergrande's Hong Kong headquarters building failed with the Chinese state-owned company Yuexiu Property pulling out a $1.7 billion bid. Besides, the Hopson acquisition of 51% of Evergrande's property development unit is still in the negotiation stage. Still, it would make sense for both sides of companies to pursue this transaction, but both sides will hope to either buy at a higher discount or sell at a higher cost to protect their interest – something that could decide whether the acquisition goes smoothly or not.
So, could the troubled property group Evergrande be rescued? Only time will tell. Looking forward, observers should expect more news about Evergrande being willing to sell parts of its businesses, providing positive information for bondholders and potential acquirers searching for good opportunities.
[ Update October 21st: The bid to acquire 51% of Evergrande's property unit failed after the company's directors and creditors opposed the deal. The reason is differences in payment methods; Evergrande prefers immediate payment to a more cautious approach from Hopson, who's after their due diligence assessing payable accounts and receivables with suppliers. This came after Guangdong's officials worked out a deal to design favourable banking loan deals to fund the acquisition. However, Hopson Development had reaffirmed that the agreement to buy Evergrande's property unit is 'legally binding' and that is still considering acquiring the unit. ]