Evergrande Real Estate, China’s second-biggest property developer by sales, denied yesterday that it has used “accounting tricks and bribes” to hide the fact that it is insolvent. Evergrande’s board made the statement to Hong Kong’s stock exchange in response to allegations made in a report published on Thursday by Citron Research, a short-seller.
The analysis, compiled over “several months”, was certainly damning. Citron described the company as a Ponzi scheme and alleged that “bribery, excessive spending and off-balance-sheet transactions are the foundation of Evergrande’s financials”, and even compared the company to Enron.
“Evergrande has misled investors and represents the worst of Chinese neo-capitalism, and therefore represents a good short opportunity in relation to other exposure in the Chinese capital markets,” it said on its website. “Whether it be the capital markets, government enforcement, hard or soft landing, the endgame for Evergrande is a certainty; the only uncertainty is the timing.”
Citron stressed that the problems are unrelated to China’s real estate bubble. “Rather, it is a tale of a company who has abused the capital markets as well as the generous lending of the Chinese government in order to enrich one man, aggrandise his personal ego and support his pet projects.”
That man is Hui Ka Yan, the company’s founder and chairman, who Citron claimed has directed $2.5 billion of the company’s money into unprofitable ventures such as Guangzhou Evergrande, a lavishly funded professional football team, and Evergrande Real Madrid Football Academy, a project to build the world’s biggest football training school.
Citron’s allegations are at complete odds with the consensus among analysts covering the stock in Hong Kong, who mostly rate it a “buy” or “outperform”. A report published on June 9 by the State Council, Tsinghua University and the China Index Academy named Evergrande as the top real estate H-share for the second year in a row, praising its strong sales performance.
Despite the overwhelmingly positive coverage, investors immediately seemed to take the Citron report seriously. Starting from around 10.30am yesterday morning, Evergrande’s share price plummeted, losing 19.6% of its value in 45 minutes.
The criticism is not entirely out of the blue. As Citron pointed out, even China’s finance ministry has found evidence of material accounting fraud at Evergrande. On October 11, 2011, the ministry fined the company for providing inaccurate information in its 2009 financial statements.
Shortly after that, in January this year, private equity fund Blackstone sold back its stake in the Royal Scenic Peninsula in Guangzhou, a real estate joint venture with Evergrande, for $112 million. It reiterated at the time that it was not pulling out of Chinese property and that it continued to believe in the industry’s long-term growth potential.
Evergrande responded to Citron’s report during lunch yesterday. “The company would like to clarify that the allegation in the report is untrue,” it said. “Further clarification announcement will be made by the company in due course. Shareholders and investors are advised to exercise caution when dealing in the shares of the company.”
Evergrande responded to the report during lunch yesterday. “The company would like to clarify that the allegation in the report is untrue,” it said. “Further clarification announcement will be made by the company in due course. Shareholders and investors are advised to exercise caution when dealing in the shares of the company.”
Fitch echoed that warning last night, saying in a press release that Evergrande may struggle to access capital markets even if the allegations are false. However, it noted that the company does not have any offshore debt maturing until January 2014 and had a cash balance of Rmb20.1 billion at the end of 2011, plus sales of Rmb26.8 billion during the first five months of the year.
High-yield bond specialists said yesterday that the allegations could have broader consequences for China’s property industry, which had been considered a “safer” sector in the wake of the accounting scandals in other industries. Chinese developers will find themselves in a tough spot if they can no longer access bond markets.
The sources speculated that Hong Kong developers, some of which have been building war chests, could then exploit the situation to buy distressed mainland companies at attractive valuations.
Citron’s report runs to 57 pages and covers everything from the fraudulent accounting that is alleged to mask an insolvent balance sheet, to Hui’s bogus academic qualifications and his over-priced house on the Peak, Hong Kong’s most exclusive neighbourhood.
The company was founded in 1996 and Citron claims that the fraud might have started as long ago as 2006. Since then, it says, Evergrande has been borrowing ever larger sums of money, backed by ever bolder personal guarantees from Hui, with each successive round of financing paying off the previous round.
Evergrande raised $720 million from an initial public offering in November 2009 and Citron speculates that the poor performance of its stock led to an escalation in “the magnitude of misstatement in Evergrande’s financials”.
Even if all that is shown to be untrue, the damage might already have been done.