Hui Ka Yan is finally taking steps to reduce the massive debt pile at his property developer China Evergrande Group, but the costs of doing so are piling up rapidly.
Evergrande New Energy Vehicle Group, the company’s electric-car unit, announced on Tuesday that it would raise HK$4 billion ($516 million) by selling 176.6 million shares at a steep discount. Investors are buying the Hong Kong-traded shares at a price of HK$22.65, which is 20% less than the stock’s closing price the day before.
The EV unit followed that announcement with another on Friday stating that it intends to issue shares on the Science and Technology Innovation Board in Shanghai, which was launched just last year. It hasn’t disclosed the size or timing of that planned offering, though.
News of the share sales wiped $4.2 billion off the market value of the EV business as the company’s stock tumbled 15% this week. The car maker is a subsidiary of heavily indebted Evergrande Group, which has seen its shares drop 24% this year, wiping out $7.3 billion from Hui’s wealth. Formerly the richest man in Asia, his net worth is currently estimated at $29.2 billion.
Raising more cash is credit positive for the loss-making EV subsidiary, but it also sends a bad signal to equity investors, according to Warut Promboon, managing partner of Hong Kong-based research firm Bondcritic.
“It is all about how much management thinks the company is worth,” he says. “In the near term, the discount only means the share price is overvalued.”
Zhou Chuanyi, a Singapore-based analyst at research firm Lucror Analytics, says selling shares at the 20% discount means the company is needing cash badly. Hui has to boost the company’s cash holdings now, so he can pay down a portion of Evergrande’s hundreds of billions of dollars in debt.
Aggressive land purchases combined with heavy capital expenditures to build electric cars have pushed Evergrande’s total debt to 835.5 billion yuan ($123.4 billion), according to its latest interim report. About 396 billion yuan is short-term debt that needs to be repaid within the next 12 months. That figure is almost three times larger than its cash and cash equivalents of 141 billion yuan.
“In the near term, the discount only means the share price is overvalued.”
Evergrande’s rising debt level runs counter to the ambitious goal Hui announced in April, when he unveiled a three-year plan to control scale and reduce the company’s total debt by 50%. It also goes against Beijing’s wish of reducing leverage and controlling financial risks associated with the real estate sector.
Authorities at government departments including the People’s Bank of China have begun adhering to a “three red-lines” policy for property developers, which stipulates clear limits on debt-to-asset ratios as well as the ratio of short-term debt to cash and cash equivalents.
Jia Yong, a partner at Beijing-based Zhong Lun Law Firm, says this policy has never been officially announced, but major real estate developers have been informed accordingly. Matthew Chow, a Hong Kong-based director at S&P Global Ratings, says that cutting Evergrande’s debt load is no longer entirely up to Hui anymore.
“The government is asking them to control the leverage ratios,” Chow says. “For the next 1-2 years, they should be under more pressure.”
Evergrande didn’t respond to emailed requests for comment. It said in a Sept.17 stock exchange filing that the company will pay down $1.56 billion worth of notes due in 2020 on October 23 through its “own resources.”
Hui’s cash-raising campaign also included selling a 28% stake in Evergrande’s property management unit for HK$23.5 billion in August to investors including Tencent, Sequoia Capital and Chan Hoi Wan, the wife of Hong Kong real estate tycoon Joseph Lau.
Aside from raising cash through equity sales, Hui also kicked off last week a month-long promotional campaign of Evergrande’s residential properties nationwide. Prices have been slashed by 30%, a move that analysts point out will bolster Evergrande’s coffers more quickly while squeezing profits.
Lucror Analytics’s Zhou estimates that any property sold at such discounts would have a gross margin of just 20%, compared with the 25% gross margin it received on real estate sold in the first half of the year. Moreover, promotions carried out earlier this year already pushed profits down by almost half to 14.8 billion yuan during the January to June period, while revenues actually increased 17.5% to 266.6 billion yuan.
“It is difficult for the company to cut prices any further,” Zhou says. “If it does, then it wouldn’t have much money to make.”
And Evergrande faces another payment overhang. It announced in 2016 a planned backdoor listing in Shenzhen of Hengda Real Estate, which holds the company’s mainland property business. If the deal isn’t completed in January 2021, strategic investors in Hengda have the option to sell 70 billion yuan worth of company shares back to Hui or Evergrande.
With the three red lines policy in place, it remains to be seen whether Evergrande can resort to borrowing more money to refinance its existing debt, says S&P Global Ratings’s Chow. “They do have quite a lot of repayments to deal with,” he says. “And the most convenient way to raise cash is to speed up their property sales.”