Friday Round-Up: 24th September 2021

Friday Round-up

24th September 2021

Evergrande: the company whose name few Western investors knew three months ago, but which is now on everybody’s lips.  There are two reasons that the mining and resource industry need to be concerned about the rattling in China.  Firstly, Evergrande itself is a massive property developer with spinoffs in such diverse industries as bottled water and electric vehicles, but its core business remains construction in mainland China, and as such it is one of the big drivers of demand for resources like steel in that enormous market.  Secondly, the company is big enough that a collapse would have repercussions for the entire Chinese economy, potentially stifling demand for a wide range of raw materials, such as copper, for whom China is an important market.

So what exactly is going on at Evergrande?  Bear in mind that as I’m writing this newsletter on Friday morning, markets are waiting for news from the company, so while this piece is as up-to-date as I can make it, the situation is evolving fast.  Essentially, the company has accumulated somewhere around USD $300 billion worth of debt over its 25-year history, and has recently realised that paying it back is going to be a struggle.  Evergrande is facing a cash crunch that was mostly fuelled by irresponsible borrowing in the overheated Chinese real estate market, but which was certainly not helped by plummeting demand for residential units as a result of the COVID-19 crisis.  There were a few reasons behind that drop in demand; firstly and most obviously, in a shaky economic situation like a pandemic, fewer people felt inclined to shell out the cash for a better flat.  But there were also flow-on effects from social factors: marriages in China, which usually lead to the purchase of an apartment for the newly-wed couple, plummeted by 40% over the corona crisis.  On top of all this were some bizarre conceits by Evergrande that, while probably not huge factors in its dicey situation, certainly didn’t help.  One of these was the establishment of a football (soccer) academy said to be the largest in the world, and another was the construction of a 100,000-person stadium shaped like a lotus flower.

This is their football academy. Seriously.

On Wednesday, the company announced that it had reached a deal with bondholders over USD $39.5 million in payments that were due yesterday.  That was good, but so far there is no news from the company on whether it will make a different bond payment of $83.5 million that was also due yesterday, and there’s another $47.5 million coming next week.  The question is therefore circulating: is this China’s Lehman Bros. moment?

Probably not.  This article quotes independent consultant Robin Bhar, who makes this very good point: “I think the consensus is that this is not China’s Lehman moment. When it comes to China, everyone owns part of the problem and at the end of the day, it’s all part of China plc. They’re not going to let it disrupt the economy.”  Indeed, there are sit-in protests in several Chinese cities by investors and buyers of unfinished apartments who are applying dramatic public pressure for this situation to be fixed.  There are around 600,000 unfinished flats at stake here, and it seems unlikely that the Chinese government is going to cut those mum-and-dad buyers loose, not to mention small investors and contractors, as that would be a colossal public relations nightmare for the supposedly people-focussed administration.  China’s government is obviously highly interventionist when it comes to the economy, and it seems supremely unlikely to me that the government will tell Evergrande to pound sand completely.  Real estate and related industries account for a whopping 30% of Chinese GDP, and the government would be insane to risk contagion spreading through that sector.

However, the CCP is clearly not moving as fast as it could, and there is pretty solid speculation that this is because the government wants to send a message to other developers.  It has been trying for over a year to rein in excessive borrowing in the real estate industry, and it knows that market is overheated, so the government could well see this as an opportunity to frighten other companies and cool the market somewhat. Property sales plunged 20% in August this year, and investment grew by a miserable (by Chinese standards) 0.3%, and these numbers were more or less predictable a few months ago.  Yet other developers just kept borrowing, to the frustration of the government.

So what can be done?  There are rumours that talks are underway or even completed to break Evergrande up into three different entities and effectively nationalise them by backing them with state-owned enterprises (SOEs), or even converting Evergrande itself into an SOE.  Alternatively, the government could directly inject capital into Evergrande so that it continue construction and sell property to get the cash to repay debts.  Nationalisation seems like a strong option in the unique Chinese landscape, since it would restore confidence in the company by alleviating short-term liquidity pressure.  Moreover, it might please the instincts of the CCP, which has become even more interventionist in recent times, because Evergrande would then be the seventh of the top ten Chinese real estate developers which are SOEs, and the government would be able to extend its control over the sector.

Evergrande apartments

By no means do I have a crystal ball, and even if the direct Evergrande crisis is quickly resolved from here, there could be unpredictable effects on the vast and complex Chinese economy still to come.  But you have to think that of all the governments in the world, the CCP is one of the most likely to step in and protect not the company, but its investors, customers and the rest of the economy from a potential collapse.  It’s playing hardball at the moment, but ultimately it’s in everyone’s best interests if something like the rumoured restructuring deal comes through, and the Chinese government knows that very well.

Around the Traps

There’s an interesting free event happening on the 29th of September: Sustainably Funding the Global Mineral Supply Chains. You can find out about ESG and disclosure matters, different jurisdictions, and what key mining stakeholders are thinking by hearing from senior experts and industry leaders.  To register or for more information, check out the event page.

For an update on the exciting junior Guanajuato Silver (TSXV:GSVR) from CEO James Anderson, check out the video below.  Guanajuato has some great gold-silver projects in Mexico, and the company also announced yesterday that it had entered into a gold and silver concentrate sales agreement with Ocean Partners.

That’s all from me this week, I hope you’re all looking forward to the weekend as much as I am!

- Jane Lockwood