Hengda (Part 7): Concluding Evergrande

Updated: Jun 27, 2023

In Part 1 of our Hengda (Evergrande) series, we introduced the Hengda (China Evergrande) conglomerate, while in Parts 2 to 4 we explored each of Hengda's publicly listed subsidiaries (Evergrande Property Services in Part 2, Evergrande Auto and Healthcare Segment in Part 3, and the now divested HengTen Networks in Part 4). Subsequently in Part 5, we conducted a financial analysis of Hengda Group, followed by a more qualitative assessment of corporate governance failures that led to the Group's decline in Part 6.

In this article, we provide a synopsis of the previous articles in this series for readers who prefer brevity, in addition to discussing several key questions:

Is Hengda Group Another Lehman Brothers?
Will The Chinese Regulators Let Hengda Fall?
What Is The Fate of Hengda's Other (i.e. Non-Core) Businesses?

Hengda (Evergrande) Conglomerate Series

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Concluding the Collapse

Hengda (China Evergrande) Group is a Chinese property developer founded in 1996 that has since expanded to become one of China's largest real estate players with a presence in 234 cities through 798 projects and 231 million square metres of land reserves at the end of 2020. The Group markets itself as a diversified conglomerate with additional businesses to supplement its core real estate development focus, including property management services (see Part 2), healthcare and new energy vehicle businesses (see Part 3), an internet-related joint venture with Tencent Holdings (see Part 4), an in-house developed mobile application to support property selling, a theme park business, a mineral water brand, a cooking oil brand, a supermarket chain, a cinema chain, and a football club. Hengda also has investments in two associate companies: (1) Shengjing Bank (Chinese: 盛京银行), the largest bank in the northeast region of China, and (2) Evergrande Life Insurance (Chinese: 恒大人寿保险), the Chinese joint venture arm of Singaporean finance and insurance company Great Eastern. Additionally, Hengda runs a wealth management platform, Evergrande Wealth Management (Chinese: 恒大财富), which has a stated purpose of selling third-party financial products similarly to a brokerage firm.

Note: for a more thorough overview of Hengda's various businesses, see Part 1.

Turning to the Group's financials, Hengda's revenues have been growing year on year while gross profit and operating income declined due to lower (clearance) property selling prices and price concession campaigns. An examination of the Group's revenue structure reveals that property development accounted for almost the entirety of Hengda's revenues each year, in spite of the Group's attempt to market itself as a diversified conglomerate. Moreover, like other Chinese real estate developers, Hengda was also highly leveraged with a peak leverage ratio of 41.6% and total borrowings outstanding of RMB800 billion in 2019, nearly half of which constituted of current borrowings due within one year. Although the Group lowered its leverage level down to 24% by the end of 1H2021, this was accomplished at the compromise of delayed payments to third-party suppliers and contractors, resulting in a colossal accounts payable balance of nearly RMB1 trillion. We gauged Hengda's liquidity standing to find that the Group's liquid current assets only covered 22% of its current borrowings and accounts payable in June 2021.

Note: for a financial analysis of Hengda, see Part 5.

A more qualitative examination of Hengda reveals that the Group's aggressive expansion was significantly fueled by attempts at regulatory arbitrage and lapses in corporate governance which allowed for the raising of alternative funding. Specifically, Hengda employed various alternative funding sources including the more common trust companies but also wealth management products, the founding of seemingly unrelated projects and companies, and even the Group's own employees, suppliers, and contractors, to dodge regulatory restrictions and channel more funds into its real estate development projects. Notable examples include Hengda's healthcare management and cultural tourism initiatives which allowed the Group to bid land and obtain public grants from local governments under a more favourable guise, the seemingly glamorous but essentially defunct Evergrande Auto which has yet to deliver a single car to consumers, and financial platform Evergrande Wealth Management which is only licensed to sell third-party products but circumvents these restrictions in practice by encouraging investors to place their money in third-party trust companies that invest in Hengda's real estate projects.

Furthermore, Hengda required its employees to invest a certain amount of money into Evergrande Wealth Management's products each year, while also generating cash advances from employees through an incentive program where Hengda employees were able to purchase the Group's properties at a discount during special events and resell the properties to buyers in the real estate market at higher prices thereafter. As part of this program, the sales proceeds gained when employees resell their discounted properties on the market were paid directly to Hengda, with a contractual agreement stating that Hengda will remit the proceeds to each relevant employee one month after payment is received from the property buyer. Since 2020, Hengda has not remitted any sales proceeds to its employees, while Evergrande Wealth Management had RMB40 billion of overdue principal repayments outstanding in September 2021. Additionally, Hengda frequently generated funding by leveraging the Group's superior market power to pressure third-party suppliers and contractors into spending a portion of their compensation on purchasing Evergrande Wealth Management products and/or Hengda debt issues. As the Group's liquidity position deteriorated, Hengda also substituted its commercial papers as compensation to counterparties in place of cash.

Note: for a comprehensive discussion of Hengda's various corporate governance related failures, see Part 6.

In the subsequent sections below, we discuss various questions and present our thoughts on the future of Hengda.

Is Hengda Group Another Lehman Brothers?

Some have questioned whether or not Hengda will be another Lehman Brothers, with the potential collapse of the company leading to a global financial crisis reminescent of what happened in 2007-2008. We don't think this is the case, as Hengda and Lehman Brothers are very different in nature. Specifically, the global financial crisis in 2007-2008 was a banking crisis with an opaque and arguably under-regulated derivatives market playing a significant role in propagating financial contagion. In contrast, a crisis caused by Hengda would be, in our opinion, relatively confined to the real economy, especially given that the Chinese regulators have generally been more conservative in regulating and thereby insulating the country's financial markets. Of course, this is not to say that there won't be (potentially substantial) economic damage sustained by Hengda's counterparties, especially in light of the company's high level of interconnectness with different suppliers, contractors, and customers.

Will The Chinese Regulators Let Hengda Fall?

We don't think the Chinese regulators will simply let Hengda collapse (in spite of the moral hazard implications), because there are too many counterparties involved, most of whom are average citizens (i.e. the property buyers, suppliers, and contractors), and because remediation may be feasible to a certain extent. While we do think that Hengda will ultimately be downsized, restructured, and likely wound down over time, we expect the Chinese regulators to step in and provide interim liquidity (at the local and/or national level) where necessary in the short to medium run in order to "simplify the equation" and ensure that suppliers and contractors will at least be able to complete and deliver already-bought properties to buyers. Of course, the final resolution process for creditors to receive their money will likely be lengthy and complex.

As an example, in December 2021, the Guangdong provincial government organized a taskforce to assess the entirety of Hengda's financial situation and connect the Group with various (real estate and/or investment holding) state-owned companies to alleviate the impact of its liquidity issues on third-party counterparties. Similarly, several cities across China have also instructed their respective municipal investment groups to discuss resolution plans with local Hengda offices regarding the Group's uncompleted projects. We think it is likely that the state-owned companies and investment groups may take on these uncompleted projects or inject funds into them so that construction can be completed, especially in the case of more promising developments with higher buyer demand. In contrast, developments with less demand may be left to the judicial system for resolution.

Note: as property buyers typically pay in stages based on project completion, once the initial liquidity is provided for contractors to resume construction, buyers will be able to continue paying for the completion of their properties rather than relying solely on funding from the state-owned enterprises that have stepped in.

Note: the state-owned intermediaries that take on Hengda's more promising, uncompleted projects may also be able to sell the unsold condos from these projects for additional cash that can be used to repay some of the Group's suppliers, contractors, and creditors.

Hengda Group Contracted Sales By Province (Source: Hengda 2021 Interim Report) (click image to enlarge)

Hengda's business is diversified across 31 out of China's 34 provincial-level administrative regions (see our China Administration Factsheet here and China Provinces Factsheet here). Clearly, much coordination will be needed across all levels for resolution to be achieved.

In our view, it is important to recognize that the so-called "Evergrande debt crisis" is a liquidity crisis rather than a solvency one. This means the regulators have more leeway to remediate the issue and soften the blow for Hengda's counterparties. Granted, there will probably be creditors, suppliers, contractors, and property buyers who suffer in the end given the size and scale of Hengda's accumulated financial liabilities and liquidity shortage. However, we don't think that all is lost and it is possible that the Group's legacy may be feasibly wound down to a certain extent.

A point of greater concern, in our opinion, is whether or not other Chinese real estate developers will also require regulatory intervention at the same time. While Hengda is an extreme case of reckless expansion with particularly disturbing corporate governance practices (or lack thereof), aggressive business models with high leverage and significant amounts of off-balance-sheet financing are not uncommon in the Chinese real estate industry. In our analysis of China's largest residential real estate players (here), we find that none of Hengda's key main competitors had sufficient liquid current assets to cover their financial liabilities due within one year. Should these companies also require government aid at the same time, we fear that certain local governments may find themselves short of resources and too financially strained to remediate the situation.

What Is The Fate of Hengda's Other Businesses?

A question remains as to the fate of Hengda's other businesses. As part of Hengda's winding down journey, we think the conglomerate may be restructured and slimmed down by selling off the more promising segments of the Group's non-core initiatives. However, we struggle to find an example of an appealing business that can be sold.

Indeed, Evergrande Auto has a seemingly futuristic business model but is struggling to survive with a growing equity deficit each year (see Part 3), while the Group's healthcare segment is merely an extension of its real estate development focus (also see Part 3). At the same time, Hengda already divested all of its stake in subsidiary HengTen Networks (see Part 4) to alleviate the Group's deteriorating liquidity position, as management also failed to reach a deal with Hopson Development Holdings (HKEX: 0754), another Guangdong-based real estate developer, to acquire Evergrande Property Services. To make matters worse, it was found last month that almost all of Evergrande Property Services' entire cash balance was enforced by banks as deposits for third-party pledge guarantees, leaving the subsidiary close to cashless (see Part 6).

Ultimately, it is possible that the Hengda conglomerate will be gradually dissolved, while customers, suppliers, and creditors wait in line to be paid off.

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Hengda (Evergrande) Conglomerate Series

Hengda (Part 1): An Overview of the Evergrande Conglomerate

Hengda (Part 2): Evergrande Property Services

Hengda (Part 3): Evergrande Auto and Healthcare Segment

Hengda (Part 4): HengTen Networks

Hengda (Part 5): A Financial Overview of Evergrande

Hengda (Part 6): Corporate Governance Failures

Hengda (Part 7): Concluding Evergrande