The Evergrande Fiasco Explained

"The Evergrande situation poses a systemic risk to the Chinese economy."

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Last week was pretty insane with Evergrande’s debt crisis stepping up to the spotlight.

If you haven’t heard, Evergrande is a Chinese real estate giant with $300 billion in debt. It may default, significantly impacting China’s economy and the rest of the world. People are comparing this situation to the U.S. Lehman Brothers bankruptcy. And as you can imagine, it’s causing the markets to panic.

“Traditional markets right now are selling off, and all the correlations you typically see when the market is fixated on one event or one risk, have come to light again,” said Roshun Patel, vice president at Genesis. “The Evergrande situation, whether it’s warranted or not, has the entire market fixated on this one thing and the fallout from it.”

Evergrande’s Debt Crisis, Explained

Founded by Hui Ka Yan in 1996 in Guangzhou, China; “The Evergrande Group” is a Fortune 500 real-estate developer with headquarters in Shenzhen, China. It's actually a pretty massive business with sales reaching over $100 billion (and adjusted core profits of ~$5 billion) in 2020.

But being a real estate developer, Evergrande needs a lot of cash to operate and grow. Real estate projects take months (or years) to complete. They require a ton of cash flow along the way. The problem is that most of the time cash collection (from buyers) comes at the end of the project.

In order to fund projects, Evergrande did two things:

  1. They made investments in electronic vehicles, an internet/media production company, a bottled water company, theme park and a soccer club.

  2. They borrowed aggressively, becoming the world’s most heavily-indebted developer (with $100 billion+ and $300 billion in liabilities).

The debt gave way to growth, transforming the company into elite status, a Fortune 500 company.

…Which is great! But there’s a catch…

As the debt grew, so was its interest payments. This would be ok if revenues and profits were also growing (but they weren’t) OR if the government wasn’t starting to restrict borrowing (which it was).

The Crisis Ensues…

On September 14, Evergrande said it may not be able to meet its upcoming financial obligations - $83 million interest payment due on Sept. 23rd and a second repayment for $47 million due on the 29th.

Even more insane was the fact Evergrande pushed employees to give short-term loans to the company - calling it “high interest investments” - so that they could receive their bonuses at the end of the year.

…. This is whole ordeal is unethical on SO many levels….

Regardless, the company fell behind, missed their payments and now the crisis is accelerating.

Protests have also been taking place at Evergrande’s offices in China. According to reports, 1 million homebuyers who paid deposits upfront for homes are in despair because their homes may never be built.

The arrogance and incredible irresponsibility of management is creating yet another financial, psychological and emotional chaos in the country… At a time when the world is still grappling with the after-effects of COVID-19.

While Evergrande was able to fight financial fires in the last few months, eventually those small flames would become a forest fire in the economy… This is what happens when there is over-borrowing, over-leveraging, and over-production of money. Crisis.

What Will the Chinese Government Do?

The Chinese government is caught between a rock and a hard place:

  • Bailout Evergrande and they’ll be viewed as condoning the problem, permitting financial excessiveness and misbehaviour (possibly suffer a reprimand by other governments too) or;

  • Allow the collapse to play out and hurt the Chinese economy, one that is still recovering from the pandemic.

The government may not buy Evergrande’s debts, but it may for example approve proposals to restructure its debts (including extending deadlines for repayments). They might come up with some creative strategies to prevent the crisis to play itself out, who knows.

The world anxiously awaits and in the meantime braces itself by doing what it does best under FUD… Liquidate.

Investors Are Panicking

Not surprisingly, bitcoin’s price fell to $43,000 USD as investors fear the Chinese market collapse and the ripple effects it would have on the rest of the world. They sold their bitcoin, stocks and other assets.

But it’s precisely these moments that define our future…

When everything goes wrong, when the market is crashing your investments, when there is doubt, when it hasn’t been a good year for you; this is the most important moment.

You must decide: do you give in to the pressure and deviate your investments? Or do you stay put?

Right now, it seems like most investors are falling apart. They’re doubting their beliefs and strategies. They’ve opted to think short-term. Rather than be patient - which investors know they should do in theory - they go down the slippery slope of liquidating to cash in whatever small wins they can.

They inch their way towards a few extra hundred or thousands of dollars, sacrificing their hard assets, like bitcoin.

As investors, we are required to do a difficult thing. That is to stay patient.

Remember the wise words of Charlie Munger (billionaire investor and one of the best minds of the 20th century):

"You need to keep raw irrational emotion under control. You need patience and discipline and an ability to take losses and adversity without going crazy. […]. It’s waiting that helps you as an investor, and a lot of people just can’t stand to wait.”

A Final Thought

The world feels extremely fragile right now. As investors grow increasingly more uncertain, they’re gambling with the most short-sighted mindset we’ve seen in history.

Rather than hold onto their winners, investors are selling them. Opting to liquidate rather than protect themselves with arguably the world’s hardest, most decentralized and most secure asset that is bitcoin.

My friend, this is the time to accumulate, not liquidate. Your best days are ahead of you.

You may also enjoy The Misfit post on “Lessons From The Best Investors in the World.


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