One of the most decisive battles during the Three Kingdoms Period was the Battle of Red Cliff (208 AD). Cao Cao, the warlord who occupied the North, needed to defeat two rulers in the South – Liu Bei and Sun Quan – before he could unify the country. But by the time Cao sailed close to the Red Cliff, which was along the Yangtze River, his army was weak because it was not used to living on ships. So Cao decided to chain his vessels together to reduce the seasickness in his forces.
Observing this, Sun sent Cao a letter feigning surrender. Thinking that victory was nigh, Cao allowed Sun’s ships to sail close, assuming they wanted to give up. He didn’t spot that the boats were filled with bundles of kindling, reeds and fatty oil. As the squadron came close, Sun’s sailors set their ships ablaze. Carried by the strong wind, they careered into Cao’s fleet and set it on fire. Because they were chained together, not one of them could escape the calamity. The story later inspired the idiom “the burning of chained barges”, implying a contagious crisis across interlocking interests.
Now analysts are worried that the same lesson could apply to some of China’s largest property developers, after news that Chen Zhuolin, the founder and chairman of Guangzhou-based Agile Property is being investigated by prosecutors in Yunnan province.
The bigger problem? Sina Finance says that the “Guangdong Gang” – which includes developers like Evergrande, KWG, Country Garden and R&F – could be closely linked. The property firms are primarily based in Guangzhou (although Country Garden is in Foshan, an hour from the provincial capital) and their bosses socialise in largely the same circles. The fear is that if one real estate mogul is found guilty of corruption, the others could be vulnerable to the fallout.
Currently, it seems that Agile’s main difficulties don’t originate in Guangdong at all, but in Yunnan. Back in July, Zhang Tianxin, former Party boss of Kunming, the provincial capital, was detained for alleged graft. Century Weekly reported that Zhang’s investigation then led to evidence of bribery by Agile. Several other Yunnan-based executives from Agile have also been detained in recent weeks, and the company said one of them was “unreachable”.
Previously Agile has unveiled ambitious plans for Yunnan, a tourist hub famous for its rainforests, mountains and ethnic minority cultures. Since 2011, the property firm has signed investment agreements with three municipal governments there in quick succession.
In June it reached a fourth deal for an ‘International Ecological Resort District’ covering 667 hectares in Kunming, bringing Agile’s total project area in the province to about 4,900 hectares, worth over Rmb60 billion ($9.8 billion), says the Financial Times. Those investments raised eyebrows not only because Agile acquired the land at “relatively low costs”, CBN suggests. It also managed to secure coveted plots in areas like the Gaoligong Mountains Nature Reserve, a nationally protected zone. Previously, few developers from outside Yunnan had been able to develop projects in the province, CBN also observes.
At the moment, it’s too early to tell what’s going to happen to Agile’s proposed projects in Yunnan. But analysts don’t seem too optimistic about the company’s prospects and both Standard and Poor’s as well as Moody’s have lowered Agile’s credit ratings.
Adding to the rumours, Agile admitted last week in a regulatory disclosure that Chen had been required by prosecutors to stay at a “designated residence” (a status that indicates he is not yet under formal arrest). The firm’s shares, which trade on Hong Kong’s stock exchange, promptly slumped by as much as 31% this Monday to five-year lows as they resumed trading after a week’s halt.
“If the company chairman of a state-owned enterprise was arrested, the central government will just send a new person in his place and all the problems are solved. But for a private enterprise, once the boss is gone, it is like the company has lost its brain. It could even lead to infighting amongst the employees. [Retail chain] Gome is a good example (its chairman is still in prison),” warns the Hong Kong Economic Journal.
For Agile, the timing couldn’t be worse. The developer is in the process of raising funds to repay some of its debt amid a housing downturn. According to its financial statements, Agile’s net gearing ratio had risen from 73% at the end of 2013 to 82% in June.
It also needs to repay a $475 million bridge loan due in December.
To that end, it announced plans to raise $360 million in a rights issue last month. The deal, which involved the Chen family borrowing from the company’s bankers to pay for its portion of the rights issue, was at a steep discount to its share price, at only 0.3 times book value. The move implied that the developer was desperate for fresh capital.
But that plan has had to be scaled back after Chen was put under virtual house arrest – with the new target to raise only $200 million.
Investors may find comfort, however, on news that the Chen family has committed to underwrite the offer and purchase any unsubscribed shares. (Ming Pao newspaper says Chen has put at least six of his commercial properties in Hong Kong up for sale since last week, to raise $80 million.)
Meanwhile Reuters has reported this week that Agile is also in talks with its creditors about extending the bridge loan that comes due in December.
For other members of the “Guangdong Gang”, the news has also had negative consequences. On Monday, shares in R&F fell 4.4%, while Country Garden’s stock dropped 2%. Investors in the property sector are concerned that if Agile collapses, it will suck liquidity out of an already fragile system.
But HSBC reckons that the fears are overblown. “It seems that the Guangdong-based developers are bearing the brunt of the impact. In our view though, it is not rational to attribute a higher risk to Guangdong-based developers, as the known information suggests the region in question should be Yunnan,” the bank’s analysts have suggested in their latest report on Agile’s situation. HSBC also believes that these other developers have all completed their own refinancing exercises this year. So in the near term, Agile’s financing difficulties shouldn’t affect the whole sector.
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