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Jim-Chanos-China-Wine-Country-Presentation

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					China: The Edifice Complex

Wine Country Conference
April 5, 2013




James Chanos
Kynikos Associates
The China Way

• What we have learned
    –   Guanxi is a way of life
    –   Caveat emptor in acquisitions
    –   Beware reverse merger listings
    –   “Audited” numbers?
• What goes on in China Inc.
    –   Gaming receivables
    –   Questionable “Other Income”
    –   Property on the side
    –   Copper and steel financing
• Foreign technology partnerships
    – “Absorb and digest”
    – “Re-innovate”
    – Undercut partners
                                         Source: shutterstock
                                                                2
“The Number” Is Paramount

•      GDP drives economic activity, not
       vice versa                                                                 “GDP: Killing the Hen to Get the Egg”
•      Countervailing priorities
        – Set centrally and locally
        – Stability for Central Government
        – Vehicle of ambition for local officials
•      Regional-to-national GDP gap
       continues to grow
        – Gap of RMB 5.8T in 2012 vs.
              RMB 2.6T in 2009
         – “Size of Guangdong’s economy”1
•      Capacity overinvestment (2008-2012
       CAGR)
         – Cement 12%
         – Steel 10%
         – Autos 18%
    Source: “GDP gap in China the size of Guangdong economy”, South   Source: China Media Project
    China Morning Post, February 5, 2013                                                                                  3
The Law Of Diminishing Returns

• Unprecedented fixed asset            Gross Fixed Capital Formation/China GDP
   investment boom

• Gross fixed capital formation
   as a percent of GDP in
   China has increased from
   previously high levels over
   the past decade

• Law of diminishing returns

• Asset depreciation liabilities

                                   Source: National Bureau of Statistics of China
                                                                                    4
The ‘Shā Chén Bào’ Of Money is Wealth Destruction

•   Large-scale capital projects grow
    sillier by the day
                                                                        Hard To Keep Up
     – New South China Mall – world’s
       largest and loneliest
     – New Ordos – empty city in Inner
       Mongolia
     – Sky City One – world’s tallest building
       to be built in only 90 days
•   Massive infrastructure spending
    continues
     – 1,188 new shopping malls by 2015
     – Airports: 14 opened in 2012 and 12
       to be constructed in 2013
     – Subways: 28 cities get approval to
       build or expand subways
•   Feasibility is secondary thought
     – Overstate revenue and understate
       maintenance costs
     – Is economic depreciation being
       factored in?
                                                 Source: Global Times
                                                                                          5
Pervasive Growth Of Credit Driving Boom

•   Bank lending remains high
     – 2012 saw a YoY increase in new bank
         lending by 10% to RMB 8.2T
     –   2013 new lending forecasted to grow
         yet again
•   Banks poorly capitalized for potential
    losses
•   Rapid growth in shadow banking
    spurring total social financing
      – Greater portion of social financing being
         done outside banking system
     –   Increasing difficulty of controlling
         liquidity within the system
•   Chinese culture of credit
     – The myth: China has no history of
         credit-fueled booms and busts
     –   Reality: History proves otherwise
     –   Over 40% of banks loans went sour
         post-1990s boom


                                                    Source: PBOC
                                                                   6
Wealth Management Products are the Democratization of Credit


 • The triumvirate of shadow banking
     – Local Government Financing
         Vehicles
     –   Trust Products
     –   Wealth Management Products
 • Wealth Management Products
     – 66% growth rate in 2012
     – Substitute for deposits on or hiding
         assets off balance sheet
     –   Dubious investments
     –   Investors expect both yield and
         protection
 • First cracks appearing
     – Huaxia Bank
     – CITIC Trust: Recent questions on
         viability of three trusts
 • Warning from bank regulators
                                              Source: CBRC, BoA Merrill Lynch, Barclays, Kynikos Associates
                                              estimates                                                       7
Urbanization: Last Refuge of the Bulls

 • Goal of 80-85% urbanization
    rate
     – Bulls look to 600 million people
         migrating
     –   Will be lower based on 250
         million floating population and
         some farmers
     –   Cities change boundaries and
         definition
 • Leads consumption economy
     – Urban dwellers consume more
     – Increased demand for social
         services
 • Is urbanization national?
     – New theory migration will be
         towards the Eastern coast inside
         the high speed rail network
     –   Go West policy in doubt

                                            Source: China Daily
                                                                  8
Property is the Lynchpin

 •   China’s current urban real estate
     boom
      – 2012 Total Real Estate Under
         Construction approximately
         10.6B sqm vs. 5.7B sqm in 2009
      – 2012 Total Real Estate per capita:
         14.9 sqm
      – 2012 Total Real Estate sqm per US$
         1M GDP dollars : 1,283 sqm/US$1M
 •   Oversupply is an overlooked issue
 •   Property management fees are
     rarely paid
 •   Lack of affordability remains an issue
 •   No one can identify the buyers
 •   Commercial real estate is the future
     issue


                                              Source: CRI English
                                                                    9
Residential Real Estate Affordability?



 • Major Chinese cities versus                   Residential Affordability Comparison
                                             Beijing
    NYC and London                    30
                                            28.1 yrs.



 • Generational investment:           25
                                                        Shanghai
                                                        20.9 yrs.
    Parental savings funding          20
    purchase of real estate by next
                                                                    Chongqing
    generation                        15                             14.5 yrs.    Wuhan
                                                                                 12.9 yrs.    London
                                                                                              10.8 yrs.       NYC
 • Speculative fever provides         10
                                                                                                            10.0 yrs.

    breeding ground for corruption
                                      5


 • Mass market buyers priced out
                                      0
                                            Years to pay off Apartment (Apartment price / Household Income)


                                       Source: Soufun (China), National Bureau of Statistics of China, US
                                       Census Bureau, The City of New York, The Land Registry (UK),               10
                                       Greater London Authority (UK). China real estate values as of
                                       December 2012, NYC 07-11 Average, Greater London Nov 2012
Rising Wages: No Longer the Workshop of the World

 • Chinese wages are up
                                                                               “Evil Factory! Return My Annual Bonus”
       – Private sector manufacturing
            pay up 20% in 2011 and 16% in
            2010
       –    Minimum wages continue to rise
            13% through 2015
 • Margins are thin, profits down
       – SOE profits down 11.4% first
            nine months 2012
       –    SOEs under local governments
            profit decline 20.4%
 • Regular protests for back wages
 • Chinese unit costs to the US not
     as cheap as they were
 •   Factories offshoring from China

 Source: “Chinese SOE Profits down 11.4% in the first nine months”,   Source: The Epoch Times
 Gov.cn                                                                                                                 11
Wealth Gap: Straining the Harmonious Society

• Popular resentment growing
• Gini coefficient is “out of the lamp”
        – Not released for ten years
        – January 2013 official release:
             0.474 in 2012 with peak 0.491 in
             2008
        –    Academic study estimates 0.61 for
             20101
• The New Government plan
        – Raise low incomes and “adjust
             over high incomes”2
        –    Details vague with watered down
             proposals and loopholes
• Corruption crackdown?
        – New regime vows to crack down
             on corruption
        –    Recent restriction to property
             ownership information
 Sources: 1) “More Findings from the China Household Finance Survey”,     Source: China Daily
 Li Gan, Texas A&M University, January 2013                                                     12
 2) “China approves income distribution strategy”, Reuters, February 5,
 2013
Property Graft Is An Issue

 • Dirty money hides in property
        – Exposed officials have multiple                                            Official sacked over property scandal
              properties
        –     Not concerned with liquidity or
              mobility
 • “Home Purchase Restrictions are
      only for the ones not smart”
 •    Fake Hukous can be bought for
      RMB 30,000 to RMB 50,000
 •    Foreign passports advantageous
 •    High profile catches
        – Newspapers carry rogues galleries
              of corrupt officials
        –     “Grandpa of Property” -
              Guangdong Policeman with 192
              properties
        –     “House Sister”- 41 properties

 Source: “Hukou forgery scandals highlight police corruption”, Xinhua,   Source: China Daily
 January 24, 2013                                                                                                            13
Faith in Government: Are People More Satisfied Today?

• Leadership change was not                                                                    "This is us [China] today!”
      seamless
• Frustration with self interest
        – New anti-corruption policy
        – Netizens are the Fourth Estate
• Quality of life
        – Pollution blots out the sun
        – Food and baby milk scandals
        – Cancer villages
• Demonstrations are a way of life
        – 2010: mass incidents estimated
              between 180,000 to 230,0001
        –     Environmental protests
        –     Selected local strikes
• More spent on internal security
      than the military2
• Will there be real reform?
 Sources: 1) “Social Unrest in China”, Europe China Research and Advice    Source: China Media Project
 Network, 2012                                                                                                               14
 2) “China's defense budget outweighed by internal security”, Want China
 Times, March 11, 2013
Shifting the Focus from the Real Problems

 • Cold war tactics in
    Senkaku/Diaoyu dispute
 • Staged demonstrations
 • Pressuring neighbors
     – New Chinese official map
        includes disputed islands
     – Hainan Province announces
        policy to board and search
        vessels
 • Reaction to foreign press
     – Newspaper hacking
     – Reporting equipment stolen from
        hotels
     – Visas revoked
 • Attempts at intimidation
                                         Source: Global Times
                                                                15
Chinese Proverb: “When the Tree Falls, the Monkeys Scatter”


 • Unprecedented fortunes
      amassed by leaders’ families                                                                   Tunneling Out of China


 • Buying foreign property and
      citizenship

 • Getting the money out
        – $2.7T cumulative outflows
              from 2001 through 2010
        – 2010 estimate of $420B
              almost 3x 2001 estimate

 • “Playing” in Macau
        – VIP Baccarat is the channel
        – Estimated in 2012 at $18B

 Source: Global Financial Integrity “Illicit Financial Flows from Developing   Source: China Media Project
 Countries: 2001 – 2010”                                                                                                      16
Don’t Take our Word for it

• “GDP figures are ‘man-made’     Li Keqiang, 1st Vice Premier China
   and therefore unreliable, Li   US Embassy Cable March 15, 2007
                                  Wikileaks – December 4, 2010
   said.”
• “To some extent, this is        Xiao Gang, Chairman Bank of China
                                  “Regulating shadow banking”
   fundamentally a Ponzi          China Daily, October 10, 2012
   scheme.”
• “The bubble must be             Wang Shi, Chairman China Vanke
                                  “Vanke boss sees bubble in spike”
   controlled, or both the real   Standard , January 29, 2013
   estate market and domestic
   economy will be jeopardized”
• "The government has             Chinese Netizen
                                  “Chinese companies trusted in China, says US
   already been considered        report; Nope,Say netizens”
   untrustworthy, let alone       Want China Times, February 6, 2013
   businesses…"
                                                                                 17
          Thank You to
the Wine Country Conference and
 the Les Turner ALS Foundation




                                  18
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