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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 Important Disclosure THIS DOCUMENT IS FOR PRELIMINARY INFORMATIONAL PURPOSES ONLY AND IS NOT AN OFFERING TO SELL INTERESTS IN THE STRATEGIES. 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