Evergrande Equity De-Placement: Musical Shares

About 9-10 weeks ago, Chinese authorities called a dozen large real estate developers onto the carpet with very little lead time and askedproposed mandated they participate in a "pilot programme" called Three Red Lines.

"Pilot programme" is a nice way of saying - "Here are the new rules, and they apply to you first."

In this case, it meant there were three criteria, and if as a developer you met all three, your company could increase debt by 15% vs the previous year. If you met two, it was 10%, and if one, 5% was the cap. If you met none of them, you would not be allowed to increase debt.

Evergrande Real Estate Group (3333 HK) was one of those twelve companies, and it met none of the criteria to allow it to increase debt. Given the company's funding costs and extraordinarily large supplier finance position, that leaves wiggle room only to the downside. The gross book has to shrink.

Five weeks after the meeting, it was reported in local media that the company had sent a letter asking for assistance to the Guangzhou government four days after the Three Red Lines intro meeting, warning of the possibility of funding difficulties and default, in part due to a RMB 130bn (+ redemption premium) redemption of private shares issuance due at the end of January 2021. When this came out, the company denied the existence of the letter, but various media outlets said they had seen it. This was discussed in Evergrande May Be Facing a Funding Squeeze.

The shares fell, and this was slightly problematic because despite having a buyback programme which allowed the company to buy back up to 10% of shares outstanding, under the HKEX Listing Rules, it only had room to buy about 20mm shares as of the end of its buyback splurge in May and June 2020. Media outlets then reported that the company had obtained assistance in convincing many (but not all) of its investors in the Hengda Real Estate subsidiary to not ask for their money back 3 months hence. That sent the shares back up.

Then two weeks ago, the company announced a sale of up to US$1.3bn (including greenshoe) in shares at an 11.1-14.7% discount. I wrote about Evergrande's share sale in Evergrande Equity Placement - Musical Shares. It turns out the company could not place more than about half the base amount, at the widest discount in the range, which was 3% below the average price paid in the May-June buyback highlighted in yellow.

The shares fell sharply the next day (14 October), soundly breaking the offering price. The chart below is as of close of business post-placement.

The "musical shares" I saw implied in the placement was that the amount raised was immaterial to its prospects of having an equity buffer, or in raising funds to reduce debt. It was less than one-tenth the amount of Hengda which was left without a guarantee of a refinance or extension. It was well under one half of one percent of Evergrande debt.

The lack of success of the offering caused shares to drop further, reaching HK$14.20 on Wednesday 28 October and opening below HK$14.00 yesterday.

What the placement DID do was afford Evergrande more room to buy back shares. After the buyback at end June, the company had room to buy 20mm shares. Not enough to affect much.

Two weeks after the placement of shares at HK$16.50 caused the shares to fall sharply from the HK$19 area to which they had rebounded, the company announced they had bought back 900,000 shares.

This came earlier, and at a higher price, than I thought likely. Yesterday, the company bought back shares at a 10.6% discount to where they had just placed shares a week ago, and at a 7% premium to where they had been trading earlier in the day.

Subtlety is not the company's strong suit.

More discussion below the fold.