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China: The Edifice Complex

Wine Country Conference

April 5, 2013

James Chanos Kynikos Associates

The China Way
The China Way
The China Way

The China Way

The China Way
The China Way
The China Way
The China Way
The China Way
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

partnerships – “Absorb and digest” – “Re - innovate” – Undercut partners Source: shutterstock 2
“The Number” Is Paramount
“The Number” Is Paramount
“The Number” Is Paramount

“The Number” Is Paramount

“The Number” Is Paramount
“The Number” Is Paramount
“The Number” Is Paramount
“The Number” Is Paramount
“The Number” Is Paramount
“The Number” Is Paramount

GDP drives economic activity, not vice versa

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%

“GDP: Killing the Hen to Get the Egg”

10% – Autos 18% “GDP: Killing the Hen to Get the Egg” Source: “GDP gap in
The Law Of Diminishing Returns
The Law Of Diminishing Returns
The Law Of Diminishing Returns

The Law Of Diminishing Returns

The Law Of Diminishing Returns
The Law Of Diminishing Returns
The Law Of Diminishing Returns
The Law Of Diminishing Returns
The Law Of Diminishing Returns
The Law Of Diminishing Returns

Unprecedented fixed asset 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

Gross Fixed Capital Formation/China GDP

Asset depreciation liabilities Gross Fixed Capital Formation/China GDP Source: National Bureau of Statistics of China 4
The ‘Shā Chén Bào’ Of Money is Wealth Destruction
The ‘Shā Chén Bào’ Of Money is Wealth Destruction
The ‘Shā Chén Bào’ Of Money is Wealth Destruction

The ‘Shā Chén Bào’ Of Money is Wealth Destruction

The ‘Shā Chén Bào’ Of Money is Wealth Destruction
The ‘Shā Chén Bào’ Of Money is Wealth Destruction
The ‘Shā Chén Bào’ Of Money is Wealth Destruction
The ‘Shā Chén Bào’ Of Money is Wealth Destruction
The ‘Shā Chén Bào’ Of Money is Wealth Destruction
The ‘Shā Chén Bào’ Of Money is Wealth Destruction

Large-scale capital projects grow sillier by the day

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?

Hard To Keep Up

and understate maintenance costs – Is economic depreciation being factored in? Hard To Keep Up Source:
Pervasive Growth Of Credit Driving Boom
Pervasive Growth Of Credit Driving Boom
Pervasive Growth Of Credit Driving Boom

Pervasive Growth Of Credit Driving Boom

Pervasive Growth Of Credit Driving Boom
Pervasive Growth Of Credit Driving Boom
Pervasive Growth Of Credit Driving Boom
Pervasive Growth Of Credit Driving Boom
Pervasive Growth Of Credit Driving Boom
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

and busts – Reality: History proves otherwise – Over 40% of banks loans went sour post-1990s
Wealth Management Products are the Democratization of Credit
Wealth Management Products are the Democratization of Credit
Wealth Management Products are the Democratization of Credit

Wealth Management Products are the Democratization of Credit

Wealth Management Products are the Democratization of Credit
Wealth Management Products are the Democratization of Credit
Wealth Management Products are the Democratization of Credit
Wealth Management Products are the Democratization of Credit
Wealth Management Products are the Democratization of Credit
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

viability of three trusts • Warning from bank regulators Source: CBRC, BoA Merrill Lynch, Barclays, Kynikos
Urbanization: Last Refuge of the Bulls
Urbanization: Last Refuge of the Bulls
Urbanization: Last Refuge of the Bulls

Urbanization: Last Refuge of the Bulls

Urbanization: Last Refuge of the Bulls
Urbanization: Last Refuge of the Bulls
Urbanization: Last Refuge of the Bulls
Urbanization: Last Refuge of the Bulls
Urbanization: Last Refuge of the Bulls
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

will be towards the Eastern coast inside the high speed rail network – Go West policy
Property is the Lynchpin
Property is the Lynchpin
Property is the Lynchpin

Property is the Lynchpin

Property is the Lynchpin
Property is the Lynchpin
Property is the Lynchpin
Property is the Lynchpin
Property is the Lynchpin
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

an issue • No one can identify the buyers • Commercial real estate is the future
Residential Real Estate Affordability?
Residential Real Estate Affordability?
Residential Real Estate Affordability?

Residential Real Estate Affordability?

Residential Real Estate Affordability?
Residential Real Estate Affordability?
Residential Real Estate Affordability?
Residential Real Estate Affordability?
Residential Real Estate Affordability?
Residential Real Estate Affordability?

Major Chinese cities versus NYC and London

Generational investment:

Parental savings funding purchase of real estate by next generation

Speculative fever provides breeding ground for corruption

Mass market buyers priced out

Residential Affordability Comparison

Beijing 30 28.1 yrs. 25 Shanghai 20.9 yrs. 20 Chongqing 14.5 yrs. Wuhan 15 12.9
Beijing
30
28.1 yrs.
25
Shanghai
20.9 yrs.
20
Chongqing
14.5 yrs.
Wuhan
15
12.9 yrs.
London
NYC
10.8 yrs.
10.0 yrs.
10
5
0

Years to pay off Apartment (Apartment price / Household Income)

Rising Wages: No Longer the Workshop of the World
Rising Wages: No Longer the Workshop of the World
Rising Wages: No Longer the Workshop of the World

Rising Wages: No Longer the Workshop of the World

Rising Wages: No Longer the Workshop of the World
Rising Wages: No Longer the Workshop of the World
Rising Wages: No Longer the Workshop of the World
Rising Wages: No Longer the Workshop of the World
Rising Wages: No Longer the Workshop of the World
Rising Wages: No Longer the Workshop of the World

Chinese wages are up

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

“Evil Factory! Return My Annual Bonus”

from China “Evil Factory! Return My Annual Bonus” Source: “Chinese SOE Profits down 11.4% in the
Wealth Gap: Straining the Harmonious Society
Wealth Gap: Straining the Harmonious Society
Wealth Gap: Straining the Harmonious Society

Wealth Gap: Straining the Harmonious Society

Wealth Gap: Straining the Harmonious Society
Wealth Gap: Straining the Harmonious Society
Wealth Gap: Straining the Harmonious Society
Wealth Gap: Straining the Harmonious Society
Wealth Gap: Straining the Harmonious Society
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

2010 1

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

– Recent restriction to property ownership information Sources: 1) “More Findings from the China Household

Sources: 1) “More Findings from the China Household Finance Survey”, Li Gan, Texas A&M University, January 2013

2) “China approves income distribution strategy”, Reuters, February 5,

2013

Source: China Daily

12

Property Graft Is An Issue
Property Graft Is An Issue
Property Graft Is An Issue

Property Graft Is An Issue

Property Graft Is An Issue
Property Graft Is An Issue
Property Graft Is An Issue
Property Graft Is An Issue
Property Graft Is An Issue
Property Graft Is An Issue

Dirty money hides in property

Exposed officials have multiple 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

Official sacked over property scandal

- 41 properties Official sacked over property scandal Source: “Hukou forgery scandals highlight police
Faith in Government: Are People More Satisfied Today?
Faith in Government: Are People More Satisfied Today?
Faith in Government: Are People More Satisfied Today?

Faith in Government: Are People More Satisfied Today?

Faith in Government: Are People More Satisfied Today?
Faith in Government: Are People More Satisfied Today?
Faith in Government: Are People More Satisfied Today?
Faith in Government: Are People More Satisfied Today?
Faith in Government: Are People More Satisfied Today?
Faith in Government: Are People More Satisfied Today?

Leadership change was not

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 230,000 1

Environmental protests

Selected local strikes

More spent on internal security than the military 2

Will there be real reform?

"This is us [China] today!”

Will there be real reform? "This is us [China] today!” Sources: 1) “Social Unrest in China”,
Shifting the Focus from the Real Problems
Shifting the Focus from the Real Problems
Shifting the Focus from the Real Problems

Shifting the Focus from the Real Problems

Shifting the Focus from the Real Problems
Shifting the Focus from the Real Problems
Shifting the Focus from the Real Problems
Shifting the Focus from the Real Problems
Shifting the Focus from the Real Problems
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

– Reporting equipment stolen from hotels – Visas revoked • Attempts at intimidation Source: Global Times
Chinese Proverb: “When the Tree Falls, the Monkeys Scatter”
Chinese Proverb: “When the Tree Falls, the Monkeys Scatter”
Chinese Proverb: “When the Tree Falls, the Monkeys Scatter”

Chinese Proverb: “When the Tree Falls, the Monkeys Scatter”

Chinese Proverb: “When the Tree Falls, the Monkeys Scatter”
Chinese Proverb: “When the Tree Falls, the Monkeys Scatter”
Chinese Proverb: “When the Tree Falls, the Monkeys Scatter”
Chinese Proverb: “When the Tree Falls, the Monkeys Scatter”
Chinese Proverb: “When the Tree Falls, the Monkeys Scatter”
Chinese Proverb: “When the Tree Falls, the Monkeys Scatter”

Unprecedented fortunes amassed by leaders’ families

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

Tunneling Out of China

– Estimated in 2012 at $18B Tunneling Out of China Source: Global Financial Integrity “Illicit Financial
Don’t Take our Word for it
Don’t Take our Word for it
Don’t Take our Word for it

Don’t Take our Word for it

Don’t Take our Word for it
Don’t Take our Word for it
Don’t Take our Word for it
Don’t Take our Word for it
Don’t Take our Word for it
Don’t Take our Word for it

“GDP figures are ‘man-made’ and therefore unreliable, Li

said.”

“To some extent, this is fundamentally a Ponzi scheme.”

“The bubble must be controlled, or both the real estate market and domestic economy will be jeopardized”

"The government has already been considered untrustworthy, let alone businesses…"

Li Keqiang, 1 st Vice Premier China

US Embassy Cable March 15, 2007 Wikileaks December 4, 2010

Xiao Gang, Chairman Bank of China

“Regulating shadow banking”

China Daily, October 10, 2012

Wang Shi, Chairman China Vanke

“Vanke boss sees bubble in spike” Standard , January 29, 2013

Chinese Netizen

“Chinese companies trusted in China, says US report; Nope,Say netizens” Want China Times, February 6, 2013

Thank You to the Wine Country Conference and the Les Turner ALS Foundation 18
Thank You to the Wine Country Conference and the Les Turner ALS Foundation 18
Thank You to the Wine Country Conference and the Les Turner ALS Foundation 18
Thank You to the Wine Country Conference and the Les Turner ALS Foundation 18
Thank You to the Wine Country Conference and the Les Turner ALS Foundation 18
Thank You to the Wine Country Conference and the Les Turner ALS Foundation 18
Thank You to the Wine Country Conference and the Les Turner ALS Foundation 18
Thank You to the Wine Country Conference and the Les Turner ALS Foundation 18
Thank You to the Wine Country Conference and the Les Turner ALS Foundation 18
Thank You to the Wine Country Conference and the Les Turner ALS Foundation 18

Thank You to the Wine Country Conference and

the Les Turner ALS Foundation

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Important Disclosure
Important Disclosure

Important Disclosure

Important Disclosure
Important Disclosure
Important Disclosure
Important Disclosure
Important Disclosure
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