Short sellers launched a rocket at Evergrande, China’s second-largest property developer, last week. It hasn’t quite hit the mark. Citron Research, the maverick investment house that launched the allegations of bribery and dodgy accounting, may have shot itself in the foot by fudging some numbers, and leaping to unlikely conclusions. Yet the Hong Kong-listed Evergrande’s red flags are real, even if the supposed fraud isn’t.
Evergrande, now worth just under $8 billion, has lost $1 billion in market value since Citron called it “insolvent” and “fraudulent”. Yet on some counts, Citron just got it wrong. A calculation of how Evergrande cooked the books on its average price of land acquisitions looks impressive – except that to get there, it seems Citron used a pure “land bank” figure when it should have used a different number that includes unfinished buildings.
In other cases, Citron may have just laid it on too thick. Its suggestion that an unexplained growth in “other accounts receivable” represents fraud sounds thin. That line of the books can increase faster than seemingly related accounting entries for non-fraudulent reasons too, such as paying deposits for land or lending to buyers of assets. Large increases wouldn’t thrill shareholders, but they aren’t fraud.
In some ways, however, Citron’s objections to Evergrande’s business model are valid. The company has relied too heavily for profit on revaluations of its investment property. The creep into other businesses – like running a football team – is concerning. Meanwhile the company’s use of trust structures to provide financing is risky, although common practice for Chinese developers.
Evergrande might have avoided some of the brickbats by being clearer. The company itself mixes and matches different land bank numbers to flatter its own acquisition costs. And required disclosure on trust structures is sketchy at best. Wall Street analysts, who overwhelmingly rated Evergrande a “buy”, have rushed to its defence. But even without fraud, investors should retain a healthy scepticism.