What's up guys and welcome back to wall street millennial, if you've been paying attention to the stock market, you may have seen the embattled chinese property developer. Evergrand continue to free fall with stock price, losing another 5 of its value. In the past 5 days, ratings agency s p says that the company is likely to default and also cut its credit rating on other property developers in the country. The downfall of evergrant seemed to come out of nowhere with the stock price declining more than 90 percent.

In just the past year, institutional investors, including blackrock hsbc and ubs, were loading up on the company's debt in the months leading up to the collapse. But for more than a decade there have been obvious red flags around the company's precarious financial structure, corporate mismanagement and shady business dealings. As early as 2012 famous short seller, andrew leff was sounding the alarm on evergrand, saying that the company was fraudulently understanding its liabilities and was on the brink of insolvency. By that time, evergreen was already an extremely influential company in china, and hong kong.

Taking them head-on was not going to be easy. In 2016, the hong kong financial authorities found left guilty of market misconduct and said that his allegations against evergrand were false and misleading. He was fined millions of dollars and banned from trading hong kong listed stocks for five years. Andrew left has taken a lot of flack for his disastrous gamestop short position earlier this year.

While his call on evergren turned out to be premature, he turned out to be dead right in the end in this video we'll go over less 2012 short report about the company, the hong kong government's crusade against him and how evergren was able to stay afloat. For so long before finally collapsing in 2012, andrew left citron research published a report accusing evergrand of hiding its debts and engaging in illegal business practices. At this point, they had only publicly traded for a few years and had a market cap of about 9 billion us dollars. Many investors wanted to get a piece of the red hot chinese, real estate market and evergrand looked like the best way to play this.

Between 2006 and 2011, their assets increased more than 20-fold, far outpacing the growth of their peers, but left thought he found accounting irregularities that they used to overstay their assets and understate their liabilities. After adjusting for these, he said their book equity value was negative. 36 billion rmb, while the company is reporting equity of positive 35 billion on their balance sheet. Additionally, he alleged that they bribed government officials to buy land for their developments at below market prices, and finally, he claimed that they used a ponzi-like financing structure where they rely on growing pre-sale down payments to finish existing products and service their debt load.

All these factors led left to make the conclusion that the company was fraudulent and would eventually collapse. He initiated a short position and published a report in the summer of 2012, immediately causing the stock to fall. 20 we'll take a deep dive into each of his allegations. While evergrants assets had grown tremendously so had their debts and while they were reporting net profits, their operating cash flow was negative almost every year since 2006..

That alone isn't necessarily a bad thing, depending on how they book their revenues and expenses, it might be legitimate for their operating cash flow to be negative, while their net profit is positive, but his next allegation was far more damning. He said that evergrand uses off-balance sheet joint ventures to hide billions of r b worth of debt and falsely classify it as equity. This is a bit complicated, so we'll explain it with an example: evergrand wants to make a new development at a cost of 100 million dollars, but they don't have 100 million dollars of cash, so they find a partner to finance part of it. Evergrande will put up 51 million dollars for a 51 stake in the project, while their partner will put up 49 million dollars for a 49 stake.

Let's say the property price has decreased by the time. They finish the project and they can only sell the development for 80 million dollars, because evergrand only owns 51 of the project. They only incur 10.2 million dollars of the loss, while their partner incurs the remainder, because this is an equity joint venture. Evergrand wouldn't have to report the 49 million dollars from the partner as debt.

They have no contractual obligation to cover the losses for the partner if the development makes a loss left argued that evergren's jv's actually had a very different structure. They guaranteed a specific rate of return to the partner, for example, they might guarantee a 10 return, which means, regardless of how the project turns out. The partner is entitled to 54 million dollars from their original 49 million investment. If they only end up being able to sell their properties for 80 million dollars, there will be only 26 million dollars left for evergrand after paying the partner.

This is a much more risky proposition for evergrand, because they'll have to make a large loss if the development slightly underperforms their projections. It could be the case that the partners view evergreen's developments as very risky, so they're only willing to put up capital if they can get guaranteed returns left argues that these joint ventures are really dead, but evergrand falsely classifies them as equity, so they can keep them Off the balance sheet and make their leverage ratios look better. He said that these off-balance sheet debts added up to 23 billion rmb. This is eerily similar to enron, which also had tens of billions of dollars worth of debt in a convoluted system of off-balance sheet vehicles.

The next issue that left brings up is allegations that evergrand bribed government officials to get better deals when acquiring land in their 2011 financial statements. They recorded 73 million dollars worth of cost of land premium without official invoices left inferred that this means bribes evergrande bought land from local chinese governments at a 67 discount to their peer group. They possibly bribed government officials to sell them state-owned land in an uncompetitive process. At below market prices, they also allegedly pulled bait-and-switch tactics where they would sell properties under development to home buyers.

Once the property was complete, it looked significantly different from what the buyers were originally promised. In some cases, their business practices resulted in protests where evergrand's private security personnel got physical with protesters left argues that the chinese government could eventually force them to forfeit their illegally acquired land. That would destroy evergrand's business as they would still retain the debt that they used to buy. The land left also said that evergrand's heavy reliance on pre-sale down payments resembled a ponzi scheme.

They desperately needed cash to make interest payments and contractually obligated payments to their jv partners to fund this. They needed to book an ever-increasing amount of pre-sales. This led them to desperately take on unattractive projects with poor economics, such as a large development in yinko city, which already had a glut of residential housing. Evergrande's, founder and chairman goes by the title dr hui and their corporate website says that he is a professor at the wuhan university of science and technology.

You may also see him referred to as xujia yin, which is the mandarin pronunciation, but they're referring to the same person. You might be surprised to hear that he does not have a phd and was in fact never a professor at any university. They could legitimately claim he's an entrepreneur and self-made billionaire, so it's quite strange that they felt the need to call him a professor as well, but it just goes to show how willing evergrande is to stretch the truth to make themselves look better. The last piece of citron's report talks about some absurd non-real estate-related ventures that evergren has taken on which burn cash and destroy shareholder value.

The company bought a professional soccer team in china and paid the players 70 million us dollars per year. This is multiples higher than what other soccer teams in the country pay. They also spent more than 100 million dollars to build the evergrand football school which they use to train and recruit new players. Needless to say, this is a cash incinerator based on the evidence put forward in this short report left said that company was running out of cash and would face a liquidity crisis within the next few years.

What he failed to consider was that, as long as china's real estate prices kept inflating and sentiment remains strong, they could continue building new assets to offset their existing liabilities for many years to come, and that is exactly what they did. After the short report. The stock increased as much as 6-fold at its peak in 2017, but with evergrand now on the brink of bankruptcy. It appears that the chickens have finally come home to roost and left was proven right.

In the end, the hong kong financial authorities did not take kindly to left's allegations with evergrand being a hong kong listed company. They launched a market misconduct investigation into his short report. They said that the short report resembled a tabloid and left did not do sufficient due diligence to verify his allegations in the report. Nor did he have a complete understanding of the hong kong accounting standards after the report was released.

Many of the investment banks covering evergrand stock said the claims were false and the dip in the stock price was a buying opportunity. The authorities also found that andrew left started covering his short position almost immediately after his report was published, ultimately making a profit of one and a half million hong kong dollars in 2016. They found him guilty finding him millions of hong kong dollars and banning him from trading hong kong listed socks for five years in rendering its decision. Last week this hong kong tribunal said - and i quote mr left - consciously disregarded the real risk that his report was false and misleading as to material facts, he was reckless in his conduct.

What's your reaction today, i don't think i was reckless in my conduct at all scott. If you look at that report, it's extremely well sourced. It's well documented everything is right there, their accounting, in my opinion, was ponzi-like accounting taking from one person to pay back the person beforehand, uh and right now looking backwards. It probably wasn't the best idea to write an article on.

I think it's the largest property developer in china uh. That being said, you can take away the truth. Uh hong kong has made conscious efforts right now to curb short selling uh, to also curb any kind of criticism within the market that i was giving and uh. You know i'm proud of the fact that i went ahead.

I stood by it. I spent a lot of money on legal fees to fight it. I think the media has been very fair in understanding the fact that hong kong is trying to suppress my freedom of speech. That report had a hundred different points in it and they picked out a few that they thought can be easily tried in a court and they're really accounting issues and that's what they stayed focused on.

Oh, of course i want to appeal, but uh. You know they say if you can't fight city hall, it's pretty pretty difficult to fight hong kong city hall, and i just don't want to be in that situation. If, although i do believe what i wrote was correct, but, more importantly than being correct, what i wrote was sourced documented and was my opinion and in order to have a fair and open market, you must allow people to express their opinions at the end of the Day evergrant's financials were too complicated for anyone to definitively prove that they were committing any fraud. There can be many different interpretations of the accounting standards and evergrand vigorously defended themselves, and this also goes to show how difficult activist short selling is.

Whenever you end up being right in the end, things can take many years to play out alright guys that wraps it up for this video. Do you think evergrand was a fraudulent company? Do you think they can survive their current cash crunch? Let us know in the comments section below as always. Thank you so much for watching and we'll see you in the next one wall, street millennial, signing out.