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? Gaming receivables Questionable Other Income Property on the side Copper and steel financing

What goes on in China Inc.

Foreign technology partnerships

Absorb and digest Re-innovate Undercut partners
Source: shutterstock 2

The Number Is Paramount

GDP drives economic activity, not vice versa Countervailing priorities
GDP: Killing the Hen to Get the Egg

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 Guangdongs economy1

Capacity overinvestment (2008-2012 CAGR)

Cement 12% Steel 10% Autos 18%

Source: GDP gap in China the size of Guangdong economy, South China Morning Post, February 5, 2013 Source: China Media Project 3

The Law Of Diminishing Returns

Unprecedented fixed asset
investment boom

Gross Fixed Capital Formation/China GDP

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 Sh Chn Bo Of Money is Wealth Destruction

Large-scale capital projects grow sillier by the day

New South China Mall worlds

largest and loneliest New Ordos empty city in Inner Mongolia Sky City One worlds tallest building to be built in only 90 days

Hard To Keep Up

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

services

Urban dwellers consume more Increased demand for social

New theory migration will be
towards the Eastern coast inside the high speed rail network Go West policy in doubt
Source: China Daily 8

Is urbanization national?

Property is the Lynchpin

Chinas 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

NYC and London
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Residential Affordability Comparison

Beijing 28.1 yrs.

Generational investment:
Parental savings funding purchase of real estate by next generation

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Shanghai 20.9 yrs.

20

15

Chongqing 14.5 yrs.

Wuhan 12.9 yrs.

Speculative fever provides

breeding ground for corruption

London 10.8 yrs.

NYC 10.0 yrs.

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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), Greater London Authority (UK). China real estate values as of December 2012, NYC 07-11 Average, Greater London Nov 2012

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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

Evil Factory! Return My Annual Bonus

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: The Epoch Times 11

Source: Chinese SOE Profits down 11.4% in the first nine months, Gov.cn

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 incomes2 Details vague with watered down proposals and loopholes

Corruption crackdown?
New regime vows to crack down
on corruption Recent restriction to property ownership information
Source: China Daily 12

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

Property Graft Is An Issue

Dirty money hides in property
Exposed officials have multiple
properties Not concerned with liquidity or mobility
Official sacked over property scandal

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: China Daily 13

Source: Hukou forgery scandals highlight police corruption, Xinhua, January 24, 2013

Faith in Government: Are People More Satisfied Today?

Leadership change was not
seamless
"This is us [China] today!

Frustration with self interest Quality of life

New anti-corruption policy Netizens are the Fourth Estate

Pollution blots out the sun Food and baby milk scandals Cancer villages
2010: mass incidents estimated

Demonstrations are a way of life

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 Network, 2012 2) China's defense budget outweighed by internal security, Want China Times, March 11, 2013 Source: China Media Project 14

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 Countries: 2001 2010 Source: China Media Project 16

Dont Take our Word for it

GDP figures are man-made
and therefore unreliable, Li said.
Li Keqiang, 1st Vice Premier China
US Embassy Cable March 15, 2007 Wikileaks December 4, 2010

To some extent, this is

fundamentally a Ponzi scheme.

Xiao Gang, Chairman Bank of China

Regulating shadow banking China Daily, October 10, 2012

The bubble must be

controlled, or both the real estate market and domestic economy will be jeopardized

Wang Shi, Chairman China Vanke

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

"The government has

already been considered untrustworthy, let alone businesses"

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

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

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