Evergrande Shares Drop 11% on Accusations of Fraud

Shares in China real estate developer Evergrande fell as low as HK$3.60 per share on Thursday following accusations of fraudulent accounting and massive bribery by Citron Research, a US-based research firm often associated with short-selling.

Evergrande eventually recovered to a price of HK$3.97, as the stock became the most heavily traded in Hong Kong for the day. The closing price represented a fall of 11.4% over its level before the story broke.

The fall for Evergrande was the second big headline of the week for billionaire Hui Ka-Yan’s property firm. Evergrande had made the news earlier in the week for purchasing a plot of commercial land in Guangzhou at a record cost. The purchase price of RMB 32,968 per square metro was nearly double the RMB 17,933 rate that rival Changyuan Real Estate had paid for land in the same area during 2011.

And this type of gravity-defying business practice is a key part of Citron’s accusations against the developer.

According to Citron,

The Company’s management has applied at least 6 accounting shenanigans to mask Evergrande’s insolvency. Our research indicates that a total write-down of RMB 71bn is required and Evergrande’s pro forma equity is negative 36bn.

Over the past 5 years, Evergrande has executed an untoward program of bribes aimed at local government officials in order to build its raw land industry.

To finance growing cash flow shortfalls related to these bribes, subsequent land purchases, and related real estate construction activities, Evergrande has employed a complex web of Ponzi-style financing schemes.

These schemes are characterized by a reliance upon perpetually growing pre-sales, off-balance sheet partnerships and IRR guarantees to third parties.

The report goes on to predict a collapse for what it calls Evergrande’s “unsustainable” business model.

So far this year Evergrande had appeared to defy the challenges that had beset most other developers in China’s real estate industry, and its chairman had been cited by Forbes as the wealthiest real estate billionaire in China.

Even its Guangzhou Evergrande football team had been faring well, making headlines in international competitions after bringing on board global stars such as coach Marcello Lippi. Now, investors already jittery about China’s real estate sector will be watching the company more closely.

Citron Research told the Wall Street Journal that it has been issuing reports on listed companies for some 11 years, however, its record to date has not been spotless. While the company has successfully exposed fraudulent companies such as Xinhua Financial Media, which ultimately was delisted and its principals indicted for fraud, last year Citron flung out numerous accusations against Internet firm Qihoo 360, which ultimately were not proven.

When trading opens again on Evergrande this week we can expect at least a preliminary verdict from the investment community about whether there are any merits to Citron’s case against the developer.

The full text of Citron’s report on Evergrande is available here in case you would like to decide for yourself.