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Shorting China

April 25, 2010 | About:
We're running a posting contest on the Short Screen message boards, and this post was submitted by Short Screen member Hesperian, who is a near-term bear on China:

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Short China! Am I mad? Why would I short such a Brave New World?

Don't call Mustapha Mond on me just yet. I am going short because China's in a bubble. And bubbles...pop!

China's not experiencing just any kind of bubble, but a real estate bubble. I think we've had some experience with that. But not on the scale that only CHINA* can pull off. You've heard of the brand new, totally empty Chinese skyscrapers, have you not? http://www.youtube.com...

*or Dubai

That roaring dragon constructed the world biggest mall: http://www.youtube.com...

Wow! Impressive. Too bad that's empty too.

There are even empty Chinese cities: http://www.youtube.com...

How cute.

Even a LTCM guy, James Rickards, is calling a bubble: http://www.businesswee...

"The Chinese central bank's balance sheet resembles that of a hedge fund buying dollars and short-selling the yuan", said Rickards

The main reason why this bubble hasn't already popped is because the totalitarian Chinese government is propping up the markets. But all that will do is make the landing even harder.

Mark Faber agrees: "There are some symptoms of a bubble building in China, with the increase in foreign exchange reserves, rapidly rising property prices," Faber, the publisher of the Gloom, Boom & Doom report, said in a Bloomberg Television interview today. "From here on, the China economy will slow down regardless. Whether it will crash this year or later, I don't know." http://www.businesswee...

"Some symptoms". Lol. He is being modest. Look at the magic recovery in home prices (scroll about halfway down) here: http://seekingalpha.co...

Hey! I've seen those kind of charts before. On certain OTC stocks. (Disproportionately Chinese OTC stocks, too.)

Faber continues:

"Excessive credit growth in January, and 11.7 percent increase in property prices in one month alone" are "danger signals," Faber said. "The lending rate in China should be at least twice as high as it is now."

A slowdown in China would hurt the Hong Kong property market as well, particularly the luxury segment, he said.

"I'd rather think that with a clampdown, they will have a lot of losses in China, and less funds for Hong Kong," Faber said. "If you have a crash in China property prices, the high- end sector in Hong Kong property will get hit very hard."

Also, we have this:

"The stock of residential properties, developer inventories and land pledged to banks by local governments exceed by three times the nation's gross domestic product. Rental yields in most cities fail to cover depreciation costs. The price-to-income ratio, a measure of housing affordability, is routinely above 20 in major cities, which means an average Chinese citizen would spend his or her entire income for 20 years to buy an average-priced property"

In most countries, that price to income ratio is about 4.

As to be expected, the great American intellectual Thomas Friedman is incredulous: http://www.nytimes.com...

Uninterrupted global growth is such a heart-warming narrative. How could anyone dare suggest a correction might be in order? He ends his article with a condescending remark to Chanos

"Shorting China today? Well, good luck with that, Mr. Chanos. Let us know how it works out for you. "

Oh, but only after he returns the favor to you, you smug twit. It's a good thing you don't put money on your predictions.

There's plenty of additional evidence of a Chinese RE bubble out there, but anyone familiar with a search engine can find it. Now I'm going to talk about why I chose CTRP and HMIN to short. But before I do, one last summary: http://www.businessins...

For starters, if I'm going to short the China bubble, I will want to short the companies most directly tied to the Chinese RE market. There are only so many Chinese companies with high levels of Chinese RE exposure listed in the US. The largest ones are: XIN, HTHT, HMIN, CTC, CRIC CAHS* and EJ.

*joke

Of these, HMIN is the most overvalued, and still in bubble mode, near its highs and trading at a 52 PE. Volume has been slowing, and I doubt it will go much higher. The Chinese RE bubble is being widely whispered about, so it is not completely out of the market's scope of consciousness. And investor worth his salt would be out of his mind to buy this at a much higher valuation.

As a hotel developer/operator, HMIN has obvious exposure to the Real Estate market in China. Yes, it has had strong growth thusfar. However, I think that it will be disproportionately impacted by an economic slowdown due to overbuilding in the Hotel sector specifically ( http://www.investors.c... ), the law of large numbers* (how long can a 1.4B company keep posting the insane growth that justifies a 50+ PE) and that the Chinese government is unlikely to force people to travel in lean times to save the likes of HMIN (but they may positively intervene in other industries). Traveling is a luxury, and it is highly sensitive to any economic downturn.

* "When HMIN was a young company with just a few hotels under management, it was easy to double or triple revenue just by adding a dozen more hotels to the mix. But now that HMIN has reached critical mass, it will be difficult to maintain the growth trajectory simply because of the law of large numbers. The last four quarters have seen revenue grow by 53%, 43%, 38%, and finally 29% in the fourth quarter. That's still impressive growth but not nearly as exciting as the triple digit revenue gains the company used to put up. "

From http://zachstocks.com/...

While reading about HMIN, I came across CTRP, a company that was founded by the same guy. Lo and behold, this stock was in bubble mode also. It is fresh off of new highs and sports a 55 PE. It is a pure travel company highly leveraged to the leisure class, selling things like VIP tickets to nightclubs. With a slope even steeper than HMIN's, it has attracted a number of short sellers (8% short interest) who aren't drinking the China-to-infinity-and-beyond kool-aide. While CTRP doesn't have the direct RE exposure that HMIN has, I think it acts like a highly-levered proxy for the real Chinese economy. When times are good, it absolutely soars. When times are bad, it will plunge. Keep in mind that the business it is in does not have especially high barriers to entry. In fact, on of CTRP's competitors, LONG, might end up on the short block also.

The risk of shorting companies like HMIN and CTRP is that on an individual level, they show few signs of stress. They are not debt laden, and may well be the leading companies in their markets after the impending Chinese bust. But stocks do not have to be unprofitable, debt laden companies to be worth shorting. They just have to be overvalued in an unsustainable revenue stream. Remember Crox?

The line of reasoning that lead to me choosing these companies to short is as follows:

1. China is nearing the end of a massive RE bubble.

2. This bubble will curtail growth for at least the Real Estate (epicenter) and Luxury (no bailouts for you!) markets when it pops.

3. HMIN and CTRP are severely overvalued in light of the macroeconomic situation, even compared to their peers. Their valuation is unsustainable and will cause their stock prices to decline significantly.

About the author:


Rating: 4.0/5 (14 votes)

Comments

Vincent911
Vincent911 - 4 years ago
I live in China since 1990

I don't think any Chinese living in China use Ctrip to buy tickets

1) their price is not cheaper than the traveler agent

2) their site is really suck

Good luck to all who buy their stocks!

p.s. do you know anyone who have bought anything from Ctrip ?
superguru
Superguru - 4 years ago
Does this china real estate bubble apply to Honkong too?

Third Avenue (whitman) has a quite a lot invested in real estate companies in Honkong.
DaveinHackensack
DaveinHackensack - 4 years ago
Vincent,

Thanks for the feedback about CTRP. It's always good to hear from someone familiar with a company's product.

Superguru,

I don't know what Hesperian's views are on Hong Kong, but I'll ask him.

I don't share his overall bearishness on the Chinese economy. I think China's economy is big and diverse enough that the collapse of a real estate bubble won't sink it. And the Chinese government has a lot of tools at its disposal to keep the overall engine of the economy running.

That said, my biggest stock holding is indirectly levered to the continued Chinese demand for iron ore, which in turn is dependent on the continued growth of the Chinese economy. So I have been hedging against that possibility.

Max7777
Max7777 premium member - 4 years ago
you write:

"For starters, if I'm going to short the China bubble, I will want to short the companies most directly tied to the Chinese RE market. There are only so many Chinese companies with high levels of Chinese RE exposure listed in the US. The largest ones are: XIN, HTHT, HMIN, CTC, CRIC CAHS* and EJ."

and I tend to agree with your concept and the fact that Chinese real estate market chart has been going up insanely, so it will have to either take a pause for a few years or crash soon.. but then I do not follow why you give us HMIN and CTRP as stocks to short to take advantage of a coming fall in Chinese overheated real estate market. As you state one is a hotel builder and the other an Internet travel site.. Even HMIN is not a condo developer with huge debt and big risks and empty buildings ( and I understand there are plenty of empty high rises in China today..) as for CTRP it has nothing to do with this concept of overpriced real estate..
extramiler
Extramiler - 4 years ago
Playing devil's advocate . . . the fact that China can build enormous empty cities and shopping malls may be a sign of its strength rather than its weakness. They have so much capital to (mis) allocate because they are the world's low cost producer and biggest exporter. This is very different from Dubai, a tiny country that rose and fell due to a commodity boom/bust cycle.

DaveinHackensack
DaveinHackensack - 4 years ago
Max7777,

[/i][i]as for CTRP it has nothing to do with this concept of overpriced real estate..

Hesperian explained why he picked CTRP to short in this paragraph:



While reading about HMIN, I came across CTRP, a company that was founded by the same guy. Lo and behold, this stock was in bubble mode also. It is fresh off of new highs and sports a 55 PE. It is a pure travel company highly leveraged to the leisure class, selling things like VIP tickets to nightclubs. With a slope even steeper than HMIN's, it has attracted a number of short sellers (8% short interest) who aren't drinking the China-to-infinity-and-beyond kool-aide. While CTRP doesn't have the direct RE exposure that HMIN has, I think it acts like a highly-levered proxy for the real Chinese economy. When times are good, it absolutely soars. When times are bad, it will plunge. Keep in mind that the business it is in does not have especially high barriers to entry. In fact, on of CTRP's competitors, LONG, might end up on the short block also.
Extramiler,

that China can build enormous empty cities and shopping malls may be a sign of its strength rather than its weakness.

I generally agree. The Chinese government has built up a huge fiscal surplus over the last decade or so. Though I think the Chinese economic authorities wouldn't mind seeing their real estate sector deflate a little. They can keep Chinese working by building bullet trains, or new submarines for their blue water navy. Whether they build trains, submarines, or shopping malls, they'll still be using steel, which requires iron ore. Which will be good for my stock that sells to the iron mining industry.
superguru
Superguru - 4 years ago
"This is very different from Dubai, a tiny country that rose and fell due to a commodity boom/bust cycle." - Extramiller

Dubai's boom bust has nothing to do with a commodity boom/bust cycle. Dubai is not oil rich like their neighbour Abu Dhabi.

"the fact that China can build enormous empty cities and shopping malls may be a sign of its strength rather than its weakness. They have so much capital to (mis) allocate because they are the world's low cost producer and biggest exporter." - extramiller

- In short term yes they can keep the party going, but it is going to come crashing down sooner rather than later. Chanos is most likey right on China.
Max7777
Max7777 premium member - 4 years ago


I did read this "While reading about HMIN, I came across CTRP, " and to say the least, it was weak - In his write-up he gives a ton of links for his concept of overpriced properties in china, but saying "China" is like saying Europe - there is a huge difference between Norway and Portugal's finances, as there is between China's inland and coastal real estate builders - between Big industrial cities and the others. The real estate price appreciation has also been very different between all these parts of China. Then you look at how someone like Paulson picked the most risky tranche of the sub-prime market and bet against that and I assume you want to take the time and find the most overpriced region of China, and in there you want to find the company that has the most empty buildings with the biggest leverage.

But instead he goes into " I came across CTRP, a company that was founded by the same guy. Lo and behold, this stock was in bubble mode also. It is fresh off of new highs" well this means absolutely nothing to me. It could be the next Google for all I know. Just because the PE is up is no reason to short a stock and it has absolutely nothing to do with his real estate concept.Shorting requires just as much work as going long, and probably more, since you in the long term markets go up.

When he has not yet found any company that match the correct short requirements to take advantage of the Chinese real estate bubble (Most Overpriced region of China, most over-leveraged, most empty buildings with no income and low sales) just seem odd to me to then jump to CTRP because it was out there..
Hesperian
Hesperian - 4 years ago


One of the reasons why I don't participate in internet message board discussions anymore is because I inevitably get drawn into largely fruitless arguments. With that said, I also want to preface my response to the replies here that I'm not table-pounding these ideas. I am learning as I go just like everyone else, and I may well have made a mistake and end up losing money on these shorts, as anyone can with any investment. But I want to clarify some things real quick for those who gave feedback and expressed skepticism.

their site is really suck

Yes, it looks very cluttered and amateur to me. I find it hard to believe anyone uses that site.

"but then I do not follow why you give us HMIN and CTRP as stocks to short to take advantage of a coming fall in Chinese overheated real estate market."

If you take a look at the pure-play Chinese RE companies out there, they're already pretty beat up. The idea is to get the dominoes that haven't been toppled over yet, since I was late to short the pure-play RE companies.

As I wrote on Dave's site, (out of the hope that other people would contribute the the message board dialog there)

"For those who didn't get HMIN's ties to RE, there is overbuilding (due to RE bubble) of Hotels. Plenty of hotel operators may find their businesses suddenly unprofitable when 1) they can't charge as much 2) their properties aren't worth as much and 3) people aren't traveling as much."

as for CTRP it has nothing to do with this concept of overpriced real estateI wouldn't say "nothing to do with", since if the property bubble bursts, then people are more likely to save money by traveling less (we saw that here in the US). I thought I was rather clear in the content of the post that the relationship was tangential.

the fact that China can build enormous empty cities and shopping malls may be a sign of its strength rather than its weakness.

How many empty cities are they going to build before they move into something more productive? I think they've built enough to last a long time. But point taken, I admit I do not know how long the China bubble will continue. I do know that the longer bubbles go on, the more dangerous they are. And I know that all bubbles eventually pop.

"and to say the least, it was weak - In his write-up he gives a ton of links for his concept of overpriced properties in china, but saying "China" is like saying Europe - there is a huge difference between Norway and Portugal's finances, as there is between China's inland and coastal real estate builders - between Big industrial cities and the others."

I remember similar comments being made about why we couldn't have a nationwide property bubble in the United States. If you look at the price chart I linked to showing the property prices of *70* major Chinese cities, I think the generalization here is still relevant.

" Then you look at how someone like Paulson picked the most risky tranche of the sub-prime market and bet against that and I assume you want to take the time and find the most overpriced region of China, and in there you want to find the company that has the most empty buildings with the biggest leverage. "

You also could have short almost anything when Paulson did and made money. But I agree that if I had access to the Chinese mainland exchanges, I could be more precise.

I came across CTRP, a company that was founded by the same guy. Lo and behold, this stock was in bubble mode also. It is fresh off of new highs" well this means absolutely nothing to me. It could be the next Google for all I know.

Google also has made shorts good money at times, after particularly exuberant market periods.

Shorting requires just as much work as going long, and probably more, since you in the long term markets go up. LOL. I don't believe that there is a law out there that says markets always go up. That sounds like something from generic Suze Orman advice. And I don't think these companies will go belly up, I'm not shorting them forever.. Going long and going short are not mutually exclusive concepts.

Sell the leapers and buy the creepers. CTRP has just made a huge leap and a correction is in order.

"When he has not yet found any company that match the correct short requirements to take advantage of the Chinese real estate bubble (Most Overpriced region of China, most over-leveraged, most empty buildings with no income and low sales) just seem odd to me to then jump to CTRP because it was out there.."

What is "correct" here is a matter of opinion until the passing of time chooses a side. I didn't choose it because it was out there. I chose it because it looks like an overpriced growth stock in bad need of a correction, a correction that could be precipitated by less-than-perfect news about the Chinese economy.

I originally planned on writing some about the founder of these companies, but that was more speculation than I really feel like defending to anyone. Basically, the gut feeling I get from reading the CTRP and HMIN narratives is that they were just a way to cash in on the booming emerging market story. I do not think there is a highly committed team behind these companies. But that's just a hunch I'm throwing out there.

Max7777
Max7777 premium member - 4 years ago


I stand by all that I said and especially " you want to take the time and find the most overpriced region of China, and in there you want to find the company that has the most empty buildings with the biggest leverage" Maybe you can do it your way, but for myself, I feel not doing that is basically not doing my homework and if there is anything I learned from all the gurus here from WEB to Soros to Paulson or Klarman is that they do not try to catch a market but they do more detailed homework than most to reduce risk and still be in the sweet spot and this over time is eventually reflected in their result.

But y
ou are right that this inevitably gets drawn into largely fruitless arguments so all I will add is that despite all this I still greatly appreciate your original post and I thank you for your reply. We agree to disagree.
DaveinHackensack
DaveinHackensack - 4 years ago
Five starts to Max7777 for being a gentleman. And a steak dinner to Hesperian if he maintains his lead in the contest for another week.

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