Investors should avoid China’s bond market after the first onshore default because state intervention and debt restructuring could prompt losses, according to New York-based hedge fund Maglan Capital LP.
The best way to make money from distressed companies in the world’s second-largest economy is by betting against listed stocks, according to David Tawil, co-founder of Maglan Capital, which invests in companies struggling to repay their debt.
“In China, government involvement is much more pervasive, especially in industries like banking and real estate,” Tawil said in a March 21 phone interview. “The only way to play the distressed cycle is shorting equities. The problem in fixed income is, I don’t know if the bonds are going to drop, and even if they do drop, the government may come in and rescue them.”
China had its first onshore default earlier this month when solar-cell maker Shanghai Chaori Solar Science & Technology Co. missed part of a bond-coupon payment due March 7. Closely held Zhejiang Xingrun Real Estate Co. collapsed on March 17 after government officials familiar with the matter said it didn’t have enough cash to repay 3.5 billion yuan ($565 million) of debt. While China Credit Trust Co. was bailed out in January, Premier Li Keqiang said this month defaults may be unavoidable in some cases.
Maglan Capital was founded by Tawil and Steven Azarbad in 2010. Both Tawil and Azarbad are former leveraged finance bankers with Credit Suisse Group AG and have also worked as debt restructuring lawyers.
The company’s $70 million Maglan Distressed Fund gained 10 percent net of fees this year through February, according to figures on its website. That compares with a 0.6 percent advance by the Standard & Poor’s 500 Index during the same period. The fund returned 59 percent in 2013.
While Maglan doesn’t have any bets against Chinese companies yet, Tawil said he’s bearish on investments directly tied to interest rates and real estate, and would also avoid metal producers and some lenders.
Glaucus Research Group California LLC initiated coverage of China Lumena New Materials Corp. (67), which sells polyphenylene sulfide products in China, today with a strong sell rating, saying the company had made “numerous material misrepresentations to investors.” The company’s stock was suspended in Hong Kong after dropping 7.4 percent in early trade.
Chaori Solar’s bondholders are weighing a lawsuit to recover their money, according to a March 10 filing to the Shenzhen Stock Exchange from China Securities Co., which managed the note offering in 2012. The manufacturer sold 1 billion yuan of five-year securities at par in March 2012. The notes were quoted at 57.44 percent of face value on March 24, according to Chinabond.
Suntech Power Holdings Co., once the world’s largest solar-panel maker, is among China’s biggest casualties in the U.S. dollar bond market after it defaulted on $541 million of convertible notes last year. It filed for U.S. bankruptcy protection in February as it liquidates in the Cayman Islands.
Its securities, sold to investors at par in 2008, were trading at 9.3 cents on the dollar on March 17 to yield 32.26 percent, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. The company’s creditor working group includes Clearwater Capital Partners LLC and Spinnaker Capital Ltd.
While China’s economy remains sound, rapid urbanization and the emergence of a large middle-income group since 2008 has caused overheating, according to Tawil.
Investors should expect some slow down and that’s “acceptable the sooner it occurs,” Tawil said. “The real question is whether Beijing will try to mask the downcycle or let it play out publicly.”
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