How The Global Bubble Spread: 50% Of Remy Cointreau Profits Came From China--Before The Comrades Cracked-Down On Corruption & Extravagance

HONG KONG (MarketWatch) — When President Xi Jinping launched his new administration with an anti-graft campaign against government extravagance, a common reaction was “Here we go again.” In China’s recent past, a succession of clampdowns on decadent nightclubs or upscale karaoke establishments have been short-lived.

So reports that government officials must swap banquets and bottles of Maotai liquor for canteens and water were taken with a large pinch of salt. But not any more — 18 months on, and various high-end drinks and luxury-goods companies are finding their China business may never be the same again.

It was always difficult to predict the impact of these curbs on extravagance, given the extensive reach of the state across industry and the fact that so much official entertainment goes on in restaurants’ VIP rooms or behind closed doors....

Investors are now coming to terms with the reality that government money — which kept large chunks of China’s luxury sector on a super-charged growth path — is gone forever.

Société Générale says in a new report on China’s high-end spirits sector that government money will never come back. The policy changes are structural not cyclical, which means liquor brands will need to start targeting the “normal” market — one where people spend their own money.

They trace a systematic escalation of measures targeting government-related indulgence, from gift-giving to entertainment. After banning serving alcohol at military events, the next move was to forbid the use of public money to be spent on luxurious entertainment celebrating the Mid-Autumn Festival.

In December last year, comprehensive guidelines were issued restricting the use of government funds for gifts and banquets involving officials. There have been other measures too, such as an edict banning the military from buying any foreign-made vehicles. In recent months, there have also been widening crackdowns on prostitution and other adult-entertainment venues, particularly in Guangzhou province’s Dongguan.

The sector that has been hardest hit is luxury goods, such as fashion accessories, ultra-high-end spirits, restaurants and hotels. Last year, 2,168 restaurants closed in Beijing, while the occupancy rates at local high-end hotels have plummeted.

In the spirits business, those most exposed to the removal of government expense accounts are in the ultra-prestige segment, says SocGen. Here, Remy Cointreau earned over 50% of profits and 30% of sales from China in 2012, while Moet Hennessy earned just under 30% of profit from Chinese operations.

Latest figures from the Scottish Whisky Association also point to a hard landing: There was a drop of 27% in the volume of whisky sold in China last year, along with a 41% drop in sales.

The fiscal reality behind this anti-graft campaign also suggests it will not be easily rolled back. China’s credit bubble has reached its moment of reckoning, with bad debts now becoming a problem. Lavish entertainment is not just bad politics, but also financially unsustainable.

China’s new belt-tightening has some parallels with Japan in the aftermath of its 1990 crash in stocks, and later property. Back then, lavish entertainment was the norm, and after the bubble popped so did the entertainment party. Regulations were subsequently introduced to tighten up expenses. Three decades later, you still find older Japanese brokers reminiscing about the good old bubble days.

Chinese officials could also be left to reminisce about the good old days of grand banquets....

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