Vanke Faces Selling Pressure from Private Equity: What's the Next Move?
Background:
This financial report is a news article written by me and published on a Chinese financial news platform, Daily Business Report, during my part-time engagement with the company in November 2021. Vanke is one of the largest real estate companies in China, ranking 178th in the 2021 Fortune Global 500. The company achieved operating revenue of CNY 503.84 billion ($78.52 billion) and a net profit attributable to shareholders of CNY 226.2 billion ($35.29 billion) in 2022.
Note: Currency unit in parentheses is USD.
Category: Financial News
Keywords: Vanke; Real Estate Company; Chinese Economy
In recent times, many insurance funds have been frequently selling off their equity stakes in real estate companies. Over the past two months, China Pacific Insurance has reduced its holdings in Country Garden Group by 5%, while Poly Developments and Sunshine City have also faced divestment by Taikang Life Insurance. Among them, the most notable case is China Life Insurance's continuous reduction of its holdings in Vanke A shares over five consecutive quarters, with its stake dropping from 2.16% to 0.73%.
In fact, Vanke's stock price has experienced significant volatility and decline since March. It reached a peak of CNY 32.25 ($5.03) on March 3, but as of November 19, the closing price stood at CNY 19.90 ($3.11). This represents a decrease of over one-third and a decline of 38.29%.
On November 16, Vanke headquarters issued a document titled "Initiative on Cost Reduction and Creating a 'War-Time Atmosphere' at Vanke Group Headquarters," which emphasized that "all employees should adhere to the business philosophy, clearly define the goals to be achieved, formulate action plans, and resolutely execute them, subtracting actions and expenses that do not generate value, and achieving great results with minimal expenditure."
This initiative quickly stirred up a buzz. Discussions in Vanke's online investor forum became unusually active, with some expressing full confidence and increasing their holdings in Vanke, while others described it as a "sunset industry" and even called for the removal of Vanke's top management.
Is Vanke prepared for the industry's winter? As a company known for its solid and healthy financials, how will Vanke adapt to the new survival strategies in the real estate sector? Could this be a sneak preview of the industry's future?
Cost-
saving
The initiative states that in order to reduce unnecessary expenses, Vanke has called on its management team to lead by example and practice thriftiness and cost-saving measures, such as optimizing travel arrangements based on cost efficiency and turning off lights when not in use. Additionally, it aims to avoid excessive internal interactions, refuse unnecessary transportation, banquets, or gifts, and discourage regional units from presenting gifts or local specialties to the headquarters during festive occasions.
Everything boils down to one word: cost-saving. Vanke seems to imply that if the company's financial turnover is not carefully managed, it could face problems.
Clues can be gleaned from its financial reports. On the revenue front, the company has maintained strong sales data. According to the Q3 report, Vanke's sales expenses reached an impressive CNY 72.83 billion ($11.37 billion), marking a substantial year-on-year increase of 25.48%. This figure nearly matches the total sales for the entire year of 2018. As of the end of September this year, Vanke has achieved operating revenue of CNY 1,043.7 billion ($162.72 billion), demonstrating a consistent year-on-year growth of 9.7%.
However, the profits are not as impressive. In the first three quarters of this year, the net profit attributable to shareholders of the listed company amounted to CNY 166.9 billion ($26.02 billion), a decrease of 16% compared to the same period last year. In particular, the net profit attributable to shareholders in the third quarter was only CNY 56.4 billion ($8.81 billion), a significant decline of 23.3%. The gross profit margin for Vanke's real estate development and related asset operation business in the first nine months of this year was 17.5% (tax and surcharges deducted), a decrease of 5.4 percentage points compared to the same period in 2020. The weighted average return on equity was 7.31%, a decrease of 2.82 percentage points from the same period last year.
Key indicators such as net profit and gross profit margin are worse than the same period last year, and the dilemma of increasing revenue without increasing profitability continues—the decline in business performance directly impacts Vanke's financial situation.
In the third quarter of this year, Vanke generated a net cash flow from operating activities of -CNY 55.61 billion (-$8.68 billion). As of the end of September this year, Vanke's cash and cash equivalents amounted to CNY 1,471.1 billion ($229.78 billion). While this figure is higher than the sum of short-term borrowings and interest-bearing liabilities due within one year, which amounts to CNY 782.9 billion ($122.27 billion), it has decreased by CNY 481.1 billion ($75.15 billion) since mid-year and nearly CNY 500 billion ($78.11 billion) since the end of 2020.
Undoubtedly, this has triggered Vanke's alertness and sense of crisis. Daily Business Report noticed that during Vanke's "2021 Business Communication Meeting" held in October this year, President Yu Liang repeatedly emphasized the need to "cherish money" and "earn small profits" to weather the industry's painful period.
Extended Reading:
Measures
Boldly advocating for "belt-tightening" and a "wartime atmosphere" is not only a measure made by Vanke but other stakeholders are also making practical decisions as they face the crisis, followed by Evergrande's crisis starting from this September.
Right issue is one option. On the morning of November 18th, Country Garden Services announced a temporary trading halt of its shares on the Hong Kong Stock Exchange. Subsequently, insiders revealed that Country Garden Services plans to issue 150 million shares at a price of HKD 53.35 ($6.84) per share, aiming to raise $1.03 billion. Similarly, on the evening of November 14th, Sunac China Holdings released an announcement stating that the company plans to issue 335 million shares at a price of HKD 15.18 ($1.95) per share.
Generally, right issues do not disrupt the balance between existing and new shareholders, making it a favored method for companies with funding needs. Analysts believe that Country Garden Services' move is fundamentally aimed at obtaining financing and indirectly indicates the company's significant funding requirements.
Asset divestment is another approach. On the evening of November 16th, China Jinmao Holdings announced that its subsidiary sold 90% of the equity of its project company, Qingdao Fangjia Real Estate Co., to Qingdao Qingyuehui for CNY 2.43 billion ($384.6 million). According to reports from Interface News, apart from introducing partners to reduce risk exposure by reducing the shareholding percentage in the project, Jinmao's introduction of Qingyuehui is also intended to attract capital.
As reported by Feng Financial News, prominent players in the real estate industry such as China Communications Construction Real Estate, China Resources Land, Shanghai Urban Development Group, Shanghai Real Estate Group, and China Merchants Shekou have undertaken the transfer of equity in their subsidiary companies. Notably, these companies, including Jinmao, hold significant influence within the real estate sector.
According to industry experts, real estate companies frequently selling assets may be driven by their objective to optimize cash flow. The rationale behind this strategy lies in the timely divestment of projects with long durations, low gross margins, and unfavorable locations, which also require substantial funding. Such a move can effectively bolster cash flow and is considered a prudent decision in the current market climate. Moreover, these companies face the imperative of deleveraging due to their previous phase of excessive expansion, which further underscores the need for strategic consolidation.
Extended Reading:
Excellent
Student
Vanke has not reached the point of selling assets to survive. In this way, Vanke remains relatively stable.
Vanke has been actively responding to industry dynamics with a series of strategic moves since the start of this year. The company has prioritized its transformation initiatives, with its non-real estate business steadily progressing. While the proportion of each business segment has remained relatively stable, the growth rate of transformation projects has been noteworthy. In response to investor inquiries on November 3rd, Vanke attributed the substantial increase in accounts receivable in the third quarter to the rise in receivables from non-real estate operations. This suggests that Vanke has likely achieved sales growth in these related business areas.
Also, Vanke has actively engaged with financially distressed small and medium-sized real estate companies since May, aiming to capitalize on the industry downturn and maximize profits. During the period from May to July, Vanke strategically acquired equity in various companies under the CIFI Group, integrating their projects into its portfolio. According to an insider at Vanke, the M&A team has been extremely busy this year, frequently traveling and diligently assessing a constant flow of project materials on their computers.
In terms of prices, it can indeed be considered as "bargain hunting".
Displaying cautious operations that have always been associated with Vanke, in September 2018, when the real estate market was thriving, Vanke's Chairman, Yu Liang, unexpectedly stated, "The first thing Vanke needs to do is conduct a strategic review with 'survival' as the ultimate goal."
At that time, these three words seemed incomprehensible, but in the current sluggish environment, they are particularly relevant. Vanke has been implementing its strategy of "survival," which is most evident in its financial and fund management.
According to reports from Lishi Business Review, Vanke has maintained restraint in capitalizing interest expenses. The interest capitalization rate for the first half of 2021 was 39.88%, further decreasing from the full-year rate of 50.88% in 2020. Additionally, Vanke applies cost-based calculations for its self-owned properties and does not include fair value changes in its profit statement. This means that Vanke's financial reporting is relatively authentic and allows for more reserved profit allocations in the future.
Simultaneously, Vanke Group's Hong Kong-listed company, Vanke Enterprises (02202.HK), has announced plans to spin off its property management subsidiary, Vanke Property Cloud, for a separate listing. Public information shows that for newly listed companies, the primary benefit of accessing the capital market through an IPO is the opportunity to raise substantial funds, which are often used to improve financial structures or expand operations. Prior to the decision to spin off and list, Vanke Property Cloud's registered capital has increased to CNY 1.05042 billion ($16.333 million). According to analysis by the Jiayuan Home Property Service Research Institute, Vanke Property Cloud is expected to surpass the financing scale of Sunac Services in 2020, setting a new record for property-related IPO financing. This will greatly aid Vanke in improving its cash flow and reducing its debt burden.
Through these efforts, Vanke has consistently excelled in meeting the "three red lines" requirements. As of the end of June 2021, Vanke held CNY 195.22 billion ($30.429 billion) in cash and cash equivalents, far exceeding the total of interest-bearing liabilities due within one year at CNY 84.30 billion ($13.146 billion). After deducting regulatory funds from presales and restricted funds, the cash-to-short-term debt ratio stood at 1.67 times. The net debt ratio was 20.2%, and the asset-liability ratio, excluding advances from customers, was 69.7%, classified as a green line.
Lastly, looking at stock performance, despite the existence of insurance companies' sell-offs, brokerage firms' evaluations of Vanke remain higher than other companies. On November 17th, China International Capital Corporation (CICC) released a research report, maintaining an outperform rating for Vanke A shares with a target price of CNY 23.6 ($3.673), representing an upward potential of 21.27% compared to the closing price on that day. On November 9th, Orient Securities issued a research report, maintaining a "buy" rating for Vanke A shares with a target price of CNY 25.88 ($4.028).
In the Hong Kong market, on November 8th, UBS and Credit Suisse respectively gave buy and hold ratings to Vanke Enterprises.
Some media outlets have summarized Vanke's approach as "preferring to endure hardships for future gains." Perhaps it is this cautious attitude that has prevented Vanke from losing control today. This approach may also offer lessons and reflections for other real estate companies: whether the prudent and austere "Vanke model" will be the future for the real estate industry after deleveraging and reducing debt.
Extended Reading:
