Talking Point

Urban legend

Legend Holdings sells property unit amid toppish market

Sun Hongbin

Prodigal son: for Sun Hongbin, Liu Chuanzhi has played a decisive role in his road to riches

Before becoming a real estate developer, Sunac China’s chairman Sun Hongbin began his career at Liu Chuanzhi’s computer firm Lenovo (then known as Legend). Sun joined in the same year as Yang Yuanqing, now chairman of Lenovo, but back then everyone was convinced that Sun, not Yang, would one day succeed Liu as boss. After a couple of years at the company Yang was still a salesman but Sun had already been promoted to the role of corporate development manager.

Taking the ambitious young man under his wing, Liu even got Sun to come to his office each day and tell him a story so he could help Sun lose his thick Shanxi accent.

But the story of the wunderkind took a sobering turn in 1990. Sun was convicted by a Beijing district court of embezzlement. Then 27, Sun was sentenced to five years in prison. He was granted early release in 1992.

After Sun emerged from prison, amazingly, the first thing he did was to ask Liu out for dinner to apologise. The two patched things up.

When asked about his time in prison, the engineer-turned-developer was reasonably zen about the experience: “I didn’t feel unhappy in prison,” he says. “It was just a lot of toil and drudgery, but it wasn’t enough to work you to death.”

(For the record: Sun maintained he was innocent and filed for an appeal. In 2003, a judicial review found him innocent of the charge and overturned the earlier verdict.)

Actions speak louder than words

It was Liu, in fact, who helped the ex-con to return to the business world. In 1994 he offered to lend Sun Rmb500,000 as seed money for his new start-up. With that cash, Sun entered the property industry, setting up his own firm called Shun Chi in Tianjin. But Sun leveraged up too quickly and Shun Chi was eventually sold to another developer.

Learning his lesson, in 2003, Sun founded Sunac and focused on high-end residential projects.

Last week, the former mentor and his protégé were in the news once again. Legend Holdings (the parent firm of Lenovo) announced that it had sold its entire property portfolio to Sunac for Rmb13.9 billion ($2.08 billion). The portfolio – largely of residential projects – spans 16 Chinese cities including Beijing, Tianjin, Chongqing, and Hangzhou, accounting for over 7.3 million square metres of land.

Hong Kong-listed Legend says that getting rid of this real estate portfolio will help it focus on its core businesses, which include sectors like “domestic and overseas financial services, healthcare services, agriculture and foods and innovative consumer services”.

The property arm has been earning less and less for its parent. Last year, the unit contributed Rmb500 million, or 10% to Legend’s net profit (versus Rmb1.3 billion in 2013).

Most analysts, however, view the deal as overwhelmingly favourable for Sunac.

For a start, most of the projects are located in second-tier cities where the developer already has a presence and high brand recognition. Secondly, some of the projects are already generating cashflow – with buyers prepared to pay deposits for the unfinished units, an indicator of their desirable locations.

Indeed, for some of the Chinese media this is no ordinary deal. Editorial narratives have been laced with a more emotional arc – linking the older and younger tycoon, and portraying their special bond.

“On one side of the negotiation table sits the protégé and his mentor on the other. The man sent him to prison, but also gave him a helping hand when he most needed it after he was released. Perhaps in the bottom of Liu’s heart, Sun was always the best successor for Legend. But no matter, today he has still handed over one of his sons [i.e. Legend’s property business] to him,” says Time Weekly.

Sina Finance goes as far as saying that Sun could be a dark horse candidate to take over Legend Holdings’ chairmanship from the 72 year-old Liu.

“Many developers want to buy Legend’s property unit but why has Liu preferred to deal with Sunac? Obviously Liu is preparing for the future of Legend [after his retirement],” it speculates.

Is Sunac doubling down on China’s housing market?

In addition to buying Legend’s property portfolio, Sunac continued its shopping spree last week with the announcement that it had spent another Rmb4 billion to buy a 17% stake in Jinke Property – making it the Shenzhen-listed firm’s second largest shareholder. Jinke owns the largest land bank in Chongqing (China’s most populous municipality, it is home to more than 30 million people and is one of the country’s fastest growing cities).

“We believe that this strategic investment is only the beginning. What is going to follow is the two developers will work together on the project level. This will accelerate Sunac’s expansion plan,” surmises the Economic Observer.

For Sun, now older and wiser, there are ambition to turn Sunac into a leading developer to compete with the likes of Vanke and China Evergrande. But this time he seems to be prepared to grow his market share using an M&A strategy.

Already, Sunac has raised its full-year sales goal from Rmb80 billion to Rmb110 billion, having surpassed a previous target in the first eight months of the year. “The recent acquisitions suggest that Sun wants to scale-up quickly,” an industry insider told the Economic Observer.

Still, there are reasons to be bullish.

Take Hangzhou. Just last week, a new project in the capital city of Zhejiang province attracted thousands of buyers, who lined up overnight to buy apartments. In August, average new home prices in the city reached Rmb181,000 per square metre, up 22% from a year earlier. More homes were sold in the first eight months of the year than in the entirety of 2015, according to E-House China R&D Institute.

The manic activity in Hangzhou is not an isolated case. Housing markets in other second-tier cities are reported to be hitting bubble-levels. In Nanjing, the cost of an average home is up 36% compared to 12 months ago, while in Xiamen home prices have soared an even greater 44% from a year ago.

Prices in some of the cities have gone up so fast that local authorities are now imposing tighter controls to weed out speculators. On Monday, Nanjing became the fourth second-tier city to impose new purchase restrictions. From now on, non-permanent residents will not be allowed to buy new or second-hand homes if they already have property in the city. On Tuesday, Hangzhou introduced a new rule that buyers at land auctions will have to pay up within a month, a move the Financial Times says is “aimed at reining in China’s infamous ‘land kings’ – developers prepared to pay above the market rate during price booms”.

But the bad news…

The problem, however, is that while sales of newly built homes continue to climb, land prices are soaring even faster. In August, Fujian-based developer Ronshine grabbed headlines for beating 17 bidders to win a plot of land in Shanghai’s Jingan district for Rmb11 billion. At an average cost of Rmb100,000 per square metre, it is the most expensive land ever sold in China.

Even Wang Jianlin, the chairman of Dalian Wanda and China’s biggest commercial landlord, has warned that the local property market is spiralling out of control. It’s the “biggest bubble in history,” he told CNNMoney in an interview this week.

The frothy housing market hasn’t translated to higher profits for the country’s developers. In the first half of the year, China’s developers reported an average profit margin of about 8.15%, compared with 10.1% in the same period last year when the real estate sector was struggling, according to China Real Estate Business.

“The housing market today is reminiscent of the bubble in 2009. But the difference, however, is that last time only selected cities saw ‘flour being more expensive than the bread’. But this time round, so many first- and second-tier cities share the same problem. No matter how much money the developer makes from a project, they give it all back in the next land auction,” comments 21CN Business Herald.

Analysts reckon consolidation is on the horizon. In addition to Sunac’s latest round of acquisitions, rival firm China Overseas Land also spent Rmb31 billion in April to acquire the residential property assets of state-owned conglomerate Citic Group.

Beijing’s big dilemma…

China’s central government doesn’t want a bubble but it certainly can’t afford a recession either. Keeping the property market in good shape is critical as the country grapples with a big slowdown in the domestic economy’s rate of growth. Why so? The housing market is a key driver of loan growth, commodities demand (think steel and cement) and employment.

To that end, Beijing has been flooding the economy with credit, with much of the lending going to the mortgage market (see WiC339). In fact, most of the new lending in August (which doubled from July) went to finance mortgages rather than corporate investments.

“We believe credit expansion is the fundamental driver for this latest property boom,” HSBC wrote in a research report earlier this month. “Although the central government recently raised the subject of curbing asset bubbles, land prices in top-tier cities have showed no sign of retreating. To us, it is clear that market participants believe Beijing will not burst the property bubble any time soon, which may lead to systemic risks.”

What type of risks?

In the last few years, WiC has covered (fairly extensively) the structural problems that have plagued the country’s property sector: while the housing market in top-tier Chinese cities has been more vibrant than ever, third- and fourth-tier cities are still struggling to digest huge stocks of unsold houses and apartments.

“Third- and fourth-tier cities are stuck: they have so much excess inventory, there is no end in sight,” says China Report. “According to sales data, first- and second-tier cities now have about 8.5 months of [unsold] housing supply (assuming no new projects hit the market), while lower tier cities are still holding over 15 months of supply. Some more extreme cases like Zhanjiang (Guangdong province), Yuncheng (Shanxi province), Jiangyin (part of the Jiangsu city of Wuxi) have an inventory that would take over 20 months to destock.”

If the current boom comes to a halt, developers will have trouble paying their debts. Take Sunac, for instance. The developer’s net gearing ratio as of the end of June – that is, before the deal with Legend, which will further exacerbate its debt load – was 85.1%, one of the highest among its listed peers.

Evergrande, another developer that is highly leveraged, reported a net debt ratio of 89.6% in the same time period. “Before digesting the projects that have lower margins from the last cycle, developers are now stepping into the next cycle, investing quite heavily in land acquisitions,” says Christopher Yip from Standard and Poor’s, adding that such “rapid land-banking” will hurt developers’ balance sheets.

But Sun remains unfazed. Just this week, the tycoon, who is already the majority shareholder of Sunac, spent $360 million to raise his stake by around 12 percentage points to 53.2%.

“Time hasn’t changed Sun’s gambling spirit,” says China Entrepreneur. Indeed, with market leader Vanke’s management distracted by a hostile takeover attempt, Sun is betting that his time has come. Upping his stake suggests that after the early adversity he experienced at Legend, he feels he got a good deal out of Liu – especially now that his real estate peers are finding prized land so costly to buy.


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