In November 2013, Guangzhou Evergrande became the first Chinese football club to win the Asian Champions League. Right after popping the champagne, its players and the head coach – Marcello Lippi – were ushered to a press conference to launch Evergrande Spring, the property developer’s new bottled water business.
The timing made sense. Winning Asia’s equivalent to the UEFA Champions League turned the developer into a household name. The country’s consumption of bottled water was also on the rise. “Evergrande Spring will be the only bottled water I will buy in the future,” one Guangzhou football fan told the Global Times at the time.
But last week, Evergrande announced that it is pulling the plug on its diversification strategy. The parent company of the football club has sold three of its non-core units, which include dairy, grain, oil and the water business, to three separate bidders for a total of Rmb2.7 billion ($400 million). The developer says it is divesting the subsidiaries “for strategic considerations” so it can focus on its property development and real estate-related operations.
The for-sale businesses have been bleeding cash. Together they reported a net loss of Rmb4.5 billion ($674 million) in 2015. Take Evergrande Spring. Between 2013 and May 2015, the unit generated Rmb1.3 billion in revenues and reported a loss of Rmb4 billion. To jumpstart sales the company had lowered the price of the bottled water twice since September last year.
Meanwhile, China’s housing market is, arguably, hotter than ever (see last week’s Talking Point). In the first eight months of this year, sales at the developer’s core property business jumped 98% year-on-year to Rmb233 billion.
Nonetheless, Evergrande, already the most highly leveraged listed property firm in the country, needs to rethink how and where it invest its resources.
That said, most industry observers concur that the problem faced by Evergrande’s diversification in recent years has been the competitive environment. “The reason Evergrande’s fast-moving consumer goods business has failed to take off is because operationally, it lacked the expertise and experience to run businesses in such a big market,” says Nanfang Daily. “And besides, competition in the water, oil and grain industry is already fierce. It is just not ideal for a new company to enter those businesses.”
Now the good news: even though the three subsidiaries are not profitable, Evergrande has fetched a surprisingly good price for them. The sale will also allow Evergrande to get rid of the units’ Rmb3.3 billion debts. As a result, the company announced it is able to recognise a Rmb5.7 billion pre-tax and one-off gain from the disposals.
But why would the buyers (one of the counterparties is a Shenzhen-based car dealer for BYD, paying Rmb1.8 billion for Evergrande Spring) be interested in the lossmaking businesses?
Some analysts reckon that there is more to the transactions than meets the eye. “Spending so much money to acquire Evergrande’s money-losing businesses doesn’t make any sense,” Hong Kong’s Ming Pao Daily muses. “We believe that the deals weren’t valued based on fundamentals. What the acquirers want is the opportunity to partner with Xu Jiayin [Evergrande’s chairman] in future real estate projects.”
After shedding its non-core businesses, Evergrande’s restructuring is not quite finished. This week, the developer announced that it has agreed to a backdoor listing deal in which it may inject most of its property assets into a Shenzhen-listed real estate firm in return for cash and stock. .
“The proposed reorganisation to backdoor list Evergrande’s businesses in A-shares is overall positive if it goes through,” one analyst told the China Daily. “Mainland investors may price Evergrande’s assets at a higher valuation and the deal would provide a new onshore platform for financing.”
© ChinTell Ltd. All rights reserved.
Sponsored by HSBC.
The Week in China website and the weekly magazine publications are owned and maintained by ChinTell Limited, Hong Kong. Neither HSBC nor any member of the HSBC group of companies ("HSBC") endorses the contents and/or is involved in selecting, creating or editing the contents of the Week in China website or the Week in China magazine. The views expressed in these publications are solely the views of ChinTell Limited and do not necessarily reflect the views or investment ideas of HSBC. No responsibility will therefore be assumed by HSBC for the contents of these publications or for the errors or omissions therein.