In Part 1 of our Hengda Group series, we provided an overview of the Evergrande conglomerate. In this second instalment of the series, we examine Evergrande Property Services (Chinese: 恒大物业) (HKEX: 6666), Hengda's property management arm that is also one of the conglomerate's three publicly listed supplementary business units. Evergrande Property Services is the only supplementary business unit that is in and of itself an operating segment for financial reporting purposes on Hengda's annual reports (see Part 5). It is also one of Hengda's more successful supplementary businesses, although Evergrande Property Services does face significant concentration risk due to its large exposure to and financial reliance on Hengda.
Hengda (Evergrande) Conglomerate Series
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Overview
What is Evergrande Property Services?
Evergrande Property Services is Hengda's property management arm that has been contracted to provide property management and related services to 2,443 projects in 317 cities across 31 out of China's 34 provincial-level administrative regions as of Q2 2021. In February 2021, the business unit had a total contracted area of 810 million square metres, including 450 million square metres of area under management. Of the 450 million square metres under management, 138 million are developed by third-party (i.e. non-Hengda) developers.
What Types of Properties Does Evergrande Property Services Manage?
The majority of properties contracted to Evergrande Property Services are residential in nature, although the business unit also manages a diverse range of commercial properties such as office buildings, theme parks, industrial parks, healthcare complexes, and schools. Residential properties constituted close to 99% of all properties under management by gross floor area (GFA) up until 1H2021, during which the proportion decreased to 80% as the company was able to diversify its portfolio through contracting a wide range of non-residential projects.
Based on June 2021 data, 34.9% of contracted GFA and 41.7% of GFA under management are located in the more economically prosperous region of eastern China (i.e. Shanghai and surrounding provinces), while projects in south, southwest, and central china each consist around 13% of contracted GFA and GFA under management. In contrast, the poorer regions of north, northwest, and northeast China constitute smaller shares of GFA.
Funding and Going Public
Evergrande Property Services received funding from high profile investors including Sequoia Capital China, CITIC Group, Yunfeng Capital (a private equity firm co-founded by Alibaba's founder Jack Ma), and Tencent, before being spun off and going public on the Hong Kong Stock Exchange in December 2020 (HKEX: 6666).
Failed Acquisition by Hopson Development Holdings
As mentioned in Part 1, Evergrande Property Services and Hopson Development Holdings (HKEX: 0754), a Guangdong-based real estate developer, both requested a trading halt of their shares in early October, citing a potential acquisition. However, on October 20th, the two companies subsequently announced that the deal did not go through, with inside rumours surfacing that Hopson Development Holdings and Hengda founder Hui Ka Yan could not reach an agreement as to where and how the acquisition money should be allocated.
Business Model
Evergrande Property Services generates revenue from three business lines:
#1: Property Management Services
Evergrande Property Services provides a wide range of property management services to property owners, residents, property developers, as well as tenants in non-residential properties under the company's management. These services include butler services, security services, cleaning services, repair and maintenance services, and greening services.
Properties developed by Hengda Group constituted nearly 100% of Evergrande Property Services's properties under management by total GFA until 1H2021, during which this number dropped to 69.3% as part of the company's diversification efforts to garner more contracts with third-party developers.
Property management services have the lowest profit margin out of Evergrande Property Services's three lines of business, but contribute to over half of the company's total revenues.
#2: Value-Added Services to Non-Property Owners
Evergrande Property Services offers property developers value-added services that cover various stages of the property development and delivery cycle, including preliminary property management services in the process of construction (e.g. construction site management and security patrol) and pre-sale process (e.g. sales office management, property tour arrangements, consulting services), pre-delivery services (e.g. cleaning and inspection of properties to be delivered), post-delivery repair and maintenance services, and property transaction services (e.g. selling parking spaces and leasing retail spaces).
Value-added services to non-property owners have relatively moderate margins and contribute between a quarter to a third of Evergrande Property Services's total revenues.
#3: Community Value-Added Services
Evergrande Property Services offers community value-added services primarily to property owners and residents. These services include community operations services (e.g. leasing out the common area in residential buildings to third-party vendors, and other services such as electric vehicle charging stations and drinking water stations), community asset management services (e.g. parking space rental services, recreation centre operations, and second-hand property transaction assistance services to help property owners sell or rent out their properties), and community living services (e.g. housekeeping, home furnishing, and repair and maintenance).
The community value-added services segment has the highest profit margin out of Evergrande Property Services's three business lines, although the segment constitutes the smallest proportion of total revenue.
Financial Snapshot
We next present and summarise the company's key financial highlights.
Total Revenue, Gross Profit, and Operating Income
In the first half of 2021, Evergrande Property Services recorded total revenues of RMB4.76 billion and operating income of RMB2.58 billion. The company's total revenue, gross profit, and operating income have been increasing year on year.
Revenue Breakdown by Business Line
The graphs below break down the company's total revenue by business line, in both raw monetary terms and percentage terms.
As mentioned above, property management services constitute approximately 60% of Evergrande Property Services's total revenues, value-added services to non-property owners account for between a quarter to a third of total revenue, while community value- added services contribute to only about 10% of total revenue.
Evergrande Property Services provides a more thorough revenue breakdown for the value-added services to non-property owners and community value-added services segments.
Value-Added Services to Non-Property Owners - Segment Revenue Breakdown
Within the value-added services to non-property owners segment, preliminary property management services contributed to 54.5% of total segment revenue, pre-delivery services contributed to 28.7% of total segment revenue, post-delivery repair and maintenance services contributed to 12.5% of total segment revenue, and property transaction assistance services contributed to 4.3% of total segment revenue in fiscal 2020. The company does not provide a breakdown for 1H2021.
*percentage of segment revenue denoted in parentheses
How Much of Evergrande Property Services' Revenues Come From Unfinished Projects?
We note that preliminary property management services and pre-delivery services take place before a real estate project is considered to be fully completed. Given that these two services combined constituted 83.2% of segment revenue from Value-Added Services to Non-Property Owners, and that the Value-Added Services to Non-Property Owners segment constituted 27.8% of Evergrande Property Services' total revenues in 2020, it can be deduced that approximately 23% of Evergrande Property Services' revenues depend on projects that are not yet fully completed.
The question is, then, how many of these uncompleted properties are developed by Hengda? According to Chinese law, ownership of a property is officially transferred from the developer to the buyer upon full completion of the property, so the developer would be responsible for paying any property services fees prior to completion. Given Hengda's financial difficulties and its role as Evergrande Property Services' main contractor, we think the latter's future revenue stream could be at risk if Hengda's financial standing continues to worsen. Moreover, even if Hengda's uncompleted properties are transferred to other property developers as part of a resolution scheme, the new development companies may not choose to contract with Evergrande Property Services in the future.
Community Value-Added Services - Segment Revenue Breakdown
Within the community value-added services segment, community operations services contributed to almost half of total segment revenues, community asset management services contributed to approximately 40% of total segment revenues, while community living services contributed to just over 10% of total segment revenues.
*percentage of segment revenue denoted in parentheses
Gross Profit Margin by Business Line
The average gross profit margin across all business segments was 37.3% in 1H2021 and 38.1% in 2020.
In the graph below, we look at the individual gross profit margin for each business segment.
Community value-added services... have substantially higher gross margins (about 60%) than the other two business segments since the relevant services provided are significantly less labour-intensive. The company explains that the growth in profit margin over time is due to the expansion in coverage of businesses and launch in new services to better meet consumer needs.
Value-added services to non-property owners... have moderate margins in the 30% range. Evergrande Property Services claims that the segment's profit margin increased by 8.7% from 2019 to 2020 primarily due to economies of scale, including an expansion in scale of repair and maintenance services, as well as growth in services with higher margins, including pre-delivery services and property transaction assistance services.
Property management services... have the smallest margins as this line of business is the most labour-intensive. According to the company's financial reports, the segment's profit margin increased significantly from 2019 to 2020 due to a combination of factors, including an increase in proportion of newly delivered property management projects with higher property management fees, the charging of property management fees for parking spaces that were not charged such fees in the past, an increase in technological integration and reduction in labour reliance, as well as additional cost control measures.
How is Evergrande Property Services Connected to Hengda Group?
To develop a better idea of how Evergrande Property Services and the Hengda mother company and remainder of the Evergrande conglomerate are financially related, we examine and summarize the Continuing Connected Transactions section of Evergrande Property Services' annual report. For the purposes of this section, "Hengda" refers to Hengda Group, including all subsidiaries, joint ventures, and associates of the Group.
It is noted that for each continuing connected transaction, Evergrande Property Services includes both an annual total transaction amount as well as a cap of payable/receivable service fees. The company does not provide any accompanying explanation as to how the two numbers are related or can be reconciled.
What Does Evergrande Property Services Owe Hengda?
#1: Car Park Leasing Space Fees
Evergrande Property Services leases certain car parking spaces from Hengda, with a total transaction amount of RMB90.1 million during 2020 and a total lease fee payable of no more than RMB121.8 million for the year.
#2: Fees for the Procurement of Goods and Services
Evergrande Property Services procures certain goods and services from Hengda, such as maintenance materials, staff uniforms, and office and communication equipment. The total transaction amount was RMB122.1 million in 2020 with maximum fees payable of no more than RMB146.1 million for the year.
In total, Evergrande Property Services owed Hengda Group RMB212.2 million in 2020 based on the total transaction amount.
What Does Hengda Owe Evergrande Property Services?
#1: Recreation Centre Operational Management Services Fees
Evergrande Property Services provides operational management services for recreation centres in properties developed and owned by Hengda. The total transaction amount in 2020 was RMB4 million with total service fees payable by Hengda of no more than RMB4.2 million for the year.
#2: Property Transaction Assistance Services Fees
Evergrande Property Services provides transaction assistance services with respect to the leasing to third parties of properties (excluding car parking spaces) owned by Hengda, as well as the sales to third parties of the car parking spaces in properties developed by Hengda. The total transaction amount for the year was RMB118.5 million with a maximum service fee payable by Hengda of RMB121.7 million for the year.
#3: Property Management and Related Services Fees
Evergrande Property Services provides Hengda with (i) property management services for Hengda's unsold properties and other properties owned by Hengda, (ii) pre-delivery services such as construction site management, property sales and consultancy services, and pre-delivery cleaning and inspection services, and (iii) repair and maintenance services during the warranty period for properties developed by Hengda. The total transaction amount during 2020 was RMB3.90 billion (approximately 37% of Evergrande Property Services' total revenue for the year), with a maximum service fee payable by Hengda of no more than RMB3.95 billion for the year.
In total, Hengda Group owed Evergrande Property Services RMB4.02 billion based on the total transaction amount.
Quantifying Evergrande Property Services' Significant Concentration Risk
The amounts payable by Evergrande Property Services to Hengda represent a small proportion of Evergrande Property Services' expenses and constitute a very negligible proportion of Hengda's total revenues. In contrast, the amounts payable by Hengda to Evergrande Property Services is only a very small proportion of Hengda's total expenses, but constitute almost 40% of Evergrande Property Services' total revenue. Specifically, 37%, 38%, and 31.5% of Evergrande Property Services' total revenue are generated from transactions with Hengda in 2019, 2020, and 1H2021 respectively.
Unsurprisingly, in its mid-year 2021 report, Evergrande Property Services emphasizes that if Hengda's financial situation doesn't improve or deteriorates even further, there could be an impact on the company's operations. Although Evergrande Property Services has been diversifying its revenue source to include more contracts from third-party companies, we believe that very significant concentration risk still remains. As of 1H2021, Evergrande Property Services has accounts receivable of RMB2,415.2 million (approximately 23% of 2020 total revenue) and notes receivable of RMB19.1 million due from Hengda.
The Future of Evergrande Property Services
We now turn to the future of Evergrande Property Services, including the business strategies that management has in mind and crucial factors that can shape the future trajectory of the company.
Management's Key Business Strategies
Management mentions three key strategies going forward for the company:
#1: Commercial and Geographical Diversification
From a broad perspective, Evergrande Property Services plans to continue pursuing multi-disciplinary development, including commercial properties such as office buildings, industrial parks, and public services projects, rather than focusing so heavily on residential properties. Geographically, the company also wants to attain a more balanced regional layout across China.
#2: Growing Community Value-Added Services
At the individual business segment level, management states that they are focused on expanding community value-added services, which have the highest profit margins out of Evergrande Property Services' three main business segments. A notable element of the company's business segment expansion is its acquisition of Evergrande Insurance Agency (Chinese: 恒大保险经纪有限公司), an insurance brokerage firm not to be confused with Hengda associate and insurance company Evergrande Life Insurance (Chinese: 恒大人寿保险) mentioned in Part 1. Management claims that Evergrande Property Services acquired Evergrande Insurance Agency in April 2021 to enrich the comprehensiveness of services provided in the neighbourhoods managed by the company.
We think Evergrande Property Services acquired Evergrande Insurance Agency as the latter has the required license to sell insurance products, which will allow Evergrande Property Services to sell such products to residents who live in neighbourhoods managed by the company. Indeed, management mentions in their 2021 interim report that Evergrande Property Services will start providing insurance brokerage services.
#3: Greater Intergration with the Evergrande Conglomerate
Management plans to further integrate Evergrande Property Services with the remaining Hengda conglomerate such as by providing services to community healthcare facilities developed by Evergrande Health Industry Group (now known as Evergrande Auto) (see Part 3) and by cooperating with Hengda's property transaction platform Fangchebao Group (see Part 1) to provide real estate broker assistance services (for example, letting Evergrande Property Services employees conduct property viewings in place of third-party real estate agents). However, for reasons that will become evident as the Hengda series progresses, we think that the discussion of these integration plans is rather superfluous and will have very little economic impact on the company's future or business model.
Key Questions That Determine The Company's Future
We consider two crucial questions surrounding the key factors that determine the future success of the company: effective revenue diversification and organic growth in third-party contracts.
The Question of Effective Contract and Revenue Diversification
The key question at hand is, will Evergrande Property Services be able to sufficiently diversify its customer and revenue source so as to minimize any potential negative impacts from a worsening in Hengda's financial position? While less heavily emphasized in the company's reports, we think management is undoubtedly trying to diversify its contract base in order to reduce exposure to Hengda, especially given the latter's precarious financial position. At the end of 2020, 99.7% of the property management services segment revenue were generated from properties developed by Hengda Group. This number dropped to 80.3% in 1H2021, although we feel that very significant concentration risk still remains, especially considering that transactions with Hengda still account for over 30% of Evergrande Property Services' total revenues.
The Question of Sustainable Third-Party Organic Growth
From 2020 to the first half of 2021, Evergrande Property Services acquired 12 property management companies, including five companies with property management contracts and customer relationships worth RMB61.8 million in 2020 and seven companies with property management contracts and customer relationships worth RMB1.05 billion during 1H 2021. The question that crosses our mind is, how many of Evergrande Property Services' contracts with external developers (including local governments) are obtained via acquisitions of other property management companies as opposed to organic growth? In light of Hengda's financial difficulties, we think the question of sustainable organic growth is a very important one, as it is unlikely that Evergrande Property Services will be able to continue growing at the same rate as before by relying on completed and uncompleted Hengda properties.
Concluding Evergrande Property Services
Evergrande Property Services is one of Hengda's relatively successful supplementary businesses. However, the company's success has largely derived from fulfilling property management services for properties developed by Hengda Group during the real estate giant's rapid growth phase. While the property management services business model is not unpromising, we are concerned by the company's significant concentration risk and whether or not Evergrande Property Services will be able to diversify its contract base organically. Moreover, given the status quo, we feel that third-party developers may be hesitant to contract with Evergrande Property Services due to the potential financial difficulties the company may face if Hengda's liquidity troubles intensify.
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Hengda (Evergrande) Conglomerate Series
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