The mania in China's property market has implications far beyond its borders. The prolonged boom, and the glut of demand it generates, has been crucial in supporting commodity exporting economies, such as Brazil and Australia, in the post financial crisis era.
In 2016, according to the FT, property investment accounted for 10 per cent of the red state's GDP. When steel, cement, glass, furniture and other property-related sectors are included, this number is closer to a whopping 20 per cent.
By comparison, in the UK this figure is almost 1 per cent of GDP, excluding related sectors.
To give a sense of scale, in 2016 China accounted for two-thirds of all skyscrapers built worldwide, according to the Council on Tall Buildings and Urban Habitat.
So this morning, expectations were high when Hong Kong listed Sunac Holdings, a property developer in mainland China, reported their financial results for 2017. Particularly given the recent sixfold increase in their share price:
Results, on the surface, indicated a blowout.
Revenue was up 86 per cent year-on-year, gross profit rose 181 per cent -- due to a 7-per-cent rise in margins -- and net profits grew a staggering 344 per cent. To top it off, Sunac reported a healthy cash balance of 97bn RMB, up 39 per cent from the year before.
On closer inspection, however, things are not quite what they seem. Here is the full profit and loss statement (click to make bigly):
You may notice that the 86-per-cent rise in revenues coincided with a 385-per-cent rise in operating expenses, and that the 'other expenses' line managed to grow 47,000 per cent.
Sunac also found 27bn RMB revenue down the back of the sofa -- or a spare 17bn RMB when we take the net total of 'other income' and 'other expenses'.
Usually, these items are excluded from operating costs as they do not reflect the day-to-day economics of the business. Sunac are in the field of selling real-estate, not writing up investments.
So without the extra 17bn RMB, Sunac would have lost 6bn RMB over the year.
Here is how the pocketed change breaks down, from Item 11 of the report:
So 25bn RMB, or 93 per cent, came from 'business combinations', or acquisitions of new businesses. Sunac offers up further detail here:
Our eagle-eyed readers may spot one name of particular interest, Wanda.
Dalian Wanda is a sprawling Chinese conglomorate whose interests include America's AMC theatres, Legendary Entertainment and, up to recently, Athletico Madrid.
Last June, thanks to a crackdown on off-shore investments, foreign capital flows and over-leveraged holding companies by Chinese regulators, Wanda were forced to unwind some of their overseas deals. This graphic from an FT article last February gives the full picture of their M&A activity since 2012:
Sunac sensed a deal to be made from Wanda's troubles, purchasing a 91-per-cent equity stake of 13 cultural tourism projects last July for 44bn RMB.
It also acquired an 80-per-cent stake in Tianjin Xingyao, a property development business, for 10bn RMB in May. When we include 2bn RMB spent on a small real estate site, Sunac spent a reported 56bn RMB on acquisitions over the year.
It is possible the group made other major investments we have missed. But if you assume it “mainly includes income” from the purchase of “interests in certain Wanda cultural and tourism projects”, that implies the value of Sunac's acquisitions rose about 25bn RMB, or 45 per cent, within six months of the deal's closing.
From the cash flow statement, however, it is clear these gains were not in the form of cold, hard fiat:
So perhaps Sunac were picking up these distressed assets for pennies on the dollar?
Granted, Wanda were in a period of relative distress during their dealings with Sunac, but it is also true their problems largely derived from struggles funding their foreign investees, and not from financing local assets.
Sunac were hardly in a position of negotiating power either, as they initially planned to borrow half the debt to purchase the assets from Wanda, before being forced to reduce their offer due to financing concerns. It seems unlikely they would have got a bargain price under such circumstances.
The equity stake in Tianjin Xingyao, a who own sites like a semi-abandoned ghost suburb 130km from Beijing, does look like a good deal if these half-baked projects can be successfully revived. Whether such a revival can be achieved just seven months after its acquisition is another matter.
Sunac are not the first, or the most prominent, business to supplement their profits with gains on investment during difficult years.
However, if Sunac cannot make a profit during market euphoria, what does it say about their business model, or indeed, the true state of the Chinese construction business?
We have reached out to the company, and will update if and when we receive comment.
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