September 26th, 2015
by Elliott Morss, Morss Global Finance
As an investor in Xinyuan (NYSE:XIN), I have been following the company closely. So when the opportunity arose to meet with George Liu, Chief Financial Officer and May Shen, Investor Relations Director, I took it. The meeting was held at XIN's mid-town Manhattan office on September 15th. In what follows, I summarize XIN's 2nd quarter results and report on my interview.
2nd Quarter Results
We hear daily about economic problems in China - growth rates falling and stock markets crashing. Despite this, XIN's 2nd quarter was quite positive: Sales, income and property under development were all up in comparison to the second quarter of last year. And overall, it appears that XIN has done a pretty good job in holding the line on prices - up 14% from the 2nd quarter in 2014 and down 7% from the 1st quarter in 2015.
These results are a testament to the fact that XIN sells most of its properties to China's rapidly expanding middle class. And this huge group will want to upgrade their housing as their incomes grow. And keep in mind that while the Chinese GDP growth rate is down, it still exceeds 6%.
Interview with XIN Management
The following provides details on the interview. It was not recorded but I took notes and gave George and May the opportunity to correct factual errors. My questions/comments are identified by EM. George Liu's responses/comments are identified by GL.
EM: In 2014, XIN reported 180,094,704 diluted shares. This year, XIN reports only 147,238,151 shares. What is the reason for this reduction?
GL: It is mainly due to the company's repayment of TPG's convertible bond of $75.8 million, equivalent to 25,253,670 common shares had the conversion been made.
EM: Some Western observers allege that XIN does not care about its stockholders. Who are the largest stockholders in XIN?
GL: Yong Zhang, XIN's founder and chairman holds about 36 of the shares. TPG is the second largest with about 8% of the shares. Senior staff get stock options for exceptional performance. All will significantly benefit from a higher share price.
EM: Aside from being a large stockholder, does TPG have any remaining role in XIN?
GL: Yes. TPG has a seat on the Board of Directors. In addition, TPG has a vote on the important 4-person Investment Committee. When it comes to new investments, TPG tends to be conservative.
EM: The following table shows changes in revenues and expenses (mil.US$) between 2012 and 2014. The revenues are quite similar, but there are large increases in the costs of real estate sales, selling and distribution, and SG&A expenses. Why have these costs grown so much?
GL: XIN bought large amounts of land in both 2013 and 2014. The Company completed 4.2 million m2 GFA from 1997 to 2014. However, the Company's GFA under construction and GFA under planning totaled approx. 4.4 million m2 as of the end of 2014. In retrospect, one could argue we bought too much. All of these cost increments are the result of these purchases and development.
EM: As mentioned earlier, it appears that you have tried to keep from reducing your prices, even if that means carrying housing inventory for an extended period of time.
GL: This is a common strategy in the industry.
EM: Alternatively, you could adopt a strategy to reduce your leverage, either defined as your debt/equity ratio or your inventory to debt ratio. That could be done by showing more flexibility on prices so as to sell off more property to reduce your debt.
GL: Going forward, I think you will see more flexibility on our pricing. One of our top priorities is to reduce leverage. We are hoping that lower leverage will increase of our equity values.
EM: As you know, a number of your Western investors want you to buy back shares and/or increase dividends to increase share prices.
Consider first the share buy-back argument. The following table shows the impact on earnings per share of real estate investments at different rates of return against a buyback. It suggests that you would have to see a 20% return on a $100 million real estate investment to prefer it over a share buyback of the same amount.
GL: We will be doing some buying back. We plan to continue to repurchase from time to time.
EM: The dividend? You are only paying out 25% of income. Most of the real estate companies listed in Hong Kong pay out a larger share of income than XIN.
GL: Our plans are to keep the payment where it is. At $0.20 per ADS annually, it provides a good return.
EM: Investors noted your investment in Malaysia. Are you planning to expand your operations into other countries?
GL: We are not planning to launch new projects in other countries. Someone came to us unsolicited with the Malaysian idea. It is best to think of this as nothing more than an option to move forward. We are currently examining this opportunity but have not as yet decided to move forward.
The US is a special case and we are very pleased with our Brooklyn property. The US is special because it has become the leading recipient of Chinese real estate investment monies. We are hoping to use our Brooklyn success to attract other Chinese real estate monies for further investments in the US.
EM: Have you considered using Western finance for individual projects? I had some experience with them when working in Shanghai (1995 - 2005). We met with: West LB, Merrill Lynch, Lehman, Carlyle, CS First Boston, Goldman Sachs, Colony Capital, Morgan Stanley, JP Morgan, Fidelity Investments, GE Capital. They all had people travelling up and down the Asia-Pacific seacoast looking for real estate investments. They all operated in pretty much the same manner: they wanted to get their money out first but would leave a lot of profit on the table if the project sold out at reasonable prices.
GL: We are always looking for investment partners. And we are learning a lot from the meetings we are attending here in New York. There is one other point on debt that I want to mention. The central government has just launched a program that will allow companies to issue their own bonds. Our estimates suggest that switching our debt to our own bonds would reduce borrowing costs by almost 50%. Companies must get approval from the central government to issue their own bonds and we are actively working on this.
EM: As you are aware, XIN, as a Chinese company, has an image problem in the US. This is in large part the result of American ignorance over anything not American. The following comment to an article appearing on Seeking Alpha is typical:
"Interest is down because people stopped believing the reported numbers. This is a Chinese penny stock after all. Even if the reported numbers aren't inflated, the company is still misdirecting any potential upside into dilution and perks like the corporate jet. You make the mistake of thinking that a Chinese company will operate like a Western one and try to make you, the ordinary shareholder, good returns. Chinese companies have a long track record of totally ignoring their shareholders - they care about maximizing returns to themselves. That's why XIN is spending millions per year on the corporate jet rather than buying back your shares. Don't be frustrated, this is just how things go with US-listed Chinese companies."
EM: But there are more legitimate reasons to be concerned. I believe you are the third financial officer in as many years.
GL: I can see how the high turnover in my job would cause concern. I have only been at XIN for six months. But I can tell you, I really enjoy the job. And equally important, I enjoy the people I am working with. I can see me staying in my current position for many years.
EM: XIN's image problem also results from the resignation of two Western Board members in the last year. I am hoping you can find some respectable Westerners to take their places in the near future. I am sure it would help.
GL: We are working on it. But as you know, bringing someone into an already functioning organization has to be done with care. Did you know that several of our senior staff have a Western orientation? I got my MBA from Cornell and John Liang, the head of our New York office got his MBA from Wharton. In addition, the Chairman's son is currently an undergraduate at Columbia.
EM: The final image problem is the company plane. I know that the US and Chinese cultures are different and having a plane in China is a sign of success. But the rags to riches image that Americans like are the hard working company with no frills.
And then there are the costs. The 8-year lease required a $6.7 million deposit in 2012. And every year for the duration of the 8-year lease, XIN must pay $5.7 million. Also, there are the plane's operating costs - $752,000 in 2014. To keep this in perspective, XIN's annual dividend payments total about $15 million.
GL: The plane decision was made before my arrival. We probably cannot justify the plane as a cost-saving measure. However, charter companies write their agreements to make sure there are stiff penalties for breaking leases.
XIN put together an informative presentation for their New York trip that can be found here.
Reflections on the Interview
George addressed every question I put to him. George and May were eager to share and discuss the details of the XIN story with me. I take several important points away from the interview:
- George has been at XIN only since April. He said he was enjoying his work with the senior staff at XIN. Hopefully, he will be there a long time. His eagerness to engage with Westerners in press briefings and interviews is refreshing.
- He said one of XIN's main objectives was "deleveraging" via more sale price flexibility and some share buybacks.
- The dividend will stay where it is.
- George was very positive on the new China program that will allow companies to issue their own bonds. He sees this reducing XIN's borrowing costs by a significant amount.
- It is clear XIN is looking to find new financial partners. The presentations in New York introduced XIN to possible Western investors. In addition, XIN is hoping the success of their Brooklyn project will attract Chinese partners for further US investments.
- Real estate development is a risky business and mistakes will be made. But with XIN's focus on the growing middle class of China, it will be hard to get too far off track.