posted on 13 April 2016
by Elliott Morss, Morss Global Finance
I bought my first shares of Xinyuan Real Estate (NYSE:XIN) in early 2014. At the time, it looked like a very reasonably priced Chinese real estate company. I was impressed that it focused on the large and growing "secondary" cities of China. Many did not agree with my assessment. They were concerned that XIN was not legit, and its hiring and its rapid turnover in CFOs did not hurt. But now, Atbed, Fitch and others are coming to appreciate XIN. And despite its recent run-up, the ADS still pays a 4% dividend with a price/earnings ratio of less than 6.
On March 30, Xinyuan (XIN) submitted its annual report (SEC form 20-F) to the SEC. The report, running 173 pages with a 70-page annex, is far more detailed and extensive than its quarterly reports (SEC form 6-K). In what follows, some notable items in the report are discussed. Data in all tables came from XIN's 20-F for 2015.
XIN's Board has approved two open market share repurchases. On July 12, 2013, the Board approved a US$60 million share repurchase program running through July 2015. Effective December 28, 2015, the Board approved a new US$40 million share repurchase program through December 2017. The activity under these programs is provided in Table 1. Clearly, here was significantly more activity under these programs in 2014 than in 2015. As a point of reference, there were 142,802, 936 diluted shares outstanding at the end of 2015 or the equivalent of 71,401,468 ADSs.
Table 1. - Repurchase Program Activity
At end of 2015, XIN had 989 employees, up from 688 at the end of 2013. XIN reported that for the fiscal year ended December 31, 2015, the aggregate compensation to its executive officers (10), including amounts paid to persons who are no longer serving as executive officers was US$9.3 million. XIN also we made contributions of US$10.7 million to employee benefit plans in 2015.
Beyond direct compensation, XIN set aside 6,802,495 common shares for staff incentives. As of December 31, 2015, 6,592,390 options had been issued and outstanding under the 2007 plan. Adjustments have been made and XIN now reports 666,048 shares remained eligible for future grants under the plan. The options are exercisable mostly at $1.71 per share, or $3.42 per ADS. Table 2 lists the options granted under the 2007 plan. This certainly does create a real incentive for employees to get the price up!
Table 2. - Options Granted, 2007 Plan
In 2014, the Board agreed to another incentive device - the Restricted Stock Unit Plan (RSU). 10,000,000 additional shares were set aside for RSU.
In 2015, the Board authorized yet another plan - 20 million new shares authorized with options exercisable at $1.71 per share. At the end of 2015, XIN had 146,487,949 diluted shares outstanding. That means that together, these plans amount to about 25% of outstanding shares.
Overall Share Ownership
Table 3 provides data on XIN's largest shareholders. Together, XIN employees alone owned 43.5% of the shares. And the compensation plans discussed above provide an additional 4.5% of shares to XIN employees. I know very little about compensation norms, but it would appear the officers of XIN are treating themselves quite generously.
Table 3. - XIN - Largest Shareholders
Together, XIN officers and TPG own a bit over 50% of XIN shares.
Oosten - The Major US Project
As of December 31, 2015 the cumulative cost incurred on the project was US$215.5 million. The site was purchased in September 2012. Construction started in November 2013, and income from sale of units should be seen in 2016.
CFO Liu has made it clear XIN has no interest in increasing the dividend at this time. At 20 cents per ADS, there is plenty of coverage with 2015 earnings per ADS of $1.82.
A number of Western investors have had a negative reaction to XIN's airplane as being wasteful and unneeded.
Here are the facts. On September 12, 2013, XIN leased a corporate aircraft by putting down a deposit of $6.7 million. The lease has an eight year term and expires on September 15, 2021. The Group agreed to make 32 quarterly lease payments of $1.4 million totaling $45,645,920. When the lease agreement ends, the $6.7 million deposit may be used as full and final payment for the aircraft. The effective interest rate for the capital lease obligation is 10.47%. In addition to the lease costs, XIN must pay the operating costs of the plane.
a. Exchange Rates
It appears that exchange rate fluctuations have become a significant factor affecting XIN's bottom line. Table 4 gives the RMB to dollar exchange rates for the last 3 years along with what XIN reported as exchange rate gains or losses. The company made money on the fluctuations in 2013 but lost $19.7 million in 2015.
Table 4. - The Impact of Exchange Rate Fluctuations on XIN's Income
As Table 5 indicates, the margins on XIN's properties vary widely. This means XIN's income will depend on which properties it sells in any given year.
Table 5. - XIN's Margins and Revenues from Selected Developments
c. Guaranteeing Loans
XIN guarantees mortgage loans. As of December 31, 2015, it guaranteed mortgage loans in the aggregate outstanding amount of $1,513.7 million. Shades of AIG?
XIN is a Cayman Islands company. In its 20-F, it reports:
This is definitely worrisome. XIN clearly qualifies as a taxable entity in China. The government could take action at any time.
My limited real estate experience in China flags this as a potentially serious problem. Real estate development companies need to time things right so as to not get "overextended." But this could happen at any time and result in significant costs and delays. In recognition of this, many of the larger Western real estate investors will not provide any capital to Chinese partners until all resettlement issues have been resolved.
There are different definitions of leverage. In Table 6, cash and real estate assets are examined against debt. The lower the asset/debt ratio is, the greater is leverage. By this measure, XIN's leverage has grown substantially in recent years.
Table 6. - XIN's Cash and Real Estate Assets Compared with Debt (thous. US$)
It appears that more and more people are coming to recognize XIN as a legitimate real estate company. This growing recognition should cause its stock price to increase. But don't expect much from its share repurchase program: XIN is not eager to spend much on anything other than buying land and building.
Finally, it should be kept in mind that real estate development is a risky business. Of course, XIN's management is aware of these risks and is being paid well to mitigate their effects. But the risks remain.
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