Evergrande’s struggling electric vehicle unit is a warning to other property developers

The company launched its electric vehicle unit, Evergrande NEV, in 2018 and vowed to outstrip market leader Tesla despite—in Evergrande chairman Hui Ka Yan’s own words—having “no technology and no experience” in building cars.

Nevertheless, investors bought into Hui’s bravado, and Evergrande NEV raised tens of billions of dollars in share sales while earning exactly zero dollars in car sales. The unit boasts a portfolio of six models but hasn’t shipped a single automobile, as executives repeatedly push back production schedules. The subsidiary reported losses of $740 million in the first half of the year.

Yet Evergrande’s dismal foray into EVs is only the property giant’s latest bid to diversify its business interests. Previous gambits include bottling mineral water, producing music, and managing football club Guangzhou FC—all of which have failed or are sustained at a loss. The failed ventures don’t weigh heavily on Evergrande’s total $300 billion of debt—most of which comes from the group’s property sector—but Evergrande’s desperate bid to diversify flags a bigger issue facing all of China’s property developers.

The Chinese property market is maturing, and the government is reining in runaway house prices, which is increasing costs and cutting profits for real estate companies. To survive, builders like Evergrande need to diversify their holdings or risk being saddled with low returns and mounting debts—but they need to avoid the missteps that Evergrande’s EV venture has made.

Maturing property

Evergrande isn’t the first or only real estate developer in China to diversify away from residential property as the sector, once a bedrock of China’s economic growth, matures.

In 2012, Wanda Group—then China’s largest commercial property developer—began an aggressive acquisition drive, purchasing U.S. cinema operator AMC for $2.6 billion that year and snapping up Hollywood production studio Legendary Entertainment for $3.5 billion in 2016.

In 2014, another one of China’s leading property developers, China Vanke, began expanding beyond its core residential property business. The group expanded into warehousing and logistics operations as company executives warned there “could be a problem” with real estate that year as property sales declined.

“Fifteen years ago, the government would promote the real estate industry as a pillar for economic growth,” says Zoe Yang, assistant professor at the Chinese University of Hong Kong. “But as prices rose too high, the government introduced policies to cool down the market.”

Chinese households have long held property as the preferred asset class, with some 70% of household wealth tied up in the property sector. But rampant speculation raised prices and pushed new buyers out of the market, prompting Beijing to restrict the number of properties individuals can purchase and limit financing options for secondary home purchases.

Last year, Beijing slapped financing restrictions on property developers too—forbidding banks from issuing new loans to developers with fundamentals that breeched one of three “red lines.” Evergrande breached all three of those thresholds, which ultimately squeezed the group’s access to fresh capital and precipitated its devastating cash crunch. But China’s other developers aren’t in much better shape.

“The whole property business is a sunset sector,” says Bo Zhuang, China economist at Loomis Sayles, estimating that China will be “overbuilt” by 2030 if development continues at its current pace. Real estate developers need to diversify to survive and, Zhuang says, one way of picking industries to expand into is simply to “listen to Xi Jinping.”

New energy

To its credit, Evergrande did just that.

China President Xi Jinping has charted an ambitious road map to make China the leading producer and buyer of electric vehicles (EVs) over the coming 15 years, pledging that all vehicles sold in China after 2035 will be “eco-friendly.” A raft of supportive policy measures to meet that target sparked a boom in the domestic EV market and, in 2018, Evergrande entered the fray.

Evergrande NEV, the property developer’s EV unit, listed in Hong Kong in 2018 through a restructuring of the Evergrande Health unit—another defunct diversification wing—that was languishing on the bourse. Measured by share price alone, the new EV unit was a success. Evergrande NEV was valued higher than Ford in April this year, at a peak of $87 billion, despite never having sold a car.

“It’s a weird company,” Bill Russo, the founder and chief executive officer of advisory firm Automobility in Shanghai, told Bloomberg earlier this year. “They’ve poured a lot of money in that hasn’t really returned anything, plus they’re entering an industry in which they have very limited understanding.”

Officially, Evergrande posited that it could bundle EVs and homes together: build EV charging stations into residential car parks and incentivize buyers with offers of free or discounted charging. Although the unit was running at a loss, Evergrande figured it could be profitable further down the line when the property sector started to mature.

Unofficially, however, Evergrande’s bid on EVs served another purpose: opening access to government land.

Factory and a house

Evergrande deployed its tactic of snagging land deals alongside manufacturing pledges in the city of Nantong, on the outskirts of Shanghai, where Evergrande promised to invest $2.7 billion in an EV plant in 2019, according to the Wall Street Journal.

The plant hasn’t been built yet but, last September, the local government auctioned a plot of residential land where it accepted bids only from companies that had invested at least $1.55 billion in local EV production. Evergrande was the only property developer that qualified and secured the land without a bidding war.

S&P director of Greater China property, Matthew Chow, says competition for new land allocation is so high that most developers no longer compete through standard land auctions, where land typically sells at a 66% premium on its original value. “Lots of developers are finding ways to get cheaper land,” Chow says.

Evergrande also used its EV business as a fundraising vehicle by selling shares in the unit. If Evergrande used those funds to prop up its main property business, they weren’t enough. By September, shares in Evergrande NEV had plummeted 92% from their April peak. The debt-laden developer even failed to offload the loss-making EV venture to Xiaomi last month, when the smartphone maker was seeking an entry to the EV space.

“No one wants to catch a falling knife,” says Zhuang.

Future property

Most analysts expect Evergrande will default on a new raft of payments due this Thursday, which could finally topple the company. Observers worry the giant property developer’s collapse could precipitate more defaults across China and even overseas.

Analysts caution that the government will likely intervene to prevent such contagion but will still allow Evergrande to fall—more of a controlled demolition, than a collapse—as a warning to other developers not to build bad debt piles. But as the property sector matures, developers will have to take on debt to diversify into other areas.

“The government policies are so strict even the big firms like Evergrande, Country Garden, and Soho face pressure,” says Yang. “Eventually it seems like only state-owned enterprises can compete in land auctions and could eventually crowd out private firms, which would stifle competition in the market.”

The struggle for private property developers will be choosing how and where to diversify. Wanda’s bid on overseas property and cinemas fell flat after the government accused it and other acquisition-heavy firms of using credit to fund capital flight in 2017, forcing the property group to sell off its overseas assets. The government scrutiny and Wanda’s subsequent retreat cost Wanda founder Wang Jianlin $32 billion in personal wealth. The group has said it will stop buying new land.

China Vanke’s pivot to property management may offer a more stable future and is a route other land developers have favored. Building management services is Vanke’s second-highest revenue earner, after property sales. Even though profits from management services are far lower than building sales, the sector is more sheltered from government regulation, and Vanke, following the lead of Country Garden and China Resources, is reportedly looking to spin off its property management unit through a $2 billion Hong Kong IPO.

“It’s getting harder to make money from the development business,” Vanke president and CEO Zhu Jiusheng said during a shareholders meeting in July. But the transition to whatever’s next will be hard too.