Baffled of Beijing – Sketches from a Recent Visit to the Nation’s Capital

One of the sillier stories in recent weeks has been about the debt of the China Railway Corporation (CRC) being twice as large as Greece’s. The observation being irrelevant of course without some discussion of what’s on the other side of the balance sheet. In Greece’s case not a lot; we are and should be concerned. In the CRC’s case it’s the railway network of the world’s second largest economy which, as anyone who has used it recently will confirm, is being enthusiastically utilized.

My point is to remind that debts are less scary when they’re owed by either prosperous individuals, growing economies or vigorous enterprises. That China has prosperous individuals, is a growing economy and is home to many vigorous enterprises is not in contention. A recent visit to the nation’s capital though served to remind me of these facts and if you’ve been persuaded by noisy doubters that China is somehow fumbling I strongly urge you to make a similar trip.

The capital is only half [Surely a third? Ed.] finished but the half that’s done is beyond world class, its setting new standards; and the half yet to come? I can only begin to imagine what this conurbation will look like in 30-years’ time? Surely London, Tokyo and New York will continue to inspire for their very different reasons. Beijing on the other hand is in the process of establishing a grandeur and scale that not only reflects the progress of ‘New’ China but will be an inspirational beacon for the world in a way perhaps that Manhattan was for those living in the early part of the last century?

Some Specifics

I’ll start with an aside about a hotel. I wouldn’t normally waste time puffing lodging but in this single property a lot of what I’m referring to can be referenced. On your next visit to Beijing try to stay at or at least visit the NUO Hotel near the 798 Art Zone. At a cost of U$500m unlisted SOE Beijing Tourism Group (BTG, they recently acquired Homeinns for U$1.7bn) has created a property unlike anything you’ll have seen. It’s new, which is nice. The rooms are big, which is welcome and the facilities, gym, spa, pool and etcetera are knockout; but none of this is especially remarkable for a new five-star hotel. What is truly exceptional is the design and execution.

The concept was to create a contemporary Chinese luxury experience. This no longer means a vast lobby with a gopping chandelier in the center, a pianist in the corner, and hot and cold running flunkies. The aim was to take style elements from China’s golden era the Ming Dynasty and tastefully incorporate them into a contemporary project. In addition a very significant budget was set aside to acquire signature pieces from some of China’s most prominent contemporary artists (the collection is now valued at over U$50m the General Manager informed me).

A huge Zheng Fan Zhi sculpture greets guests on arrival and his more familiar painting work is prominently featured behind the check in desk. Original prints decorate all the rooms and in the common areas works curated by Mr. Zheng from installations to glue-gun shot three dimensional accent pieces are on discreet display. I’ll stop gushing here and again recommend you go see this for yourself. This hotel BTW is just the first of what BTG hopes to develop into a chain with both a domestic and international footprint.

[Value investors will be particularly interested in the price. I paid Rmb1,300 per night (U$206) which included breakfast, in room wi-fi and 15% tax. I sense that’s a come-on rate as they’re new and the brand is unknown. Go before that changes]

Down to Business

I didn’t go all the way to Beijing to stay in a nice hotel, there was some work involved. The purpose of my visit was to check in with an investee company and visit some of their real estate projects. This was a particularly useful exercise as I was able to visit a range of properties from high end luxury residential products to brown field mixed use developments with a stop off at a retail outlet mall on the way.

High end luxury now in Beijing will set you back around Rmb180, 000/m². The apartments I saw in that bracket come fully fitted and I looked at units ranging in size from 270 m² to 375 m². That translates to unit prices of between Rmb50m~Rmb68m (U$7.6m~U$10.2m). These are aimed at China’s uber-rich and the majority of buyers pay cash. Properties in this space don’t get banged out in a scrum at a sales office but trade by appointment and I was told 20 or so discussions with potential buyers were presently underway.

Beijing has two areas the government have fostered for business use. One is now officially referred to as the CBD. This was originally intended to concentrate all business activity but had to give up finance in favor of the second area of concentrated business activity a financial district clustered around the Central Bank, other financial regulatory authorities and the Beijing Financial Street. Problem, the financial district itself is now maxed out and a new area is being developed to handle the over spill in Lize in the southern part of the city. It’s mostly a brown field now but four towers being built by my hosts are sprouting and will be ready for occupation next year. Just a useful reminder how China gets things done. The total site is huge and I guess a lot of businesses and homes have had to be relocated; so they were.

On to an outlet mall (Beijing now has five of these). Indistinguishable to similar I’ve visited in the U.S. and surprisingly busy for a Friday. I was shown pictures of weekend activity when there are specific promotions and I was glad I was able to make my inspection during the week! The downturn in high-end retail has been very much to this operator’s advantage and sales growth was double digit last year and is strongly ahead so far this.

Finally on to a development near what was originally called the Beijing High-Technology Industry Development Experimental Zone, this area in the Haidian district is now generally referred to just as Zhongguancun or more simply the Silicon Valley of China. Another brown field, this one in the process of turning itself into an upscale residential area for the successful operators in the tech space. They’d need to be pretty successful as the plans I reviewed are for units planned to go on sale for between Rmb150, 000/m²~Rmb175, 000/m². It’s a large project and will have several phases. The developer though has already secured strong interest for over 80 units (no deals are officially possible before a percentage of completion has been achieved; but they, er, sort of, are).

I wouldn’t call my day an exhaustive trawl of the Beijing property scene but my experience sat well with other anecdotes recently received about the China property market, in all classes, being in robust good health; at least in the major conurbations.

Baffled of Beijing

As we rode in the car on our way to the various site visits I and my host, a young mainlander, discussed a number of related topics, including the company’s valuation. Presently the stock of this de facto SOE is trading in Hong Kong on price to historic book of 0.5x, the historic P/E is 3.3x and the yield assuming an unchanged dividend after 10% withholding tax is over 8% [Pinch me!]. I asked how this situation was reconciled internally and received the refreshingly honest answer, ‘We’re baffled’.

So they should be. Their gearing is high but as an SOE and one prominent in the Beijing area banks will regard them as having the full faith and credit of China Inc. The portion of the portfolio I visited could easily be worth their entire market capitalization and they have other projects in twelve Chinese cities, most of these with names you’d recognize immediately. Their pipeline is solid and visibly in demand and the management is stable and clearly competent. Why then are they valued as if going out of business?

It’s The Debt Stupid!

I won’t waste time here going into an argument which is now fundamentally faith based. The fact is the majority of investors domiciled outside of China believe there is a problem both at the national and the corporate level and these investors are responsible for valuations of Hong Kong listed companies.

An anecdote from a meeting with a planner a while back though might help those with an open mind to understand the situation more clearly. Was he concerned about the fragility of the financial markets in China and the possibility of systemic risk in any way I inquired? In reply I was told that his department had studied Japan’s problems at length and would not allow China to suffer a similar calamity. The U.S. Savings and Loans crisis had also been dissected to make sure China wouldn’t fall foul of a similar caper. Lessons from the Baring’s collapse and the Asian Financial Crisis had also been drawn. Finally, he concluded, ‘Thanks to America, probably the chief architect of the Global Financial Crisis, we have another interesting model to study to make sure China doesn’t go there either’.

A Balance Sheet of Two Halves

To return to my earlier point. To focus entirely on debt in China without considering the nature of the many productive assets on the other side of the balance sheet is to make the same mistake as drawing a line between the Greek debt burden and the Chinese railway system. It may be effective click-bait; but its sloppy analysis.

My few days in Beijing were a useful reminder of a fact fundamental and applicable in all markets. Debt when combined with growth is very much to an owner’s advantage. Especially if that debt is balanced by assets that are increasing in value as most are in China.

In Conclusion

If you harbor negative views on China based on either the shamelessly partisan braying of hedge fund titans or the work of paid-by-the-click financial commentators it’s probably time you paid another visit. If, like many, you harbor negative views on China’s prospects and have never been, please take the time.

Never, in my experience, has the difference between the perception of China and on-the-ground reality been as bafflingly wide as now.

Mementos

Beijing last Sunday from the NUO hotel. You can’t quite make out the Great Wall but it was a delightfully clear and, as you see, sunny day. Sure, there’s a smog problem, I’ve been when the air is either putrid or the sand is coming in from the desert, or both; but these conditions are by no means something the citizenry have to suffer all year round.

In the first picture at the bottom on the right you can see what looks like a small abandoned factory. Here it is in more detail. Beijing is littered with similar relics of a bygone era that are gradually being turned into much more valuable assets. This facility was once the neighborhood heat and hot water supplier and, since it was coal fired, hasn’t operated for many years.

So why is it undeveloped? Funny story. A developer bought it some time ago when it wasn’t surrounded by the classy properties that it now is. The failure to develop it quickly now means they can’t just dynamite it and truck out the rubble. It’s removal has become a much more costly and margin eroding proposition. They’re calling shenanigans on the local government and are asking them to help with the cost of removal, the government of course maintain that the process was incorporated in their original price.

No doubt some compromise will be reached and on my next visit the area will be thick with concrete pumps erecting another shining monument to progress?

Respectfully yours,

Baffled of Beijing