is Light in Assets
15 April, 2015 – A lecture at Shenzhen Stock Exchange
During the eighth entrepreneurship forum of the Shenzhen Stock Exchange (SZSE) held on April 15, Wanda Group Chairman Wang Jianlin gave a keynote speech entitled “The Asset-Light Model at Wanda”, where he elaborated for the first time on the Group’s asset-light strategy.
Below is the transcribed speech:
As a leading world-class estate developer, Wanda now boasts the largest properties (measured in combined floor area) under management all around the globe. Revolving around property development, we have expanded our business presence into many other sectors. The company has embarked on a full-scale transition since last year, based on analyses of the future trends in the real estate industry: from a geographical perspective, we are driving a shift in the company toward a multinational enterprise; in terms of business lines, the company is in the midst of a transition from a property-oriented enterprise toward a high-tech service supplier. Today, I will focus my speech on the transition of Wanda’s core business – commercial real estate.
1. The asset-light strategy at Wanda
What is asset-heavy? The city complex is the main product of Wanda Commercial Properties. This product model starts with the construction of a large Wanda Plaza, supplemented with auxiliary properties such as offices, retail stores and apartments, whereby the supporting properties are sold and the resulting proceeds are invested in the Wanda Plaza for long-term operations. The absence of long-term property investment financial products in China means that Wanda has to rely on property sales for its leasing business. All Wanda Plazas are owned and managed by the company itself, and it also receives full rental revenues – this model is called asset-heavy.
And what is asset-light? It is a different model where the construction of Wanda Plazas is funded exclusively by external investors, and Wanda takes care of site selection, project design and construction, tenant attraction and property management, leveraging the brand appeal of Wanda Plaza and its unique “Huiyun” intelligent business information management system. With this model, the rental income is shared between Wanda and the investors according to a certain distribution ratio. We started developing this totally new model (namely asset-light Wanda Plaza) last year, and have put it into practice now.
Going forward, Wanda will move toward the asset-light model. As of the end of 2014, a total of 109 Wanda Plazas have been opened, with 26 new projects due to open in 2015, bringing the total area of properties under management to over 25 million square meters. All of the new plazas this year will be operated under the asset-heavy model – given the three-year construction cycle involving site selection, negotiations, architectural design, land purchase and opening, it is impossible to apply the asset-light model to the new projects in 2015. However, of the 50 plazas planned for 2016, more than 20 will be developed and operated as “light assets”. From 2017 onward, we will keep opening at least 50 new plazas every year, and over 40 of them will be asset-light. Of the 90 million square meters of our existing land reserve, over 20 million are planned as self-owned properties, and 70 million are developed for sale. We plan to digest these 70 million square meters of properties within five years. In other words, “heavy assets” will disappear from Wanda Plazas, meaning that Wanda Commercial Properties make the transition from a real estate developer to a business investment service operator – similar to hotel management companies – featuring fully asset-light operations.
2. What caused the asset-light transition?
Wanda’s asset-heavy business has been performing well and has good potential for future growth. Urbanization is still in full swing in China, and the Wanda model has been copied by many property companies. So why did you decide to move toward asset-light?
(1) To increase our competitiveness
With 135 Wanda Plazas in operation by the end of 2015, we will be the largest commercial real estate developer in the world. It would be an achievement big enough for us to become complacent. Sit back and relax and watch property leasing grow naturally. But we have more ambitious goals – relative to a market with nearly 1.4 billion consumers, our market share is still too small, and we must continue to scale up to consolidate our competitive edge. The asset-heavy model is inherently influenced by the cyclical nature of the property industry. During a property boom, it is very easy to increase sales and maintain a healthy capital flow as well as driving business growth. However, we believe the Chinese real estate industry has come to a turning point in terms of supply and demand, and the era of huge profit has come to an end. Going forward, property developers must achieve high standard branding, pricing, marketing, etc. operations to survive in the marketplace. There is still room for the asset-heavy model to develop further, but it is confronting increasing challenges. The asset-light strategy is the answer to scaling up our businesses. The Wanda Plaza brand has a solid reputation. Many organizations and individual investors have come to us asking for investment opportunities. It is an opportunity too good to miss. As the fashionable saying goes, the best business is to do your business with investments from others. We aim to grow bigger and bigger during the next five years and beat all our competitors. We are building a wider and deeper “moat” for the Wanda brand.
(2) To tap into markets in small/medium-size cities
Some analysts asked me why shouldn’t Wanda keep focusing on tier one and two cities? Are housing prices and rents high enough in tier three and four cities? This represents a misperception about the real estate business. The most important indicator in property development is not the housing price or rent per square meter. Rather it is the rental yield, i.e. the ratio of rent to investment (the annual rental revenue after deducting taxes divided by total property development). In this respect, property projects in tier one and two cities may even be inferior to those in tier three and four cities, because the former entails greater land costs and heavier investments.
The housing price is the primary consideration in the asset-heavy model, where investment is limited only to projects with high sales profits. This would keep us out of tier three and four markets. By contrast, the asset-light model only involves pure investment without property sales, whereby investment can be made in projects as long as the local urban population is large enough to maintain a reasonable rental yield. This enables us to enter the local markets of many tier three and four cities. The biggest challenge in these markets lies in how to attract retailer occupants, and such a barrier prevents most developers from entering these cities. For us, retailer resources happen to be one of our biggest competitive advantages – we have more than 5,000 contracted retailers, many of whom have close business ties with us and follow Wanda wherever we go. In fact, we do not attract retailers, but select them. As a zero tolerance rule, in any given year, a Wanda Plaza retailer cannot open more stores than 50% of the number of Wanda Plazas opened that year – the number was lowered even further to 33% last year. This is a precaution against potential risks – if 500 Wanda Plazas are opened in total and all of the properties available for a particular business (supermarkets, for example) are leased to the same retailer, it would put the entire operation at risk if the retailer encounters business difficulties. Secondly, such a rule also prevents corruption. Bribing our retailer business managers will not give the retailer unlimited access to stores at Wanda Plazas. We have worked out the maximum number of stores allowed for each brand.
The relatively cheap land supplies in tier three and four cities allow us to select favorable locations. From our experience, a tier three or four city with 400,000-500,000 local residents is totally capable of supporting a large-scale Wanda Plaza. Furthermore, consumers in these cities tend to have higher brand loyalty.
Through years of real estate operations, we found that commercial property investment in China is currently in a state of development imbalance, where the markets are over-saturated in major cities, whereas investment in tier three cities and some popular tier four cities has remained scarce. Many of them don’t even have a multiplex cinema, let alone large city complexes. Judging by our revenue statistics alone, 70% revenue growth is contributed by tier three to four cities. Despite relatively low spending per customer, the combined population in these cities and high customer loyalty make it easier to establish Wanda Plaza as the central business center. In addition, properties in these cities offer a return on investment more or less equaling that in large cities. This presents an ideal opportunity for the Wanda brand.
(3) To achieve marginal benefit
With the transition toward “light assets”, our objective is to speed up development of the Wanda brand. We now open 26 new plazas (about five million square meters in total floor area) every year. It is an unprecedented – perhaps also unrepeatable – speed of development across the world. If history offers any guide, the real estate industry is inextricably linked to the urbanization process. Key urbanization developments in a country last for 20-30 years, and major real estate development opportunities will disappear once the urbanization process ends. Wanda is blessed with a golden opportunity amid China’s urbanization, and we embraced the opportunity with thorough preparation. We will continue to step up our efforts and tap into the full potential of Chinese cities of varying sizes. From a financial perspective, asset-light businesses possess a favorable return on investment: the combined operating profit from two asset-light projects equals that of an asset-heavy project – assuming that the rental income of a standard asset-light project is 100 million yuan, Wanda will receive 70 million in rental revenue from every two asset-light projects (total profit 200 million yuan), which is roughly comparable to the average rental income (gross rental of 100 million yuan after deducting operating costs and taxes) of a standard asset-heavy project.
More importantly, rapid expansion of asset-light businesses will also lead to marginal benefits. Take Wanda Cinema Line, listed on the Shenzhen Stock Exchange, for example. Most Wanda cinemas operate within Wanda Plazas and have enjoyed fast development driven by the rapid growth of Wanda Commercial Properties as a whole. As another example, we are currently working on KIDSPLACE, the first comprehensive child entertainment project in China, integrating amusement park, education, food and retail businesses. We developed it because the absence of amenities for children would result in an age gap among Wanda Plaza customers. Our data show that the addition of children’s facilities results in double-digit growth in customer traffic.
Why do we decide to do it ourselves? It is because that there is no partner able to keep pace with us. Children’s business operators in China focus either on games or retail, and none of them integrate different businesses. We also talked with foreign companies in Europe, Japan and South Korea, but they were afraid of entering the Chinese market. Even if they come here, they can’t do it that fast. Opening a couple of stores every year is far too slow for us, so we decided to do it ourselves. Founded last year, Wanda Children Entertainment opened nine stores in just one year. Given the rate of development of Wanda Plaza, KIDSPLACE will soon grow into the world’s largest children’s entertainment business. Furthermore, the expanding Wanda Plaza network will also benefit our O2O and Internet finance operations in terms of generating more resources.
3. How to make asset-light operations effective?
(1) A standard asset-light module
With the asset-heavy model, Wanda Commercial Properties focused on profit as the main criteria in local branch assessment, with the house price serving as the main indicator of the suitability of local markets for investment. In the case of the asset-light model, investment target selection is appraised mainly on investment cost and rental income instead. Wanda has developed hundreds of real estate projects over the past 20 years throughout the country, and has a clear understanding of the construction costs in different regions. First, we attach great importance to cost analysis, and spend one full year in developing four versions (A, B, C and D) of cost standards for each project. Furthermore, cost standards for southern cities with good geological conditions are different from those implemented at “soft foundation” areas. Similarly, two distinctive cost standards have been developed for northern cities according to geological differences.
In the past, the development of new Wanda Plazas was led by the development department, which was responsible for local project negotiations and project data collection. New projects were reviewed by the cost control department based on cost and profit analyses. The two departments then debated over the feasibility of the projects, and only with the consent from both sides, the proposal was submitted to the president and chairman for approval. After the introduction of the asset-light model, the decision now rests with the business management company with rental revenue as the sole criteria. As the manager of Wanda Plaza, the business management company makes conservative projections of leasing revenue. As a further precaution, we asked the commercial property research department to work out a set of rental estimation models for local markets, based on which separate projections are conducted independently. If the results of the two departments match each other, the project in question is considered highly reliable. And if there are significant discrepancies between the findings, the project will be sent back for reconsideration. As such, a complete set of standard modules is in place for asset-light investment operations.
(2) Project management reforms
Our project management model has also gone through several major reforms in a bid to expedite asset-light development. In the past, the project management process used to be complicated and time consuming, involving bidding, budgeting and final accounting. It proved too inefficient to keep pace with project development after the rollout of the asset-light strategy. For this reason, we introduced the turnkey project model, which represents a major innovation in the management of Chinese real estate projects. It involves Wanda partnering with the four companies under China Construction Group in the joint development of four versions of Wanda Plaza project pricing schemes for different areas. Wanda pays standard prices to the builders, and they carry out construction in compliance with relevant standards and deliver turnkey projects according to schedule – Wanda only needs to assess project quality without being involved in subcontractor recruitment/management. The turnkey construction project model is very popular in developed countries, where a high degree of specialization and subdivision can be achieved, allowing the investor, builder and manager to focus on their own businesses. On the contrary, Chinese property developers emphasize “all round” capabilities and insist on taking on everything by themselves, ranging from investment, land purchase, design and construction. This is decided by the current development phase of the Chinese real estate market.
The benefits of turnkey projects include cost effectiveness – the project company used to recruit 60-70 people for each Wanda Plaza, and the turnkey model has led to a two-thirds cut in headcount. There is also improved efficiency and a facilitated management process. This leads to win-win development – in turnkey projects, the builders become general contractors, whereas they used to be responsible only for civil works (accounting for no more than 50% of the total project cost), with Wanda taking charge of subcontracting for façade, interior decoration, mechanical and electrical operations. The new model lets the builders reap all construction revenues (including a certain amount of management fees charged on subcontractors) and higher profits. Therefore, turnkey projects are warmly welcomed by our strategic partners. It also enables Wanda to eliminate project corruption altogether. Needless to say, all subcontractors must be selected from our brand database.
(3) IT-based business management
The dramatic development speed of Wanda makes many people worried about a possible “hard landing” in the future. After the introduction of the asset-light strategy, the workload of business management increased against a reduction in project management operations. We currently launch over 20 Wanda Plazas a year, and this will be doubled from next year onward. How can Wanda manage to keep pace with the increased development speed? Business management has therefore become the decisive factor to our lasting success.
Given the large number of Wanda Plazas in China, it is simply impossible to manage all of them manually. We have built a fully developed IT-based management system. Our highly innovative “HuiYun” intelligent business information management system was officially rolled out in all Wanda Plazas across China in 2014, after a trial run in 2013. Integrating 16 sub-systems (covering fire management, mechanical and electrical management, energy management and operations management) into one intelligent platform, HuiYun, enables us to control all aspects of business management via a single computer monitor.
A high concentration of catering services is one of the most salient features of Wanda Plazas, and 30-40 restaurants can be found in every plaza. Ten years ago, I said the success of Wanda Plaza was not because we sold well, but because we served the diners well. Catering facilities necessarily result in increased fire hazards. To address the risks, we developed a kitchen automatic fire extinguishing system jointly with the national fire department. The system has been granted a global patent. It measures the temperature in the kitchen and cuts off the gas supply automatically, if the warning threshold is triggered; if the temperature continues to rise, automatic sprinklers will be activated to prevent fire accidents.
As well as supporting business management operations and ensuring security, the IT-based system also serves to reduce management costs. In the past, managing a 150,000 square-meter plaza required 131 employees, but now it has come down to 80 (a 40% headcount cut).
(4) Asset-light financing channels
How are Wanda’s asset-light businesses funded? (One way is through external financing channels, e.g. funds, insurance companies and other institutional investors) thus far, we have concluded 25 legally binding projects, meaning over 100 projects can be executed as and when needed. There are also internal financing channels – the company has set up its own ecommerce company and acquired 99bill.com. Both companies are in the midst of developing brand new wealth management products, and product release is planned for next month. This will provide financing through crowdfunding for asset-light operations at Wanda Plazas. The investment targets of Wanda’s financial products are real entities, thereby ensuring a reliable return for investors. We project that the cash return will be 6% on an annualized basis. Each Wanda Plaza will be disposed of in five to seven years, and the resulting earnings will be shared among the investors. Disposal is conducted through two methods, capitalization or sale. Real estate investment trusts (REITS) are now being tried in China, with pilot programs in progress in many cities. Wanda’s financial products are designed as quasi-REITS, and even if REITS turn out to be unviable five years later when the Wanda Plaza becomes fully developed and generates high rental income, it can still be sold at a favorable price. Factoring in both the sale proceeds and yearly cash return, the annualized ROI of Wanda Plaza is estimated to be over 10%. If an investor has a financial emergency and needs to withdraw his investment urgently, he may sell the products on the warrant trading platform (we have agreed with two financial reform pilot zones to set up such a platform, and the market maker has also been appointed) – our financial products are liquid and can be traded one month after purchase. The investors also agree with Wanda Ecommerce and 99bill that a certain amount of earnings will be paid upon disposal of Wanda Plaza. This way, profits will be guaranteed for the e-commerce company. If successful, our financial products will offer funding for asset-light projects, thereby minimizing reliance on external investors.
The asset-light transition of Wanda Commercial Properties is not a random, arbitrary decision as it may seem. Instead, it is our conclusion after a lengthy process of studies and analyses on the cost standard module, turnkey model, IT system and financing channels. We have made thorough preparations for over a year, but the decision was only recently announced.
4. Objectives of the asset-light strategy
We have set out two strategic targets for asset-light projects. The first is increasing the number of Wanda Plazas to 400-500 by 2020, a nearly two-fold increase from the original target (240-250) under the asset-heavy model. By 2025, we strive to open 1,000 plazas in China. It may sound unrealistic that we will be able to launch 100 new plazas every year in five years. But this is indeed a completely realistic goal given our current execution capability, especially considering the growth in this ability over the next five years. For those who are suspicious, let us wait and see. Our second target is that by 2020, two-thirds of net profit at Wanda Commercial Properties will come from leasing businesses. It would be inappropriate to call a company a real estate developer if more than two-thirds of its net profit is contributed by businesses other than property sales. Therefore, we plan to remove “Properties” from the company’s name, and rename it “Wanda Commercial Investment” or “Commercial Investment Management”. This will mark the completion of the shift away from the real estate-reliant model, and reintroduce Wanda Commercial Properties as a service operator.