Hang Lung Makes $5 Billion China Bet to Dodge Rivals

Ronnie Chan, chairman of Hang Lung Properties Ltd., is betting $5.1 billion on China’s consumers.
Soon after taking the helm in January 1991 of the Hong Kong developer his late father founded 30 years earlier and against the wishes of a reluctant executive team, Chan began plans to build shopping malls in China, anticipating an economic boom. This year, the opening of its fourth mall in the nation may propel the company’s rents from the mainland above Hong Kong’s.
“I was chairman and they just had to go along,” he said in an interview at his office in the Standard Chartered Building in Hong Kong.
Chan is spending $5.1 billion to build malls and offices in five Chinese cities outside Shanghai to tap demand for luxury goods, a market CLSA Asia-Pacific Markets estimates will be the world’s biggest in a decade. That’s reduced his reliance on apartment projects at home and steered him away from residential developments in China, housing markets with concerns of a bubble.
It’s also pitting Hang Lung’s fortunes against inflation that threatens to push up construction costs and derail luxury spending. China’s central bank raised interest rates last week for the third time since mid-October to cool prices.
He has been “arguably too bullish, though I think he can continue to deliver,” said Hugh Young, Singapore-based managing director of Aberdeen Asset Management Asia Ltd., which owns Hang Lung shares. “He’s successfully engineered a major shift in the company. We’ve followed the company for 20 years through various booms and busts and there’s depth and substance to him.”
Hang Lung shares fell 0.3 percent to HK$31.50 as of 11:34 a.m. in Hong Kong today. They have declined 13 percent this year.

Commercial Landlord

Founded in 1960 by Chan Tseng-hsi and listed on the Hong Kong stock exchange 12 years later, Hang Lung Group Ltd., the parent of Hang Lung Properties, became one of the first developers in the city to invest heavily in commercial properties. Properties built to lease accounted for 83 percent of total assets at the end of June 2010, according to the company’s annual report.
Its focus on becoming a commercial landlord has helped the company avoid going head-to-head with larger, residential- focused competitors on the mainland, such as China Vanke Co. Hang Lung is Hong Kong’s third-biggest developer by market value.
“I’m too short and when I bump into big guys I let them go first and try to find other ways,” said Chan, 61, who stands at about 1.6 meters (5.2 feet). China’s residential property “is a big market, but also one that has so many mega-domestic players with their own vast and extensive systems in place. How can we compete with them?”
Vanke, China’s biggest developer by market value, last year made 48 billion yuan ($7.3 billion) in revenue from residential sales, while China Overseas Land Ltd., a mainland-based developer listed in Hong Kong, took in HK$36 billion ($4.6 billion), more than any other Hong Kong-based builder.

Ninefold Increase

Hang Lung shares have risen more than ninefold since Chan took over in 1991, while its assets have grown about 8 times. The company is the third-best performer among Hong Kong’s major developers since Chan became chairman, trailing only Sun Hung Kai Properties Ltd. and billionaire Li Ka-shing’s Cheung Kong Holdings Ltd., the city’s two biggest builders, over the period.
Hang Lung, which means “eternal prosperity” in Chinese, completed Grand Gateway in Shanghai in 1999 and last year opened the Palace 66 in the northeastern Chinese city of Shenyang, its first mall outside of Shanghai. Over the next five years, it plans to add at least 1.5 million square feet of mall or office space a year in cities including Jinan, Wuxi, Dalian and Tianjin.
The average rental at major shopping malls in Shanghai at the end of last year was 46.7 yuan per square meter per day, an 87 percent increase from the same period in 2005, according to Seattle-based property broker Colliers International.

‘New Challenges’

The management of those malls may prove challenging, Morgan Stanley analysts led by Coral Ching wrote in a Jan. 27 report.
The company “lacks a proven track record in running a large property portfolio in China,” the analysts wrote. The new malls over the next three to five years will pose “new challenges for Hang Lung at operation level.”
The group’s rental income from Shanghai, where it now operates two mall-and-office complexes, has increased more than threefold since 2005. The opening in August of the Jinan shopping mall will probably help Hang Lung’s rental income from the mainland surpass Hong Kong’s for the first time, Chan said.
Hang Lung’s rental revenue from Hong Kong was HK$2.61 billion in the 12 months ended June last year, compared with HK$1.93 billion from the developer’s mainland China properties.

Luxury Demand

“Their business model is simple: focusing on the retail segment and riding on mainland China’s burgeoning consumption demand,” said Lee Wee Liat, a Hong Kong-based analyst at Samsung Securities Ltd. “It’s hard not to fall in love with a company whose management and local staff have such a clear conviction and passion on the things they do.”
Samsung Securities has the highest 12-month price target, at HK$49.30, among 22 analysts that track the company, according to data compiled by Bloomberg.
Demand for luxury goods and travel from Greater China will account for 44 percent of the global total by 2020, up from the current 15 percent, as its “burgeoning middle class is adopting previously unattainable high-end lifestyles,” CLSA’s Hong Kong- based analyst Aaron Fischer said in a report on Feb. 2.
Stores in Hang Lung’s 120,000 square meters (1.3 million square feet) Shanghai mall include Burberry and Armani. In Shenyang, tenants include Omega and Cartier. The Jinan mall is 86 percent let, Hang Lung Managing Director Philip Chen said at the company’s Jan. 26 earnings announcement, declining to give tenants’ details.

‘Never Again’

Hang Lung’s decision to avoid residential real estate in the world’s most populous nation as housing prices surged may be paying off. With China’s government trying to cool home prices that climbed for a 19th month in December, analysts including Hong-based Eva Lee at Macquarie Securities Ltd. prefer Hang Lung for its relative immunity to potential house price declines.
China has approved property tax trials in Shanghai and the western city of Chongqing and raised the minimum down payment for second-home purchases.
“We tried one small apartment project and after that I said never again,” Chan said. “The taxes are high and mainland officials are mindful about residential prices because it impacts ordinary people’s livelihood. But would they care about how much I’m charging international banks and high-end fashion brands?”
Investors are betting the answer is no: Hang Lung’s shares have gained as much as 200 percent from the trough during the global credit crisis. They are trading at about 16 times 2010 earnings, the highest among Hong Kong’s 20 biggest developers, and 1.5 times book value, the third highest, according to data compiled by Bloomberg.
Unsold Apartments
Hang Lung is seeking to buy more sites in China, Chan said, declining to give details. The company in November raised HK$10.9 billion selling shares, bringing its cash and near cash to HK$24.6 billion, according to the earnings on Jan. 26.
The company has about 1,500 unsold apartments in Hong Kong with an estimated value of about HK$20 billion, according to Samsung Securities’ Lee. Chan said Hang Lung will gradually offload the apartments in stock to fund its mainland expansion.
“We expect to see them start to sell more properties in 2011 and early 2012 to lock in the very high margins on their apartments and recycle capital into their mainland developments,” said Andrew Lawrence, a Hong Kong-based analyst at Barclays Capital.
Chan, who has an MBA from the University of Southern California, lived in the U.S. for a decade and running the family’s business in California when his father died in 1986. He took over from his uncle, who held the chairmanship on an interim basis after the elder Chan’s death.

‘Big Picture’

“When I first took over, our management looked at trivial items like how much a chair or a pen cost, but rarely at the big picture,” said Chan, a former director of Enron Corp. “They didn’t even want to go out and meet investors. So when I said we had to go into mainland China, many of them, of course, were apprehensive.”
Today, his transformation of the company is nearly complete: Hang Lung hasn’t bought any land in Hong Kong for at least 10 years. Hong Kong’s home prices have gained more than 55 percent over the past two years, prompting the government to impose measures to curb the surge.
“I won’t say we’re through with Hong Kong cause you can never say never,” said Chan. “But why would we invest here if our projects in mainland China are giving us nearly 30 percent unleveraged return? For me to start buying in Hong Kong again, things will have to get pretty ugly. I’m not sure I want to see that happening.”