TheChek News Flow

Company previously wanted to take its Hengda Real Estate subsidiary public

China Evergrande Group, EGRNF 3.13% the heavily indebted property developer, has scrapped plans to list a key unit after striking deals with co-investors that should avert a near-term cash crunch.

However, after abandoning the plan to take its Hengda Real Estate subsidiary public, Evergrande still needs to find ways to cut its borrowings so that it isn’t in breach of official red lines on property-industry debt, analysts said.

Evergrande was China’s largest property developer by contracted sales last year and is Asia’s largest junk-bond borrower. The heavily indebted company is known for unconventional financial tactics and for venturing into other business lines like electric vehicles.

Evergrande first proposed listing Hengda on the mainland in 2016. It raised 130 billion yuan, equivalent to $19.7 billion, by selling a little more than a third of Hengda to strategic investors and was on the hook to repay those investors if the unit wasn’t public by January 2021.

It has waited years for approval of the backdoor listing, via a merger with the publicly traded Shenzhen Special Economic Zone Real Estate and Properties (Group) Co., as China has made it harder for property developers to raise funds.

Evergrande’s shares and bonds sold off steeply in September after documents circulating online appeared to show it requesting urgent approval for the deal. Evergrande said those documents were fake.

Late Sunday, Evergrande said it dropped the backdoor listing plan. Investors holding 122 billion yuan of Hengda stock—or nearly 94% of the total outside shareholdings—had either already agreed to hold on to their stakes and not demand a buyback, or would enter “supplemental agreements” to this effect soon, the company said. It said it would buy back 3 billion yuan worth of shares and is still negotiating over 5 billion yuan more.

Leif Chang, an analyst at Nomura, said the termination of the listing plan was no surprise after a four year wait and progress with strategic investors was better than expected.

“The latest progress reassured the market that Evergrande might be off the hook for now,” Mr. Chang said.

Evergrande shares rose 2.3% in Hong Kong on Monday to HK$16.86 and its dollar bonds edged up in price. The stock has swung sharply in recent months and is down nearly 22% this year.

Luther Chai, an analyst and credit strategist at CreditSights in Singapore, said he remained wary about what specific terms Evergrande had agreed upon with investors to persuade them to stay on board. No terms were disclosed in the filing.

Still, he said the worst case for now was a payout of 8 billion yuan, which would be small compared with its cash on hand.

“So it looks [like] a fairly good resolution to what happened in the past two months,” he said.

Mr. Chai’s team estimates Evergrande may need to refinance some 263 billion yuan worth of short-term debt by the end of the year, mainly from maturing bonds and trust loans. That means Evergrande needs funding of about 58 billion yuan in excess of its cash, which totaled 205 billion yuan at the end of June.

Likewise, Chuanyi Zhou, a credit analyst at research firm Lucror Analytics, said there was little clarity on how long outside investors would retain their stakes, or the financial terms Evergrande had agreed upon in order to strike the deal. An Evergrande spokesperson didn’t comment beyond the company’s release.

Ms. Zhou said Evergrande had other ways to cut its debt. These included listing its property management arm in Hong Kong, selling stakes in its electric-vehicle business to strategic investors or via a Shanghai second listing and boosting home sales through additional price cuts, she said.

Japanese conglomerate’s Vision Funds posted big investment gains

TOKYO—Technology investor SoftBank Group Corp. 9984 5.37% logged a profit of more than $6 billion in the July-September quarter, driven by rising share prices for some of its portfolio companies.

The strong performance continues a remarkable comeback for the Japanese conglomerate—best known for its $100 billion Vision Fund—as well as its mercurial Chief Executive Masayoshi Son. Half a year ago, he said that dud investments and tanking stock prices amid the coronavirus pandemic had pushed the company into a $9 billion annual loss at the end of March, its worst ever.

In the six months ended Sept. 30, SoftBank booked an investment gain of ¥2 trillion, equivalent to $19 billion, including ¥1.3 trillion from improved performance at the Vision Fund as well as its more modest successor, Vision Fund 2.

For the July-September quarter, net profit came to ¥627.5 billion, or $6.1 billion. In the July-September quarter a year ago, SoftBank logged a $6.4 billion net loss. That was caused in part by writing down the value of its investment in office-share firm WeWork, which Mr. Son described as a lapse of judgment on his part.

One star performer this past quarter has been Chinese online real-estate broker Beike Zhaofang, a Vision Fund 2 investment whose share price has shot up since it went public in New York in August. SoftBank said it had booked paper gains of ¥537 billion on the investment.

SoftBank has been the sole funder for Vision Fund 2, after an attempt to attract outside investors flopped last year. Mr. Son has said the search for outside investors could continue once the Vision Funds’ track records improve.

Those investment returns are all the more important since SoftBank in recent months has turned itself into a purely investment-driven conglomerate. It merged Sprint Corp. of the U.S. into T-Mobile US Inc. and reduced its stake in its Japanese mobile-phone unit to less than half.

Since March, SoftBank has also been implementing one of the world’s most aggressive asset-sale and share-repurchase programs, signing more than $90 billion in deals—including a September agreement to sell U.K. chip designer Arm Holdings, to U.S. chip maker Nvidia Corp. for up to $40 billion. And it has bought back around $11 billion of its own stock so far.

SoftBank’s shares have soared, rising 5.4% on Monday to ¥7,083, equivalent to $68.49. That is more than double the stock price’s March low.

SoftBank has said it plans to buy back roughly $12 billion more in shares, and earmark a similar amount to repurchase debt and bolster its cash holdings. That still leaves the company with potentially tens of billions of dollars in surplus cash to spend.

Investors expressed concern after news came out in September that a new SoftBank asset-management arm overseen by Mr. Son himself invested billions of dollars into publicly listed tech stocks such as Alphabet Inc. and Amazon.com Inc. The new arm spent billions of dollars on options derivatives tied to some of those stocks as well.

The news pushed down SoftBank’s share price as much as 7% at the time, and left some investors wondering if Mr. Son was deviating from his long practice of taking early stakes in innovative technology startups.

In recent weeks, Mr. Son has countered such concerns in public speeches, talking about SoftBank’s latest investments in young tech companies that he believes have the potential to shake up their industries.

With international travel on pause, China’s domestic e-commerce market is one of luxury’s largest growth opportunities. Now, a new alliance is redrawing the battlefield.

SHANGHAI, China — In China’s highly competitive and hugely lucrative e-commerce market, tech giant Alibaba and luxury titan Richemont have historically been pitted against Farfetch, a far smaller company with major backing from Alibaba arch-rivals JD.com and Tencent.

Last week Alibaba and Richemont announced plans to pour around $1 billion into the e-commerce marketplace and establish a new China-focused joint venture.

The tie-up represents a major shakeup in China’s e-commerce ecosystem and an unlikely realignment in luxury alliances. Farfetch has long been linked to Alibaba’s chief e-commerce competitors, Tencent and JD.com (also one of the company’s largest shareholders). Meanwhile, Richemont owns Farfetch rival Yoox Net-a-Porter, which runs its China business via a joint venture between Richemont and Alibaba.

The deal illustrates how the pandemic is redrawing the luxury landscape and reinforcing China’s importance as the world’s largest market for both e-commerce and luxury.

"This agreement is very meaningful for the luxury e-commerce landscape as you are basically moving from a very fragmented approach to one where an undisputed leader has emerged," said Erwan Rambourg, author of Future Luxe: What's Ahead for the Business of Luxury.

Even before the global health crisis, Chinese consumers represented 35 percent of luxury spending, but much of their shopping took place abroad. With the collapse of international travel this year, that demand is shifting to the mainland and creating a fresh imperative for luxury brands to tap into the market. Farfetch pegs the value of that market at $70 billion, a hugely lucrative prize.

The deal illustrates how the pandemic is redrawing the luxury landscape.

“We believe that digital channels will take the lion's share of this $70 billion latent demand, given how vast China is and how underdeveloped the physical store networks are in China for most luxury brands,” said Farfetch Chief Executive José Neves.

There’s also huge potential for further growth. At present, just 3 percent of luxury fashion sales in China take place online, Mike Hu Alibaba Group vice president and general manager of its Tmall for Luxury, Fashion and Fast Moving Consumer Goods, told a Shanghai event in September. But that could hit 15 percent within a few years, he said.

For luxury brands, growth will likely be driven by young consumers in China’s lower-tier cities, where it’s unusual to find a Louis Vuitton or Gucci flagship at the local mall. Over 50 percent of luxury consumers in China live in cities that are second-tier or lower, but they have limited access to luxury western brands’ store networks, according to a report by the Boston Consulting Group and Tencent.

“As we always say in the industry, whoever owns the young generation in luxury owns the future,” Judy Liu, Fafetch’s managing director for Greater China, told analysts last week.

However, it hasn’t been easy for luxury brands or international multi-brand retail platforms to make e-commerce work in China in spite of the clear opportunity. The landscape is dominated by Alibaba and JD.com and crowded by smaller competitors, leaving luxury brands unable to attract Chinese netizens to standalone e-commerce sites. On the other hand, luxury has long been wary of joining forces with China’s tech giants. Their e-commerce platforms were thought to be a poor partner for luxury, in part because they sold such mass market merchandise, but also because of the prevalence of fakes.

In 2017, as Alibaba and JD.com both pivoted to luxury by launching specific luxury flagship store avenues for brands, this attitude started to change, but it wasn’t until the pandemic forced stores across China to close that a critical mass of luxury brands decided to join forces with one or more of China’s major platforms.

If there is one company that can really scale up Farfetch in China, it’s Alibaba.

Still, so far partnership efforts have had muted success. Richemont and Alibaba’s joint venture focused on Net-a-Porter launched almost exactly a year ago on Alibaba’s core luxury platform Tmall Luxury Pavilion. It brought with it 130 brands that sell through its shop-in-shop flagship, but neither company have provided details on its performance.

Meanwhile, Farfetch said its 18-month-old storefront on JD.com “did not ramp up as we expected.” The venture will close as part of its new partnership with Richemont and Alibaba. Instead, Farfetch will open shops on Tmall Luxury Pavilion, its luxury outlet platform Luxury Soho and its cross-border marketplace Tmall Global.

Under the terms of the new deal, Alibaba and Richemont have invested $300 million each directly in Farfetch, plus $250 million each in a new joint venture, Farfetch China. They’ll own a combined 25 percent stake in the unit, with the option to acquire another 24 percent. The deal nets Farfetch the support of China’s most powerful e-commerce player, with 751 million active consumers.

“If there is one company that can really scale up Farfetch in China, it’s Alibaba,” said Patrice Nordey, a Shanghai-based managing partner at digital agency Fabernovel. "Have JD.com and Tencent helped Farfetch explode in China? Not that much. They have nice growth, but they haven’t exploded. It’s kind of normal, strategically, for Farfetch to look in the other direction to see if Alibaba can do better,” he said.

For Alibaba, backing Farfetch is another bet on luxury e-commerce. The tech giant has ambitions to capitalise on the opportunity to entice more luxury brands to its e-commerce platforms during the pandemic. One of Tmall’s aims for the coming year is to attract significantly more independent and niche brands to its platforms, Tmall’s Hu said in a recent interview. This job will be made much easier via a Farfetch storefront on the Luxury Pavilion, as Farfetch have already done the legwork in recruiting thousands of these brands.

It remains unclear how Alibaba and Richemont will balance their joint ventures with direct competitors Farfetch and YNAP. To be sure, their business models differ: YNAP operates a majority wholesale business known for its brand and curation, while Farfetch operates a marketplace model that connects luxury brands, boutiques and customers, and offers a wider product selection.

"Farfetch and YNAP will continue to have a separate approach and also carry different brands so both will hopefully get a boost from the set up and the incremental investments, with FarFetch also offering advice and tech solutions as a key complimentary service," Rambourg explained.

Richemont Chairman Johann Rupert said he was attracted by Farfetch’s strength in technology, but remains committed to YNAP.

The deal also ratchets up the pressure on JD.com, underlining Alibaba’s dominance in China’s e-commerce sphere. But the platform remains in the game, and Farfetch wasn’t the real centrepiece of its luxury strategy.

The deal also ratchets up the pressure on JD.com.

Like Tmall, JD.com has signed numerous new luxury fashion names to open flagships on its platform in the wake of China’s initial coronavirus outbreak. It now boasts names as diverse as Delvaux, By Far and A-Cold-Wall. The company also benefits from its market position selling expensive branded products (mainly electronics and household appliances) to a large swath of China’s lower tier cities, a market position that may make it more attractive to luxury brands.

“Luxury has been growing very, very strongly this year for us,” President of International Business at JD Fashion, Kevin Jiang, recently told BoF.

What Tencent’s next move in relation to Farfetch will be is unclear. Earlier this year, the internet giant added another $125 million investment to Farfetch coffers, along with another $125 million from San Francisco-based Dragoneer Investment Group, with the express purpose of accelerating the platform’s growth in China.

Farfetch said it will retain its relationships with Tencent via its presence on WeChat, where it works with 90 luxury brands via its subsidiary, the marketing firm Curiosity China. Neves said the platform remains key to building brand awareness in China.

Exactly how the deal will play out remains to be seen, but it reframes one of the most important landscapes in luxury and signals wider ambitions for the parties involved.

“Our mission is to be the global platform for the luxury industry,” Neves told analysts on Friday. The deal is “a global partnership, which extends beyond China.”

Growing income and wealth inequality have allowed European luxury brands to raise prices at about double the rate of other consumer goods categories. But some brands are better positioned to hike prices than others, writes Luca Solca.

Prices of European luxury goods increase at about two times the broader consumer price index (CPI), which measures changes to the price of a standard basket of consumer goods and services. This is confirmed by both analyses of specific product SKUs over 40 years as well as analyses of broad-based baskets of luxury goods and services, such as the Cost of Living Extremely Well Index produced by Forbes. While the broader CPI grew at around 3 percent CAGR over the past 40 years, the Cost of Living Extremely Well Index increased at 5 percent annually.

Luxury price inflation has been underpinned by growing income and wealth inequality. Over the same 40-year period, the net worth of the Forbes 400 grew by 10 percent annually, far faster than the CPI. And, following this trend, the prices of iconic luxury products — such as Hermès’ Birkin and Kelly handbags, Gucci’s Horsebit loafers, Louis Vuitton’s Speedy bag, Chanel’s 2.55 handbag and Rolex’s Submariner watch — increased by approximately 5 to 7 percent annually.

This would appear to be good news for luxury brands. But luxury’s pricing power must be taken with a huge pinch of salt. Some brands are better positioned to hike prices than others, and not all luxury price hikes are great news.

To be sure, strong brands can support faster price increases. Our analyses indicate that the brands with the strongest organic growth can increase prices the fastest, driving EBIT margin expansion. Gucci, Louis Vuitton and Moncler are recent examples. But excessive price increases can lead to significant damage. Here, Richemont offers a cautionary case, surfing on gifting one day, cutting prices the next. Its Cartier brand still seems to be atoning for its excesses in the early years of the century and has had one of the weakest price dynamics in recent years, at least in watches.

At an advantage are brands with untapped price increase reservoirs. They have high consumer desirability and strong organic growth momentum and have implemented only restrained price increases in the recent past, meaning they have unrealised pricing upside. On the other side of the spectrum are labels that have increased prices too fast, ahead of brand desirability, and may be forced to face painful downward price corrections that eventually damage brand equity.

How to tell the weak from the strong?

One way is to compare a brand’s price increases to the resale value of its products. Hermès, for example, has exercised remarkable restraint and has chosen to increase prices much less than it could have. Rolex, too. The fact that you have long waiting lists to get a Daytona or a Birkin — and a situation where demand far outweighs supply — signals very significant untapped price increase reservoirs.

The China Pricing Gap

The gap in prices between luxury goods sold in Europe and those sold in key markets like China and the US has moderately reduced on average between 2016 and 2020. But foreign exchange fluctuation explains much of the perceived cross-regional price convergence. When we calculate price increases in euros, price inflation in Europe, the US and China looks similar.

Here, soft luxury brands are split into two groups: those that have continued to increase prices in China faster than in Europe (Louis Vuitton, Hermès, Burberry, Saint Laurent) and those that have increased prices in Europe faster than in China to close the gap (Gucci, Tiffany, Dior, Bulgari, Prada).

Interestingly, soft luxury brands with the strongest consumer traction in most recent years — Gucci, Louis Vuitton, Dior — are also the brands that maintain the biggest price gaps between China and Europe. Again, the law of supply and demand seems to be at work here, too.

For years, the Chinese government had pressured luxury goods companies to reduce the price difference between their products sold in China and Europe, so as to encourage repatriation of Chinese luxury spend made abroad to the Mainland.

In 2019, the Chinese bought luxury goods outside of the Mainland worth about €70 billion, or about 70 percent of their total €100 billion spend on luxury products. But Covid-19 has changed the game and, in 2020, Chinese consumers have done virtually 100 percent of their luxury purchasing at home, with their total spend around or above 2019 levels in the third quarter of the year.

Chinese authorities seem keen to try and maintain this situation and have amended duty free regulations accordingly. Thus far, Chinese appetite for luxury has far proven stronger than cross-regional price gaps.

The private equity firm will pour €56 million into the Swedish footwear-turned-lifestyle label after its online sales soared during the pandemic.

PARIS, France — Eurazeo Brands, the multinational investment firm’s consumer arm, is making its first pandemic-era fashion bet: on sneakers.

The group has agreed to pay Swedish footwear label Axel Arigato €56 million ($65.5 million at current exchange rates) for a majority stake in the business. Founders Albin Johansson and Max Svärdh will continue to operate the brand — which generates upwards of $40 million annually in sales of its trendy colour-block footwear, streetwear and other accessories — and remain shareholders.

The deal marks Eurazeo Brands’ first investment in a European company. Since its establishment in 2017, the firm has backed a mix of companies in the fashion, beauty and lifestyle space, including Pat McGrath Labs, Bandier and Herschel Supply Co. (This year, it has focused on the food and beverage category, with investments in Waterloo Sparkling Water and Dewey’s Bakery.)

Founded in 2014 in Göteborg, Axel Arigato’s online sales have soared during the pandemic. The company responded to the crisis swiftly, changing the way it communicated with customers and leveraging powerful social channels to replace in-store events.

“We started to talk to the customers in a different way that was more uplifting,” Svärdh said. “More acting as a friend rather than a company.”

The company also began investing in TikTok. While it’s amassed just 15,000 followers, the hashtag #AxelArigato has been used nearly 16 million times. Some of its posts — mostly filmed in-store, by a host hired specifically for the gig — have generated almost one million views. Johansson compared the TikTok account to a television channel.

They also took a more customer-centric view to design, launching the sportier “Genesis Vintage” runner in April, now the number-one seller in the shoe category.

Almost 70 percent of the company’s sales come from direct retail, mostly online. From the period between May 1, 2020 and October 31, 2020, e-commerce doubled year-over-year, and was up 185 percent between August and October. The company’s largest online market, the United Kingdom, was up 129 percent.

Laurent Droin, managing director of Eurazeo Brands in Paris, liked that Axel Arigato reflected the long-term consumer trend to dress more casually, not just the pandemic-era desire for extreme comfort. “These are not only sneakers that you wear on Sunday morning,” he said.

Axel Arigato has been profitable since the end of 2018, and the founders said they didn’t need to raise money to hit their future sales goals. (For 2020, sales are projected to be up 60 percent year-over-year.) However, more cash will allow them to expand rapidly online and offline. While the focus will be on Europe in 2021, they plan to expand further into the Middle East and North America with an eye on opening physical retail stores in those regions, as well as regional offices, in the not-so-distant future. They are also looking to Eurazeo to advise on corporate social responsibility. The company is committed to a “360-degree” approach to sustainability, “from the floor material in our store to the packaging to the product itself,” Svärdh said.

As for Eurazeo, Droin said the firm hopes to represent a happy medium between hands-off and “interventionist” investors, providing strategic support where needed. “We’re not the private equity grey suit, nor are we the guy who is on their back every day,” he said. “We want to add value.”