Hunger or Squid? The Game China’s Developers Are Really Playing

(Bloomberg Opinion) -- South Korea’s dystopian drama “Squid Game” is poised to become Netflix Inc.’s biggest hit ever. The destitute and desperate enter a bloody contest where they play a series of traditional children’s games with just two outcomes: death or a $40 million cash prize.

A blend of “The Hunger Games” and “Parasite,” the show has struck a nerve globally. While many see it as an exercise in class warfare, the grotesque storyline will resonate within China’s business community.

In the first game, a creepy larger-than-life sized doll commands the players to run when she shouts “green light.” Those who can’t stay still when she shouts “red light,” or those who can’t cross the finishing line in time, are killed.

This is what China’s real estate developers are playing right now. I recently wrote that the situation was like The Hunger Games. But on second thought, it’s really Squid Game.

The so-called “three red lines” that China formalized last summer were meant to rein in developer debt, giving them limits they should not cross. It was a game changer for an industry that accounts for about 15% of the nation’s economy. The edicts from on-high have been so absolute that developers can no longer profit from building residential blocks. Some cities embraced price controls. New home sales have slumped. Meanwhile, the funding channels that property developers have depended on — including day-to-day supply chain financing — have all but dried up.

China Evergrande Group, the nation’s second largest developer with more than $300 billion in debt, is at the brink of a default. Country Garden Holdings Co., the nation’s biggest home builder, has slumped 28% this year to only $22 billion market cap. In other words, if you’re a private property developer — hold still —  building residential homes is no longer for you. You’ve become a sunset industry.

Like humans, businesses have survival instincts. A company wants to be able to pay bills and earn profits. And in this age of the three red lines that companies can’t cross,  the only “green light” developers are now getting is in the property management business. Builders now want to become building managers. And the top players can’t diversify fast enough.

Selling new homes isn’t the right look this summer, now that President Xi Jinping’s “common prosperity” has instilled a politically-required socialist woke-ness. The higher prices that developers need to make money are seen as a burden on the middle class — and the main reason that exacerbates wealth disparity in China. Property management, on the other hand, is still politically acceptable. No one in China has complained about rising services fees. Yet.

This explains a flurry of acquisition deals in the management space, and the lack of in project developments — not even at fire sale prices. Country Garden has been an active buyer of services, and Evergrande might just be able to offload its management subsidiary soon to pick up much needed cash.

They are onto something. In the first half of the year, the 12 publicly listed property management companies tracked by CLSA reported a 70% rise in core earnings from 12 months before. Country Garden Service Holdings Co, the market leader, is up 15% this year. Trading at 36 times 2021 earning, it now boasts a higher market cap than its parent’s core development unit, which is valued at just four times earnings. 

That’s all good for now. But “Red Light, Green Light” is only the first of six games in the Korean drama. There will be harsher tugs of war, fitful alliances and melodramatic betrayals. As the drama intensifies, the show throws out a simple question: “Who are you?” Conglomerates changing their natures in the middle of China’s current business crisis probably are asking themselves the same thing. Are the policy makers resetting the playing field for a profitable and stable future? Or are they just watching — with Machiavellian cruelty — who survives and who does not?

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Shuli Ren is a Bloomberg Opinion columnist covering Asian markets. She previously wrote on markets for Barron's, following a career as an investment banker, and is a CFA charterholder.

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