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Navigating China’s Property Market

A rebound in the Chinese property sector, spurred by the post-COVID reopening and government support, was short lived, and the prospect of a broad recovery…

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A rebound in the Chinese property sector, spurred by the post-COVID reopening and government support, was short lived, and the prospect of a broad recovery in 2023 seems unlikely due to high leverage and excess housing stock in lower-tier cities. As a result, investing in the Chinese property bond market is challenging.

But we see light at the end of the tunnel. Although the opportunity set has narrowed significantly, with more than half of developers we cover in deep distress (some facing default), we expect surviving developers to be less levered and more cautious about their future development, resulting in a healthier investment environment.

In this two-part series, we’ll take an in-depth look at the Chinese property market, first explaining how we got here, then delving into the outlook.

How Did We Get Here?

Credit-driven growth and speculative behavior in the property market led to tightening measures from Chinese policymakers. Specifically, in August 2020 the government implemented what it called the “Three Red Lines.” This policy imposed specific limits and requirements on property developers’ borrowing capacity in an effort to contain leverage growth in the sector.

Concurrently, the People’s Bank of China (PBOC) and China Banking and Insurance Regulatory Commission (CBIRC) established an upper limit to the ratio of mortgage and property loans in relation to the total outstanding loans for banks. Other tightening measures included limitations on bond quotas and access to escrow accounts, adding to the pressure on the sector.

The developer business model also contributed to the downturn in the industry. Property developers relied heavily on presale financing, using buyer deposits for future projects (including new land acquisitions, which were then used as collateral for further borrowing). Developers also used creative forms of credit, including securitized loans and borrowing from trust and other shadow banking financial institutions, as the chart below shows.

Notably, property developers also focused on new starts relative to completions, as the chart below shows. This lack of progress in project deliveries—aggravated by tighter financing conditions—would later spark the mortgage-payment boycotts that took place in 2022.

Meanwhile, heightened restrictions in mortgage lending and buyers’ disinterest in real estate during the zero-COVID period resulted in a decline in demand. This decline, coupled with funding constraints, triggered a profound liquidity squeeze, ultimately leading to a record number of debt defaults. As of June 2023, of the 45 developers we monitor, more than 20 have defaulted on their offshore bonds, representing 38% of the 2021 sales market share of developers in our coverage.

The surge in defaults, the underwhelming recovery prospects for the sector, and the lack of visibility in policy support have eroded market confidence. Even three years after the downfall of the sector, last-12-month sales through June 2023 were 16% lower and real-estate investments were 14% lower year-over-year.

The sector’s leverage has also shown little improvement. While property loans as a percentage of total bank loans have decreased to 24% after reaching a peak of 29% in 2019, as the chart below illustrates, the sector’s leverage has shown little improvement.

The estimated debt of the developers we track remained at RMB 5.1 trillion as of fiscal year 2022, only marginally lower than the peak. As the chart below shows, these developers’ ratio of liabilities to assets stands at 83%, higher than two years ago.

How Has the Chinese Property Market Changed Since 2020?

The varying responses and changing behaviors from Chinese regulators, property developers, home buyers, and financial market investors over the past few years have combined to reshape the Chinese property market in several ways.

First, there has been a fundamental shift in the government’s approach to stimulus.

During previous broad economic downturns in 2009, 2012, and 2015-16, the Chinese government used the usual tactics of credit expansion and investment spending to stimulate the economy.

However, the Xi Jinping era of Chinese growth, which emphasizes common prosperity and reconsolidation of power, led to several changes. These include 1) a regulatory clampdown on excesses, such as overpowering tech sectors and imbalanced educational opportunities from private institutions; 2) a demotion of the real-estate sector to a secondary growth engine; 3) a moderation of infrastructure spending due to over-construction; and 4) the transformation of the

Chinese growth model (which is now led primarily by the consumption, services, and manufacturing sectors, and new economies such as digital, technology, and renewables), as shown in the chart below.

When it comes to Chinese property, policies are aimed at stabilizing the sector by ensuring completion of ongoing projects rather than enabling unrestrained levered growth.

Second, a change in business models has affected local governments.

The business model for most Chinese property companies tended to focus on growing their land bank with rapid (sometimes excessive) construction. This led to high leverage. Now, developers are ditching their land-bank-expansion business models, instead prioritizing the completion of existing projects to unlock cash previously restricted in escrow accounts.

This changing strategy has exposed the extent to which local governments rely on land sales to developers for fiscal revenues. With land sales down 23% year-over-year as of fiscal year 2022 (see chart below), local governments are now resorting to lower (but stable) local tax revenues and higher transfer payments from the central governments to bridge fiscal shortfalls.

But fears have now emerged about the sustainability of local government financing vehicle (LGFV) debt issued over the past decade. Fiscal health is significantly impaired by the property sector downfall and changing business model of property developers—and is hitting low-income, geographically unprivileged local governments particularly hard.

Third, recoveries have differed by region.

Given its vast size, China naturally has structural, demographic, and economic differences between regions. This has led to an uneven recovery in the property sector at a provincial level. For example, during the recent downturn, tier 1 cities (such as Beijing and Tianjin in the north), tier 2 cities, and the eastern provinces in general, whose local economies are dominated by the services sector, have shown strong resilience to both price pressures and volume adjustments.

Conversely, tier 3 and tier 4 cities and landlocked provinces in central and western regions, which are mostly populated by lower-income households, fared much worse in sales and price adjustments given already high inventory levels, as shown below. Tier 3 and lower cities are also less economically diversified because their local economies are mainly driven by the manufacturing sector.

Fourth, trends in urbanization have changed.

Urbanization used to be the main driver of Chinese property sales growth. However, it appears that the urbanization rate is plateauing at a national average of 65%, with the 2022 urbanization rate growing less than 1% year-over-year in the last two years.

This view is also supported by an International Monetary Fund (IMF) study[1] that estimates the urbanization rate in tier 1 and tier 2 cities has already reached 90% and 80%, respectively. Tier 3 cities, however, still lag, with an urbanization rate of less than 60%.

The PBOC aims to lift the national average urbanization rate to 75% over the next decade to be more on par with developed markets, suggesting there could be incentives for the government to provide more support to homebuyers in lower-tier cities.

This will be a daunting task for the government: Not only must a major destocking process take place in lower-tier cities first, but weakening demographics (such as the first population decline in years in 2022) and high youth unemployment are also casting a shadow over the long-term growth prospects of the sector.

Coming Up

Stay tuned for part 2 of this series, in which we discuss China’s efforts to revive its property market and explain what we think is the way forward. Or, get that information now in our white paper.

Anezina Mytilinaiou, CFA, is a corporate credit analyst on William Blair’s emerging markets debt (EMD) team.

Clifford Lau is a portfolio manager on William Blair’s emerging markets debt (EMD) team.

Want more insights on the economy and investment landscape? Subscribe to our blog.

[1] Rogoff, Kenneth, and Yuanchen Yang. 2022. “A Tale of Tier 3 Cities.” IMF Working Paper 2022/196, International Monetary Fund, Washington, D.C.

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Four burning questions about the future of the $16.5B Novo-Catalent deal

To build or to buy? That’s a classic question for pharma boardrooms, and Novo Nordisk is going with both.
Beyond spending billions of dollars to expand…

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To build or to buy? That’s a classic question for pharma boardrooms, and Novo Nordisk is going with both.

Beyond spending billions of dollars to expand its own production capacity for its weight loss drugs, the Danish drugmaker said Monday it will pay $11 billion to acquire three manufacturing plants from Catalent. It’s part of a broader $16.5 billion deal with Novo Holdings, the investment arm of the pharma’s parent group, which agreed to acquire the contract manufacturer and take it private.

It’s a big deal for all parties, with potential ripple effects across the biotech ecosystem. Here’s a look at some of the most pressing questions to watch after Monday’s announcement.

Why did Novo do this?

Novo Holdings isn’t the most obvious buyer for Catalent, particularly after last year’s on-and-off M&A interest from the serial acquirer Danaher. But the deal could benefit both Novo Holdings and Novo Nordisk.

Novo Nordisk’s biggest challenge has been simply making enough of the weight loss drug Wegovy and diabetes therapy Ozempic. On last week’s earnings call, Novo Nordisk CEO Lars Fruergaard Jørgensen said the company isn’t constrained by capital in its efforts to boost manufacturing. Rather, the main challenge is the limited amount of capabilities out there, he said.

“Most pharmaceutical companies in the world would be shopping among the same manufacturers,” he said. “There’s not an unlimited amount of machinery and people to build it.”

While Novo was already one of Catalent’s major customers, the manufacturer has been hamstrung by its own balance sheet. With roughly $5 billion in debt on its books, it’s had to juggle paying down debt with sufficiently investing in its facilities. That’s been particularly challenging in keeping pace with soaring demand for GLP-1 drugs.

Novo, on the other hand, has the balance sheet to funnel as much money as needed into the plants in Italy, Belgium, and Indiana. It’s also struggled to make enough of its popular GLP-1 drugs to meet their soaring demand, with documented shortages of both Ozempic and Wegovy.

The impact won’t be immediate. The parties expect the deal to close near the end of 2024. Novo Nordisk said it expects the three new sites to “gradually increase Novo Nordisk’s filling capacity from 2026 and onwards.”

As for the rest of Catalent — nearly 50 other sites employing thousands of workers — Novo Holdings will take control. The group previously acquired Altasciences in 2021 and Ritedose in 2022, so the Catalent deal builds on a core investing interest in biopharma services, Novo Holdings CEO Kasim Kutay told Endpoints News.

Kasim Kutay

When asked about possible site closures or layoffs, Kutay said the team hasn’t thought about that.

“That’s not our track record. Our track record is to invest in quality businesses and help them grow,” he said. “There’s always stuff to do with any asset you own, but we haven’t bought this company to do some of the stuff you’re talking about.”

What does it mean for Catalent’s customers? 

Until the deal closes, Catalent will operate as a standalone business. After it closes, Novo Nordisk said it will honor its customer obligations at the three sites, a spokesperson said. But they didn’t answer a question about what happens when those contracts expire.

The wrinkle is the long-term future of the three plants that Novo Nordisk is paying for. Those sites don’t exclusively pump out Wegovy, but that could be the logical long-term aim for the Danish drugmaker.

The ideal scenario is that pricing and timelines remain the same for customers, said Nicole Paulk, CEO of the gene therapy startup Siren Biotechnology.

Nicole Paulk

“The name of the group that you’re going to send your check to is now going to be Novo Holdings instead of Catalent, but otherwise everything remains the same,” Paulk told Endpoints. “That’s the best-case scenario.”

In a worst case, Paulk said she feared the new owners could wind up closing sites or laying off Catalent groups. That could create some uncertainty for customers looking for a long-term manufacturing partner.

Are shareholders and regulators happy? 

The pandemic was a wild ride for Catalent’s stock, with shares surging from about $40 to $140 and then crashing back to earth. The $63.50 share price for the takeover is a happy ending depending on the investor.

On that point, the investing giant Elliott Investment Management is satisfied. Marc Steinberg, a partner at Elliott, called the agreement “an outstanding outcome” that “clearly maximizes value for Catalent stockholders” in a statement.

Elliott helped kick off a strategic review last August that culminated in the sale agreement. Compared to Catalent’s stock price before that review started, the deal pays a nearly 40% premium.

Alessandro Maselli

But this is hardly a victory lap for CEO Alessandro Maselli, who took over in July 2022 when Catalent’s stock price was north of $100. Novo’s takeover is a tacit acknowledgment that Maselli could never fully right the ship, as operational problems plagued the company throughout 2023 while it was limited by its debt.

Additional regulatory filings in the next few weeks could give insight into just how competitive the sale process was. William Blair analysts said they don’t expect a competing bidder “given the organic investments already being pursued at other leading CDMOs and the breadth and scale of Catalent’s operations.”

The Blair analysts also noted the companies likely “expect to spend some time educating relevant government agencies” about the deal, given the lengthy closing timeline. Given Novo Nordisk’s ascent — it’s now one of Europe’s most valuable companies — paired with the limited number of large contract manufacturers, antitrust regulators could be interested in taking a close look.

Are Catalent’s problems finally a thing of the past?

Catalent ran into a mix of financial and operational problems over the past year that played no small part in attracting the interest of an activist like Elliott.

Now with a deal in place, how quickly can Novo rectify those problems? Some of the challenges were driven by the demands of being a publicly traded company, like failing to meet investors’ revenue expectations or even filing earnings reports on time.

But Catalent also struggled with its business at times, with a range of manufacturing delays, inspection reports and occasionally writing down acquisitions that didn’t pan out. Novo’s deep pockets will go a long way to a turnaround, but only the future will tell if all these issues are fixed.

Kutay said his team is excited by the opportunity and was satisfied with the due diligence it did on the company.

“We believe we’re buying a strong company with a good management team and good prospects,” Kutay said. “If that wasn’t the case, I don’t think we’d be here.”

Amber Tong and Reynald Castañeda contributed reporting.

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Petrina Kamya, Ph.D., Head of AI Platforms at Insilico Medicine, presents at BIO CEO & Investor Conference

Petrina Kamya, PhD, Head of AI Platforms and President of Insilico Medicine Canada, will present at the BIO CEO & Investor Conference happening Feb….

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Petrina Kamya, PhD, Head of AI Platforms and President of Insilico Medicine Canada, will present at the BIO CEO & Investor Conference happening Feb. 26-27 at the New York Marriott Marquis in New York City. Dr. Kamya will speak as part of the panel “AI within Biopharma: Separating Value from Hype,” on Feb. 27, 1pm ET along with Michael Nally, CEO of Generate: Biomedicines and Liz Schwarzbach, PhD, CBO of BigHat Biosciences.

Credit: Insilico Medicine

Petrina Kamya, PhD, Head of AI Platforms and President of Insilico Medicine Canada, will present at the BIO CEO & Investor Conference happening Feb. 26-27 at the New York Marriott Marquis in New York City. Dr. Kamya will speak as part of the panel “AI within Biopharma: Separating Value from Hype,” on Feb. 27, 1pm ET along with Michael Nally, CEO of Generate: Biomedicines and Liz Schwarzbach, PhD, CBO of BigHat Biosciences.

The session will look at how the latest artificial intelligence (AI) tools – including generative AI and large language models – are currently being used to advance the discovery and design of new drugs, and which technologies are still in development. 

The BIO CEO & Investor Conference brings together over 1,000 attendees and more than 700 companies across industry and institutional investment to discuss the future investment landscape of biotechnology. Sessions focus on topics such as therapeutic advancements, market outlook, and policy priorities.

Insilico Medicine is a leading, clinical stage AI-driven drug discovery company that has raised over $400m in investments since it was founded in 2014. Dr. Kamya leads the development of the Company’s end-to-end generative AI platform, Pharma.AI from Insilico’s AI R&D Center in Montreal. Using modern machine learning techniques in the context of chemistry and biology, the platform has driven the discovery and design of 30+ new therapies, with five in clinical stages – for cancer, fibrosis, inflammatory bowel disease (IBD), and COVID-19. The Company’s lead drug, for the chronic, rare lung condition idiopathic pulmonary fibrosis, is the first AI-designed drug for an AI-discovered target to reach Phase II clinical trials with patients. Nine of the top 20 pharmaceutical companies have used Insilico’s AI platform to advance their programs, and the Company has a number of major strategic licensing deals around its AI-designed therapeutic assets, including with Sanofi, Exelixis and Menarini. 

 

About Insilico Medicine

Insilico Medicine, a global clinical stage biotechnology company powered by generative AI, is connecting biology, chemistry, and clinical trials analysis using next-generation AI systems. The company has developed AI platforms that utilize deep generative models, reinforcement learning, transformers, and other modern machine learning techniques for novel target discovery and the generation of novel molecular structures with desired properties. Insilico Medicine is developing breakthrough solutions to discover and develop innovative drugs for cancer, fibrosis, immunity, central nervous system diseases, infectious diseases, autoimmune diseases, and aging-related diseases. www.insilico.com 


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Another country is getting ready to launch a visa for digital nomads

Early reports are saying Japan will soon have a digital nomad visa for high-earning foreigners.

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Over the last decade, the explosion of remote work that came as a result of improved technology and the pandemic has allowed an increasing number of people to become digital nomads. 

When looked at more broadly as anyone not required to come into a fixed office but instead moves between different locations such as the home and the coffee shop, the latest estimate shows that there were more than 35 million such workers in the world by the end of 2023 while over half of those come from the United States.

Related: There is a new list of cities that are best for digital nomads

While remote work has also allowed many to move to cheaper places and travel around the world while still bringing in income, working outside of one's home country requires either dual citizenship or work authorization — the global shift toward remote work has pushed many countries to launch specific digital nomad visas to boost their economies and bring in new residents.

Japan is a very popular destination for U.S. tourists. 

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This popular vacation destination will soon have a nomad visa

Spain, Portugal, Indonesia, Malaysia, Costa Rica, Brazil, Latvia and Malta are some of the countries currently offering specific visas for foreigners who want to live there while bringing in income from abroad.

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With the exception of a few, Asian countries generally have stricter immigration laws and were much slower to launch these types of visas that some of the countries with weaker economies had as far back as 2015. As first reported by the Japan Times, the country's Immigration Services Agency ended up making the leap toward a visa for those who can earn more than ¥10 million ($68,300 USD) with income from another country.

The Japanese government has not yet worked out the specifics of how long the visa will be valid for or how much it will cost — public comment on the proposal is being accepted throughout next week. 

That said, early reports say the visa will be shorter than the typical digital nomad option that allows foreigners to live in a country for several years. The visa will reportedly be valid for six months or slightly longer but still no more than a year — along with the ability to work, this allows some to stay beyond the 90-day tourist period typically afforded to those from countries with visa-free agreements.

'Not be given a residence card of residence certificate'

While one will be able to reapply for the visa after the time runs out, this can only be done by exiting the country and being away for six months before coming back again — becoming a permanent resident on the pathway to citizenship is an entirely different process with much more strict requirements.

"Those living in Japan with the digital nomad visa will not be given a residence card or a residence certificate, which provide access to certain government benefits," reports the news outlet. "The visa cannot be renewed and must be reapplied for, with this only possible six months after leaving the countr

The visa will reportedly start in March and also allow holders to bring their spouses and families with them. To start using the visa, holders will also need to purchase private health insurance from their home country while taxes on any money one earns will also need to be paid through one's home country.

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