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EJ - Devil is always in details 3

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money8 May 11, 2012 (Chinavestor) From the previous article, Devil is always in details, we can see E-House Holdings (NYSE:EJ) has been losing money four quarters in a row in 2011. In the 2011 annual report, E-House reported a net loss of $465 million. Compared with the net income of $ 48.7 million in 2010, $117.4 million in 2009 and $39.5 million in 2008, this loss looks really terrible in the history records.

 

So what’s wrong with E-House (NYSE:EJ)? Will this result continue in 2012?

First let’s examine some key income statement items again.

EJ_20120511_1

From the chart we can see the terrible loss was mainly due to a sharp decrease of net income in the third quarter in 2011. As analysed before, that decrease was mainly because E-House recognized a goodwill impairment loss of $ 417,822,000. The loss contributed more than 98% of the final loss. The impairment loss was due to a 31% decline in stock price of China Real Estate Information Corporation (NASDAQ: CRIC). Now E-House has merged CRIC and CRIC ADSs will delist on NASDAQ once deregistration becomes effective. It seems a goodwill impairment loss will be unlikely to happen in 2012.

Taking out this effect, the fluctuation of profit margin was not very obvious. To further see how E-House’s operating results deteriorated in the past four quarters, we take a look at the revenue, operating income and operating margin.

EJ_20120511_2


Operating income and operating margin changed from positive numbers to negative numbers from the beginning of last four quarters. This was mainly due to surging cost of revenue and SG&A expenses.

Cost of revenues was $163.0 million in 2011. There was 56% increase from $104.8 million for 2010, mainly because of: 1. Higher wage expenses for added sales staff in the primary real estate agency service segment. 2. Adding of the property promotional event began from the quarter two of 2010. 3. Additional expenditures related to amortization of capitalized payments paid for Baidu’s Brand Link product, which CRIC began to offer in August 2011.

The increasing cost was mainly devoted to strengthening sales force and bringing revenue up. These efforts were not in vain. From the graph we can see revenue in 2011 was generally quite good considering harsh external environment in Chinese property industry.

Now the question is will E-House continue this revenue growth in 2012?

To answer the question, let’s observe some data first.

According to China Real Estate Index System, in April, the residential property index in ten major cities in China continued downward trend, with a decrease of 0.34% and an enlarged spread of 3% compared to last year.

The real estate transaction volume was decreased in 70% of the major observing cities in China. In some cities, such Chengdu, Chongqing and Shenzhen, the decrease is as high as 30%.

It can be seen that accumulate effects of harsh policies will continue to put high pressure to residential housing transaction volume and price. E-House is deemed to suffer a lot from the bear outlook.

Apart from transaction volume and price, another important factor that affects revenue is commission rate.

EJ_20120511_3


Usually commission rate is positively correlated with sales revenue. Higher the transaction volume and value, higher the bonus commissions being recognised upon achieving specified sales target. However, reality is not always the same. From the graph we can see, primary agency service revenue has increased from 2008 to 2011. However, average commission rate ran the other way round. It dropped from 2.8% in 2008 to 0.9% in 2011, almost reaching average industrial level. E-House is losing advantage in commission rate. Combined with the pessimistic expectation of transaction volume and price, we can hardly expect commission rate to grow in the short term.

In total, E-House has ended up its high growth period and entered into stable growth stage in its primary agency service segment. To gain sustainable growth rate, E-House need to make changes in business pattern and find a new profit driver. In April 25, E-House announced the completion of merger with China Real Estate Information Corporation (NASDAQ: CRIC). After the merger, E-House intends to build a new infrastructure that integrate online and offline sales and enhance online transaction capabilities. E-House will not only be the agency in the property transaction, but will also build a transaction platform itself. It seems to redefine and reshape the way real estate agency works. The increasing costs occurred in 2011 can be seen as a price of translation or a foregone of short-term profit to pursue a long-term profit.



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