Phoenix Tree Holdings Ltd. which operates China’s co-living platform Danke Apartment, offered 9.6 million American depositary shares (ADS) at a price of $13.50 per ADS. The IPO raised about $130 million. Each ADS represents 10 Class A ordinary shares. The company’s IPO fell short on both its offering size and price. They were looking to offer 10.6 million shares in the price range of $14.50-$16.50. The ADS started trading on the New York Stock Exchange under the ticker symbol “DNK” on January 17.

The cool reception to Phoenix Tree’s IPO is not surprising. Public market investors have been wary of companies with heavy operating losses, despite strong revenue growth since the collapse of the WeWork offering. 

Founded in 2015, Phoenix Tree Holdings is one of the largest co-living platforms in China with 406,700 apartments and triple-digit sales growth in 2017, 2018 and 2019. According to their F-1 filing, in the nine months ending September 30, 2019, sales grew by 198% to $699 million, but the company had net losses of $352 million.

In the same period, net cash used in operating activities was $227 million, with capital expenditures of $223.3 million, which resulted in a negative free cash flow (FCF) of $450 million. They had $320 million of cash on hand, in September 2019. 

Huge Serviceable Addressable Market

China’s residential rental market is expected to grow at a CAGR of 10% from 2019 to 2023. The residential rental market in China’s tier 1 and tier 2 cities reached RMB1.2 trillion in 2018 and is expected to grow to RMB2.0 trillion in 2023. 

The average monthly residential rent index in China is increasing. In tier 1 and tier 2 cities, the average monthly rent is expected to increase by 42% from 2016 to 2023. However, the rental market is very fragmented and transactionally inefficient. 

Phoenix Tree operates in tier 1 and tier 2 cities. The company indicated its total serviceable addressable market is RMB 2 trillion, or approximately $289 billion according to its filing. 

Properties operated by co-living platforms only accounted for about 2% of all residential rental properties in China based on data from December 31, 2018.

Business Model Provides Solution to Inefficient Rental Market

Phoenix Tree’s mission is to provide more affordable housing for young Chinese working in large urban cities. They have two brands, the main Danke Apartment brand, and Dream Apartment, a lower-tier brand introduced in November 2018. 

For their Danke properties, they lease apartments designed for a family of three to four — the more common type of urban housing in China — and reconfigured them into smaller units that are rented out as private rooms or as entire apartments. These accommodations are more affordable for young professionals who wish to live in nicer neighborhoods. Danke provides convenience by taking care of housekeeping and maintenance.

Dream Apartment targets the large, but underserved blue-collar apartment segment. The company leases entire buildings or floors in a building, transforms them into dormitory-style apartments, and rents them to corporate clients for employee housing. 

Phoenix Tree does not own their properties. The company signs six-year contracts with property owners and one-year leases with residents. The payback period for the apartment units typically ranges from 12 to 20 months.

Currently, it operates in 13 of China’s tier 1 and tier 2 cities, but is a major player in at least 10 cities. About 53% of sales come from Beijing, Shanghai, and Shenzhen. 

The company operates 406,000 apartments, an increase of 679% since January 2018. Their occupancy rate has risen to 86% in July 2019 from 76% in January 2018. According to the company, its co-living platform accounts for 52% of the studio and one-bedroom market.

Favorable policies supporting the residential rental market

China’s rental housing market has been booming in recent years as the Chinese government wants to promote affordable apartments in a country where few have the means to buy a property. As a result, investors and entrepreneurs have been piling into the rental market and this gold rush has created unexpected risks.

Techcrunch outlined one of these risks:

One much-criticized byproduct is the development of so-called “rental loans.” It goes like this: Housing operators would obtain loans in tenants’ names from banks or other lending institutions allegedly by obscuring relevant details from contracts. So when a tenant signs an agreement that they think binds them to rents, they have in fact agreed to take on loans and their “rent” payments become monthly loan repayments.

Housing operators are keen to embrace such practices because the loans provide working capital for renovation and their pipeline of properties. On the other hand, the capital allows companies like Danke to lower deposits for cash-strapped young tenants. “There’s nothing wrong with the financial instrument itself,” suggested Shen. “The real issue is when the housing operator struggles to repay, so the key is to make sure the business is well-functioning.”

Danke, alongside competitors Ziroom and 5I5J, has drawn fire for not fully informing tenants when signing contracts. Shen said his company is actively working to increase transparency. “We will make it clear to customers that what they are signing are loans. As long as we give them enough notice, there should be little risk involved.”

Massive Opportunity, But Could There Be Cracks Ahead

There are compelling reasons why co-living in China is a massive opportunity. It alleviates pain points for both property owners and renters in a market of rising property prices. Demographic trends support this category of accommodation — the migration to urban cities and the lifestyle shifts of young professionals who are more open to private and communal spaces and who desire for design and convenience.  

However, there are signs of deceleration in Phoenix Tree’s revenue, perhaps the industry as well. Meanwhile, expenses related to rental costs, marketing, and administrative costs have risen, which resulted in a higher operating loss for their year ending September 2019, compared to a year earlier. 

In Europe, we are seeing co-living companies looking into secondary cities for growth and lower costs. Although we don’t expect this in China yet, given market penetration in tier 1 and tier 2 cities remains low.

The company has been aggressively raising funds for growth. It closed a Series C round a year ago, led by Tiger Global Management and Ant Financial, Alibaba’s financial arm. 

The company will use the IPO proceeds to source and renovate more real estate, improve their technology capabilities and increase marketing and potential acquisitions, although there is no acquisition expected in the near term according to their F-1 filing.

Phoenix Tree’s offering was led by Citigroup Inc., Credit Suisse Group AG and JPMorgan Chase & Co.


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