China's "cracked eggshell".
How Danke rose to fame and came crashing down.
大家好/ Hello everyone,
The number one goal for an up-and-coming Chinese start-up is growth at all costs. Ideally, you want to innovate and gobble up as much market share as possible before the inherent competitors pop up, or one of the big monoliths (Tencent, Alibaba & increasingly others like Bytedance) create a solution of their own. If you do well, you get a nice foothold, you get a sizable investment from Tencent/Alibaba and maybe even IPO in the Hong Kong or New York stock markets. All seems to be perfect, then comes a worldwide pandemic, you don't adapt fast enough and your wings burn from flying too close to the sun.
2020 was tough for everyone. The pandemic is still ailing many communities around the world, as well as entire industries. With that in mind, last year the rental industry and more specifically Danke 蛋壳 ("eggshell" in English) suffered badly, with the Beijing-based company creating a crisis not yet seen in the housing market.
This week I want to tell you a start-up story that, in my opinion, has a resemblance with the myth of Icarus. A company that resembles many others in China and that should serve as a lesson.
Index:
Intro;
Rise to fame;
Diving down;
The “eggshell”.
Rise to Fame
Danke Apartment 蛋壳公寓, also known as Phoenix Tree Holdings Ltd, is a 2015-founded company specialized in the management of apartments from property owners (landlords) and renting them out to residents (tenants). They also offer the design, renovation, and furnishing of those same apartment units. In a nutshell, Danke was an intermediary between landlords and tenants that would fix up apartments and aimed to add convenience to the whole process. The company went through several funding rounds and entered the New York Stock Exchange (NYSE) in 2020.
The company was touted for its solution to the housing difficulties faced in China's big cities such as Beijing, Tianjin, Shanghai. They would rent a bigger apartment and divide it further into modern, well-designed, and standardized micro-units that would then be rented by young professionals, whose aim was to live in better neighborhoods without breaking the bank. As a bonus, you could add weekly cleaning services to your package, and you would always have a brand-new and secure digital padlock.
Financial backers such as Ant Financial (Alibaba) and Tiger Global, were enticed by Danke's goal of digitizing entirely the rental housing market, and use AI-based technology to decide market prices based on demand. After 6 rounds of funding, and before its IPO, Danke had raised 874.7 million USD. These funds were used to fuel a massive expansion project. At a point, the company operated more than 415,000 apartment units in 13 cities across China.
China's property market has been a sore thumb from the government's perspective for a long time. Housing prices have been growing at an incredible rate since the '90s due to several reasons, but mostly the lack of reliable financial vehicles where individuals/families could park their money. Apartments stay vacant, or in the big cities, most rents are simply not realistically sustainable for most of China's office workers. Danke's, and others' like Ziroom, initial success was due to their aim to fight these property prices by providing an affordable solution for the young workforce that wanted to move cities.
Although Danke never turned a profit, that wasn't an issue for most investors, after all, a "digital revolution" was happening. Until Covid-19 came along...
Diving Down
To be fair, the pandemic wasn't the only issue behind Danke's fall. I will try to further divide this section in a way that tells when the Company started to have issues, why those issues were at the core of the company's business model, and how did Danke's users react to everything.
When?
Since its inception, Danke's business model had been highly dependent on outside funding.
"For the first quarter of this year, its net loss grew by 51.2% year-on-year to 1.2 billion yuan ($174.3 million), the company’s latest earnings report showed. (...) Since the second half of 2019, Danke has demanded that its landlords reduce — or completely waive for a certain period — the rent it pays, sparking an uproar."
Although the company reiterated that there is no relation with those past measures, the company's CEO, Gao Jing, was placed under investigation by local authorities in June 2020. On that day Danke's shares went down 9% and subsequent investment deals were deferred which badly hurt the company's finances.
In October 2020, reports that Danke was not paying its employees' salaries started to emerge online. The reason? The Covid-19 crisis made many tenants lose their jobs, return to their hometowns or simply led them to be too skittish about signing a rental agreement during a country-wide lockdown. The already thin-margins that the rental intermediary was dependent on were chipped away throughout the first 2 quarters of 2020 and the last drop had been "squeezed" from their finances. In that same month, debt-ridden Danke was asking the Beijing Housing Commission for help in finding a buyer to remain in operations, which did not happen. Furthermore, Beijing's city private equity arm was even rumored to be considering helping the company. These same rumors were rejected by the same institution on December 3rd. It seemed like Danke was a hot potato that no one wanted to be the last one to grab.
November was the reckoning month for the company. Tenants were being kicked out from their apartments during winter, getting their water/electricity cut, or being visited by angry landlords. Why? Danke hadn't sent the expected monthly payments to the landlords. But the interesting part is that tenants had already paid for those rents well in advance! Where did the money go?
Why?
Remember when I compared this story with the myth of Icarus? In it, the son of a master craftsman was given a set of wings made of feather and wax and was told to "fly neither too high nor too low". In the end, the character decides to fly too close to the sun, the wax melts and he falls in the sea and drowns. This story talks about the need for moderation. Danke's "wings" was the funding provided by the requirement of its tenants to pay multiple rents, which would be later on used to add more and more units to their portfolio and advance the growth of the company. Being too greedy too fast will inevitably melt your wings and drown you in the ocean of competition.
The whole conundrum was possible because Tencent-backed WeBank was Danke's financial partner. Through their rent-financing agreement, tenants would sign a lease with Danke and at the same time a rental loan contract with WeBank. The online bank would then pay a full year's rent in advance to Danke and collect the monthly payments from the tenants. This, in theory, should work as it provides a good cash flow to the company, and the opportunity to have liquidity in case push comes to shove, and there is a crisis.
Danke, though, to gain market share would:
use those advance funds to pay for refurbishing or units for future tenants;
offer higher rents to landlords than it collected from tenants i.e paying 5000 and asking for 4500 yuan per month.
WeBank also suffered from Danke's downfall as they were criticized for accepting this risky agreement that other banks would normally simply refuse. The lack of visibility of how and where Danke would use those funds was one of the factors that contributed to this issue in the first place. The risk control of the financing arm simply wasn't there.
How did the public react?
As you can probably guess, the public did not react well. Landlords and employees were mad that they were not being paid, and tenants were being harassed or worse, thrown in the streets from an apartment for which they had already sent their money. Deposits were lost, refunds not possible to make, and overall, there was a lack of communication from the company.
According to Caixin News, Danke faced around 520 million USD of unpaid debts at some point with an almost 50/50 split owed to WeBank and landlords/renters (the rest owed to contractors that worked on the units). On the Chinese business data website QCC.com there is information regarding 288 judicial cases against the rental intermediary, most of them in regards to that same debt.
After crowds were gathering in Danke's headquarters, the company had to start a complaints system. Due to the high demand from the public, the local governments stepped in and helped to organize more stations.
Housing authorities from Nanjing, a city close to Shanghai in Eastern China, ordered from December that this type of rental intermediary companies should deposit the tenants' rent payments in supervised accounts when 3 or more months were paid upfront, to avoid further chaos.
The financial markets were also not kind to the company. Since its IPO, Danke's shares fell around 75% before Christmas to the 3.31 USD mark. At the moment those same shares are 2.36 USD.
With all of this in mind, the biggest loss of all was the case of a 20-year old tenant in Guangzhou who took his life after being asked to vacate his apartment even though he had already paid for it.
The "eggshell"
On December 3rd, WeBank announced that all outstanding loans would be extended by three years. Also, the credit scores of the tenants wouldn't be affected, and the debt would be transferred to Danke, which would foot the bill. The rental intermediary company started a process of restructuring of debt and started repaying WeBank at the end of 2020. On Christmas day 2020, Danke also stopped listing properties on its app.
The chaos provoked by the company's downfall was reiterated politically. During the 2021 Two Sessions event (a political gathering preceding the announcement of a new 5-year plan), one of the Communist Youth League's heads recommended that China would address the business model of Danke - getting paid on a long-term basis and paying to landlords on a short-term basis - and aid young renters issues in terms of housing in large cities.
Chinese social media reports revealed that this month, Shanghai's Consumer Protection Commission released data showing that in 2020, more than 3,000 complaints related to long-term rental apartments were accepted, of which 1,368 were related to Danke apartment units. Danke's Weibo (a Chinese social media platform) and other public accounts are silent and both its CFO, Zhang Zheng, and one of the executives in charge of dealing with the crisis, resigned from the company.
Danke is still searching for a new buyer but without success. The local governments are slowly stepping in to help affected tenants. Now it will be up to the judicial courts and Housing commissions to deal with all the cases, which will undoubtedly take time.
The story of Danke is not yet finished, of course, but I wanted to tell it either way. This is a lesson that, even though strong expansions work in certain markets and industries, without a proper safety net, everything can go South as fast as it went up. Hopefully, regulations are made, and situations like this are avoided in the future.
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My name is Jorge and China Abridged is where I write weekly about Chinese technology and society. I have a B.A in Asian Studies with the University of Lisbon, won a scholarship from the Confucius Institute for academic excellence, and lived for 2 years in the Middle Kingdom.
For the past 4 years, I have been involved with one of the biggest fintech startups in the world and now I spend my time honing my language skills, perusing articles about 中国, and perfecting my RSS feed.
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Love it. Thanks for the research! That's also a consequence of fast growth by using VC hot money, I think, which is also a commonality in the Chinese market.