KE Holdings: An Excellent Growth Candidate For Your Portfolio

Summary

• KE Holdings (BEKE) is a leading Chinese real estate service platform with a unique business model and technological advantage.
• The company is a first mover in offline to online in the $3.5 trillion Chinese real estate market (more than 6.5 times the US investment volume) and is expanding.
• This investment opportunity has a good overall upside and limited downside risks.

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Investment thesis

KE Holdings (NYSE:BEKE) is committed to building a trustworthy brand and in delivering value to customers. The company has a unique business model and a significant technological advantage over competitors. It is not unreasonable for BEKE to attain a 30% market share by 2023, as compared with only 15% in 2020. The company’s gross transaction value (GTV) grew by 50% per year in the past two years. It has a good overall upside and limited downside risks, and is expected to be profitable from 2021.

Overview

Industry context: The residential property market in China is the largest in the world, estimated at about CYN 22 trillion ($3.5 trillion) by gross transaction value) and grew by 3% year-on-year in the last year, according to CIC research consultancy in Hong Kong. Real estate digital market platform business can reach out more easily to many customers than the traditional offline business model. This is evident by the success of similar business models in other countries such as Rightmove and Zoopla in the UK. There have been attempts by other players to enter the digital domain in China but none has so far made a significant impact. Examples of other online players include Fang Holdings (SFUN) (a real estate Internet portal) and FangDD (DUO) (which connects construction developers to customers).

KE Holdings has a unique and effective business model, which integrates two previous businesses: an 18-year-old offline brokerage business “Lianjia” and a two-year old online market platform “Beike Zhaofang”. Lianjia is expanding with offices and agents in 29 cities across China. It is the first mover in technology transformation, moving from an offline to a hybrid (offline and online) business model. The company provides a winning multi-listing service for the Chinese real estate market in the form of a software as a service.

KE Holdings has several inherent advantages over its competitors. It is a veteran in real estate brokerage, and has a deep understanding of the challenges facing digital transformation in the Chinese real estate transaction market (e.g., fragmented and lack of transparency). It charges transparent but higher commission rate (3%) as compared with the industry average of about 2%, incentivising agents to cooperate and provide superior customer services. In addition, it has over the years developed the Agent Cooperation Network (ACN), which is a technologically driven network that supports the coordination and cooperation of agents. Through information technology, big data and internet platform, BEKE and its agents can effectively reach out to customers across the country. It also has a strong network of more than 120,000 agents (as of 2019).

KE Holdings had an IPO in August 2019 at $20 per share with a market cap of $23 billion. It is currently trading at just over $60 per share with a market cap of over $71 billion. It is expected to generate profit from 2021.

Valuation of KE Holdings

Two valuations models were developed to evaluate BEKE, one based on a ten-year discounted cashflow (DCF) projection (see figure 1 and table 1) and the second method based on a comparative valuation of price multiple (see table 3 and 4). It is assumed that the growth in BEKE’s share price would be proportion to its growth in sales/revenues. The target price is determined by the comparison valuation method, which is a better fit (at $90 per share by end of 2021). This is because the fundamental DCF valuation does not take into account BEKE's high growth potential associated with contribution from its networks of internal and external agents.

Fair value (DCF valuation): $48.82 per share

Figure 1. KE Holdings: Revenues and free cash flows

(Billions of CNY)

Source: Author’s calculation, with data from KE Holdings.

Table 1: KE Holdings: Fair value share price

	Value	Calculations / Source
Discount Rate (cost of equity)	8.82%	Risk free rate + (levered Beta x equity risk premium)
Perpetual Growth Rate	3.0%	Chinese real-estate industry growth rate By CIC Research Consultancy in Hong Kong
Risk Free Rate	1.87%	5-year average long-term US bond
Equity Risk Premium	5.8%	S&P global
Chinese Real Estate unlevered Beta	0.94	www.infrontanalytics.com
Re levered beta	1.20
PV 10 years of free cash flow	94,854.0
PV Terminal Value (Millions CNY)	183,856.2
Total Equity Value (Millions CNY)	278,710.2	= CNY 94,854.04 + CNY 183,856.19
Shares Outstanding (Millions)	883.68	Bloomberg
Equity Value Per Share (CNY)	315.40
Exchange Rate CYN/USD	6.46
Fair Value per share ($)	$48.82

Click to enlarge

Comparison valuation: $89.69 per share

Finding comparable peers for KE Holdings is difficult. A portfolio of hybrid business models was selected, which include Alibaba (BABA), Meituan (OTCPK:MPNGF), Pinduoduo (PDD), JD.com (JD), and Autohome (ATHM).

Table 3. Comparative valuation of KE Holdings and competitors

Indicator	KE Holdings	Hybrid Comparisons						Competitors
		Alibaba	Meituan	Pinduoduo	JD.com	Autohome	Average	Leju Holdings	Fang Holdings	Average
Market cap ($ Billions)	67.79	769.68	223.14	217.88	137.84	11.67		0.31	0.12
EV ($ Billions)	62.01	769.68	223.14	212.26	124.43	9.61		0.16	0.48
Trailing P/E		30.78	412.40	..	30.52	24.21	124.48	17.89	147.32	82.61
Forward P/E		31.55	102.04	303.03	37.88	19.76	98.85	9.16	12.61	10.89
P/S		9.86	15.41	1.24	1.27	8.92	7.34	0.44	0.52	0.48
EV/Revenue	6.91	4.96	17.16	4.85	0.18	1.11	7.02	0.09	2.17	1.13
EV/EBITDA	1.07	27.31	457.61	..	3.88	2.9	15.88	2.77	-11.7	-4.47

Click to enlarge

Source: Author’s model, with data from Yahoo Finance.

Table 4. KE Holdings: Target price calculation (Millions of Dollars: Unit)

		Multiple	Equity Value	EV 2021	Liabilities 2021	Price
Sales (2021E)	13,210	7.34	96,961	..	..	109.72
Revenues (2021E)	9,895	7.02	..	55,927	7,920	69.65

Click to enlarge

Source: Author’s calculation.

Based on table 4, the average target price is $89.69.

Growth drivers

BEKE has a good growth potential given its expanding business (registering about 50% growth per year by GTV) in a growing RMB 22 trillion real estate market (see table 5), with few competitors. Through “Beike Zhaofang” market platform and ACN, BEKE is able to rapidly increase its market share and became a dominant industry player. It is not unreasonable to expect BEKE to achieve a 30% market share by 2023, as compared with less than 15% market penetration in 2020. In addition, Tencent is a major backer and a principal shareholder of BEKE. It provides operation and digital support to BEKE, such as access to Tencent’s (OTCPK:TCEHY) (OTCPK:TCTZF) advertising networks and cloud services. Tencent also provides support in consumer traffic through its networks of digital platforms.

Table 5. KE Holdings: Market penetration by GTV (CYN trillions)

	KE Holdings GTV (SEC.org IPO prospectus)	China real-estate market GTV (Forbes)	Market share (%)
2017	1.01	17.0	6.0
2018	1.15	19.1	6.0
2019	2.13	20.6	10.3
2020 (estimate)	3.18	21.3	14.9

Click to enlarge

Source: Author’s calculation.

Risks

There are risks that could impact on BEKE’s business outlook. They include the following:

1. Susceptible to economic risks (low to moderate impact):The real estate market is sensitive to economic conditions. A severe or prolonged downturn in the global or Chinese economy could negatively affect the business, financial condition and operating results. A change in interest rate policy is also a factor.
2. Geographic risks (high impact):A substantial portion of BEKE’s revenue is concentrated in a few major urban areas (specifically Beijing and Shanghai). Economic downturns in these cities could affect BEKE’s revenue streams.
3. Regulations (high impact): It is uncertain if the PRC government will adopt additional measures to further curb speculation, and control the operation and financing of real estate market. In an extreme situation, the government could nationalise housing information, which could then impact on BEKE’s proprietary hosting directory and AI system.
4. Delisting (high impact - unlikely): The USA has recently signed a bill to delist foreign entities from the US exchanges that do not comply with US regulatory standards. It is unlikely that BEKE could be caught in this regulatory development as the bill targets mostly Chinese companies that are linked to the Chinese Government and are of concern to the US national security (including data security). Three Chinese companies have been targeted for delisting (i.e., State backed China Unicom (CHU), China Telecom (CHA) and China Mobile (CHL)).

Conclusion

Investors should consider buying BEKE as a long-term investment. This investment opportunity has a good overall upside and limited down side risks. The company has had an exponential growth, with further growth expected through 2021. If BEKE carries on with its current growth rate, the share price could have the potential of reaching $90 per share by end of the year.

Analyst’s Disclosure: I am/we are long BEKE. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.