After Spending More Than 5 Billion Yuan, Evergrande Is Selling Its Water Business: How Did a Hit Become a Burden?

Three years, more than 5 billion yuan — how did Evergrande Spring end up here?

"We will spare no cost to make Evergrande Spring a great consumer-goods brand. Success is the only option. Failure is not."

Hui Ka Yan, chairman of Evergrande Group, was full of confidence back then. He did spare no cost. But the upshot is that Evergrande will no longer have a consumer-goods brand at all.

On September 28, the Hong Kong-listed Evergrande Group announced that, in order to concentrate on its core property business, it would sell off three units — mineral water, dairy, and grain and oil — for a combined 2.7 billion yuan. Three Shenzhen companies will take over the businesses and the debts that come with them.

If the deal closes, Evergrande expects a gain of 5.7 billion yuan, and a return to being a property company that grows mainly by selling homes.

Over the past few years Evergrande has pushed what it calls "diversified development," throwing off one sideline after another: sports, cultural industries, consumer goods. The group now holds at least 16 listed companies and two more quoted on the NEEQ over-the-counter board. In Hui Ka Yan's earlier plan, the water, dairy, and grain-and-oil sidelines were each supposed to list in Hong Kong too.

And now? Cutting the losses fast is what matters. Take the water business. The group stopped breaking it out in its financial reports after the first half of 2015, but the figures it did disclose over the three years before that add up to losses of nearly 4 billion yuan. That is before counting the 5.54 billion yuan already spent on plants, sales channels, and advertising.

Hui Ka Yan has probably worked out that selling homes, and only homes, is now the fastest way to lift Evergrande's market value. In the first half of this year the property arm sold 140 billion yuan worth of housing, and the company has since raised its full-year target to 300 billion yuan — level with Vanke, the industry leader.

So how did this property man, so skilled at financial engineering, talk himself into charging at a consumer-goods business he knew nothing about? And why did it take him so long to decide to get out?

Let's start with that bottle of Evergrande Spring.

Every Evergrande fan, every Evergrande homeowner, would surely buy Evergrande Spring. Wouldn't they?

To call the debut of Evergrande Spring a spectacle would be no exaggeration at all.

At the AFC Champions League final on November 9, 2013, the prime advertising space on the chest of the Evergrande jersey changed overnight from Dongfeng Nissan to Evergrande Spring. Five-second Evergrande Spring commercials ran again and again in the breaks of the television broadcast. And when Guangzhou Evergrande lifted the trophy, the Evergrande Spring logo was on the backdrop behind the celebrations.

The next day the product line was formally unveiled: a spring in the Changbai Mountains, aimed at "affluent city dwellers," 3.8 yuan for a 350-milliliter bottle.

According to a report in Time Weekly, Hui Ka Yan first raised the idea of a mineral water business in April 2013, at a chance meeting with Bayin Chaolu, governor of Jilin province. From that first meeting to the launch, Evergrande took only about six months to settle on a water source, buy a local plant, assemble an operating team, and design the brand — and to catch the perfect shop window of the Champions League final.

Water was not the exception. Dairy, grain and oil, then finance, the internet, healthcare — nearly all of Evergrande's diversification moved at that speed over the past three years. Each new business was meant to become a fresh source of income for a property operation that devours capital.

"Diversified development is absolutely not a stopgap for us. It is a long-term, wide-ranging, fundamental strategy. The new industries and new projects we enter must eventually reach annual sales in the tens of billions, even above 100 billion yuan. Only then does our diversification mean anything, and only then does it serve the true purpose of strategic development," Hui Ka Yan once said.

That meant every new business Evergrande picked had to sit in a market big enough to hold it, and had to sell nearly as well as Evergrande's property arm, or better. It sounded like a fantasy.

The first sales targets Hui Ka Yan set for Evergrande Spring, for instance, were 10 billion yuan in 2014 and 30 billion yuan in 2016 — the equivalent of building a second Chinese bottled water market alongside the one that already existed.

In an earlier series on the consumer-goods industry, we looked at how unsettled that market has become in China: the internet wrecked sales systems that brands had spent decades building, practically overnight; big brands lost their grip on distributors, who stopped pushing their products. For fast-moving consumer goods, the channel — getting the product onto the shelf — is everything.

Evergrande's public line was that the Evergrande brand itself could create a "third channel," beyond the supermarket and the e-commerce site.

Hui Ka Yan never used the phrase "third channel" himself, of course. But in his picture of it, Evergrande's sales offices, already spread across the country, could serve as direct-sales outlets, and the water business could be bolted onto the property business as part of community services, delivered straight to residents' doors.

Evergrande's developments, in other words, ought to be an ideal way to reach the end consumer, and Evergrande's homeowners ought, in theory, to be Evergrande Spring's customers.

The football fans were an even bigger prize. Evergrande's club is the most magnetic part of the brand today, and the team's run of good results had produced a core of loyal supporters willing to spend on merchandise of every kind.

If you can sell them the jersey, why not sell them the water too, bundled or on its own?

Evergrande could have taken an easier and faster route to the money — licensing the brand, or contract manufacturing. Instead it chose to build the whole system itself, end to end, using its old property sales force plus people poached from Evian, 5100, Kunlun Mountain and other premium water companies. Within months it had an operating team of more than 1,000 people across 31 regions.

The likeliest explanation is that Hui Ka Yan was genuinely confident about the "channels" and the "consumers" he believed Evergrande Spring already had.

The fabled 5 billion yuan: where did it actually go?

Like nearly every premium water on the market, Evergrande Spring's advertising sold the water itself: "What we carry is not surface water. It is a 30-million-year-old deep volcanic mineral spring from the primeval forest of the Changbai Mountains."

In practice, though, the Changbai Mountains are a well-established source, and the big brands already there had long since pushed the cost of building and extracting down. Time Weekly quoted industry figures saying that a local plant with annual capacity of 100,000 tons takes around 100 million yuan in total — land, equipment, working capital included. Evergrande bought existing plants and upgraded their lines, so its two larger facilities cost only 200 to 300 million yuan between them.

The rest of the money went on advertising. By Hui Ka Yan's own account at the 2013 Evergrande Spring national distributors' conference, the company spent 1.3 billion yuan on the promotional blitz during the launch window alone, from November 9 to 30 that year, to make the brand "a household name." "When Evergrande advertises, we never think about the money."

The promotional playbook was the standard one for consumer goods, with television carrying 70% of the weight. Over six months in 2014 the brand signed four endorsers in a row: Jackie Chan, Fan Bingbing, Kim Soo-hyun, and Jun Ji-hyun.

Saturation advertising plus expensive celebrities is one of Evergrande's habitual tactics in property. Add a discount and it had repeatedly sent sales shooting up at housing projects around the country, setting off buying frenzies.

But a product like bottled water still has to travel through channels to reach a consumer before anyone buys it, and the "direct-sales outlets" and "consumers" in Hui Ka Yan's head were only a small corner of that system. So Evergrande ended up on the ordinary consumer-goods road after all: stock the shelves, build the channels.

It had never worked in the industry before, but in the early days it was clearly willing to pay for distribution.

On one side, it hired from other consumer-goods companies at two to three times the going rate. At the launch the company was full of former Wahaha, C'estbon and Master Kong staff. Zhang Hua, Evergrande Spring's marketing director, came from Nongfu Spring.

On the other, soon after the advertising broke, Evergrande called a national distributors' conference and parceled out the sales quotas. By the company's own earlier account, Evergrande Spring took orders averaging 200 million yuan a day over 30 days, and distributors across the country signed for more than 5.7 billion yuan of sales — a strong opening.

Evergrande also left the distributors plenty of room. A distributor who once ran the Harbin market for Evergrande Spring wrote on Zhihu that a bottle retailing at 3.5 yuan cost the distributor 2.68 yuan; that the staff who stocked the stores drew a base salary of more than 4,000 yuan after tax and called on 30 shops a day; that the company paid for free display stacks in supermarkets and free signboards for small shops, on top of a sizable budget for shelf-entry fees. "It would be hard not to get the stock out."

Yet by May 2015 Evergrande Spring's total sales revenue was just 1.287 billion yuan. Set against 5.54 billion yuan of upfront spending, that is one yuan back for every three yuan out.

Evergrande Spring entered a market with real promise — and even got there early

The timing of the entry was, in fact, good.

Around 2013 China's drinking water market was on the rise. AC Nielsen data put the market's average growth in 2014 at 32%: 11% to 12% at the low end, 46% to 50% for premium water. And with health on everyone's mind those two years, bottled water was growing faster than categories like carbonated drinks.

Over the long run, then, Evergrande Spring walked into a growing market. More important, it walked into a segment that was still close to empty.

The bottled water market of the time fell into two groups. Below 2 yuan were the purified and spring waters — China Resources C'estbon, Nongfu Spring, Wahaha. Above them, Kunlun Mountain started at around 5 yuan, 5100 Tibet Glacier Mineral Water retailed at 8 yuan, and at the tip of the price pyramid sat imports such as Evian and VOSS, which only a tiny minority could afford.

In the 2-to-5-yuan band where Evergrande Spring landed, there were only two real rivals: Ganten, the Baisuishan brand, at 2.5 yuan, and Kunlun Mountain at 4.8 yuan. In today's fashionable phrase, this was demand for "consumption upgrade."

Ganten and Kunlun Mountain had both arrived in the market a little earlier than Evergrande Spring, at roughly the same time as each other. But until Evergrande started spending on advertising, you hardly ever saw an ad for either of them. The exact dates are hard to check now; what is certain is that Evergrande's money bought Evergrande Spring a loud noise and drew far more attention to the whole segment.

A year later the same price band suddenly filled up with 5100, Arxan, Water Cube, Wahaha's oxygenated water and others, none of them shy about advertising. By the time Nongfu Spring came to develop three premium waters of its own, it had to compete on design.

As the competition tightened, price was the bluntest way to fight for share. In 2015 Evergrande Spring cut prices nationwide, bringing both the 350-milliliter and 500-milliliter bottles down to 2.5 yuan.

Which meant it now had to fight the very brands it had set out to avoid — Wahaha, Nestlé, Nongfu Spring — every one of them with deeper brand history and more loyal drinkers. And Evergrande Spring's own customers had been handed a reason to defect.

Evergrande Spring also still draws from a single source in the Changbai Mountains, which caps its capacity and makes shipping bottled water to the rest of the country expensive. Industry people say that to sell in Shanghai, the sensible price would be above 4 yuan. Evergrande Spring plainly has not earned that premium.

The positioning wasn't wrong, the timing wasn't wrong — but selling water is not selling houses

Bulky and heavy: ask anyone in the consumer-goods business and most will tell you water may be the most punishing category of all. And consumer goods is a thin-margin trade to begin with. The two things that decide it are marketing and channels — one keeps producing the impressions that trigger an impulse buy, the other puts the product within arm's reach.

Evergrande looked able to do both. The trouble is that thin margins mean scale is what finally produces a profit. The usual answer is a deep product portfolio, pushing as many products as possible down a single channel — P&G, the industry leader, is the model. In drinks alone, Coca-Cola has more than 20 products worldwide with annual sales above US$100 million each, and Wahaha and Nongfu Spring keep adding products too. All of it rests on a fully built system, and all of them spent years building it.

Now back to Evergrande's core business, and its most profitable one: property. That business is fundamentally about acquiring land. The competition and the market it talks about do not actually take place in front of the end consumer, and every surge in housing prices has been bound up with policy.

In the first half of this year Evergrande spent nearly 80 billion yuan on 80 land parcels across the country, more than any other developer. Eighty-four percent of that land is in first- and second-tier cities.

Having turned back toward those cities, Evergrande's sales in the first half climbed to a new high: more than half of its 141.78 billion yuan in sales came from second-tier cities, and the company's total assets, now close to 1 trillion yuan, are the largest in the country.

Against that, a consumer-goods business worth less than 3 billion yuan looks optional at best. Shedding it in a housing market this hot only makes more sense.

Over three years, Evergrande Spring can be filed as a "phenomenon" — a breakout hit, in a way. If Hui Ka Yan's 5 billion yuan of wasted money taught business anything, it is probably this: having "users" does not mean you can sell them anything. However low the bar to entry looks, every industry has walls of its own.

(Reporter Li Lirong also contributed to this article.)

Cover image from shepleyspring.co.uk