China MeiDong Auto : Letter To Shareholders

LETTER TO SHAREHOLDERS

Dear Shareholders:

We signed an SPA to acquire StarChase Motorsports Limited on December 13, 2021. At the time of this writing, we are taking over their operations. We are excited and confident because, combined with StarChase, we will be one of the largest Porsche dealership groups in China. We will work with the wonderful people at StarChase to overcome challenges during this integration phase and better serve our large customer base. Together, we will make our Porsche operations and the new Meidong better and stronger.

With StarChase and three small acquisitions earlier last year, 2021 saw, for the first time, that the store growth from M&As exceeded that from organic growth. M&As may become a significant part of our growth going forward. While we may not have as smooth a revenue growth because the timing of M&As is uncertain, we should be able to maintain or even accelerate our growth rate, judging by our sizable and ever-growing M&A pipeline.

In 2021, we continued to improve our sales, profit, and efficiency in an increasingly uncertain and challenging environment. We won't, however, dwell on these uncertainties and challenges in this letter. In fact, we talked about uncertainties in our past shareholder letters so extensively that we feel we are beating a horse long dead. Interested readers can read our letters from the past three years. Instead, we would like to focus our discussions on what we can control - how we improved our efficiency in the past and plan to do so in the future. We believe, more than ever, that making our company more efficient and healthier is the only way to deal with the roller-coaster macro environment. This year, we plan to talk about the culture we have built and the people we cherish, both of which are foundations in making efficiency a reality.

First, let us discuss the operations in 2021.

2021 SUMMARY

We had another good year in 2021. Revenue grew 16.7% to 23.58 billion RMB and profit 57.4% to 1.21 billion RMB. The gross margin of new car sales went up from 5.5% in 2020 to 6.8% and that of services up to 49.1%, resulting in a significant enhancement of overall gross margin from 10.1% to 11.8%. The growth of the new car sales margin was due to both our operational improvement and market supply shortage. Our inventory is 5.8 days, lower than 8.9 days at the end of 2020 and 8.0 days in mid-2021. Operational cash flow jumped to a new high of 2.19 billion, up 51.0% year on year. ROE and ROA both stayed at high levels of 29.5% and 12.4%, respectively. In summary, we have grown efficiently again despite numerous challenges.

LETTER TO SHAREHOLDERS

Continuing our tradition of high dividend payouts, we declared a dividend of 0.8284 RMB per share, 2.15 times the level of 2020 and representing approximately 90.0% of 2021's profit. Over the years, we simultaneously reduced our debt level and grew revenue, profit, and dividends. From 2019 to 2021, for example, we reduced our debt ratio from 70.1% to 58.0%, grew operating cash flow from 1.09 billion to 2.19 billion, and grew revenue by 45.4%, profit by 117.6%, and dividends per share by 217.4%. We believe that low debt, strong cash flow, and high ROE/ROA are key measures that reflect our company's high level of efficiency.

We put this efficiency to work in 2021 by acquiring StarChase - a company roughly 25% of our size - and will significantly grow our Porsche revenue in 2022. Over the long term, our financial capacity to acquire and grow depends on our efficiency. In recent years, by lowering debt and increasing cash, we have enhanced our company's efficiency and strength - akin to storing energy by compressing a spring. The release of this stored energy allowed us to acquire StarChase. Our future growth relies on this cycle of storing and releasing. Therefore, the key success indicator of the StarChase integration is how quickly and effectively we can improve the efficiency of the combined company. If we can successfully manage the cycle of storing (improving efficiency) and releasing (growing), we will make our company into a truly efficient one and will be able to turn market challenges into opportunities.

A CULTURE OF EFFICIENCY

If you were to do one thing and one thing only, what would you do?

I started asking this question a lot soon after I began managing Meidong. I would ask frontline employees in stores, managers in meetings, and everyone in my chat groups. At the time, my colleagues liked to be comprehensive and thorough: 23 ways to achieve customer happiness, 6 steps to be more efficient, 602 classes to train employees, etc. Brainstorms were popular, everybody opined on everything, and blackboards were filled with ideas like overflowing beer cans. People found comfort in playing both quarterback and running back in one game, as well as switching between beauty and beast at will.

So, when I demanded that people choose "one thing," and communicate this "one thing" simply and concisely, my colleagues were understandably uncomfortable. They argued that doing only one thing meant neglecting other important things. It seemed to go against common sense - even human nature. Who would go on a vacation having only booked hotels without plane tickets or rental cars? Who would invite friends to a home-cooked meal serving only BBQ pork without vegetables or bread? If we only focused on inventory turns, what about sales and profit?

LETTER TO SHAREHOLDERS

Yet, today at Meidong, "one thing" is the foundation of our communications and actions. The efficiency we have achieved - low inventory turns, high profit margin, and high ROE/ROA - stems from this relentless effort to simplify and focus. People have come to realize that solving a customer's most urgent problem is better than giving him a long checklist, that an operation is often constrained by one bottleneck, and that a particular training is probably sufficient for an employee at a time. Brainstorms and checklists can be important in enabling thoroughness and big-picture thinking, but when it comes to execution, simplifying is the key. Optimizing one important task is far more effective than being average on ten. We could have, for example, spread our energy across numerous tasks. Yet, we achieved good results by focusing solely on inventory turns, which is the best proxy for efficiency. Reducing and simplifying the checklist is often more difficult and challenging than adding to it, as reduction and simplification demand more discipline, rigorous thinking, professional judgment, and business intuition.

Our goal is to achieve the ultimate efficiency. The way to achieve that is through simplification and reduction - identifying the most important task and optimizing it to perfection.

Simplicity is the ultimate efficiency.

Simplification is the foundation for effective execution. The biggest constraint for a company is the collective bandwidth (energy, time, motivation, creativity, etc.) of its employees. An employee is limited in bandwidth and cannot possibly be good at everything, unless his last name is Jobs or Einstein, or he hails from utopia. The worst assumption a company can make is believing that an employee can work on many tasks and be good at all of them. A more rational and practical assumption is that the employee can only focus on one task and do it well. An employee spending 80% of his/her energy on a task is far more effective than one spending 20% - by magnitudes of not four times but ten or twenty times. Focusing on a single task allows the employee to accumulate knowledge quickly and to obtain feedback accurately. Good knowledge and feedback in turn enhances execution success and employee confidence. As such, how a company chooses to allocate employee time and energy is just as important as how it elects to allocate other resources like capital.

LETTER TO SHAREHOLDERS

Simplification is vital to communications as well. Information loss is natural in human communications and the loss ratio explodes as the content of communications gets complicated. We find that managers often get frustrated, saying: "I have communicated so clearly; why don't my employees understand me?" The issue often lies not in managers' communication skills or their employees' comprehension capabilities. Complicated messages without a clear focus are inherently difficult to communicate; when managers try to communicate everything, they are essentially saying nothing. We sometimes give these frustrated managers a simple test - we ask them first to look at a string of characters and/or numbers, then do 20 pushups, and then lastly recite the initial string from memory. Most of them fail. (As a reader, you can try this on your own. Ready? Here it is: 75307a2p6390837n584). These managers are not able to remember a rather simple string yet often give employees far more complicated tasks and demand 100% comprehension.

Once the most important task - the "one thing" - is identified, the best way to improve the efficiency of this task is through iteration. How to improve is often unclear or even unknown in the real world, so an iterative trial and error process is often the most, and sometimes the only, practical way. When we started CRR to enhance customer stickiness, for example, we had no idea how to improve and by how much. I proposed a method, which the team believed to be genius, and we started from there. In hindsight, my idea looks embarrassingly stupid - customer stickiness dropped, not improved. Even with such a bad start, customer stickiness a year later still went up by more than 100%. We managed to improve a little in each iterative cycle and, over time, gradually refined our approaches. This incremental refinement, coupled with rapid iteration, eventually produced big improvements. This example illustrates why iteration is robust and practical: it is less dependent on a particular idea and more on fast iterative speed. All our efficiency gains - inventory turns, cost control, M&A learnings - have come from not a single great idea but a series of ideas refined through successive iterative cycles.

In the journey of simplifying and iterating, we have learned that the best practices and ideas often come from frontline employees. They are more sensitive to customers' needs and more familiar with actual operations. They are our best teachers and the sources of innovations and creativities. Managers should be experts at discovering good ideas and should refrain from lecturing employees on this or that. In truth, however, even the two of us are not immune from the urge (or the ego) to teach and to lecture. We often find ourselves, for example, coaching frontline employees on how to sell a car or clean a toilet - the very jobs they are best at doing. Thanks to our humorous culture, our employees often listen with big smiles, cheer their "genius and mighty bosses" on, and then promptly forget everything we say, down to every comma and period.

LETTER TO SHAREHOLDERS

Simplification also means discovering and eliminating unnecessary complications. Inefficient habits and processes naturally accumulate in a company, just like fat in my belly. These things are accepted and rationalized because of their mere existence (also like my belly fat). We need to discover and remove them proactively and with discipline (still like my belly fat). Let me give an example. Tea culture is big in the 4S industry and has long been accepted as necessary, even essential. There are pretty tea sets in showrooms, beautiful ones in department managers' offices, and even more gorgeous ones in general managers' offices. Managers sit around for hours chatting, until one day, a young employee asked a simple question: "What do customers get from our managers sitting around chatting?" Today, no elaborate tea sets can be found in our offices anymore. (I have attached a note written by this employee, Lianghui. After you read it, you will probably wish that she writes all our future shareholder letters).

We are lucky to have many Lianghuis in our company. Their collective values and actions form our culture. Our culture is simple because they ask the most basic yet key questions and focus on the most important tasks. Our culture is direct because they communicate directly, even bluntly, allowing mistakes to be corrected quickly and organizational friction to be minimized. Our culture is data driven because they think independently, iterate based on data feedback, and are not easily swayed by "what others say or do". It is because of them that we can iteratively develop a culture of efficiency. Together with them, we will continue to evolve and strengthen this culture to be more efficient.

Let me end this letter by asking ourselves the question, "If we were to do one thing and one thing only, what would we do?" Colleagues often laugh at me for not knowing much about cars. That's not a big deal. Being unable to distinguish between Aston Martin and Maserati does not stand in the way of my being a bean counter, my "one thing". As for my brother, he knows cars very well. But if you give him 13 beans to count, he would have to use his toes after he ran out of fingers. So, understanding cars and the auto market is his "one thing". Outside of Meidong, he has one other thing: he likes to play chef. We can argue that he may have chosen the wrong profession. He makes the world's best BBQ pork, and

I can testify to that with my high cholesterol and belly fat.

As always, thank you for your support.

Tao & Fan Ye