Another Chinese property developer tests demand for upcoming IPO

Greentown China Holdings yesterday became the fourth Chinese property developer in short succession to seek a public listing when it started pre-marketing of a share offer of between $300 million and $400 million.

Just a few weeks ago, the developer was said to be hoping to raise at least $500 million ahead of its planned Hong Kong listing, but the sharp sell-off in global equity markets has led to higher uncertainty and forced issuers to revise down their expectations.

The initial public offering comes after Shui On Land last week shelved its planned listing - one day before the end of bookbuilding - and Yanlord Land Group cut the size of its IPO by almost 30%. Shimao Property Holdings, which is still on the road is trying to raise up to $650 million ahead of a Hong Kong listing. It has set the price range at a discount to net asset value of up to 45% in the hope of attracting sufficient demand.

Sources say Greentown, which has more than 80 projects in its portfolio, is keen to complete the share sale over the next few weeks as it would like to secure the additional cash for its ongoing and future developments. However, if the initial meetings reflect the fact that investors are still hesitant, it may decide not to launch a formal roadshow at this time, they say.

Greentown, which is being brought to market by JPMorgan and UBS, will be arguing that its focus on residential homes for mid- to high-income earners makes it an altogether different proposition from Shimao, which aside from its large-scale residential complexes also has a sizeable investment portfolio, including several hotels. Consequently, investors shouldn’t get hung up on a straight valuation comparison between the two, analysts argue.

However, a director at a local securities and asset management firm notes that Shimao has the largest land bank among the mainland developers at above 13 million square metres and it is also active in 15 cities, which means it has less concentration risk.

“Greentown doesn’t have those same features so it will have to fix the price at a more attractive level to make sure it gets enough interest,” he argues.

According to fund managers, the underwriters haven’t yet set a valuation range, but it is widely expected not to differ too much from the other Hong Kong-listed mainland developers which trade at an average 2006 PE of 10.5 times and a 2007 PE of 7.5 times after a sizeable decline in individual share prices since May 9.

Analysts argue that a valuation based on net asset value, which has been stressed by Shimao, is not that suitable for Greentown as it doesn’t have much in terms of investment properties and pre-sells most of its projects while construction is still ongoing. Instead, they will be focusing on a valuation based on future earnings multiples to capture the anticipated strong bottom line growth.

“This is a relatively straightforward equity story with the company being a leader in one of the richest provinces in China and providing great visibility on earnings,” says one observer.

Other selling points, sources say, will include the company’s sizeable land bank of 8.6 million square metres that was acquired at low cost, gross and net profit margins at the high end of industry averages and a strong brand name that is associated with quality, a green environment, social responsibility and an ethical corporate culture.

As proof of the latter, the company ranked first in a 2005 national residential homebuilding satisfaction survey conducted by the China Quality Association, the China Standardisation Research Institute and Tsinghua University.

Underpinned by China’s rapidly expanding economic growth and the massive migration from rural to urban areas, Greentown’s profit growth will be driven by a further widening of gross profit margins to beyond 40% in 2006-2008 from 35% in 2005 as its strong brand name gives it pricing power. It will also benefit from the completion of developments with a combined 3.1 million square feet of gross floor area in 2006 and 2007, observers say.

Having already locked in the bulk of its anticipated sales revenue for 2006 through pre-sales, syndicate analysts project net profit growth for 2006 will range from about 120% to 150% above last year’s Rmb623 million. For 2007 they forecast between 23% and 38% growth.

Greentown’s residential developments include villas, low-rise three to five storey apartment buildings and high-rise apartment buildings. The developments are typically equipped with facilities such as clubhouses, grocery stores, schools and sporting facilities, which is why many buyers are said to view them not only as a new home, but as a lifestyle upgrade as well.

Headquartered in Hangzhou, Greentown has most of its existing projects in this city and in Shanghai. Since 2004, it has been expanding outward, however, and over the next three years the revenue contribution from Hangzhou is expected to fall below 40% from about 90% in 2003.

The rest of the revenues will come from Zhejiang province outside Hangzhou, Shanghai, Beijing and the rest of China, which includes secondary capital cities such as Hefei in Anhui Province, Changsha in Hunan and Urumqi in the Xinjiang Uygur Autonomous Region in northwestern China.

However, the company’s focus on the high end of the market, which is precisely what the government is targeting in its efforts to reign in soaring property prices, could leave it vulnerable in the short-term.

In particular, Greentown is seen to be negatively impacted by news that the government may take back land if construction work hasn’t started two years after acquisition. The government also announced that all new housing projects began after June 1, 2006, must dedicate 70% of the total gross floor area to units that are smaller than 90 square metres.

“We believe there will be a sustainable long-term demand for residential properties, but government policies are likely to have a negative impact on near-term transaction volumes and property prices,” one syndicate analyst says. “In particular, uncertainties about implementation of these policies and the possibility of additional measures could dampen market sentiment.”

Investors are also likely to question the company’s high net gearing which partly due to a low capital base and stands above 600% at present. While expected to drop to 287% in 2006 and 155% in 2007, such high levels could stretch the company’s cashflow in case of a further tightening of lending policies. A change in pre-sale requirements could also weigh on cash flows, given that pre-sales is one of the main ways for the company to finance its future developments.

Greentown is looking to sell about 25% of the company in the form of new shares and potentially another 1% to 2% in secondary shares. As usual, 10% will be earmarked for local retail investors.

Of the total proceeds, sources say about $65 million is expected to be used to redeem the mandatory conversion tranches of a pre-IPO convertible bond issued in January. The rest of the proceeds will go towards project developments and land acquisition.

The Company’s chairman, Song Weiping, owns 52% of the group and his wife Xia Yibo holds 7%. Executive vice chairman and general manager Shou Bainian owns 39%, while Stark Investments and JPMorgan each holds 1%.

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