Property stocks were under a lot of selling pressure in December and January, but many of them have recovered close to 50% of those losses this month, creating a slightly better environment for newcomers than in January. Back then, mid-cap developer Changsheng China Property was one of four Hong Kong listing candidates to call off their IPOs before pricing due to the volatile market environment.
Having begun operations in Guangzhou in 1996, Evergrande Real Estate Group has been expanding its land bank aggressively outside its home turf over the past 12 to 18 months with the aim of becoming a true nationwide developer. It currently sits on 45.8 million sqm of development land (measured by gross floor area) in 22 cities, which is second only to Country Garden. However, it is by far the largest land bank that any Chinese developer has sported at the time of their initial public offerings. When it came to market in April last year, Country Garden had a land bank of just under 19 million sqm.
This should give Evergrande a good base to grow from. Importantly the company is also planning to significantly ramp up its production this year with syndicate analysts projecting a completion volume of about 7.5 million sqm of saleable gross floor area (GFA) in 2008. This compares with only 400,000 sqm of completed developments in 2007 and will result in a massive boost to the bottom line. The analysts put the net income at between Rmb7.5 billion and Rmb8 billion ($1 billion-$1.1 billion) this year, versus Rmb1.1 billion in 2007.
Such explosive growth can obviously not continue, but one source says turnover is expected to increase by just over 20% in 2009. Another source says growth beyond 2008 will be ôin line with the compsö.
ôItÆs going from 10 miles an hour to 100 miles an hour this year,ö notes one source. ôItÆs an exciting story and everybody wants to hear about it.ö
Of course, being interested doesnÆt necessarily mean that they will also submit orders, although it is certainly a good start. To help their investment decisions along, Evergrande last week launched an extensive ad campaign in the local Hong Kong press û reportedly in as many as 12 papers - which introduces the company and its residential developments over multiple full-page colour advertisements. Notably, even in the English papers the ads are all in Chinese, which suggests the company is specifically targeting the local population.
Evergrande is looking to sell at least two billion new shares, which equals 15% of the company and a deal size of approximately $1.5 billion. Credit Suisse, Goldman Sachs and Merrill Lynch are the joint bookrunners. However, depending on the response during the pre-marketing, which started on Monday, the number of primary shares may be increased, according to sources. It is also likely that the companyÆs pre-IPO investors will sell at least some shares, although the degree of their participation is supposedly dependent on the price range. The existing investors included Deutsche Bank, Merrill Lynch and Temasek, which bought into the company in November 2006 through convertible preference shares that they converted into common shares in December last year.
The decision on the final deal size and valuation will be made before the formal roadshow kicks off on March 6. Because the shares owned by Deutsche Bank and Merrill Lynch will count towards the free-float, Evergrande will be able to sell just 15% of its issued share capital, compared with the usual minimum of 25% - which gives it quite a lot of flexibility with regard to the issue size.
Given the scale of the production that is planned for this year, there is a lot of execution risk in addition to the uncertainties about the general macro outlook and the possibilities for further measures to clamp down on property speculation. The earnings expectations for Evergrande also vary depending on peopleÆs assumptions on average selling prices and the actual sales of its completed properties. So far, it has completed only 11 projects, all in Guangzhou, which compares with plans for more than 40 projects to contribute to its earnings this year. Observers note, however, that the Evergrande management, and chairman Hui Ka Yan in particular, have proven their credibility by being able secure this much land in such a short time.
The valuations for the Hong Kong-listed Chinese developers vary both across the range of property companies and from analyst to analyst, which makes it difficult to pinpoint where Evergrande will come. Most analysts have nationwide player China Overseas Land & Investment (COLI) trading at only a slight discount or even a premium to its net asset value, while more regional companies like Guangzhou R&F Property, Hopson Development and Agile Property, which are all used as comparables for Evergrande, trade at discounts of between 8% and 40% to their NAV. The 2008 price-to-earnings ratios span from about 6.5 to 19 times. Again with COLI at the top of the pack. Country Garden trades at a discount of about 15% to NAV and at a 2008 P/E multiple of around 16.
Syndicate analysts estimate EvergrandeÆs current pre-money NAV at about Rmb120 billion, but depending on the final size of the IPO this could grow by another Rmb10 billion to Rmb15 billion. A research report issued by DBS suggests Evergrande deserves to trade at a 5%-35% discount to its NAV estimate of Rmb109 billion at 10-16 times its 2008 earnings, which indicates how wide the assumption ranges are.
Given the quick accumulation of land, the company has also amassed quite a bit of debt, which makes it highly leveraged to the performance of the physical property market. Based on data provided by DBS, Evergrande had a gearing of about 240% at the end of 2007, although this will fall below 80% this year as the company issues more equity through the IPO. The company will also use part of the listing proceeds to repay debt, while the rest will go towards the settlement of outstanding land premiums and to cover development costs. In case it ends up selling more than two billion shares, it may set aside some of the money for future land acquisitions, one source says.
Evergrande is primarily a residential developer with only about 2% of its NAV made up from investment properties. Its main focus is on second tier cities where the growth prospects are still strong and where the bulk of the demand comes from end home-buyers, rather than speculators, making the developers less affected by government cool-down measures. Most of its developments are also quite small in size û 80% are below 1 million sqm û which results in a quick asset turnover, typically between nine-12 months. This will have a positive impact both on its gross margins and return on assets. On that basis its current land bank should be sufficient for five to seven years, analysts estimate.
No doubt the bookrunners will be closely watching the outcome of the other two deals that are currently in the market to gauge investorsÆ willingness to commit money to new and untested companies before deciding on the final deal size and, so far, the signals are promising.
Honghua GroupÆs $481 million IPO, which enters its final day today, is said to be comfortably covered but with a fair amount of price sensitivity. The Chinese manufacturer of onshore oil and gas drill rigs is being brought to market by Credit Suisse and Morgan Stanley. China Railway Construction Corporation, which started taking orders from institutional investors for its H-share offering on Monday and will open its books to the retail public tomorrow, has also attracted a lot of interest. CRCCÆs A-share offering was priced at the top end of the indicated range earlier this week, allowing it to raise Rmb22.3 billion ($3.1 billion). Citi, Citic Securities and Macquarie Capital are the joint bookrunners for the H-share offering.
Meanwhile, Want Want, the largest rice cracker producer in China, is also currently pre-marketing and is expected to make a final decision at the end of this week whether to go ahead with its IPO of about $1 billion to $1.5 billion. Assuming it does, the formal roadshow is scheduled to kick off on Monday. BNP Paribas, Goldman Sachs and UBS are the joint bookrunners.
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