Evergrande, which focuses primarily on second tier cities, is expected to deliver strong earnings growth over the next few years after an aggressive accumulation of land in the past 18 months, but based on the pricing terms it appears the company realises that this may not be enough in the current market environment.
ôIt will have to come cheap,ö one source said during the pre-marketing, acknowledging the fact that Chinese property stocks arenÆt exactly the most favoured sector at the moment.
The indicative terms announced yesterday suggest the company and its three bookrunners, Credit Suisse Goldman Sachs and Merrill Lynch, have taken such feedback to heart. Certainly, the terms appear to be designed to make sure investors give the offering a closer look.
The price range has been set between HK$3.50 and HK$5.60, which will allow the company to raise between HK$10.4 billion and HK$16.6 billion ($1.3 billion to $2.1 billion). The range is quite wide, which suggests the leads want to retain as much flexibility as possible should the market and the closest comps move rapidly in either direction during the bookbuild. It also values the company at a significant discount to its peers.
According to a source, the price indicates a discount of 46% to 65% versus the companyÆs estimated net asset value, or at a 2008 price-to-earnings multiple of 5.8 to 9.3 times, based on average syndicate forecasts.
While valuations for individual developers vary quite a lot, 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 35/40% 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, which is the only developer with a larger land bank than Evergrande, trades at a discount of about 15% to NAV and at a 2008 P/E multiple of around 15.
However, the earnings expectations for Evergrande include quite a few assumptions with regard to average selling prices and how much of its completed properties it will actually be able to sell, which means investors may come up with entirely different valuations after doing their own modelling.
If priced at the top end, Evergrande could become the third largest IPO globally this year after CRCC and IndiaÆs Reliance Power and the second largest Hong Kong property IPO after the Link Real Estate Investment Trust, which raised $2.8 billion in November 2005. If the 15% greenshoe is also used in full, Evergrande could raise a maximum of $2.4 billion. If the price is fixed at the bottom of the range, the IPO will also rank behind those of Soho China, Country Garden and Sino-Ocean Land, according to Dealogic data.
The large valuation discount may be a trade-off so that Evergrande would be able to sell a slightly larger portion of the company through the IPO. Having initially said it would sell at least 2 billion primary shares, it has now decided to offer 2.85 billion. In addition, there are a small number of secondary shares (110.9 million) on offer by Credit Suisse and a company called Xin Xin that is wholly owned by Chairman Hui Ka Yan, bringing the total number of shares up for grabs to 2.96 billion, which will account for about 20.8% of the company.
The chairman is selling only enough shares to meet an obligation to make an extra interest rate payment to the providers of a loan taken out in August last year, while Credit Suisse is cashing in on warrants it received in connection with that same loan. 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, will not be selling any shares in the IPO.
The company has signed up no cornerstones for the offering, which may indicate that it is confident of receiving enough interest through the bookbuild. However, given the still-difficult market environment, the lack of pre-agreed commitments is more likely to be a reflection of the fact that investors are becoming less keen to participate in this manner. While cornerstones get a guaranteed allocation, they are typically also prohibited from selling shares in the company for six to 12 months, which can be a risky move if you expect the market to fall further.
Having begun operations in Guangzhou in 1996, Evergrande currently owns 45.8 million sqm of development land (measured by gross floor area) in 22 cities. This 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.
Importantly the listing candidate is also planning to ramp up its production this year with syndicate analysts projecting the completion volume to increase to about 7.5 million sqm of saleable gross floor area (GFA) in 2008 from only 400,000 sqm in 2007. This should result in a massive boost to the bottom line, they say. The analysts estimates a net income of Rmb7.5 billion to Rmb8 billion ($1 billion-$1.1 billion) this year, versus Rmb1.1 billion in 2007.
Such an aggressive ramp-up obviously brings quite 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 that are affecting the entire Chinese property sector. So far, the company 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 in particular, have earned some credibility by being able secure a vast land bank in such a short time.
EvergrandeÆs IPO will stay open until March 18 and the final price is expected to be determined by the 20th. The trading debut is scheduled for March 28.
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