China Overseas Land and Investment announced a restructuring this week, moving to focus on top-tier cities as analysts increasingly fret about a property bubble on the mainland.
The company, one of the biggest state-owned property developers in China, announced after trading hours on Wednesday that it was selling some of its assets to a 38%-owned subsidiary, China Overseas Grand Oceans Group (COGO).
The restructuring will allow the company to focus more on tier one and tier two cities, which have a better growth and return prospect. But it should also cut the company’s net gearing by 1%, according to a Bank of America Merrill Lynch’s analyst estimate.
The total sale price is Rmb11 billion, funded with Rmb3.52 billion of cash and a shareholder loan of Rmb7.65 billion.
The deal appears to offer something to both parties. COLI gets to trim its portfolio amid rising fears about prices. But for that reason, COGO appears to have got a bargain-basement deal — it bought the property portfolio at a whopping 49% discount to market value of Rmb20 billion.
Get off my property
China’s property market is booming, but some analysts fear it is booming too much. The number of property sales in the country increased by 38% in the first eight months of 2016, according to the National Bureau of Statistics. The sales area grew by 25%.
But at the same time, non-performing loans and so-called special mention loans are rising. In other words, some companies and consumers are already starting to struggle, and banks may not be far behind them.
“The property frenzy is a serious issue,” wrote ANZ analysts in a note this week. “Household balance sheet and collateral will worsen if real estate price adjusts downwards sharply. Commodity prices would tumble and industrial profits would decline. It could turn out to be a global macro event.”
The Chinese government has already started to make moves to deflate the bubble. Many cities have tightened their property purchase restrictions and increased mortgage requirements.
In this context, COLI’s move came as little surprise to investors.
“In order to pre-position for the rocky road ahead, COLI has made a wise move to dispose of its lower-tier cities assets before it’s too late,” said a China property portfolio manager based in Shanghai. “Due to tight supply, tier-one cities are highly resilient especially in economic downturn.”
Still, analysts think the deal works out for COGO, too. One analyst called it a “win-win” for the two companies.
For COGO, the property portfolio is expected to contribute around Rmb75 billion of saleable volume, which is equivalent to 3.5 times of its contracted sales in 2016, according to an analyst at Huatai Financial.
Indeed, COGO's stock price rose 3.5% on the Wednesday open. COLI's stock price was roughly inline with the market.
The asset portfolio consists of residential projects in 10 tier three cities including Yangzhou, Huizhan, Huangshan, Weifang, Zibo, Jiujiang and Shantou.
The total disposed gross floor area is 9.52 million square metres, at various development stages. It represents 16% of COLI’s total development portfolio and 28% of the total development assets COLI acquired from CITIC and its parent in 2015 and 2016.
The acquisition is a substantial connected party transaction and is subject to independent shareholders’ approval at the EGM.
The interest rate of the shareholders’ loan is not disclosed. But analysts are estimating the rate to be 4-6% per annum.
The financial adviser for COGO is DBS.