Country Garden brings largest HK IPO by a Chinese developer

Hong Kong tycoons flock to the Guangdong-based residential developer which stands out because of its quick asset turnover and affordable prices.
Guangdong-based real estate developer Country Garden is currently pre-marketing what looks set to become the largest initial public offering in Hong Kong this year. At the talked-about deal size it would be more than three times China Agri-IndustriesÆ $410 million offering that tops the 2007 list so far.

It will also be the largest IPO by a Mainland property company ever, exceeding Shui On LandÆs $877 million deal (post-shoe) in September last year. Being only the second Chinese real estate company to seek a Hong Kong listing since then, Country Garden will be an interesting test of investor sentiment, coming as it does only days after China raised its benchmark interest rate for the third time in less than a year.

According to market sources, the company is looking to raise around $1.3 billion (HK$10.1 billion) by selling 15% of the company through joint bookrunners Morgan Stanley and UBS.

The smaller-than-usual free-float û the required minimum is otherwise 25% - has been approved by the stock exchange on the basis that the large deal-size will make the stock liquid enough even with 85% of the company in the hands of the controlling shareholder. The exchange normally does not grant this kind of approval unless the deal size exceeds HK$10 billion.

Sources say a portion of the deal will be set aside for financial or corporate investors, however, leaving around $800 million to $900 million to sell to other investors. None of the corporates have been disclosed so far, but most of the Hong Kong property tycoons are said to have expressed an interest. Earlier this week, Henderson Land Development chairman Lee Shau Kee told the local press that he intends to subscribe to HK$1 billion worth of shares and while this hasnÆt been confirmed, the sources say there will probably be four or five such investors who could end up buying as much as $500 million to $600 million.

ôCountry Garden isnÆt very well known by international investors, but with most of its developments just across the border in Guangdong all the Hong Kong tycoons are aware of it and want a part of it,ö one source says.

With the Pearl River Delta being home to tens of thousands of Hong Kong-owned factories more and more Hongkongers are also buying homes in this region and Country Garden does advertise its homes in the Hong Kong media.

At the low end of the talked about deal-size the company will have a market capitalisation of $8.7 billion, which will rank among the largest of the Mainland developers listed in Hong Kong.

In terms of its business, Country Garden has the fourth largest land bank among the Chinese developers behind Shanghai-listed Vanke, Agile Property and Shimao Property. Of the total 18.8 million square metres, a massive 13.3 million sqm (or 71%) is available for future developments, which puts the company in a good position to benefit if property prices continue to rise. Syndicate analysts suggest the existing land bank will sustain the company for about five years, but project it will acquire another five million sqm of land in 2007, which will extend its development horizon to eight years assuming an annual completion rate of three million sqm.

About 4.6 million sqm of the land is currently under development and the company also holds about 900,000 sqm of already completed developments that havenÆt yet been sold. More than 90% of its 27 developments are located in the Guangdong province (several in the suburban areas surrounding Guangzhou), making it one of the largest residential developer in this region.

A recent expansion outside its home turf has drawn a mixed response from analysts, who argue on the one hand that it will help sustain the companyÆs growth strategy which requires continuous acquisition of land, and on the other that it leaves it more exposed to execution risk and higher costs.

The company is a pure residential developer that specialises in the development of landscaped village-style residential hubs at the outskirts of cities that provide ample living space and natural greenery. The developments, which are targeted at middle-class home buyers, consists mainly of villas and townhouses with the addition of some low-rise apartment buildings as well as supporting infrastructure such as schools, recreational facilities, club houses and hotels.

One of the selling points of its developments is apparently its licensing agreement with McDonalds, which enables it to put the hamburger chainÆs fast-food restaurants into its building complexes.

The homes are popular with the public because the company tends to sell them at affordable prices and doesnÆt û like many other developers - deliberately withhold units in anticipation of price increases down the road. Construction is also quite quick at an average 12 months for villas and 18 months for low-rise apartments, which together with the fast selling cycle gives the company a real competitive edge.

ôCountry Garden aims at quick turnover, sometimes at the expense of sub-optimal profit margin, and efficient deployment of the cash to new products. As a result, it achieves a high return on equity while home buyers enjoy almost instant price appreciation after purchase,ö syndicate analysts note in a pre-deal report.

This, the report states, is a key reason for the companyÆs high growth rates over the past few years.

The share offer will comprise 2.4 billion new shares, with 10% earmarked for Hong Kong retail investors, plus a 15% greenshoe. As always there is a clawback mechanism that will kick in if the retail tranche is massively oversubscribed, but thanks to a second waiver from the Hong Kong Exchanges and Clearing the retail portion will be capped at a maximum 20%.

Accordingly, if the retail tranche is 15-50 times subscribed the size will increase from the initial 10% to 15%, if the subscription rate is between 50 and 100 times the size will rise to 17.5% of the total and in case it is more than 100 times covered it will go to 20%.

The price range wonÆt be determined until the launch of the official roadshow towards the end of next week, but fund managers say the valuations talked about so far suggest a flat to 20% discount to an end 2007 net asset value. Morgan Stanley estimates this NAV to be about HK$72 billion, while UBS estimates it at HK$64 billion, according to investors.

That NAV discount may seem a bit tight in comparison with Agile, which is also based in the Guangdong province and trades at a 30% discount to NAV. However, NAV-based valuations vary widely and a 20% discount would for instance put Country Garden on par with Shimao and Vanke, while a 10% discount would give it a similar valuation to China Greentown. Independent property valuer CB Richard Ellis has estimated Country GardenÆs total asset value (on a pre-money basis) at about HK$54 billion ($6.9 billion).

Given the companyÆs strong market position, strong earnings growth and quick asset turnaround it would ôprobably be reasonableö for Country Garden to trade at a small premium to NAV once the IPO discount has been erased, one banker observes.

According to investors, the two bookrunners are taking a slightly different approach in their views on the company with Morgan Stanley focused more on an NAV valuation, while UBS argues that the companyÆs quick turnaround of land and high earnings growth makes it more appropriate to value it on a P/E basis.

Investors say UBS is applying a 14 times multiple to its 2008 net profit estimates of Rmb4.9 billion to Rmb6.3 billion to come up with a fair equity value of HK$70 billion to HK$89 billion. This would rank the company above the average P/E of 10 times among the Hong Kong-listed Mainland developers, but below the current market maximum of 18 times. Agile currently trade at a forward valuation of around 13 times.

Morgan Stanley is said to be applying a PE multiple of 11-17 times 2008, but to be pushing its NAV valuation more strongly.

ôItÆs a trend for analysts to look at Chinese developers on a P/E basis, but if you do that you will have to assume that the company will be able to replenish its land bank at a decent margin,ö one sector analyst says. ôAs sales have been picking up in the past few years, this company has been able to achieve very good earnings, but the thing about property companies is that they are cyclical and there is no way to fix the margin û it can either run away or narrow very quickly.ö

Given the companyÆs focus on townhouses and villas and should be quite exposed to recent government measures to reduce the construction of this type of housing in particular. However, people familiar with the company not that these measures are primarily targeted at developments within the city centres, while Country GardenÆs developments are all located in the suburbs where land is cheaper and the authorities tend be more flexible in their interpretation of the governmentsÆ austerity measures.

Still, there is always a risk that this could change.

Country Garden is currently 70% owned by 25-year-old Yang Huiyan, who is the daughter of the companyÆs founder and present chairman,Yeung Kwok Keung. The remainder is owned by four other executive directors.

The developer could be coming to market just ahead of another sizeable IPO from China Citic Bank. The Mainland lender is expected to start marketing within the next week or two of a deal that could raise more than $2 billion. China International Capital Corp, Citic Securities, Citigroup, HSBC and Lehman Brothers are joint bookrunners.
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