KWG Properties prices IPO at the top

Retail investors take half of the $582 million Chinese property IPO and cornerstones one quarter, leaving meagre pickings for institutions.
Mid-sized Chinese real estate developer KWG Properties has priced its Hong Kong initial public offering at the top end of the range for a total deal size of HK$4.55 billion ($582 million).

Demand wasnÆt quite as hot as for larger peer Country Garden, which took the market by storm when it listed in April and caused a re-rating of the entire sector, but in relation to its size û KWG is significantly smaller both in terms of market cap and land bank - this offering too proved a hit with investors. The last few days of the roadshow coincided with renewed speculation about another rate hike in China, but according to sources, this was completely overshadowed by the IPO momentum.

The optimism, they say, stemmed from the high quality of KWGÆs projects (primarily mid- to high-end residential developments), a good line-up of cornerstone investors and an attractive valuation. Being based in Guangzhou, the company will also benefit from higher growth in selling prices versus Shanghai or Beijing developer and the fact that the Guangdong capital is seeing faster economic growth than the national average.

The retail tranche was more than 225 times covered when it closed at noon on Friday, triggering an automatic claw-back that increased the size of this tranche to 50% from 10%. The institutional tranche was about 185 covered after adjusting for the clawback and deducting the 25.3% portion that went to the cornerstones. If you add in the 15% greenshoe, which has a high likelihood of getting exercised once the shares start trading, the institutional subscription ratio falls to about 115 times.

The greenshoe may increase the total deal size to $670 million.

Including high net-worth individuals, about 350 accounts came into the institutional book and there was virtually no price sensitivity, according to a source. Among the names were a good number of specialist property funds as well as the real estate arms of large global institutions.

KWG sold 25% of its enlarged share capital, or 625 million new shares, at HK$7.28 apiece. The deal was marketed with a price range of HK$5.90 to HK$7.28.

The final price values the developer at 18.3 times its 2007 earnings, based on Morgan Stanley estimates, or at a discount to current net asset value (including the IPO proceeds) of about 5.3%. The latter valuation metric, which is still the most commonly used by fund managers, compares with a 5% premium for Hong Kong-listed Mainland developer as a group, analysts say.

However, valuations vary significantly and Agile Property, which has a similar portfolio breakdown and is also concentrated largely to one city, still trades at a discount to NAV of about 19 times, while Guangzhou R&F trades at a premium approaching 20%. Country Garden also came to market at a small premium to NAV. According to a syndicate research report, Mainland developers also trade at an average 2007 PE of about 20 times.

ôWith so may other companies now trading at a premium to NAV, investors appreciate getting something at a small discount,ö notes one observer.

Since Country GardenÆs IPO in late April there have been a flurry of equity and convertible bond offerings by Mainland developers and many of those have come at aggressive prices. This has put downward pressure on share prices and resulted in several of the CBs falling below par in the aftermarket. Country Garden itself, which soared 35% on its trading debut on April 23, has also assumed a declining trend and on Friday closed at HK$6.74, a 25% premium to the IPO price. The stock held steady during KWGÆs roadshow and bookbuilding period, however.

It was likely with this market development in mind that the company decided to sign up five cornerstone investors who could help to anchor up the deal in case it would struggle. Still, their participation is bound to have left the bookrunners feeling at least a little bit constrained as it meant having less than a quarter of the deal to distribute to other institutional investors.

The cornerstones, who together bought about $147.4 million worth of shares with a six-month lockup, included a company owned by the chairman and vice chairman of Mainland property developer Guangzhou R&F Property and Henderson Land Development Chairman Lee Shau Kee, who each bought HK$333.33 million worth of shares. Citic Pacific and its chairman Larry Yung each bought HK$166.67 million and Thomas Kwok of the Sun Hung Kai Properties group took up HK$150 million.

Guangzhou-based KWG currently has 10 projects under development, which will become available for sale in 2007 and 2008 and should boost its revenues significantly. Syndicate analysts also project a significant impact on the bottom line due to low land acquisition costs and a sharp rise in selling prices of Guangzhou property in recent years.

One report suggests the companyÆs gross margins before land appreciation taxes will be 60% in 2007 and 58% in 2008. This will pave the way for a net profit growth of 5.2 times this year to Rmb968 million, the syndicate analyst projects. The earnings should expand by another 53% to Rmb1.48 billion in 2008.

To mitigate the risk of having most of its business in one city û albeit a fast growing and highly affluent one û KWG has started to diversify by acquiring land in Suzhou in the Jiangsu province and Cong Hua City in Guangdong province. The company is also aiming to build up an investment property portfolio that can generate a stable rental income. This includes a Grade-A office building in Pearl River New Town in Guangzhou and three hotels under development in Guangzhou City, which will be operated by the Starwood Group û owner of the Sheraton, Westin, W Hotels, Le Meridien and St Regis Hotels brands.

Morgan Stanley, which owns about 10% in KWG through one of its real estate funds, was the sole bookrunner for the IPO as well as joint sponsor together with ICEA and Goldbond. The US investment bank has been on a roll recently, completing no fewer than five sizeable IPOs and block trades so far this month.

This has propelled it to the top of the Asia ex-Japan league table as of last Friday, ahead of UBS and Goldman Sachs, according to Dealogic. It also has another three Hong Kong IPOs as well as one US listing by a Chinese semiconductor company in the market at present plus a sizeable pipeline, indicating it intends to hang on to this top position at least for a while.

Back in April, Morgan Stanley was also joint bookrunner together with UBS for Country GardenÆs $1.7 billion IPO, which attracted $67 billion worth of demand. Hong Kong retail investors contributed a stunning $42 billion, making it one of the most popular retail offerings in Hong Kong ever.

KWG is scheduled to start trading on July 3, the day after the long weekend to celebrate the tenth anniversary of the Hong Kong handover.
¬ Haymarket Media Limited. All rights reserved.
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