KWG Properties to raise up to $582 million from IPO

The Guangzhou-based developer will set aside about 25% of the offering for four cornerstone investors, including fellow property company Guangzhou R&F.
Mid-sized Chinese real estate developer KWG Properties has set the indicative price range for its initial public offering at a level that could see it raise up to HK$4.55 billion ($582 million).

According to sources, the company will offer 25% of its enlarged share capital, or 625 million new shares, at a price between HK$5.90 and HK$7.28 per share. The institutional roadshow will kick off today and the Hong Kong retail offering will follow on June 18. Pricing is expected after the close of US markets on June 21 and the first day of trading is likely to be on July 3. There is a possibility that it may come earlier, but the Hong Kong holiday on July 2 means it will be tight to fit in the settlement and allocation processes before that long weekend, people involved in the offering say.

Morgan Stanley, which owns about 10% in the company through one of its real estate funds, is the sole bookrunner for the IPO as well as joint sponsor together with ICEA and Goldbond.

With the majority of its businesses in Guangzhou, sources say KWG, which focuses on mid- to high-end residential developments that are known for their high quality, is in a prime position to benefit from the economic growth and rising incomes in this city. The Guangzhou economy has expanded faster than the national average in each of the past 10 years.

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 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. Together with an increase in the property sales to 324,000 square metres in 2007 and 601,000sqm in 2008 from 122,000sqm last year, 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.

KWG is the first real estate developer to come to market since Country GardenÆs highly popular offering in April. The Beijing-based developer attracted $67 billion worth of demand for its $1.7 billion IPO, of which Hong Kong retail investors contributed a stunning $42 billion, and was a driving force for the re-rating of most of the Hong Kong-listed Chinese developers which happened around that time.

Country Garden soared 35% on its trading debut on April 2, but since then it has been on a declining trend. YesterdayÆs close of HK$6.74 represented a 25% premium to the IPO price. The decline has coincided with a flurry of fund raisings by mainland property companies, both in the form of follow-on equity offerings and convertible bond issues. Many of these have come at aggressive prices, putting downward pressure on share prices and resulting in most of the CBs trading below par.

With the market still jittery, KWG has agreed to set aside about $147 million of its IPO for four cornerstone investors, likely hoping that this will help instil confidence among other investors as well. According to sources, the cornerstones include fellow Mainland property developer Guangzhou R&F Property, Henderson Land Development Chairman Lee Shau Kee, Citic Pacific and its chairman Larry Yung (as one entity), which will each buy HK$333.33 million worth of shares. In addition, Thomas Kwok of the Sun Hung Kai Properties group will take up HK$150 million.

Based on the mid-point of the offering range, the cornerstones will buy about 25% of the deal, which will have the usual structure for a Hong Kong IPO with 10% set aside for retail investors and a standard clawback mechanism that could boost the retail tranche to 50% in case of strong demand. There is also a 15% greenshoe, which may increase the total deal size to $669 million.

According to sources, the price range values KWG at 14.9 to 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 between 5.3% and 19.6%, depending on which valuation metric one prefers.

On an NAV basis, the bottom end valuation is on par with Agile Property, which has a similar portfolio breakdown and is also concentrated largely to one city. Guangzhou R&F, on the other hand, trades at a premium approaching 20%, which indicates the widely differentiating valuations among the Mainland property companies. Country Garden also came to market at a small premium to NAV.

According to the syndicate research report, other listed Mainland developers trade at an average 2007 PE of about 20 times and at a premium of about 5% to NAV.

ôAs KWG is highly focused on Guangzhou, which we belive merits faster growth in selling prices relative to Shanghai, we are of the opinion that it should trade at a premium to Shanghai Real Estate (at a 13% discount to NAV) and Shui On Land (at a 19% discount),ö the report states.

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. As of March this year it had a total land bank of 3.3 million sqm. In terms of gross asset value, property projects in Guangzhou accounted for 71%, while its three pending projects in Suzhou made up 24% and its single planned project in Cong Hua accounted for the remaining 5%.

KWG 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 in Guangzhou City that are currently under development and which will be operated by the Starwood Group. The latter is the operator of several well-known hotel brands, including Sheraton, Westin, W Hotels, Le Meridien and St Regis Hotels.

A syndicate research report estimates that KWGÆs investment portfolio will account for 38% of its gross asset value in 2007 and 2008, and translate into rental revenues of Rmb87 million ($11.4 million) this year and Rmb235 million next year.
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