With the Hong Kong stockmarket down 1.7% on Monday and European markets showing some serious weakness amid renewed concerns that the Greek debt situation will spread to other countries, the launch of a placement shortly after 7pm local time did seem ambitious. And the fact that it came at a tight discount made the challenge even bigger.
But Longfor Properties did just that. According to investors, HSBC and Morgan Stanley launched a top-up placement in the Chinese nationwide developer with a strong base in Chengdu and Beijing, at a 3% to 6% discount to Monday’s close for a total deal size ranging from HK$3.87 billion to HK$3.99 billion ($497 million to $513 million).
A closer look at the offering showed that it was being done on a best-effort basis. This meant that if investors demanded a wider discount, the bookrunners could potentially revise the price to accommodate them without having to give up any of their fee, and would not be required to buy the shares themselves. In other words, they weren’t taking any risk. The company basically confirmed this in a statement to the Hong Kong stock exchange yesterday morning, saying that it “had not entered into any legally binding agreement or arrangement with any party in respect of a top-up share placement”, as suggested by local media.
According to sources, at least six banks were asked to bid for a deal after the market closed and even though the company did get the advice that Monday was probably not the best day to do a deal, Longfor appears to have been confident that the banks would be able to find enough buyers for the transaction, which accounted for 5.8% of the existing share capital and about 45 days worth of trading, based on the turnover in the past month. However, it did agree not to do a hard-underwritten deal, but rather to allow the banks to test the market to see if the deal would clear at the indicated discount.
Not too surprisingly, it didn’t. And about 1am Hong Kong time, when the US stockmarket was down close to 1.7%, the company chose to call off the deal. Some sources said it would have been possible to sell the 300 million shares at a wider discount, but since overseas markets were getting increasingly worse and it seemed likely Asia would take another hit yesterday, the company decided not to jam more stock into the mix.
Nobody can argue that this was not the right call. The question is why the deal launched at such a tight discount in the first place. One source said HSBC reckoned it would be able to get enough momentum to complete the deal, but when overseas markets continued to deteriorate after launch, that did not happen. Meanwhile, Morgan Stanley was probably driven by its long-term relationship with the company. The US investment bank was a bookrunner on Longfor’s $912 million IPO in November 2009 and was also a global coordinator on its $750 million bond issue in early April this year, together with Standard Chartered. HSBC also acted as a bookrunner on that same bond.
Longfor, on the other hand, was likely encouraged by the large block trades that were completed last week and failed to realise just how quickly the market had deteriorated since data out on Friday night showed that the US economy created just 18,000 jobs in the past month, compared to expectations of 105,000 (according to a Bloomberg poll). On top of that there were renewed concerns that the European debt crisis was spiralling out of control and some nervousness that the US Congress may not be able to lift the country’s debt ceiling before a key deadline on August 2, leading to problems for the world’s largest economy to pay its bills.
However, Longfor likely wanted to take advantage of the 21.2% rally in its share price in the seven days to last Friday and the lobbying by several banks to do a deal earlier in the day may have helped convince it that it could get done.
As it turned out, there was one other issue Longfor hadn’t counted on — a Moody’s report attempting to highlight potential corporate governance and accounting risks at 61 Chinese companies outside the financial sector that have outstanding bond issues. Warning signs were presented as “red flags” in five different categories, including “weakness in corporate governance” and “riskier or more opaque business models”. Among the Hong Kong-listed Chinese companies, West China Cement stood out with 12 red flags, but Longfor received seven flags, which was more than any other property company.
However, the seven issues that Moody’s red-flagged for Longfor, including aggressive growth, a short listing history, a change of CFO, a large negative cash flow and low tax payments, don’t seem that severe when compared to the accounting scandals that have surrounded a number of Chinese companies both in the US and Hong Kong during the past few months. Indeed, Moody’s said that most of these issues are common to the sector and noted that the low tax payments reflect Longfor’s relatively low land cost, which leads to higher profits and higher land appreciation tax, which is partly deferrable. The company also has a larger portfolio of investment properties than its peers, which is generating revaluation gains that are taxable, but non-payable.
The report was supposedly issued on Monday, but seemed to have reached only selected media that day and the content became known to the wider market only yesterday morning. But once it did, it had a significant negative impact on share prices. Companies with a lot of red flags, including Longfor, all fell sharply as investors chose to focus on the number of flags rather than to look at the reasons behind them — which was perhaps understandable on a day when the Hang Seng Index was down 3.1% anyway.
At the end of the session, Longfor had lost 10.1%, erasing all the gains made in the previous week.
Looking beyond the Moody’s report, investors generally like Longfor, which has a strong brand name and is known for its high customer loyalty, which enables it to command premium pricing. The company is majority-owned and controlled by its chairwoman, Wu Yajun, and her associates. During the IPO it attracted top quality cornerstone investors such as Temasek, the Government of Singapore Investment Corp and Hongkong Land.
Its projects include a wide range of mid- to high-end residential developments spanning from high-rise apartment buildings to townhouses and luxury stand-alone houses, as well as shopping malls and other commercial properties.
Longfor’s share price closed at a record high of HK$13.84 last Friday, which represents a 96% gain since its listing in November 2009 but even so, 18 of 21 analysts who cover the stock, according to Bloomberg, still have a “buy” rating on it.
Debt concerns continued to plague the headline-driven markets in Europe and the US on Tuesday and the Dow Jones index fell another 0.5% overnight. The index was up in the mid-afternoon after the minutes from the latest FOMC meeting showed that some of the committee members believe further monetary easing may be in the cards if growth remains sluggish, but then fell again when Moody’s downgraded Ireland to junk status.