Market awaits glut of China property IPO's

Two privately-owned Chinese property companies activate their listings as a third sits waiting in the wings.

The roughly $200 million flotation of SOHO China has been launched, with the analysts meeting convened last Friday and an SEC filing believed to be imminent. If successful, the Goldman Sachs led offering will break new ground for China, as the transaction represents the country's first private sector listing on the New York Stock Exchange (NYSE).

The company will also list on the Hong Kong Stock Exchange and may yet leapfrog the roughly $100 million IPO of Shanghai Forte, whose analysts meeting was held three weeks ago. The HSBC led offering should start pre-marketing in about a week, although observers were reporting yesterday (Wednesday) that it might be delayed by a few weeks. HSBC also holds the mandate for a third Chinese property company, state-owned Beijing Capital, which had been hoping to raise up to $200 million by the end of the year, although this too may be pushed back slightly.

For both SOHO and Shanghai Forte, the chief selling points are likely to centre on young entrepreneurial management, earnings that have consistently outstripped the sector average and will continue to grow faster than GDP.

Shanghai Forte is the older of the two since the company was founded in 1993 and has grown to become the city's largest private sector developer and sixth largest developer overall. It is owned by the Fosun group, established by five Shanghainese university teachers in 1992 with registered capital of $5,000. By the end of 2001, the group was recording sales of $3.7 billion and was highlighted by the Chinese government as one of 10 national private sector enterprises that had come to the forefront that year.

Aside from property, the company's main businesses are pharmaceuticals, retailing, finance and steel. The property arm is said to have a residential focus and has 1.27 million square metres of units under construction, with planned sales of 620,000 square metres this year. Analysts say 2002 earnings growth should top 500%. Having developed 17 projects to date, the company's eight most recent projects were also all 98% to 100% pre-sold ahead of completion.

By contrast Soho China is much smaller and has a shorter track record, but operates at the very highest end of the luxury market, where the biggest margins tend to reside. The company was established in 1996 by a former Goldman investment analyst, Zhang Xin, and her husband Pan Shiyi, who made his fortune in a Hainan construction boom.

SOHO is part of the Redstone Industries group and both the company and its founders have received abundant publicity since launch. Zhang and Pan regularly feature in "Chinese entrepreneurs to watch" features and their luxury avant-garde houses have won a number of architectural awards.

Their first and now completed project, SOHO New Town, comprises 480,000 square metres, with roughly 2,000 units and revenue generation of about $540 million. The Beijing-based project sold out within three months and at an average selling price of roughly $300,000, each unit went for over 10 times the city average.

It also meant that in both 1999 and 2000, the company ranked number one in terms of sales revenue for Beijing. At one point, the project even accounted for more than 10% of the national mortgage book of one of the big four state-owned banks.

Zhang and Pan's next ambitious project for which phase one has already been completed, is called Commune by the Great Wall. It will comprise 59 villas and a club house, with ultra sleek, environmentally friendly designs envisaged by 12 young Asian architects. The villas have a price tag of up to $500,000 each.

Property analysts all tend to have a neutral to fairly negative view of the Mainland property market, although most emphasise that the one bright spot is the luxury end of the market. There are virtually no direct comparables for either company, but those that exist have had a poor trading record of late.

Beijing-based property developers China Resources Land and Beijing North Star have both significantly underperformed both the Red chip and China Enterprises Index, respectively falling 47.7% and 35.7% compared to a 26% fall and 2% rise in the two indices. They are consequently trading at huge discounts to NAV - 72% and 61%.

The Chinese property sector is said to average P/E multiples of 8 to 11 times 2003 earnings and analysts say that domestic companies should trade at a discount to their Hong Kong-based peers as the market is highly fragmented and prices consequently harder to control. Because a lot of Mainland-based companies have large, but only slowly utilized landbanks, analysts comment that the best valuation metric is P/E rather than NAV.

They also say that gross development margins in China (15%) tend to be a lot thinner than Hong Kong (20%), as land is expensive, construction inefficient and corporate taxes high. As a result, many Mainland developers are said to be trying to improve margins by moving to the luxury end of the market and competition will become increasingly intense.

Because most of the companies are still in the growth phase, few pay much of a dividend. But analysts conclude that earnings growth should remain high, with the Beijing market in particular growing at 17% per annum, compared to forecast 11% GDP growth for the city.

But for many observers, the most interesting aspect of the two deals is whether investors will be willing to overcome their current risk aversion for the sake of China's growth potential and the valuation they accord private sector ownership. Both companies are highly regarded domestically, but it remains to be seen whether international accounts will once again highlight concerns surrounding corporate transparency, concentrated ownership and lack of financial muscle in the wake of Euro-Asia Holdings recent tax evasion scandal.