Separate property listing could weigh on Swire Pacific's valuation

Analysts argue that Swire Pacific may see its NAV discount widen if it realises a plan to spin-off its wholly owned property unit.

The initial positive response to Swire Pacific's announcement that it is "considering the possibility" of a separate listing of its wholly owned property unit quickly fizzled and some analysts have noted that such a move may actually put downward pressure on the Hong Kong conglomerate's valuation.

After rising 6.3% at opening on Tuesday -- the announcement of a potential spin-off came after the Hong Kong market closed on Monday -- Swire's class-A shares assumed a downward trend and finished a mere 1.1% higher. And yesterday the share price fell 0.7% in an otherwise rising market.

Arguably, a separate listing should be positive for the property unit itself, releasing hidden value and providing it with direct access to the capital markets. Any funds raised could be ploughed into further expansion of the company's investment portfolio in Hong Kong, which is focused primarily on commercial properties, or targeted towards an accelerated expansion into China.

However, it is questionable whether a spin-off would actually be beneficial for Swire Pacific itself. Analysts at Citi and J.P. Morgan argue that it would not, based on the fact that almost 90% of the company's net asset value (NAV) would be accounted for by listed units if Swire Properties is floated in the market. This would likely prompt investors to increasingly view Swire Pacific as a holding company as opposed to an operating company, and result in a widening discount to NAV.

"We believe many investors hold Swire Pacific due to its property assets...[and] if Swire Properties was separately listed, some investors would prefer to invest directly in the property assets. This would result in reduced demand for Swire Pacific shares, in our view," analysts at J.P. Morgan wrote in a research report.

Aside from the properties unit, which accounts for about 70% of the current NAV and generated 32% of the revenues in the six months to June, Swire Pacific is also involved in aviation, beverage, industrials, marine services and trading businesses in the Greater China region. It is the largest shareholder in Hong Kong's flagship airline Cathay Pacific Airways with a 40% stake. The only unlisted entities post a potential spin-off will be the beverage unit, which makes up about 4% of NAV, and the marine division, which accounts for 8%.

At Citi, a group of analysts led by Anil Daswani notes that Swire is currently trading at a 4% discount to its estimated NAV, compared with a historical average of 25%.

"If the spin-off happens, we believe Swire Properties will trade in line with the other Hong Kong property investors (at a 22% historical average discount to NAV). This would offset any potential narrowing in NAV due to increased transparency," the analysts said in a report.

Among the comps, Wheelock currently trades at a 26% discount to NAV, while Hang Lung Group is at a 23% discount, based on their estimates.

In light of that, the spin-off plan may not turn out to be quite as opportunistic as Swire Pacific may have hoped - no doubt, the company is trying to make the most of the fact that its share price has gained about 120% from the this year's low in early March. By flagging its spinoff rather early, the company may also have limited the room for a re-rating in the near future. The J.P. Morgan analysts, led by Steven Li, argued that Swire's current valuation is attractive as its price-to-book value is below its long-term average.

"While we see this as attractive, we believe the stock is very unlikely to re-rate from current levels, as investors will want to see a final decision on the potential listing," they said. "A withdrawal of the listing plans would represent the most significant upside risk to our price target."

J.P. Morgan on Tuesday lowered its target price (until June 2010) for Swire to HK$84 from HK$107 and downgraded the stock to "underweight", based on a widening in the NAV discount to 30% from 21%, as per J.P. Morgan's estimates. The new target price implies a potential downside of close to 12% versus yesterday's closing price of HK$95.35.

Citi has an even lower target price of HK$76.50 on the stock, coupled with a "sell" recommendation. Not everyone is this negative, however. According to Bloomberg, seven of the 17 analysts who follow Swire Pacific have a "buy" on the stock, and eight analysts recommend investors to "hold".

Swire Pacific provided no details with regard to its plans in the brief announcement, saying only that the separate listing will be achieved by way of a spin-off -- if it were to proceed. As of now, it has filed no listing application with the stock exchange and hasn't even put forward a formal proposal. The company also stressed that no decision has been made whether to go ahead with a listing or about the timing.

However, the announcement does come at a time when the Hong Kong commercial property market is showing signs of bottoming out, which would suggest that this is a good time to accelerate any potential expansion. (This is in contrast to the residential market, where prices have been edging higher for some time already). Whether a spin-off is the best way to obtain funds for that expansion is something Swire Pacific's existing investors will have to consider in the months ahead.

Swire Properties has a completed property portfolio of 13.1 million square feet in Hong Kong, with a further 2.4 million sqf pending or under development, according to its webstite. The majority is made up of office and retail space that is managed by the company as long-term investments. It also has about 7.7 million sqf of commercial properties under development in China.

If the spin-off plans come to fruition, it will be the second time that Swire Properties has been traded on the Hong Kong stockmarket. It first listed in 1977, but was taken private again by the Swire Group in 1984.

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