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Shimao completes largest IPO by a Chinese real estate developer

Bottom end pricing and half-covered retail tranche show caution still reigns as market conditions remain tough.
Shimao Property Holdings has defied the difficult market environment and completed its initial public offering which came to HK$3.72 billion ($480 million) after the price was fixed at the bottom of the indicated range.

The company had hoped to raise up to $650 million, but even with the low end pricing Shimao ranks as the largest IPO by a Chinese real estate developer û a feat it pulled off in a market where several other property companies have been forced to either cancel or downsize their offerings over the past couple of weeks.

Among them was Shui On Land, which called off its IPO of close to $1 billion one day before the order book was due to close. According to people close to that deal, the company sensed it would be unable to reach the targeted amount of proceeds and preferred to postpone until the markets stabilise.

The Shimao deal, which was jointly led by an unusual pairing of Goldman Sachs and Morgan Stanley, saw decent demand from institutions and hedge funds, sources say, but was snubbed by Hong Kong retail investors who appear to have lost interest in IPOs after several recent market newcomers have traded down on their debut.

Key to the success, observers say, was the fact that the price range was set wide and low enough to reflect new guidelines for land allocation announced by Beijing in mid-May and the 15-30% correction in other mainland property stocks since that announcement. Whether that will also ensure a good start in the secondary market, wonÆt be clear until July 5 when the shares are scheduled to start trading.

At the low end of the HK$6.25 to HK$8.50 price range, which is also where the price was eventually fixed, Shimao is valued at a 45.6% discount to its estimated net asset value. That compares with a sector average of about 23%, although it is in line with at least one of its closest comparables, Agile Property Holdings, which trade at a discount of about 45%, one banker says.

It also values Shimao at 11.6 times projected 2006 earnings after land appreciation tax provisions, which is in line with the median 11.7 times for its closest comparables û Agile, Guangzhou R&F Properties, China Overseas Land & Investment and Hopson Development Holdings, which have similar regional profiles and market caps.

Shimao, which sold 20% of its issued share capital in the form of 595 million new shares, will have a market cap of $2.4 billion at the time of listing. There is a 15% greenshoe that could boost the IPO to ($551 million).

The institutional order book was said to have attracted a combination of long-only funds and value investors. The latter category included hedge funds that are willing to hold on to their investments a bit longer. The long-only funds see opportunities in ChinaÆs real estate sector - in spite of the governmentÆs current attempts to ensure sufficient and affordable housing for low-income earners by focusing the allocation of land to this part of the market.

Sources close to the deal said the institutional tranche, which made up 84.1% of the offering (after deducting shares set aside for existing shareholders of its Hong Kong-listed sister company, Shimao International), was about 2.5 times covered with more than 90 investors participating. About 50% of the demand came from Asia-based investors, 30% from Europe and 20% from the US.

The remaining 10% of the deal, which was earmarked for retail investors, was only a bit more than half-covered, leaving the left-over shares to be allocated to institutional investors, the sources said.

Shimao, which is one of the largest mainland developers with a landbank of about 13.8 million square metres of gross floor area, is the first Hong Kong IPO this year to have an undersubscribed retail tranche. While that is likely to result in some negative local press, the irony is that it also made the offering more attractive to institutional investors.

ôWith fewer retail investors it is easier for institutions to get a meaningful stake and it reduces the risk that the share price will trade off immediately after it comes to market,ö one observer says, referring to the tendency among retail investors to take profits in the first couple of days in order to get cash to pay for their margin financing.

The poor retail response was also believed to be part of the reason why Shimao appeared to have attracted more hedge funds than any other equity deal since the correction began in early May.

There are clear parallels here to Guangzhou R&FÆs IPO in July 2005, which also came to market at a time when mainland property stocks were suffering due to concerns there would be more government measures to cool down galloping property prices and expectations interest rates would go up.

Here too, retail investors failed to take up all the shares set aside for them and the price had to be fixed at the bottom of the range, leading to a low valuation. But, once the markets stabilised the institutional investors who had been convinced by bookrunner Morgan Stanley to invest found themselves sitting on a real winner as the company delivered on the earnings front and the valuation adjusted upwards towards its peers.

As of yesterday, Guangzhou R&F was trading 200% above its IPO price, even though the shares have fallen 36% from the highs on May 9. No doubt, investors are hoping for a similar outcome for Shimao (some investors who bought into this one were said to have been original investors in R&F too), especially since Morgan Stanley was involved in both deals.

However, many investors are still not willing to commit fresh cash to market newcomers, after losing a lot of money when the markets turned south in early May, observers say. There is also a great deal of uncertainty over the implementation of the governmentÆs land use guidelines since it is up to individual provinces and cities to actually carry them out, which could mean there will be a cloud hanging over this sector for some time yet.

Aside from ShimaoÆs trading debut, the next test of investor appetite will be Greentown China Holdings, which is currently marketing an IPO of up to $413 million. Based on a price range between HK$6.57 and HK$9.86, the Hangzhou-baesd developer is being pitched at 6-9 times its projected 2006 earnings and at a 20-43% discount to NAV.

Shimao focuses on large-scale community style projects, which typically include high-end residential units, hotels and retail space. It has a solid track record and a well-established brand.

Having made a name for itself in Shanghai - the location of its flagship residential project, Riviera Garden - it currently has 15 residential projects, spread over 10 cities. About 85% of its projects (in terms of gross floor area) are currently located outside Shanghai.

Going forward, the companyÆs large and cheap land bank is expected to support a sustainable growth in income from pre-sales and underpin bottom-line earnings growth of at least 40% in the years to 2009, sources say.

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