Shimao starts pre-marketing of third Chinese property IPO in as many weeks

Large and cheap landbank and economies of scale expected to help investors overcome concerns about potential fallout from recent government measures.
Being the third mainland real estate developer to seek a public listing in as many weeks was never going to be easy, especially not after China just announced another round of measures to control the property market.

However, Shimao Property Holdings believes that investors who take the time to look beyond the external noise will find the companyÆs extensive landbank, strong partners and diversified portfolio of high-end residential projects, hotels and retail space to stack up well against its already listed peers.

Shimao, which is looking to raise $500 million to $600 million, is being compared with Shui On Land, which is also in the process of going public in Hong Kong. Both companies to some extent focus on large-scale community style projects and both of them have a solid track record and a well established brand that they are now leveraging outside their Shanghai home market.

But while Shui On focuses on the redevelopment and modernisation of already existing (but run-down) urban districts, Shimao usually buys raw land for its new developments which means it doesnÆt have to deal with any relocation of exiting tenants.

Shimao is commonly still associated with Shanghai because its flagship residential project, Riviera Garden, is located there - but it does in fact operate in 10 cities across the country and of its current 15 residential projects, about 85% (in terms of gross floor area) are located outside of the financial capital.

That, observers say, reduces the risk in case the real-estate market does overheat in certain areas and will make Shimao less exposed to the latest round of government policies.

The company is not expanding nationwide as aggressively as China Vanke or China Overseas Land (57 and 38 projects respectively) as its strategy is to focus on large projects in urbanised and affluent regions, one syndicate analyst notes. However, ShimaoÆs land bank of about 13.8 million square metres of gross floor area, puts it in the same league as Vanke and China Overseas whose land banks total 11.7 million and 11.0 million sq.m respectively.

Shimao, which is being brought to market by Goldman Sachs and Morgan Stanley, aims sell 20% of the company in the form of 595 million new shares. Of the total, 10% has been earmarked for retail investors while another 5.9% will be offered to existing shareholders of sister company Shimao International Holdings at a rate of one new share for every six they currently own.

There is a greenshoe that could expand the total size of the deal by 15% in case of strong demand.

With pre-marketing having started only on Monday, the underwriters havenÆt set any valuation ranges yet, but according to investors who have met with syndicate analysts the company is currently looking to float somewhere in the middle of the 20% to 40% discount to net asset value range where most other Hong Kong-listed mainland real estate companies trade.

The average discount is said to be just above 20%, however, as a couple of very liquid developers trade at a much smaller discount or even premiums û notably Guangzhou R&F Properties - to NAV.

Shui On Land, which is looking to raise up to $989 million ($1.1 billion including the greenshoe), is being marketed with a price range that values the company at a discount to NAV of roughly 13-30% based on consensus projections, or at about 13.7 to 18 times its projected forward earnings, according to sources.

Yanlord Land Group, which is currently in the market trying to raise up to $270 million ahead of a Singapore listing, is being pitched at a 20-35% discount to NAV and 10 to 12.7 times its projected 2006 earnings.

According to Bloomberg data, China Overseas Land currently trades at a 2006 PE multiple of close to 17 times, while Agile Property and Guangzhou R&F trade at about 13 times. Shenzhen-listed China VankeÆs B-shares trade at about 15 times. Valuations have come down over the past month as the leading mainland developers have seen their share prices fall by between 14% and 19% amid concerns of rising interest rates and fears the government would step in and aggressively curb demand.

This hasnÆt happened although Beijing did issue a new set of polices last week aimed at increasing the land supply and controlling property speculation û with the latter having the potential to negatively impact on demand for ShimaoÆs properties given its primary focus on the high-end of the market where speculation is the most prevalent.

The uncertainty about what effect the measures will have on the sector long-term and the volatile equity markets overall suggest there is likely to be pressure from investors for a lower valuation than the closest comparables.

ôSome investors are using the current environment almost as a tool in the negotiations (over the price), but what is encouraging is that they arenÆt turning away altogether,ö one observer says, noting that the $2.3 billion worth of shares that are expected to be sold by mainland real estate companies over just a few weeks are adding to investorsÆ bargaining position.

Some investors may take comfort in last yearÆs IPO of Guangzhou R&F, however, which came amid a similarly difficult market environment. Retail investors turned their back on the deal altogether, but underwriter Morgan Stanley managed to convince enough institutional investors of the long-term benefits to complete the sale. And once the market stabilised, the share price started climbing. As of yesterday (June 6) its shares were trading 290% above the July IPO price.

According to investors, what makes Shimao stand out compared with its sector peers is its wide gross margins which amounted to about 37.9% in both 2004 and 2005 after deducting provisions for land appreciation tax from the cost of sales. The key reason for these high numbers, anlysts say, is the economies of scale and greater bargaining power made possible because of the large size of most of its projects.

This compares with AgileÆs 2005 gross margin of 32.4%, China OverseasÆ 30.1%, Beijing Capital LandÆs 26.6% and Guangzhou R&FÆs 25%, according to syndicate research.

In 2005, net profit jumped 392% to Rmb908 million on turnover of Rmb2.5 billion ($312 million), which was largely due to revaluation gains on investment properties. Going forward, however, the companyÆs large and cheap land bank is expected to support a sustainable growth in income from pre-sales from last yearÆs Rmb4.6 billion, one syndicate analyst notes.

The companyÆs flagship property, Riviera Garden in Shanghai, has previously been selling for Rmb20,000 per sq.m, but the final of the five phases, which will be sold later this year, is expected to command close to Rmb30,000/sq.m, according to one observer.

As of March 2006, Shimao had 2.4 million sq.m of gross floor area under development and another 1.8 million sq.m for future development for which it has already obtained the land use rights. It has also acquired interests in several plots of land in Shanghai, Kunshan. Changshu, Harbin, Wuhan, Nanjing, Shaoxing and Wuhu with a development potential of 7.8 million sq.m. Most of the land is in commercial areas or has attractive waterfront or lakeside views.

Meanwhile, the companyÆs portfolio of investment properties, including its three five-star hotel projects in Shanghai and one in Nanjing in partnership with hotel chains Hyatt and Starwood and its retail business, is expected to generate a greater portion of turnover going forward. At the end of last year, this business accounted for only 1.5% of total revenues.

Aside from the risks related to the macro-environment, investors are also said to be questioning the financing risks related to the companyÆs large scale and long-term projects. As of the end of last year, it had a net gearing ratio of 77%.

The company, which was founded by chairman Hui Wing Mau in 2001, is supported by four financial investors, including Morgan Stanley, Standard Chartered, China Construction Bank and Drawbridge Capital, which were brought in about six months ago and own a combined 16% before the IPO.

Shimao will launch its official roadshow in the latter half of next week and the pricing is expected in the last week of June. The trading debut is tentatively scheduled for July 5, according to an announcement by Shimao International.

Shui On Land is being brought to market by Deutsche Bank, HSBC and JPMorgan, while YanlordÆs IPO is being arranged by CLSA and HL Bank.
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