Shui On Land hits the market with $1.1 billion IPO

Developer of Shanghai's Xintiandi district said to see good investor interest despite recent government measures.
One of Hong KongÆs most anticipated initial public offerings in the property space this year will hit the market today when Shui On Land launches the official road show for a deal which aims to raise just over $1.1 billion.

The company, which is part of Hong Kong entrepreneur and property tycoon Vincent LoÆs Shui On Group, has built a name for itself in recent years primarily through its landmark Xintiandi development in Shanghai. It is also currently working on six large-scale urban projects that aims to redevelop and modernise run-down city areas.

The projects, which have the support of local governments in four cities, are part of a trend that sees about 20 million people move from rural areas to ChinaÆs rapidly growing cities every year.

According to sources familiar with the offering, the company will sell new shares corresponding to about 20% of its share capital and another 7% of secondary shares for a total deal size of around $840 million to just over $1.1 billion. The deal includes a 15% greenshoe, which will be all secondary shares.

The offer is jointly arranged by Deutsche Bank, HSBC and JPMorgan.

The indicative price range will be quite wide at HK$5.60 to HK$7.55, which is likely designed to allow more flexibility given the present volatile market. The range will value the company at about 13.7 to 18 times its projected forward earnings or at roughly 13-30% discount to net asset value based on consensus projections, the sources say.

While analysts seem to favour a valuation based on NAV given the multi-year development profile of Shui On LandÆs large-scale projects, investors are said to be focusing on both PE multiples and asset valuations.

The valuations of other mainland developers vary widely, but the average discount to NAV is just over 20% according to syndicate research, while analysts put the average 2006 multiple at about 17 times. National developers China Overseas Land and Shenzhen-listed China Vanke trade at forward PEs of about 15-16 times.

Speaking about the discount to NAV, one analyst argues that Shui On LandÆs quality land bank, high-end projects and long-term visibility, suggests it is reasonable to expect the stock to trade near the high end of the valuation range for its peers. The analyst notes that this range spans a discount of close to 50% for Beijing North Star to a 19% premium for Guangzhou R&F Properties.

Other observers say direct comparisons are difficult because Shui On is quite a unique developer in that it tends to work with local governments to re-develop entire city sections into modern communities. Its ongoing projects have a development horizon that stretches out to 2014.

Given the sizeable retail and commercial component in these projects, Shui On Land is also more diversified than most other mainland developers which tend to focus on primarily on residential developments.

The investors response during pre-marketing is said to have been positive despite the current volatile market environment, and one fund manager said potential investors werenÆt believed to be trying to talk down the price aggressively.

ôMost people know this company and have seen the Xintiandi project. They understand that the company has high corporate governance standards and they know it wonÆt be sold dirt cheap,ö one source reckons.

Stocks of mainland property developers have been very volatile over the past month after China raised its lending rate in late April and then followed that up with a another set of measures to control the property market.

According to one observer, the new measures were primarily aimed at ôestablishing orderö in the property market and were unlikely to have much impact on the company. In the longer term the additional guidelines may even benefit the big players which have the financial strength to survive.

ôBut in the short-term it is having a negative impact on investor appetite,ö he adds.

Among the reasons to buy into Shui On Land are projections that 2006 will be the year in which its earlier investments will start to bear fruit, allowing it to report its first profit excluding property revaluations since the company was set up in February 2004.

Syndicate research forecast a net profit of about Rmb$1.7 billion to Rmb$1.8 billion ($207 million to $224 million) this year, compared with a loss before revaluation gains of Rmb26 million in 2005. Leaving out projections for revaluation gains or losses, the analysts estimate the bottom line to increase by up to 22% in 2007 and by another 10% in 2008.

While these near-term earnings growth rates are below average, the companyÆs key strength is seen to lie in its ability to grow its assets and monetise them into profits in the medium term. In particular, its successful redevelopment of ShanghaiÆs former French concession into an award-winning retail and residential area under the Xintiandi brand û or New Heaven and Earth as it is called in English - has attracted the attention of other local governments and the company is frequently invited to evaluate new development opportunities.

Aside from its massive Taipingqiao project in Shanghai, of which Xintiandi forms the first phase, the company currently also has two other projects in ChinaÆs financial capital - and one each in Chongqing, Wuhan and Hangzhou. The projects have a total gross floor area of 6.9 million square metres

Because of the large scale of its projects and its cooperation with the local governments, Shui On Land has been able to get into the projects at a low cost and it is now benefiting from the rising property prices and the increasing wealth of the population. This is allowing for wider development margins at each subsequent phase of its projects, with the average gross development margins ranging from about 30% to up to 63% at the Lakeville Regency residential complex at Taipingqiao.

Underpinning the investment case is a strong management team under chairman Vincent Lo. While Shui On Land was set up only in 2004 as the groupÆs flagship property company in the mainland, the Shui On Group and Lo have close to 35 yearÆs experience in property development in Hong Kong and 20 years in China.

Shui On Land was separated out from Shui On Properties, which now focuses solely on property development in Hong Kong. The group also includes Hong Kong-listed Shui On Construction and Materials (SOCAM), which focuses on cement manufacturing, construction, construction materials and venture capital investments. SOCAM holds more than 20% in the listing candidate.

HSBC, which has a long-standing relationship with the group, has agreed to invest about $100 million (the final size will depend on the size of the deal) into Shui On Land at the IPO price, although the shares it is buying arenÆt part of the global offering. The purchase should help boost confidence among other investors, however.

Among the companyÆs eight financial investors, which were brought onboard through a private placement in 2004, a couple are believed to be selling their entire stake, while the rest will cash in about 50% each, sources said.

Aside from the impact from the governmentÆs latest property policies, other potential risks to watch relates to the execution of the companyÆs massive projects, which typically involves the relocation of people already living in the area. While the company has a good track record in this respect, there is a risk that this process can take longer or become costlier than originally planned for.

The company also has a high net gearing of about 150%, as of the end of 2005, which is expected to rise to 250% this year and close to 400% in 2007 as it needs to settle land premiums and cover relocation costs. Because of the projected rise in earnings, however, the interest carry is expected to rise above 8 times this year from 1.9 times.

The order book will stay open to June 15 and the pricing is expected after the close of US trading that day. The trading debut is scheduled for June 23.
¬ Haymarket Media Limited. All rights reserved.
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