The unlisted flagship of one of China's most well known businessmen made its debut in the international bond markets yesterday (October 12). Vincent Lo's Shui On Land raised $375 million from a three-year private placement led by JPMorgan, the firm's main financial advisor and probable lead manager of a Hong Kong IPO expected some time next year.
Pricing of the unrated bond deal came at par on a coupon of 8.5% to yield 424bp over Treasuries or 380bp over Libor. As an additional sweetener, the deal was structured with a tranche of free warrants, equating to 3.1% of the company's share capital.
Analysts estimate the warrants are worth roughly $95 million and can be exercised over a staggered period prior to an IPO, or immediately thereafter. They can also be redeemed in shares or cash at the company's discretion.
On top of this, Shui On incorporated a call option, which allows it to call the deal away immediately and for life.
Because the transaction is a private placement and the company is unlisted, full distribution details have not been made available, nor has the company released much information about its capital structure or credit ratios. As such, the bond offering was heavily tilted towards existing investors including Chairman Lo. Specialists report an order book with participation by less than 30 investors, of whom 65% already hold equity stakes.
The bond deal follows a preference share issue last summer, which sourced private equity investment from a group of eight international investors comprising: Germany's Ergo Tru, Metro Holdings, Citigroup Venture Capital, Ocean Equity Holdings, Value Partners Funds, Standard Chartered Bank, Shanghai Hotel Investments and Jebsen & Co. The eight subscribed to $400 million in preference shares, which can be convertible into one new common share of Shui On Land at up to $1.35 per share.
The preference shares were structured with two tranches. A junior tranche has redemption rights over six years and yields 7% on semi-annual basis. A senior tranche has redemption rights over five years and yields 7.5% on a semi-annual basis. Holders of the senior tranche are also entitled to a further 7.5% per annum, payable either at redemption or on conversion into ordinary common shares.
On conversion the eight will own 27.73% of the company, while Hong Kong listed Shui On Construction will hold 24.57% and Shui On Company the remaining 47.7%.
Specialists say a high yield bond represents an obvious next step for Shui On since it is cheaper form of funding than equity. Specialists say the cost of equity for a Mainland property developer currently averages 17% to 20%.
At a time when it has huge capital raising needs and the Mainland government is trying to cool down the domestic property market, it would also seem to make sense for Shui On Land to try and diversify its funding sources away from a less receptive domestic bank market.
But comparables are few and far between. At one end of the rating scale is China Overseas Land, which has a Baa3/BBB- rating and a 5.75% 2012 bond outstanding. This is currently yielding about 6.44% or 205bp over Treasuries.
Towards the other end of the rating scale is the Shanghai-based Fosun group, which also has huge property investments and is currently marketing a $500 million deal with a seven-year maturity. The Ba3/BB- rated group has been targeting a yield around the 9% area, although the deal has yet to price.
Specialists say the curve between three and seven years is worth about 9bp to 10bp and without the warrants it seems likely Shui On would be looking at a yield of up to 10.5%. The Asian high yield market currently appears to be in a bit of a trough, which is not making the execution of any deal particularly easy.
Where Shui On is concerned, the new bond deal ranks far down the capital structure. It is unsecured, unrated and unlisted. It does have a high yield covenants package, but specialists say the company's subsidiaries retain a lot of operational freedom and will be able to leverage up to 60% in terms of debt to assets.
The deal has also come at a time when considerable uncertainty surrounds the Mainland property market and particularly Shanghai where nearly half the company's land bank is located. Some analysts believe the government will not be happy until it has seen prices in the city drop by at least 50%.
Moreover, the intricacies and complexities of the China property market are not well understood by international investors.
On the plus side, Vincent Lo is considered one of the most visionary property developers on the Mainland and his humanist, environmentally friendly approach has always played well with international audiences. The group currently has a land bank of over eight million square metres of gross floor area (one of the three largest in China) and Lo has said it will require investment topping $8 billion.
He also recently announced plans to try and replicate Silicon Valley in Shanghai via a $1.2 billion project to develop an area around the Yangpu university area. The 839,000 square metre project is scheduled for completion in 2011.
Lo's most well known project to date is Xintiandi - a residential, office and commercial development in the heart of Shanghai that has won countless awards. Rather than bulldoze the historic Shikumen houses that stood on the site, Lo renovated them to great acclaim.
In neighbouring Hangzhou he has also taken a conservationist approach with Xihu Tianti, a 30,000 square metre retail complex adjoining West Lake, one of China's premier tourist sites. In Chongqing he has acquired land on the banks of the Jialing river to develop a residential village in the style of the province's hill towns. This is due for completion in 2014.
More recently he acquired a 514,000 square metre development in Wuhan and also has a 1.2 million square metre residential project in Shanghai and 230,000 retail project known as Rainbow City.
Mainland TV viewers will also shortly see Lo front a new programme called "The Winner," which has been designed to ape the success of Donald Trump's show, "The Apprentice" in the US. Bond investors, however, will no doubt be hoping Lo does not similarly follow the flamboyant US property magnate into the bankruptcy courts.