Soho China targets up to $1.65 billion

A greater number of secondary shares and rising property stock valuations lift the total deal size well above expectations.
When commercial property developer Soho China kicks off the institutional roadshow for its Hong Kong initial public offering today, it does so with a much larger deal than previously indicated. Having initially flagged an offering of about $1 billion, the company could now end up raising almost double that, assuming a top-end pricing and a fully exercised greenshoe.

Even without the greenshoe, the deal could reach HK$12.87 billion ($1.65 billion) and surpass Sino-Ocean Land HoldingsÆ up to $1.5 billion offering, which is also currently in the market.

Including the 15% greenshoe, Soho ChinaÆs deal could swell to $1.9 billion. One reason for the larger deal is a continued strong share price performance by Hong Kong-listed Mainland property developers, which has lifted the valuation for the entire sector and allowed Soho China to be more ambitious with regard to its own multiples.

The other reason is that the deal now includes a larger portion of secondary shares than originally anticipated as the controlling shareholder will raise some cash that will then be lent on to the company that will be developing a high-profile piece of land adjacent to Tiananmen Square that is owned by Soho China. The local company is owned by the controlling shareholder.

According to sources, Soho China is offering about 1.55 billion shares of which 1.25 billion, or approximately 81%, are new. The new shares account for about 25% of the enlarged share capital. Of the 299 million secondary shares, the controlling shareholder is selling 230 million, while the rest will be offloaded by a group of minority shareholders. The offer price has been set at between HK$6.30 and HK$8.30, which values the company at between 11.5 and 15.3 times its 2008 earnings based on the consensus estimate by the three bookrunners û Goldman Sachs, HSBC and UBS.

At the low end, the price range values the Beijing-based developer at a 17.7% discount to its current net asset value with the IPO proceeds added in, while the top end pitches it at a modest 1% premium û again based on the bookrunnersÆ consensus estimates.

Other Hong Kong-listed Mainland developers trade at an average 10% premium to NAV, but the numbers vary widely, ranging from a deep discount of up to 30% for SPG Land and New World China, to a premium as high as 60% for Country Garden, but so far only Country Garden has managed to price its IPO at a premium to NAV. That suggests Soho ChinaÆs price range is likely set at an appropriate level, especially in light of the current market environment.

Among the issues the company and its bookrunners had to consider when deciding on the price range was this weekÆs Federal Open Market Committee meeting. The Fed is widely expected to cut interest rates to help support US markets in the face of the subprime loan crisis, but if it doesnÆt, or if the cut is smaller than the 50bp that many observers are hoping for, it could end up triggering renewed volatility in the equity markets. Adding to their woes, China raised its key lending rate again on Friday, increasing the cost for companies or investors who wish to fund their property purchases through loans.

ôOn the other hand, property counters have had a fantastic run-up which gives a bullish backdrop to the deal and funds are flowing in from new people looking to invest in Chinese properties,ö notes one observer.

On a price-to-earnings basis, other Mainland developers trade at an average 2008 multiple of about 20x. Sino-Ocean is offered at 13.5x to 16.1x its projected 2008 earnings. Based on its consensus NAV estimate, the IPO price ranges from a 7.2% discount to a 2.2% premium. A source close to Soho ChinaÆs offering argues that, based on its higher growth profile and higher quality assets, Soho China ôought to trade at higher multiples than Sino-Oceanö.

The two developers are very different companies, however, which makes it difficult to compare them. Sino-Ocean, which is being brought to market by BOC International, Goldman Sachs and Morgan Stanley, is a traditional residential developer with a primary focus on the pan-Bohai Rim in Northeastern China. This area, which includes Beijing, is expected to be the next Chinese region to experience rapid economic growth after the Yangtze River Delta and the Pearl River Delta, and according to analysts, it is one of the key reasons why investors should consider buying into Sino-Ocean.

Having started as a residential developer in 1995, Soho China now focuses primarily on the development of commercial properties in prime locations in Beijing, which is sells in the form of strata units to other companies or high net worth individuals, either for use or as an investment. (The name Soho is an abbreviation of ôSmall Office, Home Officeö and refers to the concept of providing flexible and multifunctional office space for small- and medium-sized enterprises).

This approach makes it different to most of its peers in this part of the market, which will typically retain commercial developments as investment properties and rent out the office and retail space for recurring income. If they choose to sell, the entire office building is usually sold as one complete unit. Soho ChinaÆs will also be the first among the Hong Kong-listed Mainland developers to offer this kind of exposure.

Soho ChinaÆs key selling points, according to people familiar with the marketing strategy will be the companyÆ strong track record with regard to profitability and margins, its high asset turnover and a high quality land bank.

Because residential properties account for only 21% of its gross floor area (GFA), the company is also relatively immune to the ongoing government crackdowns to limit property speculation and curb soaring residential property prices. Office properties account for 53%, retail for 23% and hotel properties for the remaining 3%.

The risks include the fact that most of its commercial projects are concentrated to Beijing, although it does have a few well known developments outside the capital, including two villa-style hotel developments located near the Great Wall and on Hainan Island. The companyÆs current strategy also relies on the fact that companies will continue to buy office and retail space instead of renting, and while analysts note that the demand for this type of premises is strong at the moment, it is less clear what will happen after the 2008 Olympics.

Investors will also have to decide whether they believe the company will be able to continue to acquire land in attractive locations at low prices that will allow it to maintain its high margins. So far it has encountered little competition from other developers, but this is picking up and land prices have also started to head higher. According to a syndicate report, the company achieved a gross margin of 53% in 2006, which is expected to decline to 38% this year and 40% in 2008.

The same report says the company is expected to buy several of the sites in Beijing that it is currently in negotiation about, which could total more than one million sqm of additional gross floor area (GFA). At the end of March, Soho ChinaÆs land bank consisted of 1.2 million square metres of completed GFA and 1.24 million sqm that it plans to complete in the next three years.

Seven cornerstone investors, including several Hong Kong property tycoons, have already given their nod to Soho ChinaÆs offering by committing to buy a combined $300 million worth of shares in the IPO. Their investment will account for between 18% and 24% of the total deal, depending on the final price.

The cornerstones comprise the Kerry Group and its controlling owner Robert Kuok (as one entity), Wharf Holdings, Citic Pacific, Chinese Estates executive director Joseph Lau, a private equity unit of Standard Chartered, Bank of ChinaÆs private equity unit and the Government of Singapore Investment Corp.

Aside from these big-name supporters, the company also has its own well-known promoters in the form of its founding Chairman Pan Shiyi and his wife Marita Pan Zhang Xin, who is an executive director and CEO. The chairman is a frequent speaker at conferences in China, often features in Chinese and international media and is viewed as an integral part of the Soho China brand. In 2005 he was named as one of the 25 most influential business leaders in China by Fortune (China) and is behind many of the companyÆs innovative ideas.

The deal will have the usual structure with 10% of the shares set aside for Hong Kong retail investors, but with standard clawback triggers that could increase the retail tranche to 50% in case of strong demand.

The retail offering will open on Friday (September 21) with the pricing expected on September 27. The trading debut is scheduled for October 8. Sino-OceanÆs IPO will close this Wednesday.
¬ Haymarket Media Limited. All rights reserved.
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