US investors pile into Chinese property company

Xinyuan's focus on second-tier cities attracts attention as the company becomes the first Chinese property developer to list in the US.
Xinyuan Real Estate made the right call when it decided to list in the US, becoming the first Chinese property developer to do so. According to sources, the company benefited strongly from the fact that many US investors are still underweight Chinese stocks, and because it was the first to offer exposure to the real estate sector, it was also able to escape the negative sentiment that has surrounded many other Chinese stocks in the US since early November.

Xinyuan also showed restraint and priced its offering in the middle of the range at $14, despite attracting about $1.4 billion of demand. At this price, the company raised a total of $245 million. The shares were offered between $13 and $15 apiece.

The stock was also able to trade up on its debut yesterday, even though the IPO price already valued the company at a premium to some of the other small Chinese developers such as Greentown China and Aoyuan.

The stock opened strong, but after half-an-hour was back at around $14 level. Having gathered some steam and perhaps also some support from its sole bookrunner Merrill Lynch at that level, the stock then spent the rest of the session edging gradually higher and finished the session with a 20% gain at $16.80.

The company was lucky to come to market on a day when a surprise joint ôrescue packageö from the Federal Reserve and other central banks to alleviate the global credit crunch helped the Dow Jones to recover part of the 2.1% loss it made the previous day. However, after opening high, the Dow essentially spent the rest of the session edging lower and even fell below the previous close at one point in the late afternoon before finishing 0.3% higher. This meant that Xinyuan was able to trade higher as the broader market was on a declining path.

Investors liked the company because its offers exposure to the property market in ChinaÆs rapidly-growing tier-two cities and because of its focus on providing housing for first-time home buyers and families. That means it is not really that affected by the various government measures which are aimed at curbing speculation.

Meanwhile, XinyuanÆs relationship with Samuel Zell û a well-known US born billionaire and entrepreneur with a strong focus on property investments û also made US investors feel more confident about the company and its strategies. Zell, who is credited with having listed the first US Real Estate Investment Trust, is linked with two other non-US property assets that are listed in the US û Homex in Mexico and Gafisa in Brazil û and both of these have done very well.

Or as one observer puts it: ôInvestors feel that they can make money with this guy.ö

Zell bought a 17.5% stake in Xinyuan last year through Equity International, an investment company specialising in real estate investments outside the US that he runs together with co-founder Gary Garrabrant.

According to the source, the IPO attracted about 170 investors with 55% of the demand generated out of the US. The book was said to have contained very little price sensitivity and the deal could have priced at the maximum $15 per share. But with the usual hedge fund momentum missing - many of those guys have already packed up for the year to avoid making any last minute mistakes amid the current volatility û and in light of the poor performance of several other Chinese stocks that have recently listed in the US, the company felt it would be prudent to price inside the range. Of the total demand, only 10% to 15% came from hedge funds, compared with as much as 50% to 60% on a typical US IPO.

Several of the Hong Kong-listed Mainland developers also traded down during XinyuanÆs roadshow, which would have made its valuations seem relatively less attractive. The final price pitched the company at 11.2 times next yearÆs earnings, which compares with 9.9 times for Greentown and 10.2 times for Aoyuan. However, it was offered at a discount versus some of the others such as KWG Property at 13.3 times, recently listed Zhong An Real Estate at 12.5 times, and Singapore-listed Yanlord Land at 16.1 times.

Xinyuan sold 17.5 million American depositary shares (ADS), or 30% of the company. Each ADS is backed by two new common shares. The deal also has a 15% greenshoe that could boost the total proceeds to $282 million.

Aside from Equity International, China-focused private equity fund blue Ridge China also participated in the $25 million re-capitalisation in August 2006. The latter currently holds 26.2% of Xinyuan. The rest of the shares are held primarily by the chairman and his wife (56.8%), a smaller portion is owned by other directors and executives as a group.

ChinaÆs tier-two cities are a major magnet for the migration of the Chinese population from rural to urban areas. About 100 million people are expected to make that journey between 2006 and 2010 and Xinyuan estimates that this will translate into a need for 1.5 million additional apartment units per year in tier-two cities.

Set up in 1997 with the aim of building comfortable and convenient, yet affordable housing for mid-income earners in Zhengzhou City in Henan Province, the company has over the past year expanded into four other second-tier cities.

One of the key benefits of focusing on tier-two cities is also that the availability of land is much greater than in the major cities, and can typically be acquired at a lower cost. Together with XinyuanÆs scalable business model, small land bank and quick asset turnover this is leading to wide profit margins and healthy growth in the bottom line. In the first nine months this year, net profit is already more than twice the $16.1 million profit achieved for the full year 2006, and one source says, the expectation is that it will end 2007 with bottom line of $47 million. It is forecast to double that again in 2008.
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