Monday, September 05, 2005

Shakeout in China Real Estate Could Offer Chance to Buy In

September 2, 2005

Investors befuddled by China's volatile property market should pay attention to sales volumes of residential and commercial units in October, traditionally one of the hottest sales months of the year. If sales are weak, Chinese developers are likely to miss third-quarter earnings estimates -- perhaps creating an opportunity to buy shares, according to some analysts and investors.

In real estate, publicly listed shares tend to trade ahead of trends in the physical-property market. Property shares have bounced higher this summer, while the value of physical real estate, especially residential space, hasn't kept up. Nationwide, residential-property prices rose 1.9% in the second quarter, compared with a 2.8% gain for the first quarter, according to Morgan Stanley.

To some professional investors, bubbly share prices suggest an imminent recovery in the physical market. So some investors see stronger stock performance ahead for the property sector -- and they say a short-term stumble in October could provide deft buyers with even bigger gains later on.

"The next couple of months are key," says Kenny Tse, property analyst at Morgan Stanley. Chinese government measures to curb bank loans and speculation earlier this year have had an effect, and many developers have ceased building for lack of cash. Now, the focus has turned to consumers. If demand ebbs, developers may find themselves crunched again by slow sales.

The shakeout, if it happens, will give healthy real-estate companies a chance to expand by snapping up struggling rivals and taking over distressed projects. It may be an opportune moment to buy shares of companies with strong balance sheets and corporate governance, says Peter Churchouse, who manages a real-estate hedge fund for Hong Kong-based LIM Advisors. He thinks China Resources Land, in particular, fits in this category.

The stock also appears cheap right now, despite a recent rebound in its price. Shares of the Hong Kong-listed company are trading at a substantial discount to its peers, at 7.3 times next year's projected earnings, compared with an industry multiple of 8.2. On a price-to-book basis, which factors out cyclical fluctuations in earnings, the stock is valued at 0.6 times, a rare instance in which a company's total net assets per share are higher than its stock price. The industry average for stocks of Chinese property developers is 1.28 times book value. Morgan Stanley recently resumed coverage and is predicting the stock could rise as much as 28% in the coming year.

Although Mr. Tse thinks management has been slow to adopt an effective strategy, he sees evidence that China Resources is ripe for a turnaround, citing the formerly Beijing-focused company's diversification into Shanghai and several secondary cities, such as Chengdu, Wuhan and Hefei, in an Aug. 25 report.

China Resources Land happens to own a 13% stake in another highly regarded developer, China Vanke, whose B shares, which foreigners can buy, trade in Shenzhen. China Vanke, known for sound management -- by Chinese corporate standards -- has been able to use its financial strength to push ahead with development plans, while local competitors have grappled with tighter bank lending.

China Vanke's B shares aren't cheap, trading at 11.7 times earnings and 2.44 times book value. In addition, B-share trading is cumbersome, and agile investors may find it difficult to get out if the market moves unfavorably.

A third option is Hong Kong-listed Shanghai Forte Land, the shares of which receive a richer valuation than those of China Resources Land but still trade relatively inexpensively at 5.2 times next year's earnings. Shanghai Forte shares exceed the industry average of price-to-book, at 1.65.

But not all investors are waiting for October's sales figures. Earlier this month, Hopson Development Holdings Ltd. sold a 16.7% stake to Tiger Global Management and Temasek Holdings, the Singapore government's investing arm, for $125.4 million. In a public disclosure, Hopson said it would use the proceeds for debt payments, working capital and expansion of business on the mainland.

Private-equity funds, which this year have raised piles of cash to invest in Asia, are deploying some of it in publicly listed property developers. In some cases, they have made it possible for developers to access the public market for needed capital. Guangzhou R&F Properties, the biggest real-estate developer in the southern Chinese city of 10 million, nearly had to shelve plans for an initial public offering. The real-estate market had fallen out of favor in late spring, and the company's investment banks, Credit Suisse First Boston and Morgan Stanley, had difficulty mustering institutional-investor interest in the IPO.

Instead of abandoning the offering, R&F sought financial assistance from private-equity fund Warburg Pincus Asia LLC. More than a year ago, Warburg Pincus had offered to invest a chunk of money in Guangzhou R&F but was rebuffed. The property market back then was soaring, and the developer wasn't as hungry for additional capital. In July, with its IPO prospects grim, R&F and its bankers approached Warburg, which still liked the company's plum position in one of China's largest cities. The fund invested $65 million, buying 25% of the IPO shares.

Rodney Tsang, a CSFB investment banker who worked on the deal, expects to see more private-equity funds taking equity in publicly traded companies, including those in sectors outside real estate. "Private-equity funds have to be more creative in sourcing different types of deals," Mr. Tsang says.

Softbank Asia and Carlyle Group's venture-capital fund also have leapt into real estate recently, betting on growth in secondary property sales in China. The funds have invested $30 million and $15 million, respectively, in Sunco China Holdings' real-estate brokerage business.


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