China Overseas Land & Investment took a major step forward in consolidating China’s fragmented property sector on Monday after it agreed to buy Citic Group's land bank in a $4.8 billion deal.
Hong Kong-listed but majority state-owned COLI is buying Citic’s property assets and their associated loans for Rmb31 billion or HK$37.08 billion. It will pay HK$29.72 billion of this by issuing almost 1.1 million in new shares to Citic Group at HK$27.13 apiece and also transfer a portfolio of commercial property companies worth an estimated Rmb6.15 billion to the conglomerate.
The deal is the largest real estate merger and acquisition to be conducted between two of China's state-owned enterprises and effectively gives Citic Group a 10% stake in COLI, China’s largest residential property developer. In return, COLI gets its hands on 20 million square metres of land with development potential located in mostly tier-one and tier-two Chinese cities.
A source familiar with both companies said the acquisition looked commercial in nature rather than one shaped by government-driven reform efforts, which have characterised other SOE mergers over the past year.
“In essence it’s a stronger operator consolidating a weaker operator,” she told FinanceAsia. “This is likely to be the first in a series of property consolidations going forward; a pipeline is building. The top 10 players look set to keep growing and companies outside the top 10 won’t be able to keep up.”
Consolidation within China’s property sector is building. In a separate deal, China Vanke reportedly agreed to pay up to $9.25 billion in shares to acquire Shenzhen Metro Group’s real estate projects, which would make the city metro operator its largest investor. The agreement appears an attempt by Vanke's management to fend off financial conglomerate Baoneng, which bought 23.5% of Vanke’s shares in December.
The new shares offered by COLI were priced at a 5.36% premium to its existing stock, which closed at HK$25.75 on March 10. It also offered a 7.45% premium to COLI’s average share trading price during the previous week.
COLI has agreed to buy both the properties and a set of affiliated loans attached to the assets and owed to Citic Group.
Deal rationale
China’s property market has long been on a tear at the behest of the central and, particularly, local governments, which earn money by selling land to developers.
However, there has been some bifurcation over the past year, with residential apartments in tier-one cities such as Beijing, Shanghai, Guangdong, and Shenzhen, and in a select number of tier-two cities, remaining very expensive and highly in demand, in contrast to the rest of China.
Prices in Shanghai have reportedly increased by 20% in the first two months of 2016, while prices in Shenzhen have soared by 50% in the past 12 months. The sharp increases stem in large part from investors in China pulling money from underperforming equity markets and placing it into residential property instead, combined with the People’s Bank of China slashing of interest rates six times since 2014.
Soaring property valuations have led to fears of another real estate bubble in China's leading cities but so far non-performing loans are at very low levels. Outside these prime cities, though, the picture is less rosy, with many second- and third-tier cities suffering from overcapacity and falling property prices, putting smaller developers under growing pressure.
COLI stands out as a likely winner in current conditions, given its size, status, and focus on residential development in mostly high-income areas. Citic’s land bank fits these ambitions since about 30% of the property assets sit in tier-one cities and another 60% is based in tier-two cities.
Citic, in contrast, sits well outside the top 20 property developers in terms of revenues, despite its large land bank.
“COLI is the best property developer and the most profitable, with great turnover and margins. So it makes sense for Citic, which hasn’t had the same success, to sell to COLI,” the source familiar with the two companies told FinanceAsia.
COLI, which publishes its full-year earnings on Friday, reported a revenue of HK$64.85 billion and an operating profit of HK$23.29 billion in its 2015 half-year results.
Frequent fundraiser
Like many of China’s property developers, COLI is a regular fundraiser in local and international capital markets, issuing €600 million ($667.43 million) of 1.75% July 2019 bonds in July 2015.
The company is rated Baa1/BBB+/BBB+ by Moody’s, Standard & Poor’s, and Fitch.
In December, parent company China Overseas Holdings also sold a $1.5 billion bond exchangeable into shares of COLI. The exchangeable bond issue means China Overseas Holdings’s COLI stake would fall to 58.34% if it converted the shares. The fact it didn’t want to dilute its ownership by much more with the new acquisition helps to explain why it also supplied a set of properties as part of the deal.
China Overseas Holdings is required by debt covenants on its exchangeable bond to maintain at least 51% ownership of COLI, so it would be highly unlikely to convert the exchangeable bonds following this M&A.
The acquisition will now need to go through a lot more disclosure, with COLI needing to evaluate approximately 140 project companies that form Citic’s land assets. The acquisition will then require regulatory approvals from Beijing’s Ministry of Finance, which is the ultimate owner of Citic Group, and the State-owned Assets Supervision and Administration Commission, which oversees COLI.
Assuming these proceed without a hitch, final approval will be required at an extraordinary shareholders meeting, likely in late May or June.
HSBC is sole financial adviser to COLI, maintaining its hot recent streak in China-linked M&A. The bank is also the mandated financial adviser on China National Chemical Corporation’s $43 billion acquisition of Syngenta, having in addition arranged funding for the deal.
