Country Garden raises $400 million from share placement

Country Garden last night raised about HK$3.1 billion ($400 million) from a placement of new shares, grabbing the first market window after it reported strong full-year earnings on Tuesday. The quick move means it was able to tap the market ahead of a number of other Hong Kong-listed Chinese developers that are said to be looking to raise new equity this year.

The deal attracted a lot of interest and joint bookrunners Goldman Sachs and J.P. Morgan were able to fix the price at the mid-point of the range for a discount of 8% versus yesterday’s closing price.

Part of the sale was linked to the unwinding of a total return swap that the company entered into in connection with the sale of a convertible bond in February 2008 and which has acted as a drag on its earnings ever since as the share price has fallen. By unwinding the swap it will be able to make a final write-down against its profit and loss account and it will also effectively swap a derivatives asset on its balance sheet for pure equity. Indeed, one key reason for the share sale was to reduce the existing leverage. At the end of last year, the company had a net debt-to-equity ratio of 63.3%.

All the proceeds from the share sale are going to the company, but people familiar with the transaction say Country Garden is spending about $130 million to unwind the swap, which is cash-settled. Merrill Lynch is the counterparty. Country Garden had the option to terminate the swap early (it would otherwise terminate in 2013) if any of the CB holders exercised the put in February last year. Many of them did and, according to Bloomberg data, only about 18% of the CB remains outstanding.

Some observers argued that the discount range of 6% to 10% versus yesterday’s close of HK$3.51 was quite wide, especially when considering that the share price fell 4.1% yesterday, partly due to concerns over an apparent housing policy reversal in Shanghai. Several banks were also sounding out investors about their potential interest in a Country Garden deal after the company came out of the pre-earnings blackout period, prompting some investors to start positioning for a deal. However, the stock had gained 3.4% the previous day when the company released its earnings so compared to Monday’s close the decline wasn’t that big. The share price is up 79% from the low point in early October.

One source also argued that the discount was not particularly excessive when weighed against the liquidity in the stock. Based on the average daily turnover in the past month, the placement accounted for about 30 days of trading volume and it will result in a 25% increase in the free-float.

To increase the chance of success the bookrunners approached a number of investors before launch and when the books opened the deal was already more than half covered. Several of those investors were existing shareholders as the company was said to have been keen for them to have first dibs on the transaction, given that it would result is a significant dilution. This is the company’s first return to the equity market since its IPO in 2007. When the deal closed after about four-and-a-half hours, the bookrunners had received orders for more than twice the offering size.

The deal was driven by a number of global long-only accounts, including a few real estate specialists. But in addition to those, there were also the usual participants of Asian equity placements, such as China-focused funds and hedge funds.

The deal was launched at a set size, and once the price was determined the number of shares was adjusted to match that target. This resulted in the company selling 960 million shares, which translates into 5.7% of the existing share capital. The shares were offered at a price between HK$3.16 and HK$3.30, and sold at HK$3.23.

While the share price has come down a lot from the record high of HK$13.68 that it reached in September 2007 and has traded below the IPO price of HK$5.38 since June 2008, Country Garden is still viewed as one of the higher-quality Chinese developers. And with many investors still being underweight real estate, they may have viewed this as a good opportunity to increase their exposure. In that sense, it could turn out to be a real advantage to have been the first in the sector to sell new shares.

Country Garden said during the midday break on Tuesday that its net profit increased 35% to Rmb5.8 billion ($920 million) in 2011, while its property sales rose to Rmb33.2 billion from Rmb24.6 billion in 2010. Its contracted sales were up 31% to Rmb43.2 billion, just ahead of its targeted sales for the year of Rmb43 billion.

As of December 31, the company had 103 projects under different stages of development, including 62 in its home province of Guangdong.

Concerns over China’s property market measures resurfaced yesterday, however, after Shanghai’s Housing Bureau said that it will not lift the restrictions on long-term residents without a residency permit who wish to buy more than one property in the city. It had indicated that its existing restrictions would be eased only the previous week and it is believed that the central government has pressured it into giving up those plans. The move sparked some fears that the government will not allow individual cities to offer measures to support the local property market in cities where demand is faltering.

Country Garden issued $500 million of convertible bonds in February 2008 with Merrill Lynch as the sole bookrunner. To support the deal and help create a synthetic stock borrow the company combined the CB with a share buy-back that was carried out through a cash-settled total return swap of approximately $250 million. The value of the swap has had to be marked-to-market on its balance sheet and as the share price has fallen, the value of the swap has had to be written down and passed through its earnings. When the CB was issued, the share price was trading at HK$6.71, which means it has fallen close to 50%. Hence, the move to unwind this instrument should be viewed as a positive by the market.

According to sources, yesterday’s trade wasn’t bid out among a wider group of banks, but rather the company chose to go with the same two banks that helped it arrange a CB tender and high-yield bond in 2010.