Evergrande Real Estate Group defied plunging markets on Thursday and raised $600 million in a top up placement.
The Shanghai Stock Exchange Composite Index plummeted 6.5% in one day, while Chinese property stocks fell a similar amount amid concerns Chinese brokerages are tightening margins.
The roller-coaster ride this week has wiped tens of billions in market value off of some Hong Kong-listed companies, and led some investors to question whether the recent rally in A-share and H-shares is experiencing a temporary pullback or has run its course.
Brokerages experienced similar declines. Citic Securities and Haitong Securities each slid more than 2% on Thursday as more firms raised margin-financing requirements. The declines come less than one week after Huatai Securities’ blow-out IPO, allowing China’s largest stock brokerage by trading volume to secure HK$34.7 billion ($4.5 billion) in its flotation.
Plunging markets aside, the block in Evergrande had been highlighted before, so some research argued that it was viable — at the right price. Analysts also noted that Evergrande is one of the most highly traded southbound stocks, and could therefore ride out the storm.
The deal launched Thursday in Hong Kong, with 747.6 million primary shares on offer in the Guangdong-based developer at an indicative price range between HK$6.22 to HK$6.36 per unit, representing a high 8% to 10% discount to the May 27 close of HK$6.91 per unit, according to a term sheet.
Unable to sell the shares at this price range, the syndicate convinced the issuer to restructure the deal and lower the price range to HK$5.67, a hefty 18% discount, and increase the number of shares on offer to 820 million from 747.6 million.
The syndicate borrowed the shares from the company's chairman Hui Ka Yan to facilitate the top up placement allowing the company to raise the capital.
This created share dilution, but had to be done in order to reflect market conditions, one source close to the deal said. “The closing price before [of HK$6.91] was not reflective of what the market did [on Thursday],” the source said. "It launched at an 8% to 10% discount, then the market collapses and property stock comps collapse.”
In order to reflect the decline, the deal was restructured to offer a high 18% discount, bringing the shares on offer to HK$5.67 and increasing the number of shares to 800 million.
The number of investors participating in the deal was limited, with the source describing it as more of a club deal. Participants included institutional investors that had placed meaningful order sizes and ultra-high-net-worth individuals, mainly from Asia.
CLSA, Credit Suisse and Haitong acted as joint book runners while Jefferies was a joint placing agent.
The timing to launch the block was clearly not ideal. In addition to drops in Chinese real estate stocks and the Shanghai Stock Exchange Composite Index, a number of recent research reports recommended selling shares in Evergrande, given the recent run up in performance. Year-to-date Evergrande shares are up 120.1%, and in line with the run-up in shares after the Easter holidays, it jumped 100% from April 8 up to April 27.
But shares have since pared back some of those gains, with Evergrande dropping 2.3% on April 27 before shares were suspended.
Research by China Merchants Securities noted that the April rally begged the question of what’s next for the mainland developer.
“Stocks rallied by [over 100%] in one month which we believe is mainly due to the affluent fund flows from southbound trades and a sector re-rating on the back of the property market recovery,” said China Merchant Securities research dated May 8. However, Evergrande — which focuses on developing properties in tier-3 cities in China — will benefit less from the recent policy changes, the research argued.
“The key challenge is that Evergrande’s projects in tier-3 cities face sluggish demand and [a] severe oversupply problem, while its new investments in tier-1 and tier-2 cities have yet to prove more profitable than tier-3 city projects,” the China Merchant Securities research said. The analysts reiterated a sell recommendation, noting that despite Evergrande being ranked within the top 10 stocks of daily southbound trade, “equity fund-raising could be a near-term risk given its tight cash position after the recent share price rally.”
Others were less pessimistic ahead of the block trade Thursday night. “Fundamentally, we would be inclined to avoid the deal given the stock has more than doubled in the month of April alone and is now trading above the RNAV (re-valued net asset valuation) estimates of most analysts versus its peers which are trading at a discount,” according to Smartmarka Insight research.
However, Smartkarma research noted that the shares have been amongst the top 10 in southbound flows, and the risks of share placements have been well highlighted by analysts, and therefore should not be a huge surprise to the market.
Furthermore, the shares are being offered at a 8% to 10% discount, while the recent rise in stock liquidity means the deal represents less than 7 days of recent trading volumes. This should in theory “make it easy to digest, should markets remain supportive,” the Smartkarma research said. “Thus, for momentum investors, we would be inclined to take the deal.”
It took a bigger discount, but the deal did get done.
Mainland property outlook
Chinese property developers in general are tapping capital markets for cash as the government continues to move to support the slowing industry. The central government on May 10 dropped interest rates for the third time in six months. China also lowered the down-payment requirements for some home owners.
Greenland Hong Kong raised $219 million from a secondary share sale on May 17, while CIFI Holdings secured $170.3 million in a placement on May 18.
Chinese developers are therefore trying to take advantage of the favourable conditions and raise capital to purchase more land, given the cost will likely increase in the near future.
More developers are expecting higher sales growth, particularly in tier-1 cities. “Although both mortgage and construction loans are easily accessible, developers said that they are generally staying disciplined in terms of land acquisitions and focusing on clearing inventory as well as improving cash flows,” read Barclays research dated May 28. “Most developers said they are continuing to strike balances between sales growth, profitability and cash flows.”
However, tier-3 and tier-4 cities suffer from oversupply and sluggish demand, which will likely lead to increasing inventories and weak profitability for developers focused on these segements, such as Evergrande.
Evergrande’s net profit totalled Rmb2.74 billion in 2014, compared to Rmb8.25 billion in 2013 and Rmb5.83 billion in 2012.
This story was ammended to clarify the syndicate borrowed the shares from the chairman for sale.
