Listing of Swire Properties brings China push into focus

Swire Properties yesterday kicked off the institutional roadshow for a Hong Kong initial public offering that will see it become slightly more independent from its parent company Swire Pacific which also has interests in industries such as aviation, retail and marine services.

The spin-off of Swire Properties will allow the developer and investment property owner to better position itself for its continued expansion, particularly in China, by being able to more easily raise capital as it needs it. That said, Swire Pacific and ultimate owner John Swire & Sons, are by no means letting go of this profitable business and Swire Pacific will still own 83.9% of the company after listing, according to an announcement to the Hong Kong stock exchange.

Swire Properties will offer its shares at a price between HK$20.75 and HK$22.90, which will allow it to raise between HK$18.9 billion and HK$20.8 billion ($2.4 billion to $2.7 billion). The base deal comprises 910 million new shares and accounts for 13.79% of the enlarged share capital. There is also a 15% greenshoe that could increase the total proceeds to $3.1 billion, although this is made up entirely of secondary shares sold by Swire Pacific and John Swire & Sons. The latter, which owns approximately 39% of Swire Pacific's share capital and 56.8% of the voting rights, is selling all the Swire Property shares that it will receive through a dividend in specie that will be distributed by Swire Pacific to all its shareholders in connection with the IPO. The JSS shares will make up 43% of the shoe, while the rest of the shares will come from Swire Pacific.

Five percent of the base deal will be sold to retail investors starting from May 3. In case of strong demand this portion may be increased to as much as 20% through a clawback from the institutional tranche.

Being the first major IPO by a Hong Kong property company since Link Reit in December 2005, the separate listing of Swire Pacific is not surprisingly attracting a lot of interest. The company is regarded as one of the most reputable commercial landlords in Hong Kong and has a close to 40-year track record of transformational projects that have successfully redefined several urban areas in Hong Kong. So far, it has been quite conservative in its moves into China with only four projects since its first investment in 2002 -- one of which is currently operational -- but analysts view the separate listing as a sign that the company is ready to put more focus on the mainland market. 

With the gradual completion of the company's three China projects under development, one syndicate research report suggests that the China portion of Swire Properties' completed investment portfolio will grow to 33% by 2014 from 7% (1.2 million square feet) today. The asset growth is expected to be accompanied by a similar increase in income.

"Swire Properties' full potential in China is not yet reflected in its present portfolio, in our view," the syndicate analysts stated in the report.

The company's primary focus on commercial property, specifically office and retail space, will be a welcome change for investors looking for property exposure in China at a time when Beijing is clamping down on residential property speculation. Commercial property is significantly underrepresented among the Chinese property companies listed in Hong Kong and the possibility of getting this kind of exposure through a Hong Kong company with a top-quality management, well-established corporate governance practices and a strong balance sheet that is supported by its investment properties in Hong Kong, has not passed international investors by.

An institutional investor luncheon in Hong Kong yesterday was packed with interested parties and bankers say orders are already flowing in from both long-only managers and hedge funds and there is also a lot of interest from private wealth clients. The only notable exception really, is the local property tycoons -- typically keen supporters of the top Chinese property firms -- who for obvious reasons (they are competitors in Hong Kong after all) are not expected to play a public role in the promotion of this company.

As of yesterday, there was one confirmed cornerstone investor -- Dutch pension fund APG -- which has committed to buy $200 million worth of stock, or 8.2% of the deal based on the low end of the price range. Sources said additional cornerstones may be added, although with quite a few players hesitating to commit to a lock-up, as the secondary markets remain somewhat unpredictable, the company may settle for using anchor investors instead. The initial support will be the same, as they too will commit to buy the shares at any price within the indicated range, but anchors are free to sell their shares immediately after listing. They also aren't publically disclosed in the prospectus.

However, there is seemingly no lack of support and sources note that the tight price range is a direct result of the widespread interest and feedback from real estate specialists globally. Based on the consensus valuation estimates among the joint bookrunners, the price range translates into a discount of 8% to 16% versus the net asset value, which compares with about 10% to 25% for key comparables like Hang Lung Properties, Hongkong Land and Wharf Holdings.

While the aggressive valuation is partly a result of the listing candidate's perceived high-quality and premium brand, it is also a reflection of the fact that Swire Pacific has no intention of selling its crown jewel too cheaply. If it cannot float it at a price where it will create value for the parent, then why bother doing it, one banker asked rhetorically.

Swire Properties' strong landbank of investment properties - Hong Kong office properties account for about 48% of its net asset value -- should make it a key beneficiary of the economic recovery. One syndicate report expects Hong Kong office rents to increase over the next 18 months and suggests that retail rental growth may also be stronger than expected. In 2009 it generated 55% of its rental income from its Hong Kong office properties and half its total turnover. It got another 38% of its rental income from Hong Kong retail properties, while the remainder came from Chinese retail and Hong Kong residential properties. Overall rental income increased 8.9% from the previous year.

According to a preliminary prospectus, Swire Properties expects its underlying profit to amount to no less than HK$4.226 billion in 2010, which implies an improvement of just over 10% from 2009. Underlying profits exclude the change in fair value of properties, which can fluctuate wildly from year to year. Swire Properties says it intends to pay an average of 50% of its underlying profit as dividend over an economic cycle. On top of this return comes the potential improvement in asset value that is expected as the company embarks on new development projects.

Given the company's somewhat limited income track record in China, one banker notes that the key for investors is likely to be exactly how quickly it can put its IPO proceeds to work to support future growth. Its ongoing projects are funded already and the management has not specified how it plans to spend the new money.

The IPO is being arranged by Goldman Sachs, HSBC and Morgan Stanley. The institutional order books will stay open until May 6 and the final price will be determined the following day (Hong Kong time). The shares are scheduled to start trading on May 14.