Hengsheng Group, a Chinese real estate developer based in the Yangtze River Delta, announced on Friday that its privatization plan (proposed in 2013/11, priced at 1.8 Hong Kong dollars, corresponding to 0.6 times PB) did not receive approval from the majority of planned shareholders required, that the plan would not be implemented and would expire as a result, and that the stock's listing status on the Stock Exchange would be maintained. Hengsheng Real Estate was listed in Hong Kong in October 2009 at an issue price of 4.4 Hong Kong dollars. Zhang Zhirong holds 68% of the shares as the company's chairman. At the same time, he is also the controlling shareholder of a shipbuilding company, Rongsheng Heavy Industries (1101HK). As the second largest shareholder holding 9% of the shares, China Life Insurance stated in early December 2013 that it would “irrevocably and unconditionally promise” to support the privatization plan.
Trading of the company's shares was suspended last Friday due to a court meeting and special shareholders' meeting to decide on privatization. Trading will resume on Monday (January 20, 2014). At the same time, trading will resume on the same day on the $400 million five-year high interest bond issued by the company in 2013 with a face interest rate of 13.25%.
Our point of view:
We reaffirm our holdings reduction rating for Hengsheng Real Estate. The company may choose to sell some high-quality assets based in Shanghai in the future to ease the tight cash flow situation, but we think it is difficult to expect its weak fundamentals to be effectively improved in the short to medium term.
Sales declined gradually. Although the Chinese real estate market as a whole showed a strong momentum of continued recovery from 2012 to 2013, Hengsheng Real Estate's contract sales continued to decline, from 13 billion yuan in 2011 to only 7.3 billion yuan in 2013. We believe the lack of progress and decline in corporate execution after China began implementing the strictest purchase restriction policy in history in 2011 is the main reason. While most of its peers have stepped up product transformation efforts or forced sales over the past two years to cope with market changes in the changed policy environment, Hengsheng has made little headway, and the gap with its peers has widened more and more.
Financial constraints will not change. Although the company has cut capital expenses in recent years by drastically reducing land purchases and slowing new construction, weak contract sales have kept cash flow tight. The company's latest balance sheet shows that as of the end of June 2013, it held only 2.9 billion yuan in cash (of which only 1 billion was free cash and the rest was restricted cash). At the same time, the company's net debt ratio remained high at 78%, and short-term loans exceeded 8 billion yuan. Considering that the company's contract sales for the second half of 2013 were only 3.3 billion yuan, and that it spent 1.3 billion dollars to buy land in Shanghai in November, we estimate that the company's debt ratio at the end of 2013 will rise further to 88%, and that its cash position will remain uncomfortably low.
Valuation and target prices. The company's current valuation is equivalent to 56% net asset value discount, 0.6 times 14-year P B; 22 times 14-year PE, while the current sector's average valuation is about 45% net asset value discounted, 0.9 times 14-year PB; 5.6 times 14-year PE. Looking ahead, we believe that unless companies speed up asset disposal, the catalyst is limited, and the probability of value restoration is minimal until there are more signs of positive improvements in management execution. To reflect further increased cash flow risk, we further expanded the target net asset value discount by 10 percentage points to 70%, and based on the continued reduction in net asset value per share (from HK$4.01 to HK$3.87), we obtained a new six-month target price of HK$1.16, a drop of more than 30% from the current stock price, maintaining the holdings reduction rating.