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LVGEM(CHINA) REAL ESTATE INVESTMENT COMPANY LIMITED(LVGEM)(95.HK):A SHENZHEN BOUTIQUE PLAY

LVGEM(CHINA) REAL ESTATE INVESTMENT COMPANY LIMITED(LVGEM)(95.HK):A SHENZHEN BOUTIQUE PLAY

唯高達香港 ·  Oct 30, 2015 00:00  · Researches

After asset injection from parents, LVGEM will become adeveloper with good execution track record in the cityredevelopment projects in Shenzhen which generatedecent margins

Existing investment properties are well managed andresidential projects are well located and of good qualitybased on our site visit

Earnings growth outlook in 2016 will improve from a fallin 2015. Two Shenzhen redevelopment projects in thepipeline, if acquired, shall help boost earnings outlook ina longer term

Acquiring quality assets from parents. LVGEM China hasagreed to buy a Target Company (one of the leadingintegrated property developers and commercial propertyoperators in Shenzhen) from parent at HK$13.8bn which is ata 28% discount to the adjusted NAV of the reorganizedTarget Group. Major assets in the Target Company are highquality assets in Shenzhen. It proposed to issue 1.66bn newshares at HK$2.2/share and 4.2bn convertible preferenceshares to fund the acquisition. China Vanke Co., Ltd. andShenzhen Ping An Dahua Huitong Wealth ManagementCompany Limited have announced their subscription of 300mshares each at HK$2.2/share which account for 36% of thenew shares to be issued.

Key injected assets are well located in Shenzhen. Our site visitto Shenzhen shows that (1) LVGEM’s NEO Grade A officecomplex is well located in a business area in Futian Districtand well managed, (2) Chanson Zoll Center which targets toserve nearby communities is well located in a high-densityresidential area, (3) Hongwan Garden's residential projectswhich were launched for pre-sale this year, and MangroveLuxury Garden which will be launched soon, are wellaccepted by the market and have potential to achieve decentmargins. LVGEM’s product quality is of high standard, in ourview.

Become a Shenzhen-focused player with good track record incity redevelopment projects. The Shenzhen market isconsidered as one of the best performing market amongChinese cities due to the undersupply situation, goodeconomy condition and large amount of net people inflow.New land supply is mainly through redevelopment given thelimited land availability. LVGEM has extensive experiences inexecuting 14 urban redevelopment projects in Shenzhen. Inour view, it shall enable the company to benefit from thestrong Shenzhen market with two redevelopment projectsunder construction and another two in the acquisitionpipeline.

Focus on redevelopment projects in Shenzhen, sell residentialand cultivate rental income base. The company plans to focuson key cities in PRD and YRD, especially Shenzhen andexpand into overseas (Hong Kong and Macau) markets,adopt a more diversified approach when obtaining landresources, replicate the "Zoll" business model and create aleading and scalable commercial property brand, extend thevalue chain of the Target Group's property business, integrateonline and offline resources, establish an O2O communityintegrated service platform and focus on the provision ofpost-development services, and attract, retain and motivatetalented personnel through competitive remunerationincentives and training programs.

Shenzhen's government is supportive of city redevelopmentprojects, which may help shorten development cycle andmaintain margins. The Shenzhen government is supportive ofcity redevelopment as it is considered a key way to enhancethe residents' quality of life in the city. They issued policies toenhance the transparency of relocation reimbursements andsmoothen the procedure. LVGEM recorded gross margins of50%, 41%, and 49% in 2012, 2013 and 2014 respectively.The disadvantage of redevelopment projects is their uncertaindevelopment timeline. With the supportive governmentmeasures, the development cycle may be shortened in thefuture.

Competition in city redevelopment projects in Shenzhen mayintensify as more developers join the fray. We saw moredevelopers seeking to enter the Shenzhen market due to itsgood market conditions and expect there to be morecompetition from national players in obtaining urban redevelopment projects in the future. LVGEM’s advantagewill be their negotiation skills with locals, a betterunderstanding of their concerns and thinking, and the localpeoples' trust which the company had gained in the pastprojects.

Earnings to decline in 2015 but to recover in 2016 due todelivery schedule. Total GFA to be delivered in 2015 will besignificantly lower than that in 2014. The Target Groupexpects a significant decrease in revenue for 2015 ascompared to 2014, which in turn is expected to have a significant negative impact on the financial performance ofthe reorganised Target Group for the year ending December31, 2015. However, as the company plans to deliverHongwan Garden in 2016 which has recorded significantcontracted sales YTD, we believe that its 2016 revenue islikely to recover to a high level.

Net debt ratio outlook. The Target Company maintained itsnet debt ratio between 79% and 88% during the past threeyears. Given that urban redevelopment projects usuallyrequire less upfront cash outflow since relocationcompensation is usually in the format of similar sized units inthe same project, we believe the company will be able tomaintain a stable net debt ratio as long as it does not buyland from the open market aggressively.

Fair asset acquisitions prices given their good locations inShenzhen. NEO, Chanson Zoll Center, Hongwan Garden, andMangrove Luxury Garden are professionally valued atRmb6.1bn, Rmb839m, Rmb6.3bn, and Rmb5.9bnrespectively. We consider the valuations as fair.

Main business and land bank. The Target Company startedoperations in 1995 and engages in three principal businessesof (1) property development and sales; (2) commercialproperty investments and operations; and (3) comprehensiveservices. Major assets in the targeted company includecompleted NEO Urban Commercial Complex, two completedZoll Centres, Mangrove Luxury Garden, and HongwanGarden, all of which are located in Shenzhen. As of end-Apr2015, it had 297k sm of investment properties in its portfolio,of which 217k sm had been completed and in Shenzhen and430k sm of saleable GFA which were unsold (57% inShenzhen and 42% in Maoming).Shenzhen projectsaccounted for 90% of the company’s market value estimatedby JLL. It also had two urban redevelopment projects to beredeveloped or contracted to be acquired in ShenzhenNanshan District and Bao’an District, with a total site area of285k sm. Corresponding GFA is likely to be more than doubleas per our estimation.

The translation is provided by third-party software.


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