On August 4, Bill Simpson wrote an analysis of E-House (China) Holdings (NYSE:EJ). In its debut August 9, the company raised $201.5 million in its initial public offering, issuing 14.6 million American Depositary Receipts at $13.8 each - above the indicative price range of $11.5 to $13.5. Tuesday the stock closed at $19.99.
The text of Mr. Simpson's original writeup follows:
• • •
E-House (China) Holdings plans on offering 16.8 million ADS at a range of $11.50 - $13.50. 4 million ADS will be sold by insiders. Credit Suisse and Merrill Lynch will be lead managing the deal, CIBC and Lazard co-managing. Post-ipo EJ will have 76 million ADS equivalent shares outstanding for a market cap of $950 million on a $12.50 pricing. Bulk of ipo proceeds will be used to fund capital expenditures.
Chairman and CEO Xin Zhou will own 30% of EJ post-ipo.
From the prospectus:
We are a leading real estate services company in China based on scope of services, brand recognition and geographic presence. We provide primary real estate agency services, secondary real estate brokerage services as well as real estate consulting and information services.
EJ has been the largest real estate agency and consulting services company in China for three years now (2004-2006). EJ has 2,100 real estate professionals in twenty cities throughout China. In the past five years they've sold 5 million square feet of properties worth $5.4 billion. EJ also operates the only information system that provides up-to-date, comprehensive and in-depth information covering residential and commercial real estate properties in all major regions in China.
Chinese sector leaders in fast growing sectors have done very well in the US market the past few years, usually garnering aggressive multiples. The US market has not been a 'one size fits all' for Chinese offerings; the differentiators would appear to be that sector leadership. Sector leaders tend to outperform non-sector leader Chinese ipos. Financials and valuation aside, EJ would appear to fit in the 'sector leadership outperformer' category.
Awards - EJ has been named "China’s Best Company" from the National Association of Real Estate Brokerage and Appraisal Companies in 2006, and the "Leading Brand Name in China’s Real Estate Services Industry" from the China Real Estate Top 10 Committee in 2006.
Sector - The real estate sector in China has experienced rapid growth with primary property sales revenue growing 38% over the past five years. Primary property refers to the sale of new properties, which is EJ's focus. As such, EJ's clients tend to be real estate developers who utilize EJ's middle-man services to consult on development and to sell their properties. 82% of revenues in 2006 were from services relating to 'primary' (newly developed) properties.
Approximately 45% of 2006 revenues were derived in the populous Shanghai, Jiangsu Province and Zhejiang Province.Governmental Control - Since 2006, the PRC has instituted a number of initiatives to slow the swift property growth rates. These include: requiring that at least 70% of the land approved by a local government for residential property development for any given year be used for developing low-to-medium cost and small-to-medium size units and low-cost rental properties; 70% of construction be for 'small unit space' properties; increasing the down payment required for larger properties; imposing a resale tax on properties held less than five years.
Note - EJ has very high 'receivables' for their revenues stream. The June 2007 quarter saw approximately $23.5 million in revenues, while receivables on the book totaled $48.5 million. This appears due to EJ receiving payment for services only after a development (or phase of development) has been completely sold. EJ reports revenue upon each sale, however they do not receive the actual monies until the entire development project has been completed and all units sold. I'm not real thrilled with this accounting method. It appears to be a concession EJ has made to garner business, which is fine. However they've substantial receivables on the books that they've already booked as revenues but have not yet been paid. Cash flows here are not nearly as impressive as revenues/earnings would indicate. If all goes well they would eventually see the cash, however there appears to be serious lag time here from 'booking' revenues and actually receiving monies.
$2 per share in cash post ipo.Tax Rate - EJ is taxed a little more heavily than many of the Chinese based ipos we've seen. It appears EJ's current tax rate is in the 25%-30% ballpark.
Historically, EJ has booked an outsized revenue number in the fourth quarter of the year. For example, in 2006 quarterly revenue numbers were (in millions) $4, $10, $8 and $34. I would expect a similar trend in 2007.
2006 - Revenues were $56 million, a 44% increase over 2005. Operating margins were a strong 44%. Net margins were 34%. Earnings per share were $0.24.
2007 - As the bulk of revenues will be booked in the fourth quarter, it is a bit difficult to forecast full year. However, based on the growth in the first and second quarters, I would expect revenues to rise sharply in 2007 to $115 million or so. That would be a very impressive 100%+ revenue growth in 2007. Operating margins should improve to 50%.*Note* - Both revenue and operating margin numbers assume a strong fourth quarter of 2007. Net margins should be 38%. Earnings per share should be $0.55 - $0.60. On a pricing of $12.50, EJ would trade 22 x's 2007 earnings.
*Note* - EJ's net margins and earnings per share are not quite comparable to similar sector leader Chinese ipos in that their earnings are taxed at a higher rate than most of those.
Conclusion - Strong recommend in range. In fact, EJ is so attractive in range, I expect the range to be increased here. Sector leader in a fast growing sector, 100% revenue increase expected in 2007, coming at a pretty fully taxed 21 X's 2007 earnings. EJ is coming too cheap in range.