On December 7, Bill Simpson wrote an analysis of Xinyuan Real Estate (XIN). The company raised $245 million with an initial public offering December 12 that priced within expectations. The 17.5 million offering of American depositary shares sold for $14 compared with a forecast range of $13 to $15. December 14 the stock closed at $15.40.
The text of Mr. Simpson's original writeup follows:
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Xinyuan Real Estate plans on offering 20.1 ADS (assuming overallotments) at a range of $13-$15. Merrill Lynch is leading the deal, JP Morgan and Allen & Company co-managing. Post-ipo, XIN will have 74.5 ADS equivalent shares outstanding for a market cap of $1.043 billion on a pricing of $14. Nearly all ipo proceeds will be used to acquire land use rights for future property development projects.
Chairman and CEO Yong Zhang and Director Yuyan Zang will jointly own a combined 42% stake in XIN post-ipo.
From the prospectus:
We are a fast-growing residential real estate developer that focuses on Tier II cities in China, which are a selected group of larger, more developed cities with above average GDP and urban population growth rates.
We've had one successful Chinese real estate ipo in 2007, E-House China (EJ). Where EJ is a real estate services company, XIN is a real estate developer. Simplified, XIN builds housing developments, EJ markets and sells housing developments.
Unlike many China ipos, XIN has actually been around for a while, commencing operations in 1997. From '97-'05, XIN focused operations in Zhengzhou, the provincial capital of Henan Province. Since then, they've focused on expanding to other cities. In addition to Zhengzhou, XIN currently has operations in four other 'Tier II' China cities: Chengdu in Sichuan Province, Hefei in Anhui Province, Jinan in Shandong Province, and Suzhou in Jiangsu Province.
Approximately 40% of 2007 revenues have been derived in Zhengzhou.
XIN focuses on large scale residential projects, typically multiple residential buildings that include multi-layer apartment buildings, sub-high-rise apartment buildings or high-rise apartment buildings. Target buyers of their development come from the growing Chinese middle class.
From the prospectus, 'We provide standardized mid-sized units, typically ranging from 50 square meters to 100 square meters in size, at affordable prices for this market. Our residential units feature modern designs and offer comfortable and convenient community lifestyles.'
Land is generally acquired through public auctions. XIN focuses on unencumbered land auctions which allow them to commence construction quite soon after land acquisition. As of 9/30/07, XIN had seven active residential housing construction projects with a total gross floor area (GFA) of 770,781 square meters. In addition, as of 9/30/07, XIN had in the planning stages an additional seven projects with a total GFA of 1,282,498 meters. This total does not include a 12/4/07 governmental auction win for a parcel of land located in Kunshan Town of Suzhou City with a site area of 200,000 square meters.
To date XIN has completed 13 projects with a total GFA of approximately 939,829 square meters and comprising a total of 8,645 units, 99.6% of which have been sold. Impressive sell rate, it would appear XIN is able to sell their projects out quite soon after completion.
The draw here is similar to many other Chinese ipos of the past few years targeting the growing middle classes. As XIN states, 'Increases in consumer disposable income and urbanization rates have resulted in the emergence of a growing middle-income consumer market, driving demand for quality housing in many cities across China.'
XIN plans to continue to expand operations to additional 'Tier II' Chinese cities they feel have an underdeveloped residential real estate market for the middle classes.
PRC - Recently the PRC has put in place initiatives to slow the booming Chinese real estate market. While most of these are directed at high end residential real estate, the PRC has also removed middle class residential construction from the 'encouraged' category. The latter will continue to be a 'permitted' type of investment. In addition for residences over 90 square meters total GFA, the down payment must equal 30% of the purchase price. XIN's residences tend to be smaller; however, it should be noted that the PRC appears intent on cooling the hot China real estate market at least somewhat.
XIN states in the prospectus: 'We believe that these policies have negatively affected our sales to a lesser extent than other property developers that focus on the luxury sector, because our business model focuses on the development of mid-priced housing, which is consistent with these policies'.
XIN funds a portion of their land purchases through debt. Post-ipo XIN will have approximately $233 million in debt. Compared to U.S. homebuilders, the leverage here is fairly low. Going forward, though, keep an eye on XIN's debt situation. If their business slows, the debt levels will tend to rise.
XIN does not anticipate paying dividends.
On a pricing of $14, XIN will trade 3 X's book value.
Historically, the cost of revenues for XIN has broken down to 1/3 land use rights and 2/3 construction costs.
Unlike many Chinese ipos we've seen, XIN is heavily taxed all along their various phases from land acquisitions through construction to sales. XIN annually pays a Corporate Income Tax, a Land Appreciation Tax, a Deferred Tax expense and an Uncertainty Tax expense. Reads a bit like a cable bill. Note that the 'Uncertainty Tax' expense is an accounting maneuver to attempt to better capture deferred taxes owed.
Revenues have grown briskly. Revenues in 2005 were $62 million, in 2006 $142 million and through 9 months on pace in 2007 for $310 million. XIN had a monster 9/30/07 quarter.
XIN has been profitable since at least 2004.
*Note* - Due to the nature of the business quarterly results have historically been quite choppy. This will definitely continue in the future, making projections here quite difficult.
2007 - XIN is on pace for $310 million in revenues, a 118% increase over 2006. XIN has $120 million in revenues alone in the 9/30/07 quarter. Note that XIN completed construction on two major projects in the 9/07 quarter. I've factored in a sequential slowdown in Q4 and they still look to double 2006 revenues. Gross margins should be 31%, operating margins 25%. Plugging in debt servicing and taxes, net margins should be 15%. Earnings per share should be $0.65. On a pricing of $14, XIN would trade a fully (and heavily for a China IPO) 22 X's 2007 earnings.
2008 - Due to the choppiness factor, forecasting 2008 is somewhat challenging. However XIN has a significant amount of active construction projects of which they'll be deriving 2008 revenues. They've also substantial land already purchased and planned for construction. Assuming China's real estate market and economy continue to grow nicely, XIN is poised for a strong 2008. I would anticipate XIN's 2008 will more resemble the 9/30/07 quarter of $120 million in revenues than the 3/31/07 quarter of $23 million in revenues. Note that XIN's gross margins have not been nearly as strong in their newer geographic areas so I would not look for a gross margin increase in 2008. I would not be surprised to see XIN book $450 million in 2008 revenues. Note that this is conservative as it breaks down to $110-$115 million in quarterly revenues, below their $120 million in the 9/30/07 quarter. While XIN does pre sell a large percentage of their properties, they are not anticipating completion on any projects until the second half of 2008. Assuming $450 million in revenues, XIN could earn in the $1 per share ballpark.
*Note* - this is nothing more than an educated guess because 1) XIN had an 'outside the box' strong quarter just prior to ipo and 2) they operate in a segment that is traditionally quite choppy quarter to quarter.
Conclusion - XIN is trending strongly right into their ipo. They booked a fantastic quarter just prior to this offering fueled by the completion of two major residential projects. China residential real estate has not seen the difficulties of the U.S. real estate market, so it is entirely reasonable to expect XIN to have a solid 2008. Home construction is notoriously cyclical in theWestern world; there is definite reason to assume it will be at some point in China also. On ipo though, XIN is not all that leveraged and the balance sheet looks quite lean for the sector. XIN is one of the stronger ipos from China in 2007. Recommend in range and a bit above, good looking China real estate ipo.