Dawes Points: Living Cities Property Development IPO

Living Cities Property Development IPO

Contact me on +61 2 9222 9111 or  bdawes@psec.com.au

Download LCG Prospectus

Readers of Dawes Points know my positive outlook for China.  This extraordinary national economy has almost 1,400m people living in a wide range of regional sub-economies that could each be half the size of the US.  Each sub region seems to have its unique character and not everyone has the same profile as Guangzhou (export industries), Shenzhen (technology) or Shanghai (everything!).

We all know that China has an economy that is already bigger on a Purchasing Power Parity basis than the US and that the transitioning from a rural predominant population to an urbanised one is well established but still has a long way to run.

This transition from agrarian subsistence to urbanised employment supports rising living standards.

The statistic of an average 8-10%pa growth in personal income in China over the past decade is the clear indication of rising living standards and currently is somewhat independent from GDP growth.  Increasing participation in the urban workforce and more successful domestic businesses everywhere bring up the average per capita income without really reflecting wages increases although that surely is also growing.

The Dongfang Modern Agriculture Holding Group IPO has provided an excellent window into China to see how its domestic economy worked.  DFM.ASX is now pushing A$1,000m market capitalisation after reporting a better-than-Prospectus forecast figure of A$90m.

DFM Share price chart.

DFM is now the market leader with around 2% market share of citrus harvesting measured by revenue through the sales of almost 250,000tpa of tangerines, navel oranges and the now very chic pomellos. It is a relative giant in a highly fragmented industry of citrus production and harvesting.

Dongfang has a market of 1,400m potential consumers and should be able to capture more of the market through organic growth and acquisition.

China has a very high savings rate and household bank deposits of well over RMB100 trillion (~US$17tn) so it could be expected that Chinese household expenditures will continue to rise into ever higher levels of consumer affluence.

The higher disposable income supports a higher consumption level of fruit and protein (as meat, poultry and seafood) at the expense of grains.

Property in China provides another very interesting aspect of economic transition.

China builds new cities to provide new production facilities and to accommodate retail, industrial, commercial, office and residential activities.

These cities are well planned with roads, rail, power, water and other infrastructure established ahead of time and the residential accommodation follows.

Residential complexes need food and consumer retail establishments as the people move in.

We all should already be aware of the speed with which these Chinese buildings are erected and completed with 24/7 construction at rates that in Australia we might only dream about.

We should also be aware of the market demand in many of these regional areas surrounding second and third tier cities.  Strong, without the speculative element seen in Beijing, Shanghai and Guangzhou (Note that Shenzhen property prices are again at all time highs).

Which brings us to the Living Cities IPO  (LCG.ASX).

This is an ASX relisting through a capital injection into a former mining sector shell (floated by Martin Place Securities in 2006 as direct iron smelting hopeful Ferrowest).

The Chinese backer of the Ferrowest Yalgoo Iron Nuggets Project, Sichuan Taifeng, through their Australian subsidiary TFA International Pty Ltd, is an established property developer in China and now wishes the listed company shell to move into property development – initially in China.

The concept is to establish a property development company listed on ASX with a strong Chinese local partner to participate in a series of projects in China and further down the track consider opportunities in property in Australia.

The market size is 40 times that of Australia and the deal flow is high, construction times are fast and project completions are common and rapid.

Construction standards are high and often exceed those in Australia.

This company offers Chinese investment opportunities with experienced Australian corporate governance and coming within an ASX listing.

The relisting is seeking a total of A$7.45m with A$3.0m from local investors. Sichuan Taifeng has brought in Chinese property investor Yaopeng to underwrite A$0.5m of the public offer, take a cash placement of A$2.5m and take A$1.95m in debt conversion from Ferrowest creditors. All at the same 20 cent price as the public offer.

The deal and offer structure is:

  Shares (million) Capital A$m
Existing shares on issue

5.62

 

Public offer

15.00

3.00

Committed equity from Yaopeng

12.50

2.50

Conversion of debt by Yaopeng et al

9.75

1.95

Advisor shares

0.75

 

Total

43.62

7.45

Sichuan Taifeng was established in 1997 and is a significant real estate, mining and trade partner in China with about 2,000 staff employed across almost 40 subsidiaries.

Sichuan Taifeng has a very successful operating history of over 18 years in construction through recognising and completing opportunities in high growth new cities and towns and is offering to lend its experience and connections to Living Cities (‘LCG‘)to provide a steady flow of property development opportunities.

As was noted during the due diligence process for the Dongfang Modern IPO, corporate strategies must adhere to prescriptive regulations in China.

Building regulations require the first stage of construction to `sea level’ of a building to be complete prior to the settlement of any sale of subsequent stages above ground.

This forces equity `hurt’ money to be utilised before any commercial space is sold but once sea level is reached, all the space for the full development may be sold.

The sale of commercial space thereafter is usually very rapid in these high growth towns and buyers must pay in full off the plan within very short time frames.  So equity risk becomes quite small and completed sales provide strong cashflow relatively quickly to fund construction.

The results are very high IRRs and surprisingly low risk.

The economy of China is about 10x that of Australia giving a very large market to operate in.  Moreover, in the current five year plan China will move about 50m people into urban environments over the next five years giving numerous opportunities for construction.

The first opportunity for LCG will be in a new district about 180km south east of Chengdu in Sichuan Province’s third largest city (2.8m), Zigong, where Sichuan Taifeng operates.

Sichuan Taifeng has been running its Zigong real estate operation since 2001 and currently has around 130 staff, and is a major developer of office building, convention centre, shopping centres and large scale residential property in Zigong.  It currently has 18 buildings under construction in Zigong with development costs of over CNY 1.2 billion (AUD $265m).

Sichuan Taifeng specialises in property developments that add value well beyond the simple construction process and any commodity residential apartment development.

The Yantan New District is well established and a new shopping centre is being built to cater for current population of 30,000 which is planned to grow to about 60,000 over the next three years.

Aerial view of building site  showing Yantan New District with Zigong City across highway in top left

The development is close to the centre of this new district and will be the Zigong GuoFeng Farmers Market consisting of 40 ground level retail shops, a second floor level of 500 local farmer fresh fruit and vegetables produce stalls, two stories for larger scale commercial development and a fifth floor for office space in a 5 storey shopping centre.

The site is just over 9,000m2 and all ~17,500m2 of commercial property will have been sold on completion.

Artist Impression of the Guofeng Farmers Market

Surrounding new apartments in New Yantan with site in foreground

The total cost of construction is set at around A$20m and the sales are estimated conservatively at A$37m (conservative assumed prices at the time of completion of around 25% lower than current have been used) to give a net A$14m and an actual cash surplus for distribution of A$17m.

Should the average sales prices be at current levels the total sales revenue would be almost A$10m higher and the gross after tax position would be about A$7m higher.

LCG has an option to acquire a 51% equity interest in this development of the shopping centre from Sichuan FuChuan Property Co Ltd (‘SFP’), the private company that owns the project.

LCG’s 51% share of the base case net after tax returns would be A$6.6m or A$0.15 per share fully diluted.

Site earthworks and excavation for the foundations and basement have commenced. Sale of `strata’ commercial space is expected to begin in the September Qtr 2016 which will allow additional bank funding and above ground construction to commence.  Completion is expected by March Qtr 2018.

On appropriately conservative weighted sales prices that are 26% below current market levels the successful completion and sale should result in a Net Tangible Asset value of A$0.23 for end FY2018 and after retained development capital should be able to distribute A$0.15/ share in unfranked dividends.

The IRR would be very high and well over 50%

Details are provided in this Property Investment Research review of LCG.

Comments from PIR include:-

“Key Assumptions Underpinning the Financial Estimates 

ASSUMPTION ADOPTED IN FINANCIAL MODEL COMMENT
Exchange Rate AUD1.00=CNY4.5313 As per prospectus
PRC Enterprise Income Tax 25.0% Income Tax paid in China on profits
Common Accumulation Fund 10.0% Required to be retained in Chinese entity to fund future growth
Withholding Tax 5.0% Tax payable on money leaving China
Franking Credits 0% Assumes tax paid in China is not available for franking credits in Australia
Construction Costs AUD$20.0m estimate $7.1m Land Cost
  $0.9m Site Appraisal
  $5.2m Construction Expense
  $2.9m Other Development Expense
  $4.1m Finance, Mgmt, Sales, Other
Sales Revenue AUD$37.0m estimate
(CNY 167.3m) Average Discount to market=26%
L1 Commercial – 3,621m2
Ave Mkt Sales CNY 30,250 /m2
Forecast CNY 23,000 /m2 (24% disc)
CNY 83.3m = AUD$18.4m
  L2 Farmers Market – 4,145m2
Ave Mkt Sales CNY 16,500 /m2
Forecast CNY 12,000 /m2 (27% disc) CNY 49.7m = AUD$11.0m
  L3 Commercial – 2,832m2
Ave Mkt Sales CNY 8,166 /m2
Forecast CNY 6,000 /m2 (26% disc)
CNY 17.0m = AUD$3.7m
  L4 Commercial – 1,476m2
Ave Mkt Sales CNY 5,500 /m2
Forecast CNY 4,000 /m2 (27% disc)
CNY 5.9m = AUD$1.3m
  L5 Commercial – 218m2
Ave Mkt Sales CNY 4,650 /m2
Forecast CNY 3,500 /m2 (25% disc)
CNY 0.8m = AUD$0.2m
  Underground Parking – 4,153m2
Cost Price CNY 2,550 /m2
CNY 10.6m = AUD$2.3m

Source: China United Assets Appraisal Group (Australia) Report (CUAAP).
Note: Average sale prices were based on 4 sites in close proximity as at April 2015 (ChuangXinCity, Longhu ShangCheng, GuanLan and JunHao Garden) – prices as provided by SFP and CUAAP report.

PIR Estimated Returns

Estimated Return on Project Low Base High
       
Est Return on Project – 100% Share (SFP Entity)      
Current Net Assets – SFP 1.7 1.7 1.7
Additional Expenses (excl land) to spend -15.0 -13.0 -13.0
Write down of land on sale -6.4 -6.4 -6.4
Proceeds from Sale 37.0 37.0 40.7
Net Assets after Sale (SFP Entity) 17.3 19.3 23.0
PRC Enterprise Income Tax (25% of Profit) -3.8 -4.3 -5.2
Net Assets of SFP 13.6 15.1 17.9
Pan Aust Share of Net Assets (51%) 6.9 7.7 9.1
Est return on Project – 51% Share (LCG)      
Pan Aust Share of Net Assets (51%) 6.9 7.7 9.1
Common Accumulation Fund (10%) -0.7 -0.8 -0.9
Withholding Tax (5%) -0.3 -0.3 -0.4
Net Distributable Profit to LCG A$m 5.9 6.6 7.8
Net Distributable Profit per LCG Share $0.14 $0.15 $0.18
Impact on LCG Balance Sheet      
Net Assets – as at Dec 2015 -2.2 -2.2 -2.2
Capital Raising (max subscription) 7.6 7.6 7.6
– advisors expenses -0.2 -0.2 -0.2
– operational expenses (2 years) -1.5 -1.5 -1.5
– initial investment in JV -2.7 -2.7 -2.7
– final net assets of SFP (at 51%) 6.9 7.7 9.1
– final net assets of Pan Aust (100%) 1.1 1.1 1.1
Net Assets – at end of Project 9.1 9.8 11.3
Net Assets per Share at end of Project $0.21 $0.23 $0.26
Shares on Issue (Max subscription) – m 43.6 43.6 43.6

Source: PIR calculations based on CUAAP assumptions

PIR comments

“A project manager will be appointed by the SFP for the day to day operations of the project. An existing loan with Harbin Bank is expected to be extended by an additional A$1.3m and a further A$2.9m loan will also be required. Both these loans have not yet been finalised as this is dependent on the success of the capital raising.  The total funds of around A$5.1m will allow the construction to progress up to what is known as ‘sea level’, which includes the basement and foundations. Once sea level has been reached, the project manager will be able to settle on any pre sales of the property. As pre sales are settled, funds will become available for the continued construction of the shopping centre, thereby allowing the construction to be self-funding thereafter. Expenses of the Offer are $0.075m plus up to $0.15m in shares for advisors to the placement. With a number of approvals already received, and the fast construction periods in China, it is estimated that the full construction will take about 18 months.”

Download LCG prospectus

Download LCG Presentation

Download PIR Report

LCG has a strategy to identify projects with similar economic returns with its JV partners in the Zigong and other parts of Sichuan to give it a long term and growing revenue stream. 

Contact Barry Dawes  +61 2 9222 9111  bdawes@psec.com.au

Contact LCG Chairman Brett Manning +61 8 9277 2600 bmanning@lcg.properties

Paradigm Securities would receive fees for funds raised under this prospectus.

Paradigm Securities and its associates hold shares in DFM and LCG (through Ferrowest).

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