Talking Point

On solid foundations?

Blackstone close to a buyout of SOHO China, amid choppy conditions

Wangjing-Soho-w

Wangjing SOHO, a landmark in Beijing

Robert Hotung, a comprador at Jardine Matheson, was said to be Hong Kong’s largest property owner in the early twentieth century. Before he died in 1956, Hotung made clear in his will that there were three buildings in the city that his descendants should never sell. But his wish could not extend beyond three generations in legal terms. Two of the said premises were thus sold in the early 2000s, when Hong Kong real estate prices were stuck in a six-year deflationary cycle (Tung Ying Building, previously prime office space for the best medical practitioners, went on the block for about $140 million during the SARS outbreak in 2003).

The final building of the three – once Hotung’s home on the Peak, the territory’s most expensive residential area – was then sold for a record $653 million in 2015 to Cheung Chung-kiu, a Chinese tycoon who later smashed records for property purchases in London (see WiC479).

In mainland China SOHO China is another landlord with control over some of the most illustrious real estate in Beijing and Shanghai. Its founder Pan Shiyi had also vowed that he would hang onto these commercial properties, refusing to sell them “in his next three lives”. Nevertheless, news broke last week that Pan has been in talks to sell SOHO China in its entirety to American private equity heavyweight Blackstone.

What does such a deal say about the two parties’ confidence in Chinese real estate?

What’s the property on offer?

Reuters first reported this month that Blackstone was in exclusive talks with SOHO China to take the Hong Kong-listed firm private.

The US private equity firm is valuing SOHO China at HK$6 per share, which is an almost 100% premium to the average price of the Chinese landlord’s shares in January. Reacting to the report, the company’s stock price jumped nearly 40%. In a stock exchange circular, it fanned the speculation by admitting that it had started negotiations with “overseas financial investors” to explore the possibility of a “strategic partnership” that may lead to a general offer.

According to its latest financials, SOHO China had nearly Rmb68.9 billion ($9.8 billion) in assets against Rmb32.7 billion of liabilities by the end of June last year. That would translate into a net asset value (NAV) of about HK$7.575 per share, Hong Kong’s Singtao Daily suggested.

In other words, Blackstone’s offer comes at a 21% discount to the target’s NAV.

SOHO China is one of the biggest office landlords in China. Its property portfolio, essentially eight office buildings in Shanghai and Beijing that comprise 1.4 million square metres in gross floor area (GFA), is valued at Rmb61 billion. Blackstone’s $4 billion buyout offer, if successful, would allow the fund house to take control of SOHO China’s core assets at less than half of their value.

On the other side of the table, Pan and his wife and business partner Zhang Xin, also the company CEO, will be able to cash in $2.6 billion by selling their 63.9% stake, although Reuters also reported that the couple might retain a small stake after the deal is completed.

Is SOHO China a good landlord?

Some of the most successful commercial property owners have been those that hold onto high-quality properties for a long time. Patience isn’t an attribute that SOHO China has always demonstrated in its commercial strategy, however.

It went public in Hong Kong in October 2007 at an offer price of HK$8.3. In less than a month, the stock dipped below its IPO price – a level it has never been able to recover despite a number of drastic transformations in its business focus.

Founded in 1995, SOHO China had also started out as a developer of luxury properties. By 2007 it switched to focus on commercial buildings. This explains its brand name ‘SOHO’, which stands for “small office, home office”, as it planned to cater to the demands of young entrepreneurs for office space.

Country Garden went public in Hong Kong just a few months earlier by raising a similar amount of IPO proceeds. Yet by focusing on the much bigger residential market, the Guangdong-based developer has since grown into one of China’s top three property plays in terms of floor area sales.

As of this week, its market value was 10 times as much than SOHO China’s too.

SOHO China changed tack again in 2012, with Pan telling investors that it would depart from selling newly developed buildings and focus more on becoming a commercial landlord. The company’s rental portfolio would grow to more than 1.5 million square metres in GFA within five years, he claimed, contributing Rmb4 billion a year in income. Although Pan’s rental portfolio has almost met the target in terms of size, its profitability hasn’t come close. In its 2018 financial year, rental income reached Rmb1.7 billion (almost the same as 2017).

Having shifted to the “build to hold” strategy, SOHO then changed tack again, finding more success from selling completed office buildings to investment funds. In 2018 it sold two buildings in its Sky SOHOproject in Shanghai to Gaw Capital for $798 million. The year before it also sold its SOHO Hongkou project to a consortium including Keppel Land China, Alpha Investment Partners and Allianz Insurance.

In 2015 SOHO China had also switched on to the concept of “office sharing”. Under a sub-brand called SOHO 3Q, it tried to offer shorter term rentals from a few days up to three months (see WiC273).

But again the new departture – rather like the concept of office sharing itself – proved a short-term success. Just a few weeks after WeWork cancelled its planned IPO in New York last year, local media reported that SOHO China had sold 11 of its SOHO 3Q projects.

Why is Blackstone interested in SOHO China?

Pan has lamented that life has been difficult as a commercial landlord. “In Beijing, SOHO China’s rental yield is less than 3% but the interest rate cost on bank loans would top 4%… please tell me how this is a sustainable business?” he asked a conference last year. According to International Financial News, a sister publication of the People’s Daily, the vacancy rates at many of the country’s prime office buildings had already been rising as the year-long trade war with the US took its toll on the Chinese economy. The sector will suffer further with the coronavirus outbreak bringing parts of the economy to a standstill.

However, Blackstone has been active in Chinese property since late 2018, buying $1.25 billion of Shanghai assets from Singapore’s Mapletree. A few months later it paid Taubman Centers $480 million to acquire half of its interest in its Asian shopping centre assets, which include a pair of China malls. Shortly after that it spent another HK$7 billion on real estate owned by a subsidiary of the HNA Group in Greater China.

It is also making its bid for SOHO China at a time when share prices have fallen in general. And it would be getting prestige projects, like the Bund SOHO in Shanghai’s city centre and the futuristic-looking Wangjing SOHO in Beijing, designed by Zaha Hadid, the first woman to win the Pritzker Architecture Prize.

It will be betting that this kind of real estate is more resistant to the declining rents that the sector could soon be seeing in general.

Blackstone filled up its war chest by raising $20.5 billion for the world’s largest ever real estate fund in September last year. Stephen Schwarzman, its boss, has also been a serial dealmaker in Chinese M&A (see WiC369). Nor will it need to spend too much time on due diligence before signing off on the buyout. Yan Yan, a managing director of Blackstone’s real estate team in Asia, knows its latest takeover target well. As another of the founders of SOHO China, Yan worked with the developer for 22 years before joining Blackstone in 2018.

Other investors are going long on Chinese real estate as well?

China’s financial markets have been calmer than their global peers in the last few weeks. While the spread of Covid-19 has sent US stocks plunging more than a third over the last month, the benchmark Shanghai Composite shed about 10% during the same period.

The housing market had seemed to be holding up relatively well too, although the stress in the sector is now starting to become more apparent. Sales by the top 100 property developers dropped by 44% in February, Caixin has reported, with more than 100 builders going bust in the January-February period. Evergrande bucked the trend but only by slashing asking prices by a quarter in February, with similar reductions on offer again this month.

The Financial Times expects to see a ricochet effect in the offshore bond markets, where Western investors have lent liberally to Chinese developers on high interest rates. Developers are scheduled to pay about $20 billion in maturing US dollar bonds this year, according to data from Dealogic. For some of the real estate firms, the slowdown in the economy will make that impossible.

Should panic selling start to feature in the commercial property market, there shouldn’t be a shortage of deeper-pocketed investors lining up to bottom fish, however.

One candidate is Softbank. Despite the setback with WeWork, the investment giant has made two large bets on Chinese real estate recently, the Wall Street Journal reported this month, putting $1.5 billion into a pair of property start-ups, including apartment rental platform Ziroom.

The 187 year-old British conglomerate Jardines has also been active, making more headlines last month after Hongkong Land, a key unit of the Jardines group, smashed the land sales record in Shanghai when it bought a commercial site on the Bund for Rmb31 billion.

Hongkong Land has spent more than HK$54 billion on mainland Chinese real estate in the past two years. This latest bet on Shanghai should be seen as a vote of confidence in the mainland and a shot in the arm for the Chinese government, which is battling with the Covid-19 outbreak, Hong Kong Economic Journal said.

In late February another of Hong Kong’s property groups Wheelock said the family of its former chairman Peter Woo had offered to take private the 30% stake in the company that he doesn’t already own. Wheelock owns a 71% stake in Wharf, which operates two of Hong Kong’s busiest shopping malls (Times Square and Harbour City). Over the last few years Wharf has expanded into mainland China as well, which now accounts for 71% of the conglomerate’s total property assets.

Plagued by concerns over a drying up in Chinese tourists to Hong Kong, Wharf’s market value has dived more than 30% this year to HK$39 billion. So analysts will be looking to see whether the Woo family raises its stake and makes a wider play into Chinese property, following the take-private deal at Wheelock.

And what is Pan going to do next?

At least Rmb30 billion worth of SOHO China projects have been sold since 2012, according to the Chinese press. Pan and his wife Zhang have also been investing in American real estate, spending $2 billion on three property deals in Manhattan, one that included the historic General Motors building in New York.

They could add to this overseas portfolio in the months ahead, giving up control of SOHO China’s assets in exchange for the cash to buy more real estate in the US and Europe (as SOHO China is listed in Hong Kong, a sale to Blackstone wouldn’t be subject to capital controls).

“The story of SOHO China seems to be coming to its final chapter,” International Financial news concludes, adding that Pan and Zhang have both been spending more time in the United States in recent years. The tycoons may be voting with their feet – worried by a structural slowdown in China. But if the price is right, Blackstone senses a bargain. Only time will tell who is right.


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