Country Garden Acquires Debt-Laden Rival’s Assets

According to Pitchbook, a Morningstar company, R&F’s net debt-to-total equity is at 130%. This implies that even after settling part of the debt with cash, the developer still runs 1.3 dollars in leverage for every dollar in shareholders’ equity. Also, R&K has insufficient cash on hand to pay off short-term debt, as its cash could only cover 62% of the near-term liabilities. The property firm also surpassed the 70% ceiling on liabilities to assets. Excluding advance proceeds from projects sold on contract, R&F’s liabilities is equivalent to 77% of its assets.

Officials split property developers’ debt level into four camps: Red, Orange Yellow and Green. R&F is currently sitting in the most vulnerable ‘Red’ tier in the Three Red Lines rules, which will bar it from raising more coupon-bearing debt in the coming year. R&F is also the second largest firm in the country that belongs to the ‘Red’ camp, ranking only after China Evergrande.

Due to its liquidity concerns, our senior equity analyst Cheng Wee Tan says the urgent need for asset sales to address immediate liquidity needs “come as no surprise”. On top of the sale transaction of a price up to CNY 10 billion, R&F has sourced an additional HKD 8 billion financing from two of its largest shareholders.

Urgent Cash

The timing and the scale of funding highlights the urgency of R&F’s situation, says Tan. The subsidiary on sale was a lifeline for R&F before the liquidity crunch, as the parent company planned spin-off and list it in 2021. While believing that R&F’s spin-off will be scrapped, Tan says the acquisition is in fact leading to a round of consolidation. “Country Garden Services (CGS) will be able to execute inorganic growth in a consolidation environment as acquisition opportunities arise from cash-strapped players.”

Comparatively, Country Garden Services’ parent has a more sound balance sheet. Country Garden sits in the ‘Yellow’ tier, as it does not meet the official’s requirement of lower than 70% in liabilities to assets, excluding advance proceeds from projects sold on contract. In its latest earnings call, Mo Bin, president and executive director at Country Garden, said he is aiming to bring the firm to fulfill all the solvency requirements under the Three Red Lines rule by 2023.

Commenting on the affordability, Tan says CGS has ample internal cash resources to fund the deal, and the transaction would be paid in four tranches. The total acquisition price may also be pro-rata adjusted downwards depending on the performance of the acquired units and area under management for 2021. The acquired entities would be consolidated into CGS as subsidiaries, in which R&F would be subject to non-competition for five years.

Benefits to Country Garden

While the deal is pending regulatory approval, Morningstar’s fair value estimates of Country Garden Services are retained at HKD 88, which are viewed as undervalued. Tan adds that CGS remains the currently preferred pick within the property management sector. R&F is not on Morningstar’s equity coverage.

If approved by the regulator, the acquisition will combine 552 projects located in 102 cities across 26 provinces into CGS’s portfolio. The total GFA under management is 69.4 million sqm, with a mix of 84% residential and 16% commercial. To highlight, the R&F unit has a leading position in integrated management services of urban renewal projects. Thus, Tan thinks it would benefit from policy focus on shantytown renovation. The additional projects will raise CGS’ earnings by 9% based on its 2020 profit.

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