Abaci's Common Sense Investing

Before I start on Tiananmun South, the final piece of the valuation puzzle, let me add something about Sanlitum SOHO.

The site, vacant now, is valued at $7.9 billion at 30 Jun 2007. This I already told you yesterday. So here's something new for today. SOHO mentioned in the prospectus that it acquired this site via private negotiation in 2006 and nothing more. I had to look at the footnotes of the valuation report in the appendix to find out SOHO purchased it at only $2.15 billion six months ago in Dec 2006. The seller was BJ Tongying Property Development. If you happen to know more about this company please enlighten me.

During Jan to Jun 07, SOHO spent $1.1 billion on infrastructure of the land. Also during this time land price in BJ has surged so fast that there's an immediate windfall gain of $4.65 billion (i.e. $7.9 billion - $2.15 billion - $1.1 billion), or 143% on cost even before construction permit was issued! I can only say 'winner takes all' and feel apathy for the seller, for I have much experience to share.

The above brings out the nature of SOHO's profit which relies much on land appreciation than anything else, which makes it not so different from other land developers as Pan may claim. The other point is the 100% margin on future development cost I assumed in my calculation yesterday was probably too high, since SOHO had already made a killing on land price and past overall gross profit was only about 50%. But I'd leave the calculation as it is because in all likelihood the land will continue to appreciate, though by what extent I do not know.

Now I turn my attention to Tiananmun South.

It was city center redevelopment project similar to what we have here in Graham Street, Central, and Kwun Tong, except in bigger scale. There's a total of 44 parcels of land totaling 127,000 sqm of site area and 360,000 sqm of planned GFA. The site includes 12 heritage sites where extensive conservation work will be carried out. The project owner is a company named BJ Tianjie, wholly owned by the State Owned Asset Supervision and Administration Commission (SASAC) at the beginning. The role of BJ Tianjie functions sort of like the City Redevelopment Council we have in Hong Kong, i.e. to relocate and rebuild. Relocation started in 2004 and now all land has been cleared for development. A total of $3.6 billion was incurred in relocation and pre-development, which was financed by a combination of equity put up by SASAC and bank loans.

Pan owns 49% of BJ Tianjie (with SASAC owning 51%) which holds the right to develop 33 out of the 44 parcels of land in the project. Although the interest is a minority one, Pan will be entitled to 100% profits earned from the 33 parcels of land after repaying all bank loans of BJ Tianjie and capital put forth by SASAC (i.e. a total sum of $3.6 billion). For simplicity you can treat it like a wholly owned project. The remaining 11 parcels of land will be put out for tender early next year. Agreements have been reached whereby Pan's 49% interest in BJ Tianjie will be injected into SOHO, pending the necessary regulatory approval. In fact, the main reason of listing is to raise enough funding to develop this project.

How much is the land worth now? Well according to the valuer just the 33 parcels are worth $12.3 billion! If these parcels are sold today there'll be immediate gain of $8.7 billion ($12.3 billion - $3.6 billion) already. In addition, there's a further development profit of up to $4 billion, if I apply the same 100% profit margin on development cost.

If you wonder why or when Pan's name showed up in the picture all of a sudden? That's a good question to ask. But you won't get an easy answer unless you search deep into the footnotes of the accountant's report in the appendix. There you'd find Pan acquired his 49% interest in BJ Tianjie from SASAC at $144 million in Mar 07. Yes, only half an year ago in Mar 07 and for only $144 million. Pan subsequently put in $500m as shareholder's loan. In simple math Pan/SOHO put up $644 million and is ready to reap $8.7 billion home.

But why Pan? Why would SASAC spend 3 years clearing up the site, bargaining hard with the local residents, and then just pass the development right of this highly valuable downtown site to Pan at giveaway price, without any public auction?

I definitely smell Cyberport dejevu here! don't you?

The timing of events is more suspicious because SOHO was trying hard to get listed at that time and landbank wasn't big enough.

Now it becomes clear why the tycoons* are all so eager to buy into SOHO, for one should never challenge their collective wisdom. My guess is it's nothing but raw capitalism. Pan has excellent connections in BJ which can get him excellent land, and tycoons are buying those connections. In all fairness Pan and SOHO have done excellent marketing and worked hard enough in past projects to earn their special status now.

And we all know having a status can be very advantageous, even in a communist country.

To answer the very 1st question of where's my money, here's the breakdown.

Valuation of current projects: $17.5 billion
Less all liabilities net of cash and minority interest: aprox. ($6.5 billion)

Add Sanlitum profit: $3.55 billion on land + $1.1 billion on development
Add Tiananmun south profit: $8.9 billion on land + $4 billion on development

Add IPO proceeds: $11.4 billion

Total: $40 billion
Mkt value: $52 billion

Premium is now only 30%. Of course it's a lot fairer than those absurd valuation of other property counters. More importantly I dare not to underestimate Pan's continual ability to get good deals and the tycoon's trust in him.

So don't fancy the world renowned architects, beautiful buildings, Pan's charisma, or the SOHO brand, because those are just icings on the cake and you're missing the picture! You're buying not what's written in, but rather what's NOT written in the prospectus.

* BTW, I mistyped 'tycoon' effect as 'typhoon' effect in my last post. I'm sorry if I've confused you.

DISCLOSURE: I don't hold 410 at time of writing.