Small-cap developers face risks as need for rights issues grow

Small developers’ shares run the risk of earning dilution as rising funding costs may force them to raise money through rights issues, analysts say.

“Small developers will increasingly face difficulties in placing bonds overseas if the US starts tapering its bond-buying programme. They have no choice but to go for rights issue,” said Alfred Lau, a property analyst at Bocom International, adding that more share issues would dilute the earnings of the existing ones and affect their prices.

Shares in Wanda Commercial Properties dropped 2.33 per cent on Monday and lost a further 5.8 per cent to close at HK$3.22 on Tuesday after announcing plans to raise HK$2.46 billion through a rights issue of three shares for every 10 held by investors.

Ding Benxi, chairman of Wanda Commercial, said the money raised would be used in “investing in projects on the mainland and overseas”.

Shares in Lai Sun Garment (International), the parent of Lai Sun Development, have also taken a beating since announcing on Friday that it will raise HK$215 million through rights issue of four shares for every 25 existing ones.

Lai Sun has settled on an issue price of 83.4 HK cents, a 40 per cent discount on its previous close. Its stock plunged 13.6 per cent on Monday before recovering some of the lost ground on Tuesday, when it closed up 5.83 per cent to HK$1.20.

Lai Sun Garment said the raised capital will be used for debt repayment.

“Few major developers have made rights issues in the past. If they want to issue shares, they prefer share placement rather than rights issues as investors do not like the latter,” said Johnson Hu, a property analyst at CIMB.

A company goes for a rights issue only when it does not find enough institutional investors for a share placement but still needs the money, according to Hu, pointing out that this is why normally small-cap companies choose this route.

He said funding costs through bond issues face an upside risk next year but major developers should still be able to raise funds through bonds.

“Developers need to reduce net gearing or raise capital to increase their land bank. We found that the total land purchased by developers in our research coverage in the first 11 months of this year was 90 per cent higher than for the entire last year,” said Hu.

An issuance of rights by Wanda Commercial Properties is more understandable – it needs to grow its equity base to facilitate asset injection or project acquisition, he said.

Jin said a rights issue was less dilutive than placement for existing shareholders.

Alan Jin, a property analyst at Mizuho Securities, however, said bond financing was still the preferred tool of financing in general.

“If the cost of debt financing becomes more expensive, developers will naturally shift from debt financing to equity financing. We think there are greater chances for gradual increases in funding costs in both domestic and overseas markets next year,” he said.

Jin expected more property stocks would follow the trend.

Chew Fook Aun, deputy chairman of Lai Sun Garment, said bank loans were not a good option for funding as that would further increase the company’s gearing ratio, which now stands at 36 per cent.

It was considered as high for small- to medium-sized companies, he said. Neither is the company ideally placed to tap the bond market because of the small size of its business, he added, explaining why it chose rights issue.

Correction: Chew Fook Aun was speaking for Lai Sun Garment, not Lai Sun Development (of which he is also deputy chairman) as stated in an earlier version.