Will LVGEM Be Able to Repay Bond Due in March as Scheduled

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Highlights:

• Less than two months are remaining prior to the maturity of the USD bond, and the bond price is trading roughly at $75. Credit-wise, in spite of improved market sentiment, the company faces a large fund shortfall and is not expected to raise adequate funds for repayment in the near term, suggesting a high likelihood of rollover.

• From past experience about property bonds that have been rolled over, investors have to note that there is a downside risk for this LVGEM bond.

• In the long term, the sale of Baishizhou projects is scheduled for the second or third quarter of this year, and the company's solvency is expected to improve significantly. We remain positive about the company's further development.

With less than two months left to maturity of LVGEM 12.000% 10Mar2023 Corp (USD) issued by LVGEM, we believe investors are very concerned about whether the company will be able to repay the bond as scheduled.

Significant Fund Shortfall

As a small-sized developer, LVGEM reports tight liquidity for a long time, with its cash to short-term debt ratio remaining below 1x.  While the debt is mainly made up of bank loans, which are less difficult to renew and the liquidity is still manageable level.

As of 30 June 2022, LVGEM’s total borrowings amounted to RMB 32.8 billion, of which short-term debt stood at RMB 12.6 billion. The adjusted cash balance after deducting restricted cash contracted from RMB 3.9 billion in end-2021 to RMB 2.7 billion, after the payment of land purchase for the Baishizhou project. The latest cash to short-term debt ratio was 0.2x, with a fund shortfall of roughly RMB 10 billion.

As of June 2022, LVGEM is assigned with credit facilities of RMB 20 billion from banks, but the loans could not be used for debt repayment other than the development and construction of the Baishizhou project

Moreover, the total sellable resources totaled RMB 8.0 billion as of 30 June 2022, including several property projects, such as LVGEM Amazing Plaza in Shenzhen, and LVGEM Joyful Town in Zhuhai. Given the weak sentiment of the Chinese property market now, it's pretty difficult to sell out of these projects within a short period, and therefore the cash flow generated from project sales will be limited for debt repayment. In summary, we believe that neither credit facilities from banks nor project sales will alleviate the tight liquidity.

Fundraising Is Not as Good as Expected, Sale of Baishizhou is Postponed

The large fund shortfall drives up the demand for external refinancing. At last year's interim results announcement, LVGEM revealed that the company was seeking new channels of refinancing, including offshore equity financing secured by domestic assets, onshore commercial real estate loans, and onshore bond issues.

However, none of the substantial progress in refinancing are seen since last August. On the one hand, owing to the relatively small asset base, just a few projects available can be used for pledges (Baishizhou has been pledged) and making it quite challenging for additional bank loans and bond issues. Although the Chinese government introduced policies to support the real estate industry in November last year, such as 16 Measures from PBOC and CBIRC. In practice, only medium and large developers benefited from supportive policies, rather than small-sized ones. On the other hand, equity refinancing mentioned by LVGEM requires an approval from the State Administration of Foreign Exchange, and there is no successful case, suggesting a low possibility to make it.

Under the current market environment, we believe that LVGEM is unlikely to make substantial progress in raising capital in the near term. Even though LVGEM has access to alternative refinancing channels, like private placement, the issue amount generally is too small to fulfill the payment obligation of the bond due in March, which has a principal amount of around USD 470 million.

It’s noteworthy that the sale of the Baishizhou project has been postponed from the end of 2022 to mid-2023 due to the pandemic. Previously, why we think the company could repay the bond due in March is based on the prerequisite that the Baishizhou project starts to sell at the end of 2022, as the large cash flow generated from sales could proffer protection for bond repayment.

To wrap up the points above, bondholders might have a deep understanding of the situation LVGEM faces, that is, the company has a large fund shortfall with worse-than-expected refinancing progress, coupled with deferral of sales of the Baishizhou project, forming a conclusion that the likelihood of missing the repayment of bond due in March is very high, and we expected the company to rollover the maturity of the bond by one to two years.

Long-term Prospect Remains Positive

Even if the company rollovers the bond as we predicted, we still remain positive about its further prospect. At first, different from "lying flat" developers, LVGEM is strong-willed to repay its indebtedness and keeps principal and coupon payments as scheduled. For example, the company repaid three onshore bonds due in December 2022 and is seeking new refinancing channels.

Also, the vast potential value of the Baishizhou project is undeniable. Phase I project has a total construction area of 900,000 square meters and a sellable area of 330,000 square meters, respectively. The sellable resources total approximately RMB 40 billion given that the selling price nearby averaged 130,000 per square meter. We expect the project to have a relatively high rate of sell-through, particularly in view of its excellent location and competitiveness in the Shenzhen real estate market. This is to say, the liquidity and solvency will be remarkably improved as long as the project starts to sell.

How Should Investors React?

Based on the scenario that LVGEM is very likely to extend the bond, how should bondholders react? The bond is currently trading at roughly $75. According to past experience, the bond price is hardly higher than this level after the announcement of the rollover proposal. Although the current market sentiments improved, it’s believed that the bond price still has a bigger downside risk relatively.

If bondholders are sensitive to price changes, they may consider selling the bond to evite future uncertainty. Additionally, considering that LVGEM's future development is still promising, bondholders with higher risk tolerance and a positive view of LVGEM may still consider holding it.

Appendix: Financial Metrics