Eratat Lifestyle

Poster is d.o.g @ Valuebuddies.com



Out of morbid curiousity I took a look at the bond/warrant issue.

Key Features

Principal is RMB 134m, but they are being issued for RMB 100.5m, i.e. 75% of par.

Interest is 12.5% per year, payable quarterly. Given the discount at issue, the real cash interest rate is 16.7%.

Including annual amortization of 15.3% annually (because the investor pays 75% but is repaid at par), the effective interest rate is in fact 30% per year.

Maturity is only 2 years.

Warrants' strike price is $0.25 so intrinsic value is zero, however with 2 years' life, time value is not zero so there is some value.

So what we have here is fundraising via a very short-term, very high-interest loan. Including the cost of the warrants, the effective interest rate is well in excess of 30%.

According to their 31 Mar 2013 balance sheet the company has cash amounting to 4x the amount they propose to raise. with no debt. In fact, cash is reported at RMB 545m against total liabilities of just RMB 48m. There appears to be excess cash of over RMB 500m. Even allowing for working capital, there is easily RMB 300m available. There is no need to raise the money at all.

One possible answer to this conundrum is that the company cannot actually access this cash at all. It may be pledged for various purposes, or it may simply not exist.

IMHO anyone buying into this bond/warrant issue should be prepared for a significant (even total) loss of their capital. Yes, the bonds are to be secured by Lin Jiancheng's 122m shares. But if the company doesn't redeem the bonds, the shares are not worth very much, are they?

At today's price of $0.135, 122m shares are worth $16m, less than the issue proceeds of $20.6m, so the bonds are not even fully covered. And if the bondholder seizes the 122m shares and tries to sell them on the open market, good luck trying to get "market price".

As usual, YMMV.

And this also begs the question. Rather than pay an effect interest rate of 30%, why not take a loan from the bank instead???

The CFO says it's hard to get loans in China, but I see tons of other small to medium cap China companies including s-chips which have bank loans.

Eratat would rather pay an effective interest rate of 30% then obtain a bank loan?

The positive is that SHK must have done its due diligence but I simply cannot understand how Eratat can be this desperate.

I have to say that eratat's 12.5% interest rate is calculated backwards based on the principal amount (134 million amount), and is NOT the normal way of thinking of interest. Using the more conventional way (and accurate approach), the interest would be 15.45%. (i.e. 100.%*1.1545*1.1545 = 134). Thanks for the spot from value buddies. I had read the post in value buddies before but foudn the math and statements to be wrong and biased, without a clear statement of agenda, and thus decided not to post it. However, the spot on the effective annual rate is meaningful.

However, The post made by Po Piah and Skeptic about the effective rate being 30% is mathematically incorrect. When you quote effect rate, you refer to EAR (Effective Annual rate) which has been calculated to be 15.45%. Your figure of 30% is outright wrong and misleading.

"the effective interest rate is in fact 30% per year." - This is an outright wrong statement mathematically.

I don't like that it was represented with the calculation based on the "principal sum" (which they tagged as the 134m figure instead of the 100.5m figure). As far as I am concerned, the principal sum should be 100.5m, and NOT 134m.

I'd say that they might have had an agenda for calculating this way, so the effective annual rate looks lower. However, please get your calculations right before posting, Po Piah and Skeptic. Lets keep this discussion thread as objective as possible. When just airing viewpoints, by all means let people know it's your perspective and I'm sure readers will be able to distinguish.

Cheers,
Tactician

Tactician,

If you look at the announcement again:

Principle Amount of Bonds: RMB134 million

Subscription Price for the Proposed Bond and Warrant Issue:
RMB100.5 million

Redemption of Bonds on Maturity: Unless redeemed or purchased and cancelled as provided in the conditions of the Bonds, the Company will redeem each Bond at 100% of its PRINCIPAL AMOUNT together with all accrued interest on the Maturity Date.

This means that not only does Eratat have to pay 12.5% interest on the principal amount (effectively 15.45% of the subscribed amount, it also has to pay the principal amount of 134 million rmb back to SHK after 2 years (instead of the 100.5 million that SHK put down). If you amortize this difference annually, the total effective annual interest rate is about 30%, a horrendous deal for any company.

I really don't understand why resort to this when Eratat can take bank loans instead. Are banks not willing to lend them for some reason? They can't be this desperate for cash given their current cash balance.

skeptic, a corporate bond is esentially the same as obtaining a loan but it is more flexible as it is a loan + a form of debt security, which allows people to turn a loan into an investible security.

Non convertible bond usually has higher interest rate (coupon) rate than a convertible one. And, the shorter the maturity date, the higher the interest rate.

I do not understand how the guys at Valuebuddies arrive at a interest figure of 30% but that figure seems to be kinda misleading.

From my understanding of bonds (i am not expert), the coupon rate is 12.5% so per quarter, Eratat will make a coupon payment of RMB 134 mil x 12.5% divide by 4 = RMB 6.7 mil every quarter. And at the end of two years which is Year To Maturity, Eratat will pay back the principal RMB 134 mil. The warrant as well as Mr Lim's shares serves as a buffer for protection for the company and bondholder when the principal payment at the end of two years is due. The coupon payment should be the same amount every quarter, hence not compounded and thus, I dun see how the 30% is derived.

Please correct me if I am wrong.

There are reasons why even cash rich companies issue bonds. Look at Apple, issuing bonds to do share buyback.

1) Savings of tax. Do note that in prc, the corporate tax rate is 25%. so, your deductible corporate profit will appear lesser than it should be due to the presence of debt.

2) And of course, if they do use part of the bond proceeds to fund sharebuyback, it is another savings due to the lesser dividend payment obligation.

3) another guess could be that they are going to have quite a number of new distributors coming onboard next year (which i think new distributors will be announced in 2nd half this year), resulting in sudden increase in working capital for next year. It is also a good news since we can expect them to give a plan for growth next year. It is normal for companies to raise more cash than needed to fund expansion, to give themselves a buffer. As long as they deliver the earnings we shareholders want to see, it's gd enough.

4) To fund expansion, it doesn't make sense for Eratat to issue placement or rights since the share price is way too low. Its warrants, placement etc are priced above 20 cents. Hence, a bond issue does make sense for them.

overall, the savings can outweigh the interest payments, if done correctly.

Newbiestock go look at the document again.

The principle amount is 134 million but the subscription price is only 100.5 million.

Eratat has to pay annual interest of 12.5% of principle amount (12.5% of 134 million, not the 100.5 million it received), and pay back the principle amount of 134 million after 2 years. However it will only be receiving 100.5 million based on subscription price being below par value. Go do the maths. The effective annual interest rate, if you include amortization of difference between principle amount and subscription price, is about 30%.

This is a ridiculous price to pay especially considering the amount of cash they have. Rather than pay an effective interest rate of 30%, why can't they obtain bank loans instead at much lower rates like most normal Chinese companies out there? Banks don't want to lend them?