American Oriental Bioengineering (AOB) failed to timely pay the coupon payment that was due on January 15, 2012, to holders of its 5.00% Senior Notes due 2015 ($109 million outstanding). AOB also did not issue a press release or file an 8-K notifying investors that it had failed to make the payment.
According to an email from AOB investor relations, this payment was made 18 days late, on Feb 2. What is the significance of all this?
Firstly, a company with supposedly $80mm of cash which knows that it has to make a meager $3mm coupon payment should have the money available well in advance of the payment date. Secondly, trouble is clearly brewing with the debt situation at AOB. These bonds have a redemption feature which gives each bondholder the unrestricted right to put his bonds to the company for cash, at par plus accrued, in about 17 months (July 2013).
The company states that it has over $80mm of cash and total equity of over $450mm, and these $109mm of bonds represent its only material debt - with those facts, the bonds should be money-good, trading at par. Yet the bonds are currently quoted roughly 25x45. This price range makes no sense if bondholders believe that AOB can make good (or intends to make good) on that obligation. Are the sophisticated distressed-credit hedge fund bondholders stupid? Not likely.
Plausible theories could be:
· The delayed coupon payment may have been the first shot over the bow in a game intended to frighten bondholders into an unfavorable restructuring. It's clear that AOB doesn't have enough cash to both redeem the bonds next year and support operations, so something's got to give. AOB has been a giant consumer of cash the last several years, apparently investing over $300mm into land and buildings to further its R&D activities, while presiding over a collapse of its earnings and a collapse of its stock price - and all the while, management has communicated very little of its intentions or strategies to investors, seemingly very content to just take investors' money and "do its own thing".
It seems very unlikely that management will suddenly shift priorities and try to sell assets in order to pay down debt. Other options are also lousy - for instance, selling stock to pay down debt would be horribly dilutive to shareholders. Thus it seems highly likely that a confrontation between bondholders and AOB is coming. Assuming AOB fails to repay the bonds in 2013, bondholders will likely declare a formal default, and potentially file a bankruptcy petition in the US, but since all the assets are in China, they have a long road ahead in trying to collect on that debt.
· Another alternative may be that AOB intends to basically go dark. AOB received an NYSE Notice of Delisting last September, requiring AOB to cure its sub-$1.00 stock price. Given the debt-related problems, the disclosure failures, and management's general cavalier attitude toward investors, it seems unlikely that AOB will make any special effort to rectify the NYSE listing situation.
AOB stock may be headed for the pink sheets soon, trading like many other delisted China stocks that still purport to have large operations and hefty assets and equity, but the stocks trade for pennies because management doesn't intend to play fair with investors. (Or, looking at things optimistically, AOB could do a big reverse stock split to try to stay on the NYSE, but we all know what happens to stock prices after reverse splits - they usually head right back down towards their pre-split price).
· Another alternative may be that AOB simply may not have the cash and other assets that it claims to have. This is probably the least likely scenario - E&Y is the auditor (a good thing, not a guaranty) and the high profile China stock blow-ups of last year have caused investors to continue to greatly overestimate the likelihood of fraud among China companies.
Assuming that fraud is not the problem, AOB stock appears to be cheap. Unfortunately, it has appeared to be cheap all the way from about $7.00 down to 80 cents, and may be headed a lot lower due to the issues discussed above. If management has concrete plans to pay bondholders off at par next year (without horribly diluting shareholders), and to remain an SEC-reporting company listed on a major exchange, and to generally rectify the huge damage done to stockholders over the last few years, it should reveal such plans to investors without delay, and should generally adopt a policy of communicating more openly about its strategy including ensuring that all material events are disclosed on a timely basis.
Disclosure: I have at various times been long the stock of AOB. I have no positions in AOB bonds or stock at this time, but may in the future.