W Holding Company Takes Excessive Hit On Inyx Bankruptcy

Jul.20.07 | About: W Holding (WHI)

W Holdings' (WHI) market cap took a half billion dollar bath after its loan to Inyx (OTCPK:IYXI) turned out to have been a classic lending debacle, where good money is thrown after bad. Its Puerto Rican subsidiary Westernbank is the biggest lender to Inyx, and recently filed for receivership of Inyx’s U.K. unit, which is equivalent to a chapter 11 in the U.S. Inyx responded by placing its U.S. businesses into chapter 11, sending its stock to penny levels.

Inyx got started when the wife of Armenian-Canadian businessman and Inyx CEO Dr. Jack Kachkar acquired a public shell company with the intention of running a horse breeding company. We are not sure what happened to the horses, but the shell soon purchased the assets of Miza Pharmaceuticals out of that firm’s bankruptcy. Miza was a pharmaceutical company that had been run by Kachkar in Ireland. The Miza failure led an Irish court to bar Kachkar and an associate from serving as a director of a public Irish company. Kachkar is appealing. Since Inyx does not file proxy statements, there is no disclosure about this detail in its filings.

Since taking over the assets of Miza, Inyx has been on an acquisition spree, buying business units from Sanofi-Aventis (NYSE:SNY) and UCB Pharma in an attempt to consolidate drug inhalation device firms. It has always shown losses and relied on financial support from Westernbank, as well as Kachkar and his wife.

Kachkar is a colorful character with numerous businesses interests. In addition to his failed venture at Miza, which left creditors with losses of 23 million euros, he runs another publicly traded pharmaceutical shell company, Karver International. Earlier this year, he made a bid to acquire leading French soccer club Olympique de Marseille for 115 million euros. French press quote him claiming he owned castle Château Grimaldi not far from the club’s home town of Marseille, a claim quickly refuted by that castle’s current owner. Apparently, Kachkar’s wife had toured the property, but it was not even for sale. Kachkar’s own bid for Olympique de Marseille has collapsed amid reports that French anti-money laundering authorities have launched a probe into the origin of Kachkar’s funds. In the meantime, the soccer club’s owner has sued Kachkar for the payment of an 8 million euro breakup fee, French Prosecutors have opened an inquiry over alleged forgery of bank records, and a manager at a Florida bank has signed an affidavit denying that the bank ever issued a guaranty for the 115 million euro purchase price.

Kachkar’s wife Viktoria Benkovitch, of the race horse breeding enterprise, is his businesses partner in most ventures. If warrants and shares held by a Swiss trading company are counted, she owns more Inyx shares than Kachkar. However, disclosures of Inyx ownership remain murky, because it claims that its directors are not required to file form 4 reports. Its 10-K lists only holdings of common stock, but not warrants and stock options, of which plenty appear to be outstanding. Viktoria Benkovitch is the ex-wife of Kachkar associate Alexandre Benkovitch, who has been investigated in connection with the disappearance of IMF funds destined to prop up Russia’s struggling economy in the mid-1990s. He has been linked to mafia kingpin Semion Mogilevich, but no charges were brought against him.

Inyx’s largest financial problem appears to be outsized General and Administrative Expenses - “overhead” in plain English. Selling expenses amount to a mere 6% of sales, but General and Administrative exoenses amount to almost half of sales. Despite gross margins of close to 30%, such inflated costs are recipe for disaster. The exact reason for the large costs are not known, but a close reading of the company’s filings gives some clues:

“[…]Kachkar Air allowed Inyx to utilize such leased aircraft for the Company’s corporate travel requirements. […] For the year ended December 31, 2005, the Company paid approximately $680,000 to Priester Aviation for the use, service and maintenance of the Kachkar Air private aircraft.”

“[…] the Company paid $1.47 million to Aldo Union for pharmaceutical product dossiers. […]we are not absolutely certain whether these dossiers will have a definitive benefit to future periods. Dr. Santiago Calzada, who owns 100,000 shares in the Company as of December 31, 2005 is a principal of Aldo-Union.”

In total, such related-party transactions amount to over 8% of sales in 2005, the last year for which numbers are available. Another 2-3% are spent on executive compensation, excluding options. The U.K. And Puerto Rico operations appear to run near break-even and cashflow positive and cashflow neutral, respectively; the losses and drain on cash stem from the enormous overhead attributable to the U.S. parent.

InyxHowever, Inyx’s problems appear to be not only financial in nature. Westernbank has brought a lawsuit against Kachkar and other executives under RICO statutes intended to fight organized crime. The bank also claims that $40 million were siphoned off, and another $14 million diverted to “unauthorized” accounts. This pattern is similar to what happened at Miza in Ireland. The judge justified Kachkar’s bar on holding director positions with

“Mr. Kachkar and Mr. Carrigan either permitted or directed the payment […] of €2.8m […] on the basis of inter-company charges but with no real basis.”

Employees of Inyx have been complaining in internet chat rooms about non-payment of suppliers, who in some cases had to go to court and get bailiffs in order to get paid. This may well just be unverifiable internet chat room talk, but it fits into the big pictureand leaves us with a strange feeling of deja vu. If these allegations were true, then the large corporate overhead could be explained by transfers of assets out of Inyx under the disguise of expenses, or simply corporate waste. It also makes Inyx’s pre-bankruptcy announcement of a plan to start a Dubai office look less like a just another bad management decision, and more like yet another questionable one.

We are not quite clear why Kachkar let Inyx end up in chapter 11, even though he had offered to take the firm private for $3/share. Maybe he thought he could get an easy exit like in Miza’s collapse, and then repurchase Inyx’s assets on the cheap out of bankruptcy with his Karver shell. The bankruptcy court has already allowed him to take a first step in that direction: he was allowed to provide debtor-in-possession financing to Inyx and now has a priority claim to all of its assets, over the objection of Westernbank. However, while such a strategy may have worked in Ireland, it is unlikely that it will work under chapter 11. Scrutiny of pre-bankruptcy activities is very strict in the U.S., and scores of executives have gone to jail, often when their misdeeds were revealed after a bankruptcy filing. Just think of the Rigas family, Bernie Ebbers (30 years!), Dennis Kozlowski or probably soon Lord Black as examples. Many investors bought Inyx stock after Kachkar’s buyout proposal under the assumption that a buyout stops detailed scrutiny of related-party transactions and is preferred by managers to chapter 11 filings. It is not clear what different logic Kachkar subscribes to.

Westernbank may also bear some responsibility for this disaster. As a lender, they had much more detailed access to Inyx’s books than outside investors. They should have noted the irregularities that they now complain about much earlier. It is standard practice to rotate lending officers at the first sign of trouble in order to prevent emotional attachment to bad decisions. It looks to us as if Westernbank has continued to make loans in the hope of a turnaround. Heads are likely to roll in their asset-backed lending department. Talking of heads rolling, we heard an (unverified) rumor that a large asset management company fired one of its portfolio managers over an investment in Inyx.

Nevertheless, we believe that W Holding’s stock has suffered excessively on 6/29, as its maximum exposure is only $120 million and nowhere near the almost-$500 million loss in market capitalization.

WHI 1-yr chart


Disclosure: The author manages the Pennsylvania Avenue Event-Driven Fund [PAEDX], which owns shares of Inyx.