We think the end is near for China Medical Technologies (CMEDY), and that the gears are in motion for bondholders to file the company for an involuntary bankruptcy, in order to pursue the company's assets in China and try to achieve some sort of limited recovery for creditors. Given the lack of communications from the company since the missed coupon payments beginning in December 2011, bondholders have likely seen that negotiations are unlikely to bear fruit, and are therefore probably preparing a filing. My discussions with bondholders and research analysts indicate a lack of progress as well.
It has been nearly six months since the company first missed its coupon payment on December 15, 2011. It then missed another coupon payment on February 15, 2012. To date, the company has not filed an 6-K explaining why it missed its coupon payments. In fact, the company has not issued any 6-K filings or other relevant notices since its first missed payments. It did not inform investors when its independent director, Lawrence Crum, resigned. It did not inform investors when the stock was halted by NASDAQ, or de-listed to the pink sheets. It did not even appeal NASDAQ's decision to de-list the stock, unlike many other U.S.-listed Chinese companies that have seen their stocks halted.
The company has not filed a quarterly report for the quarter ended March 31, and has not provided any explanation for why it has not done so. Naturally, we're highly skeptical that the company will file a 20-F by its July 31st deadline, or will be able to pass its audit.
Standing ahead of the equity are $413 million face value of convertible notes (see here). When including accrued interest, the face value of notes is worth more than $420 million. If a theoretical restructuring were to occur, the bonds would have to be paid out at par plus accrued and default interest before equity holders would receive a dime. That said, we don't think an actual financial restructuring or debt-for-equity swap is in the works. Rather, bondholders will likely file the company for an involuntary bankruptcy in the Cayman Islands in order to begin attempting to pursue assets in China.
As of yesterday, the company's 6.25% and 4.00% convertible notes traded at 17.2 and 37.2, compared with a face value of 100, according to Bloomberg. These levels imply severe impairment; to put it another way, bondholders expect to receive no more than 17 and 37 cents for every dollar. If bondholders are that significantly impaired, equity holders are unlikely to recover anything. Bond prices have not risen since January, indicating that communications between the company and bondholders have been uneventful and lacking progress. Below is a price chart of the company's bonds:
As we can see, bonds have traded in the 20 to 40 price range since the company's missed coupon payments. At this point, the more time bondholders wait before filing an involuntary bankruptcy, the more difficult it may become to pursue their asset claims in China. We've previously seen Chinese management attempt to transfer assets to related parties to put them out of the reach of foreign claim holders, with companies such as ChinaCast, Puda Coal or Sino-Environment.
When bondholders push China Medical into bankruptcy, we think the stock price will decline dramatically. We believe there is no value left in the equity, and a bankruptcy filing will likely provide the catalyst that will help the market recognize that.
The Company's Irrational Stock Price
CMEDY has inexplicably risen to $4.40 over the past few weeks, which ascribes an absurd market capitalization of $115 million (and an even more absurd $530mm million total debt + market capitalization valuation) to China Medical Technologies. We strongly believe this share price increase is merely one of those odd, irrational occurrences that transpire occasionally in pink sheets-listed equities, and that the fundamentals will soon catch up with the company's stock price. Specifically, the company will be involuntarily forced into bankruptcy, in our opinion, and the stock price will decline dramatically from current levels.
We're not sure whether the recent share price rise is from momentum buyers assigning undue credibility to the SC 13G disclosures of AER Advisers, short-covering, or some other fanciful reason. We don't care. CMEDY is likely to be pushed into involuntary bankruptcy by bondholders, and its stock price is likely to plummet when that happens. We can't fathom any realistic way equity holders will receive any fundamental value for their CMEDY shares in the future.
Additional disclosure: Read our full disclaimer at kerrisdalecap.com/legal-disclaimer-3. I am short and own options on CMEDY.PK and stand to realize gains in the event that the price of the stock declines. To the best of my knowledge, all information in this article is accurate and reliable, but I present the information "as is". I will not necessarily update or supplement this article in the future. Following publication, I may transact in securities of the company covered herein.