On June 15th, the bondholders finally pushed China Medical Technologies (CMEDY.OB) into involuntary liquidation proceedings in the Cayman Islands. Below are links to the Cayman Islands liquidation petition, as well as affidavits that were filed on June 15th.
The petitions and affidavits of the winding up process, which is the Cayman Islands equivalent to a Chapter 7 bankruptcy liquidation process in the United States, make for an interesting read. China Medical is a Cayman-based company, and therefore bondholders are currently pursuing a liquidation in the Cayman Islands rather than in the United States.
The first relevant document is the Winding Up Petition. The petitioner is Wilmington Trust, the indenture trustee for the bonds.
Throughout the petition, we can see that China Medical was not very responsive to the bondholders. The petition has a section titled The Company's Failure to Respond, where it writes:
The Company's Failure to Respond
33. The Company has failed and refused to communicate with the Petitioner with respect to the events of default or the amounts now due and owing under the Notes. As noted above, the Company failed to respond to the Petitioner's notices of defaults and of acceleration. The Petitioner sent a copy of the 2 March Notice to the Company's counsel as identified in the 6.25% Indenture, in response to which the Petitioner received a letter advising that such counsel no longer represented the Company in any matters. Additionally, the Company and its counsel did not respond to email communications from counsel to the Petitioner.
34. Petitioner is advised that counsel to the 6.25% Noteholders and the 4% Noteholders (together, the "Noteholders") has been unsuccessful in its efforts to engage with the Company regarding the events of default.
35. The failure of the Company to engage in discussions with the Petitioner and the Noteholders with respect to the events of default and the amounts due and owing is consistent with a company that is substantially insolvent and unable to pay.
That doesn't seem like a very good sign. Some long equity holders of China Medical stock had theorized that the company may restructure the debt with bondholders and therefore continue existing as a public U.S. company. But if the company hasn't communicated with bondholders thus far, is there really any indication it intends to restructure its debt?
As part of the petition, the bondholders have proposed the joint liquidators to be Kenneth M. Krys of Krys & Associates and Cosimo Borrelli of Borrelli Walsh Limited. According to the petition, the liquidators are authorized to take actions "necessary or desirable in connection with the liquidation of the Company and the winding-up of its affairs and to present the dissipation of the Company's assets". Mr. Krys and Mr. Borelli are qualified insolvency practitioners in the Cayman Islands and have had prior joint liquidator assignments where they liquidated Cayman Islands-based Chinese companies. Borelli, for example, was the liquidator for Zhu Kuan Group, Akai Holdings, China Milk Products and more than a dozen Cayman Islands-based Chinese companies that defaulted on bonds owed to foreign creditors. Borelli has developed a reputation for aggressively pursuing companies that have illicitly transferred assets to insiders, as recounted in a South China Morning Post article here.
Value of Equity
I'm not sure how equity holders of China Medical expect to generate any recovery now that China Medical bondholders have filed an involuntary Winding-Up Petition. The company has not been communicative with the bondholders, the trustee or counsel over the past six months since the missed interest payment, according to the Winding-Up Petition. Now, the question is whether liquidators can locate any sources of value for the $430 million of bonds and accrued interest outstanding. It could very well take years of litigation to find out.
To us, there certainly seems to be far more downside to the stock price at $8.50 than upside, given that $8.50 equates to a market capitalization of $225 million. With a management team that has not kept up-to-date with SEC filings and has been relatively unresponsive to bondholders since December, we continue to believe this stock is fundamentally worthless.
As a final point, we will address the 13D filings of AER Advisors, Peter Deutsch and William Deutsch. We don't have any special insights into why AER and the Deutsches have been purchasing shares of CMEDY.
But we don't see any practical way in which anyone could conduct a supposed buyout here. The company has defaulted on its bonds and has been pushed into involuntary bankruptcy. If any party wanted to do a take-private of China Medical, they would have to make whole over $430 million of principal plus accrued interest of bonds. They'd then have to write a check accounting for another $230 million of market capitalization, not including a requisite takeout premium.
We're not sure why anyone would want to pay $650 million for a Chinese medical devices company where management has essentially gone dark. As we have discussed, management has been relatively unresponsive to both shareholders and bondholders. Since missing its coupon payment, management has not filed any 6-Ks to update the markets on business developments. The company did not report the resignation of its independent director. When its stock was de-listed on NASDAQ in February, the company did not appeal the de-listing. It has not filed quarterly results since its September 30, 2011 earnings report.
Any company that chose not to make a $5 million coupon payment when it supposedly had $200 million of cash on its balance sheet is, in our opinion, telling the market that something is wrong with the underlying business or their previously filed financial statements. Additionally, the company was the subject of numerous negative allegations by Glaucus Research. Of all the companies available in the public markets, we can't fathom why someone would choose China Medical to take private.
As for management taking the company private, it's unprecedented to see management do a buyout of a U.S.-listed Chinese company that's stopped filing relevant financial statements with the SEC and which is in insolvency proceedings. In the few cases where U.S.-listed Chinese companies have been taken private, such as Harbin Electric or China Security & Surveillance, management has hired reputable investment bankers and counsel and has communicated with shareholders extensively during the process. We have seen none of that with China Medical Technologies. On the other hand, there have been numerous instances where management teams have stopped filing current financial statements with the SEC and essentially disassociated themselves from the U.S. capital markets. This has happened with China-Biotics (CHBT.PK), Advanced Battery Technologies (ABAT.PK), A-Power Energy Generation Systems (APWR), etc. Based on what we have seen with China Medical Technologies, we have no evidence to believe that CMEDY is any different.
Disclosure: I am short CMEDY.OB.
Additional disclosure: I am short 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.