American Oriental Generates Plenty of Financial Engineering News

American Oriental Bioengineering (NYSE: AOB) has generated more than its fair share of financial engineering news during the first four days of this week. On Monday, the company announced it would buy back up to $75 million of its shares. On Tuesday, the company announced plans to offer $125 million in aggregate liquidation preference convertible preferred stock, and on Thursday, it rescinded the convertible preferred stock offer, citing market conditions.

It’s very unusual for a company to announce it wanted to drain its cash reserves one day and then make a second announcement that it was replenishing its cash the day following. New stock often carries some inducements in the form of discounts or warrants to entice investors, so the moves had the appearance of being a long-term expensive way to get a short-term boost in the stock price of American Oriental.

At ChinaBio Today, we did not report the proposed new stock offering on Tuesday, because the press release was very short on details of the new stock being offered – no information was given on interest rate, put features, conversion details, etc. We assumed the information deficit would soon be corrected when American Oriental filed its prospectus with the SEC. Usually, when private placements of stock are announced, the agreements between the company and buyers have already been worked out, and the prospectus is released as part of the announcement. Not this time.

With American Oriental, the problem is neither cash nor profitability: the company has lots of both. At the end of the first quarter of 2008, AOB reported $159 million in cash, and 12-month trailing earnings of $46 million, or 26% of revenues. Growth? Plenty of that as well: in Q1, revenues were up 51% and earnings 46% year over year. Most of the increase was due to acquisitions while the company’s existing pharmaceutical products were nearly flat and its nutraceutical offerings declined. That’s a small negative, but only a small one.

American Oriental also took pains to point out that it reserved $16 million in Q1 to prepay for acquisitions still under consideration, and at the beginning of Q2, the company announced it paid $18 million to buy a 38% stake in China Aoxing (CAXG.OB), which has a hard-to-obtain license to produce narcotic pain drugs in China.

American Oriental does not have much debt: just $10.6 million at its most recent accounting. Of that, $2.9 million is considered “current,” meaning that it must be paid back in the next 12 months. The convertible stock position would not increase the debt side of the debt/capital ratio (currently a low .032), even though the converts would act like debt at the outset.

As we have reported several times, American Oriental raised $64 million in cash last July 2007 in an 8.5 million share secondary offering at a price of $8.60. Originally, the company had grander ambitions, filing to float 13 million shares (both offerings included some stock from selling shareholders including CEO Tony Liu). Barron’s published a negative story on the company before the offering was completed, the stock price declined, and the offering was reduced in size and went off at a lower-than-expected price.

American Oriental has a lot going for it, but management may very well feel that its stock price does not reflect the size of the company’s accomplishments. It has sound fundamentals, with above average growth and an excellent profit margin. Nevertheless, the forward PE ratio (2009 fiscal year) is just 12, and the Price-Earnings-Growth ratio (projected next five years) is only .35. Where’s the respect?

Perhaps, the pressure for recognition caused a need to create a little excitement about American Oriental, or perhaps the whole brouhaha was driven by a desire of Tony Liu to unload some of his shares, the ones originally proposed for the secondary offering but then not offered in the final, reduced version. Those kinds of insights are not available to those of us outside the company.

Nevertheless, the company is doing well financially. Probably, in view of the failure to raise new capital, the company will buy back only a relatively small amount of shares. After all, the announcement committed American Oriental only to spend up to $75 million. That way, AOB could put its capital toward its real growth driver: continuing to expand its business by acquiring other China biopharmas.

American Oriental reacted positively to the news that the convertible preferred offering would be withdrawn. The stock moved 60 cents higher to $11.68, an increase of 5%. Over the past 12 months, American Oriental has traded in a range between $14.48 and $6.83.

Disclosure: none.

Comments

[Nordic:]

I wonder if AOB's manouvre is a gimic to get more shares into favored hands at a good price. First they buy back stock from the public and then are going to issue a convertible which might result in an excellent price for somebody - favored - to buy stock in the future. I tried to get information from the company's PR firm on who was going to get this privately issued convertible. They gave me some hogwash about not being able to say because it was a private matter. I may hold my stock for a while yet, but this game makes me very dubious about what kind of management we have here.

2008 Jun 06 09:39 AM