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  • AutoChina makes a sop to investors but its business model remains a mess
    The removal of AutoChina International's (AUTC.NASDAQ) earn-out provision is nothing more than a cosmetic action designed to appease investors. If they looked harder at the financials, they would find a company living on borrowed money.
    AutoChina International (AUTC.NASDAQ), a leading commercial vehicle leasing company in China, has axed the controversial system under which its CEO gained shares each year while existing investors saw their shareholdings diluted.

    It’s a positive step, but it doesn’t resolve fundamental problems with the company’s business model.

    The earn-out provision, introduced in 2009, was supposed to remain in place until 2013, diluting shareholders’ stock by 5-20% each year. The size of the earn-out is based on growth in AutoChina’s EBITA – the more the growth rate exceeds 30%, the higher the proportion of total outstanding shares awarded to CEO Li Yonghui. In 2010, this dilution reached the full 20% as Li was issued over 2.6 million shares.

    Following a spate of bad publicity as investors expressed concerns about further dilutions, the company agreed to terminate the provision from 2012. For the fiscal years 2010 and 2011, the earn-out will only occur if EBITDA growth tops 70%, as opposed to 30%.

    This about-turn was driven by a report by The Forensic Factor, which denounced AutoChina as “the most preposterous Chinese reverse merger yet.” Accusations leveled at the company included the use of inappropriate accounting methods, artificially inflating the balance sheet, a reliance on related party transactions, and “the most dilutive, and shareholder unfriendly, earn-out that we have ever seen.”
    The day the report was published AutoChina’s share price dropped 17% to US$23.09 and it is now trading at US$20.40, a 52-week low.

    Despite AutoChina management’s timely effort to respond to TFF’s accusations. This is the lowest price in 52 weeks. Therefore, we think the earn-out termination is used as a tool to retain investors’ confidence.

    Investors may feel they have cause to celebrate: Had this vulpine earn-out remained in place – and had, Li could have gained 19.5 million shares between now and 2013, diluting existing shareholders by about 50%. (This calculation is based on AutoChina’s EBITDA growth remaining above 90%, which would entitle Li to the maximum 20% earn-out.)

    There are two reasons why this “victory” is overstated. First, EBITDA growth was 426% in 2009. Under the revised earn-out provisions for the fiscal years 2010 and 2011, if AutoChina crosses the 70% threshold, Li walk away with enough shares to dilute existing investors’ holdings by 15-20%.

    Second, the earn-out climb-down is nothing more than a compromise solution devised by AutoChina management to avoid further scrutiny that would expose its unsustainable business model, and send the share price spiraling downwards.

    We have made our case several times before (see here, here, and here), and The Forensic Factor said much the same in its report. Put simply, AutoChina is living on borrowed time. Its primary business line – buying trucks which are then leased to customers – is hemorrhaging cash, to the point that the only thing standing between AutoChina and bankruptcy is support from internal and external financing sources.

    In the first three quarters of 2010, AutoChina raised US$367 million in capital from banks (US$190 million), affiliates and related parties (US$101 million), warrants (US$10 million) and secondary offering (US$66 million). This was US$250 million more than in the same period in 2009. Link

    Most of the capital went to new vehicles leasing activities (US$176 million) and loan repayment (US$173 million), but operational cash flow for the first three quarters remained US$8.9 million in the red. Link

    Since its inception in 2007, AutoChina has failed to report even a single quarter of positive operating cash flow. It has absolutely no value to investors and probably never will.

    This is a classic case of a healthy balance sheet hiding a multitude of sins. And the company has offered no explanation as to how it plans to extricate itself from its debt-dependent position.

    The investor takeaway is simple: Stay away from this stock.
     


    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
    Tags: AUTC, Auto
    Feb 18 4:05 AM | Link | Comment!
  • Looking under the hood of AutoChina
    2010-05-28: AutoChina's (AUTC.NASDAQ) first quarter results show rapid growth, but the real story is stock dilution and cash burn

    AutoChina International (AUTC.NASDAQ) released its first quarter financials last week, and at first blush, they looked fantastic. Quarterly revenue was US$121 million, up from US$10 million a year ago, while net income rose to US$6.2 million from US$1.7 million in the first quarter of 2009. Wow!

    But Sinosage has concerns about how much cash it is taking to achieve these numbers, and took a close look under the hood.

    Cars are rated on an MPG basis, or miles per gallon of fuel used. SinoSage proposes to rate AutoChina on an MPQ basis, or millions per quarter of cash burned. The company had an MPQ of US$50 million in the first quarter.

    Cash flow here is defined as money coming in versus money going out. But cash on AutoChina’s balance sheet increased from US$36 million on December 31, 2009 to US$95 million on March 31, 2010. If the company consumed US$50 million of cash, and its reserves increased by just under US$60 million, then the company raised US$110 million during the quarter, or slightly over US$1 million per day.

    Where did that money come from, and what did the company give up? Shares. Many, many shares.

    If you owned shares in AutoChina in the first quarter, you were diluted by over 51% as the number of shares outstanding increased from 13 million on December 31, 2009 to 19.7 million on March 31, 2010. The net effect is to make a share of stock less valuable, because the increase in income can’t match the increase in the number of shares.

    Here is an example: If a company had 10 million shares outstanding and earned US$5 million of net income, it would generate earnings per share (EPS) of US$0.50. If the company issued another 10 million shares, then net income would have to double to keep earnings the same. That is not what happened here.

    In the fourth quarter of 2009, AutoChina earned US$8.3 million (calculated by subtracting the nine month net income from the full year net income). There were 13 million shares outstanding at the end of the year, so the EPS was about US$0.63. In the first quarter, the company earned US$6.2 million, and there were 19 million shares outstanding. EPS dropped by half to US$0.31.

    Substantial dilution is only half the story. The other half is the negative cash flow, which is presumably going to require even more share issuance in the next quarter. If the company continues to burn US$50 million a quarter, and has US$90 million in cash, it would seem likely that the next equity offering is going to be in the next few months.

    AutoChina CFO Jason Wang maintains the company is not burning cash, but using additional capital for expansion of the business. It doesn’t matter what you call it, the effect is the same: At some point, the company runs out of money and needs to raise more.

    The results from the next quarter will give a clearer view on that but the first quarter does not inspire confidence. So far, AutoChina has sold its dealership business for the US$48 million, and in January it redeemed all the warrants outstanding for US$20 million in cash. Then in March it placed a secondary stock offering for nearly US$67 million and obtained short term bank loans of US$51 million (conditional on a pledge of a fixed deposit, while affiliates pledge various properties as collateral against these loans).

    This is an interesting point. AutoChina is getting loans from banks secured by property, not by the business. The only conclusion can be that the banks view the business as being not as credit worthy as the property.

    As previously discussed, and not denied by the company, AutoChina pays for its trucks up front, using loans from subsidiaries owned by the CEO. The company is bound to repay the loans over a six-month period but takes in the money from its own customers, the truck purchasers, over 26 months following a 25% down payment.

    That's called a funding gap – and AutoChina’s funding gap is made bigger with every truck sold. The difference is currently made up by an affiliate company, Beiguo Commercial Building, but that company presumably does not have the ability to hold an unlimited amount of debt on behalf of AutoChina.

    We contacted the only sell side analyst who follows AutoChina, Amit Dayal, senior China analyst and senior cleantech analyst at Rodman & Renshaw. Asked about AutoChina’s weird funding arrangements, Dayal said Rodman was working with company management to review the financing structure to see whether it is reasonable or not.

    SinoSage would think that analysis should have been completed before Rodman served as lead placement agent for AutoChina’s additional offering of two million shares in March, which raised US$70 million. This is the financial transaction at the heart of the business and it either makes sense or it doesn’t.

    SinoSage remains skeptical. If you own AutoChina shares, prepare for more dilution.
    Dec 20 1:04 AM | Link | Comment!
  • China Education Alliance: Still worth watching
    2010-12-14: China Education Alliance (CEU.NYSE) has been thrown into crisis by a recent damning research report. But the company seems to be clean and its growth prospects remain strong
    It might be the most dramatic trading week that China Education Alliance (CEA; CEU.NYSE) has ever experienced. The company, which provides online and on-site guidance to Chinese students preparing for examinations, saw its share price plunge 34% to US$2.93 on November 30 after being branded “a hoax” in a research report by Kerrisdale Capital.

    The central claim in the report – that CEA’s "revenue and profit are highly overstated in its SEC [Securities and Exchange Commission] filings” – was fervently denied by the company.

    Since then, CEA’s share price has begun to rebound, reaching US$3.45 on December 3 as the company issued a statement saying that its auditor Sherb & Co had confirmed most of its bank balances in China. An investor conference took place on December 7 at which CFO Zack Pan answered all questions regarding the company’s business.

    SinoSage thinks the following three takeaways are of particular importance.

    First, contradicting CEA’s SEC filings, Pan said the company’s onsite teaching facility, Heilongjiang Zhonghe Education Training Center was not fully operational, but closed for maintenance. As CEA’s largest single training center, it will be used for tutorials of college entrance examinations based on some cooperation with local universities and vocational training after the renovation.

    Second, Pan said that the inconsistency in CEA’s financial reporting – it told the State Administration for Industry and Commerce (SAIC) that its revenues were RMB4.2548 million (US$639,000) in 2008 while the SEC was told US$24.9 million – arose partly because of differences in Chinese and US accounting standards.

    In China, the parent company and its subsidiaries are not required to consolidate financial reports and cash balances held overseas do not have to be disclosed. This could potentially wipe considerable value off the financials submitted to the SAIC.

    Furthermore, filings submitted to the SAIC are part of the annual routine through which Chinese companies renew their business licenses. As such, they are generally treated with less care than stock exchange filings. Firms often neglect to submit audited financial reports and, in some cases, minimize their disclosure to avoid information leak to competitors.

    Last but not least, Pan insisted that all financial reports submitted to SEC were accurate. He told investors an October review by the SEC of the company’s financial reporting did not find any significant misconduct.

    However, the conference call appeared not to ease investors’ concerns. Once the stock resumed trading after the call, it plunged another 28% to US$2.34, losing most of its gains since the price rebound late in the week.

    On December 8, the CEA board announced a share buyback program up to a value of US$10 million. The offer, under which the company’s common stock will be repurchased, is valid till December 1, 2011. CEA’s stock responded by bouncing back 15.38% to US$2.70.

    Questions may be asked of Sherb & Co, a relatively unknown operation that doesn’t fall within the top 100 accounting firms globally. SinoSage consulted the Public Company Accounting Oversight Board and was encouraged by its findings: Sherb has been hit with one charge of signing off on alleged revenue fabrication, but the case never went to trial and the firm emerged with its reputation intact.

    So, if investors can be confident in the quality of CEA’s auditing, then what about its business model?

    The company reported a 41% year-on-year jump in revenue for the last quarter, while net income rose 30.41% to US$5.3 million. In its primary market of Inner Mongolia, CEA is currently serving 500,000-600,000 students – only 5% of the 10 million strong target audience. Each student spends about US$28.76 per quarter (US$9.60 per month), which makes for a clear source of cash.

    Should CEA succeed in expanding its operations to cover China’s four northeastern provinces, the target market of students aged between six and 18 widens to approximately 150 million.

    Based on all the available public information and evidence, SinoSage doesn’t think there are sufficient grounds to label CEA a fraud. The company has a clean auditor and management has responded constructively to the recent crisis. Given the strong growth prospects for its business, CEA remains a stock worth watching.
    Dec 20 12:58 AM | Link | Comment!
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