Cordlife made a non-binding proposal in what effectively is a reverse merger and a way to list Global Cord Blood (CO) on the Singaporean stock exchange. This is a quick review of the deal and potential rationale for the merger.
This is an all-stock deal, meaning no cash is changing hands. The only thing that would happen is that Global Cord Blood stock owners would suddenly own stocks in the merged company which would be listed in Singapore.
The deal: Details on the proposed non-binding bid are scarce, yet in summary, Global Cord Blood shareholders would receive $7.5 per share paid in newly issued shares of Cordlife at SGD 0.5 per share for a total number of newly issued shares at Cordlife of 2.5bn, resulting in an equity purchase price (and equity raise for Cordlife) of SGD 1.25bn. This is a huge dilution for Cordlife, whose market cap stands at a comparatively low level of SGD ~0.12bn at the issue price.
As a result, the combined company's market cap at the merger price will stand at ~SGD 1.37bn =(0.12+1.25) with Global Cord Blood Shareholders owning ~90% of the combined company.
Why is Global Cord Blood changing stock market?
First: The Singaporean stock exchange should be a better home than NYSE for Chinese mid-cap companies: investor appetite and valuations seem to be higher. Chinese companies listed on the US stock markets have a bad reputation. Numerous meltdowns, including frauds, have limited investor interest and appetite for these Chinese mid-cap companies listed in the US.
Second: Cordlife's accounting standards differ in the treatment of prepayment of subscriptions for the banking service. Without going into detail: A significant proportion of clients prefer to pay the 18-year subscription fee up-front. The costs associated with this 18-year service is more related to the sales and marketing related to acquiring this newborn's cord blood (customer acquisition cost), a cost that is taken up-front. The marginal storing cost for a new customer is practically zero.
Cordlife treats this pre-paid revenue through the stage of completion method, i.e., according to how the costs are distributed, resulting in an EBITDA that is more aligned with cash flow (See page 55 of Cordlife's FY2018 Annual Report). Global Cord Blood on the other hand recognizes only 1/18th of this prepayment per year, over 18 years. Our view is that Cordlife's accounting is better aligned with the company's true intrinsic value generation of the company.
Therefore, regardless of accounting, what we urge investors to do is to look at the Free Cash Flow generation of both companies (Cordlife and Global Cord Blood) and compare how the companies are valued on an EV/FCF basis. We expect that both companies will soon present a pro-forma combined EBITDA, using Cordlife's accounting standards. Assuming Global Cord Blood would be valued on the same EV/FCF as Cordlife (7.6), the combined company value would imply a USD $15 per share price on Global Cord Blood, a 100% appreciation (including EV adjusted for all hidden assets, among them a minority stake in the Shangdong Province banking facility, which constitute half of that 100% uptick - our estimate). See table below (sources are FY 2018 Cordlife report and latest investor presentation from Global Cord Blood):
Third, synergies: Although there should not be any clear cost take-out opportunities, much smaller Cordlife (15 times smaller FCF generation, see above) has established itself internationally in a way that Global Cord Blood has not. Cordlife has offices, sales personnel and representation in India, Indonesia, Malaysia, Vietnam, Philippines, Thailand, Myanmar and Hong Kong. Global Cord Blood's (who recently changed name from China Cord Blood) international expansion ambitions would be benefiting from Cordlife's international presence, as it would not need to set up parallel offices. Furthermore, Global Cord Blood has a huge cash pile of RMB worth ~1bn of SGD, which it could now use to grow more aggressively in these new regions.
Forth: Although we are not certain, there might be less restrictions on capital flows between China and Singapore, than between US and China, making it possibly easier to exchange the huge RMB cash pile to SGD than to USD, to potentially buy back stock or dividend out cash to owners.
As result, we intend to keep our investment, support the merger, and follow the company to Singapore.
Disclosure: I am/we are long CO.