- On Jan. 30, Kandi's $15 warrants expired.
- Kandi in the past has had a reputation of extending warrants.
- Transactional Hedge funds use warrants to protect ongoing short positions
- This is the second set of hedge fund warrants/options Kandi has let expire in three months.
- Effectively over the 5 years all of the past warrants have been held by two Fund Groups in three Transactional Hedge Funds.
First Some Background
Two and a half years after first trading in the US, China based NASDAQ listed Kandi Technologies Group (NASDAQ:KNDI) naively agreed to enter into its first US Financing by way of an unregistered Two year $10 million toxic convertible notewith Three year attached Warrants. This financing was done with three "transactional" hedge funds, Hudson Bay Fund Ltd, Hudson Bay Overseas Fund, Ltd. and Capital Ventures (affiliated with Heights Capital Management and Susquehanna). Without getting into the sordid details as to why this deal was "toxic" (you can find it yourself by visiting the above links), suffice it to say that the attractive initial $6.25 per share convertible price and $6.56 warrant exercise price with the stock at $5.65 ended up being completed at significant reductions from those levels.
But as bad as the initial offering ended, the major ongoing problem with these funds was a requirement of "right of participation for subsequent financing". A burden that until recently has made it almost impossible for the Company to escape their clutches and bring in new upscale Investment Bankers. So to date, all subsequent financing raising close to $150 million and causing more than a doubling of shares outstanding were done under the control of these same Transactional Funds.
Now you may wonder what is a Transactional Fund?
A Transactional Fund as compared to an Investment Fund, is a fund that by charter will do a financing based on the "transaction" economics alone". In the case of Convertible securities, while it may initially appear the conversion price is at a premium, they usually also require warrants and "reset" provisions to both the convert and warrant strike prices that all but guarantee a profit. In the case of a Stock offering, they require "Units" made up of stock and warrants with deep enough discounts to basically guarantee they will get their money back. To assure this goal they calculate stock trend, current volume, stock sentiment and overall market conditions, along with sophisticated stock shorting and options hedging. Some investors were surprised that shortly after the initial offering discussed above, in spite of the stock only trading in the $3 area, public stock options began trading in mid-2010. This was not surprising to me at the time since Susquehanna, the parent of one of the above funds is well known as a major options Specialist firm. By having KNDI options trading, it gives much more depth to their hedging capabilities.
Prior to the initial financing and inclusion in public options trading, though listed on NASDAQ for over a year and a half, the reported short in KNDI's stock was negligible. After the above initial financing, the reported short started quickly increasing to as much as 15% of the 2010 float. For the two year term of this note alone, though the stock spent most of the time trading under the ultimate $3.60 conversion price, the short continued to grow and the stock traded as low as $1.90. Now to the less knowledgeable, one might wonder "what incentive would a convertible or warrant holder have trading a stock from the short side under conversion or strike price"? PLENTY! In fact most transactional funds would rather not have a quick and large move up shortly after their offering was completed. They would rather have the stock settle into a somewhat predictable trading range that lasts the term of their convert or warrants giving them numerous opportunities to short and cover all the while being protected against loss on an explosive move up by the convert or warrant.
Now don't get me wrong. There is absolutely a necessary place and a need for TFs as a funding source for infant companies, and the Susquehanna and Hudson Bay groups are about as fair and well respected as any I have seen in my 41 years as a market pro in this usually "scummy" space. Where it not for the $150 million plus they have provided over the past four years, it is not very likely KNDI would be in its current position as China's dominant EV Company.
But now as the leading EV Company in China, it's time for KNDI to move on and "upscale" it Investment Banking/Broker (IBK) relationships. No major US IBK firm is going to give more than a passing "look" to a Company that is "glued" to TFs with ongoing Right of Participations (NYSE:ROP) and a lot of overhanging warrants. Why waste the time of negotiating a Banking relationship with the risk that they can lose the deal simply by the TF taking over their deal? As far as Analyst are concerned we have the same problem. The Analysts that count are the ones working for the major IBK firms. If they can't see how their firms can make money; why waste their resources?
But there is a "light at the end of the tunnel" for this conundrum KNDI has been in for the past five years. Last September when the Company completed its last rather complex looking $71 million 4,127,908 TF "Units" offering at $17.20 which included 4,127,908 shares and 743,024 $21.50 Warrants (complex due to an attached 100 day option which expired without exercising on Nov. 17, allowing the same TFs to purchase an additional $30 or around 1.74 million of the same units at the same price). While there is still a subsequent ROP attached to that financing, it has dropped to only 30% and even this expires on September 4, 2015.
OK, so now we know why there is such a big difference in stock performance after offerings to TFs as compared to similar direct offerings to Investment Institutions and Retail Brokerage firms. In KNDI's case as in most TF funded companies, professional short-sellers know the constraining stock pressure of overhanging warrants held by TFs and feel more comfortable in initiating large short positions; particularly in KNDI's case, the company contributed to the "comfort" by extending warrants on at least two occasions as you can see from the blue ovals in the chart below. Those who don't know the company well, might even have mistaken these warrant extensions as a sign of "desperate need for cash" causing even more short selling. However, in spite of neither extension culminating with any additional warrants exercised, ergo any additional cash raised, the current accelerating growth should belay that now apparent wrong supposition.
So How Does This Affect Where Does The Stock Goes From Here?
At the close of business on Friday, IMO, a little observed but very important event took place. An event that could portend the beginning of a major move up in the stock price. In fact, due to KNDI's solid performance over the week, closing higher four out of the five days in spite of another supposedly damning short seller attack article on Tuesday, the "move up" may have already begun.
As you can see from the chart below, at Fridays close, the seventh of eight continuous TF warrant issues (and hopefully last) with a strike price under $21.50, expired worthless. The issue that expired had a strike price of $14.99 and was for a substantial 1.43 million shares. The last remaining warrant issue outstanding with a strike price of $21.50 is a smaller issue of only 743,000 shares and expires Feb 6, 2016.
I might add, the short term $17.20 Option on the chart was the 100 day option to buy 1.74 million additional units mentioned prior which were also allowed to expire without extension. I might also note here that another by-product of having so many warrants outstanding is their effect on reported GAAP accounting numbers under "change of fair value of financial derivatives." With a lot of warrants outstanding, the more a stock moves up from quarter over quarter, the bigger the "GAAP" loss in the following quarter. The converse when a stock goes down from quarter to quarter. Strange but true. (There are still a few hundred thousand warrants left, mostly in the $20+ level, but not in the hands of TFs)
Now looking at the above chart and all of the continuous "upside protection warrants" the TFs have been armed with to trade from the short side, it doesn't take a market genius to begin to see why it has been so difficult to see the stock move up alongside fundamentals. As further evidence that having this "protection" is so important to the TFs, you can see from the chart that they had two very good opportunities during the one year life of the$15 warrants that just expired to "cash out" with at least a $5 profit. But to their way of trading, keeping the warrants alive to "trade against" was perceived more valuable in their long run.
So, now where do these TFs likely stand today? Well, one thing is for certain. You can bet they have been in constant contact with the Company over the last week or two trying to convince Mr. Hu, the CEO, to once again extend the warrants. Knowing Mr. Hu as well as I think I do, he likely kept his options on this decision open with them until the last few days until he probably made it clear he was not going to extend early last week. Based on the recent swings in price, you can also bet that they had been carrying a very significant short position against these $14.99 warrants. With the continuous light volume we have been seeing over the past weeks, even if they have been carrying as little as 750,000 short or only 10% of the reported 7.6 million share reported short, covering that short at the current price levels without a hedge would not be easy. But I would be willing to bet that a good bit of the upward movement this past week was caused by these funds attempting to flatten out their short. Some in the open market, and some by hedging in the options market. We did see some pretty aggressive positive options action, both in Calls and Puts this past week.
Now as I mentioned above, as far as TFs are concerned, these Pros have a reputation for being fairly "square shooters". As compared to most of the short sellers in KNDI, they are only short as part of their chartered trading strategies. They know how to do their Due Diligence and were/are not short because they have any fears about the Company, if they were concerned about items like the old "SEC Investigation" which the Company reported in March, they sure would not have taken down the $71 million financing in September. In fact the Parent Company of one of the TFs, Susquehanna, has consistently been KNDI's top Institutional holder.
So my guess is that with these last of the low priced warrants expired, one of at least two positive things are now going to happen.
1) IF these funds are still carrying an unhedged short position, they will cover it this week. This would likely be almost mandatory since most TF charters don't give much leeway in carrying unhedged positions.
2) But even more important, until the stock gets up close to the $20 price where the much smaller 743,000 21.5 warrants start coming into play, you won't be seeing the rest of the 7.6 million share short position aided by these funds.
...AND, one outlier possibility since the "Parent" of one of these TFs has historically been long a significant amount of KNDI stock, we could see aggressive heavy buying over and above any short covering by one or more of the non-transactional funds controlled by these two groups. They know as well as I, and now you should too, that the "overhang" of all these warrants has compressed the stock price over the years, this latest expired piece recently. With the massive size of the current short position which makes up over 25% of the non-insider owned float, most recently reported 9.3 Days to Cover and stock borrowing costs as high as 99% in recent days, it only takes one or two aggressive 500,000 buyers to prime the pump and squeeze the stock up to where the $21.5 warrants start coming into play.
Let's Get Down To What's Really Important Here: The Facts
As a 41 year stock market pro to include Stockbroker, Stock Brokerage Firm President, Investment Banker, OTC Market Maker, last 20 years investor only and author of more than 30 articles and blogs on KNDI, who has researched and owned KNDI stock continuously since mid-2007 and also visited the Company twice in China (2010 and 2013), I venture to say I probably know more about this Company than any other Western investor. With that said, I could care less about who buys or sells KNDI stock. It is your money and you should do with it what feels right. If I have a Mission with my writings, it is only to inform with facts and observations in the public domain to help investors to make an objective decision as to whether to be a KNDI shareholder or not.
I have gladly stood in defense of the Company against some 35+ attack articles (seven in just the last several weeks) written by those who have attempted to publish personal opinions under the guise of fact. While the 35+ have penned "rumor, innuendo, distortion, misinformation and out of context statements, I find it curious that none have dared to make claims of "fraud" or any derivative of the word based on their independent findings in any of the articles. I also find it curious that in spite of their attempts to "protect" innocent investors and support their reported short positions, that not one has taken the time and spent a few thousand dollars to go visit the Company in China. Why? IMO because the truth is not their friend in this argument.
However, as a long term holder who has no interest in "trading" the stock, contrary what one might think, I embrace these authors' feeble attempts to discredit the Company as the main reason KNDI currently has such a passionate and strong investor base and growing name recognition. A situation no amount of promotional money could have bought, particularly for an exclusively US traded China based company who has, even in its infancy, already proved to be a true and awarded EV Innovative Disruptor in the eyes of top level National government officials in its 1.3 billion populated home country.
For those who are avoiding the stock due to the most recent attack articles who's primary subjects of attack are; a 2013 SEC Fact Finding Investigation covering events that may or may not have taken place in 2009 by early promoters of the stock, I suggest you read my recent Seeking Alpha blog titled: " Why Kandi Technologies Inclusion In A 14 Month Old SEC Investigation Gives Me Comfort And IMO, Any Intelligent Investor Ought To Find Comfort Too". And most recent attack article which in ten thousand words attempts to accuse the Company and or its CEO of likely falsifying recently reported EV sales numbers from KNDI's 50-50 Joint Venture with China's largest ICE passenger car manufacturer, Geely Automotive (OTCPK:GELYF). If this latter article concerns you, let me leave you with a few pertinent thoughts on this subject.
In order for one to believe the latter accusation being likely, then one would also have to believe the following:
1. KNDI's JV Partner Geely Auto and its Founder CEO Li Shifu would have to be equally liable as a "co-conspirator", a very dangerous situation for either Hu or Li with President Xi JingPing's campaign in high gear to wipe of business fraud and corruption, particularly in light of the PRC government alone handing over a subsidy check for around $8,100 for each JV car claimed sold. (for some reason the attack writer has avoided including Li in his accusations.)
If you think Geely's CEO is separating himself from KNDI, here is a translated quote in their mutual home town newspaper, the Zhejiang Daily Jan 6th from Li Shifu about his feelings for his JV Partner, Hu Xiaoming.
Hu Xiaoming is my good partners and good friends. His path to the development of electric vehicles in China has a very clear understanding, we were looking at the "micro-bus" from ideal to become a reality, the electric car will be the future of the automotive industry. Xiaoming is an "old car people", and has been a breakthrough Chinese electric car industry and marketization of dreams, this feeling, I agree, is also very supportive."
2. Since the published CarShare numbers (both short term rental and long term lease) being painted as false by KNDI have all been in the last few months, you would have to believe that KNDI CEO is "thumbing his nose" at the SEC and his own Securities Counsel and publishing false statements in the middle of an SEC Investigation. And for what reason? He certainly doesn't seem to care about promoting the stock right now or he would have put out a PR on he and KNDI winning the 2014 Green Car Innovator award given Hu just a week ago or a PR in the US about the accolades heaped on the Company and its CarShare (micro bus) program by top level PRC Ministers as I linked above. When I sent an email to KNDI IR last week after finding the article in China about the "Innovator" award, here is the email I received in return from IR:
"Thank you for your email and thoughts on the Green Innovator Award. At this time we do not plan to issue a press release about the award. While we are proud to be recognized, of course, we must also balance this with our desire to sustain our credibility with US investors. As you are aware, investors will usually discount or ignore the news flow from management teams they consider overly promotional. In other words, too many announcements can end of devaluing the truly important news. Mr. Hu determined that this award, while desirable, did not rise to the level of national or global significance, so we are electing to let the news filter out naturally. You found it easily enough-- we are confident in an age of Google Alerts, Seeking Alpha alerts and so forth, that our investors will rapidly become aware of the recognition; we do believe a press release will add value on top of that. You may or may not agree, but keep in mind that we are balancing many competing factors in order to maximize our credibility with investors. Their trust is the surest way to foil short sellers and improve our valuation."
Does this response to shareholders sound like that which would come from a Company pumping its stock?
With all this said, let me leave you with one last obvious reminder. When it comes down as clear cut a decision as recent attack articles have left you with; Believe what the Company CEO tells you, or believe what an attack writer's opinion, if you feel you cannot trust what this or any Company CEO for that matter tells you, then it is time you got out of, or avoid, that stock.
Disclosure: The author is long KNDI.