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Why I'm not long CCME

|Includes: China MediaExpress Holdings, Inc. (CCME)

Using the facts that both the long and short side agree on I think you can easily show that something does not add up in the CCME story. Starr did a 30M private placement in the company in the beginning of 2010. For 30M they got, quoting the press release:

Each of the 1,000,000 shares of Series A Convertible Preferred Stock will be convertible at any time into three shares of CME common stock. The newly issued warrants will be exercisable at any time into one share of CME common stock at $6.47 for each warrant held. Concurrently with the closing, certain CME shareholders will transfer an additional 150,000 shares of outstanding CME common stock to Starr International for no additional cash consideration.

The lowest price of the CCME stock in the month before the announcement was made was 10.27 (this was actually on the day the announcement was made) and the highest price was 12.66 on December 21, 2009. Using the lowest market price CCME got for 30M a total of:

  • 1,000,000 Convertible shares worth 1,000,000 x 3 x 10.27 = 30,810,000
  • 1,545,455 Warrants worth 1,545,455 x (10.27 - 6.47) = 5,872,729
  • 150,000 Common shares worth 150,000 x 10.27 = 1,540,500

For a total value of 38,223,229 and if we would use a more realistic metric for market value such as the average share price of the past month the value of the deal would easily be more than 40M.

Giving up some equity if the company is in a desperate need to raise capital could make sense, but CCME was at the time - according to their own SEC fillings - hugely profitable. The company reported having 57 million in cash the quarter before the deal was done, and even more interesting it agreed to huge penalties in case certain profit targets are not met. Quoting the CCME's 10k:

As long as Starr owns at least 3% of the issued and outstanding shares of Common Stock, on a fully diluted, as-converted basis, it will also have the right to require certain stockholders to purchase its Preferred Stock and the Common Stock held by Starr or issued upon the conversion of Preferred Stock or exercise of the Purchased Warrants upon the occurrence of the Company’s failure to achieve audited consolidated net profits (“ACNP”) for 2009, 2010 or 2011 are less than $42 million, $55 million and $70 million, respectively (each, a “Profits Target”) or to fulfill certain of its obligations under the Purchase Agreement. The Performance Adjustment Amount payable in any of 2009, 2010 or 2011 will be a fraction of $343,462,957 which is proportionate to the amount by which the Company’s ACNP in such year falls short of the then applicable Profits Target. The Performance Adjustment Amounts will be payable in cash or stock, but only to the extent such stock, together with the shares of Common Stock acquired or acquirable as a result of Starr’s ownership of the Preferred Stock, the Purchased Warrants and the Transferred Shares, will not exceed 19.9% of the total number of shares of Common Stock of the Company issued and outstanding as of the date of the Purchase Agreement.

Some people argue that the company agreeing to terms like this is a good sign, since it shows that the company is very confident in the growth of the company. And if the company is legit, they would have to be very confident to agree to terms like this. It implies they need to improve profits by 31 percent in 2010 and 27 percent in 2011, and failing to do so results in a huge penalty. If the company would for example post a profit of "just" 60 million in 2011 - still a very good result compared to the 2009 numbers - they would have to pay a penalty of 343,462,957 * (1-60/70) = 49,066,136. Yes, you're reading it right; this penalty is bigger than the amount of money they got from Starr in the first place, and if the company failed to produce growth the penalty would become big enough to wipe out the entire company.

So why would management agree to this? They are taking on a huge risk for just 30M additional capital that they don't directly need in the first place - they have already 57 million on the balance sheet - and they are also confident that they easily generate that amount of cash the next year, since failing to do so would already trigger a huge penalty.

And if they want capital, why not take a bank loan or issue bonds? Given the cash flow of the business and the balance sheet of the company they should be able to get way cheaper financing than selling 40 million worth of shares and warrants for 30 million (since they would be able to pay back a bank loan back in a year, it represents an interest rate of at least 33%+).

Another consideration is the fact that the management is apparently very confident in increasing the profits of the company - otherwise they would not agree to the penalty terms. But if they are confident in those numbers, why sell equity if you know that the share price in the future should be a multiple higher based on those results?

So there are only two conclusions possible, either the management is grossly incompetent, or CCME is a fraud. I believe the latter option is more likely; if you can just make up the numbers, it's always easy to agree to future profit targets. And if you are a fraud; taking 30M of money is the goal of the game.



Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Additional disclosure: I would be short if I could for a reasonable borrow rate.