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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 (NYSEARCA: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.