You Shouldn't have done it
You do not need the money
According to your latest published financials, you were a net cash company. As of six months ending June 2019, you had a net cash balance of 928 million RMB. According to the same financial statements, you generated an operating cashflow of over 4bn RMB and a free cashflow of over 2.7bn RMB in just the first six months of 2019!
That is an enviable situation for any company, especially given that in your case, you managed to remain in a net cash position even after completing the acquisition of Amer Sports, in which you invested slightly over EUR1.5billion (Note 12 of 1H2019 report). According to some sell-side analysts, you incurred a debt of 850 mm Euros for the acquisition. We failed to find this specific information in any of your publicly disclosed documents, including 1H2019 financial report. However, our own quick calculation from reading of Note 18 of your financial statements suggests a slightly lower debt incurrence.
The deluge of cash that you generated from your businesses in 1H2019 is not a one-off phenomenon. In the year 2018 and 2017 also, you generated a free cashflow of 3.45bn RMB and 2.67bn RMB respectively, as highlighted on page 10 of your 2018 annual report.
If we assume business 'as usual,' (and there is no reason not to), then your should be in a position to completely pay down the existing debt from your operating cashflow in less than two years.
If we assume business 'as usual,' (and there is no reason not to), then your should be in a position to completely pay down the existing debt from your operating cashflow in less than two years.
Your 'disclosed' list of reasons for the issuance do not make sense
In the release issued by you to the Hong Kong stock exchange announcing the bond, you list the following as the reasons for issuing the bond:
"provide the Company with additional funding at lower cost to repay its existing debts and optimize its financing structure, to further strengthen the working capital for the Company, as well as potentially enhance the equity base of the Company."
There is no doubt that as net cash company, your financing structure was far from optimum. However, anyone who's taken Corporate Finance 101 in the university or business school would be able to argue that taking on additional convertible debt would make your financing structure even less optimum.
An 'optimum' capital structure, according to corporate finance theory, would involve a combination of debt and equity, with a reasonable gearing that would result in optimum 'cost of capital.' Taking this additional convertible debt would only increase your 'gross' cash balance, therefore making your capital structure even more sub-optimal than it currently is.
An 'optimum' capital structure, according to corporate finance theory, would involve a combination of debt and equity, with a reasonable gearing that would result in optimum 'cost of capital.' Taking this additional convertible debt would only increase your 'gross' cash balance, therefore making your capital structure even more sub-optimal than it currently is.
Working capital, by its very nature, is a short-term liquidity need of the company and it is best met by short-term sources of fund such as a cash-credit facility or a working capital loan from a bank. Convertible debt, because of the potential equity conversion, is the longest term source of financing (ranking only behind plain vanilla equity fund raising).
Finally, I do not know what you even mean by 'potentially enhancing the equity base.'
If these were the reasons provided to you by your bankers, then I lament the quality of young chaps going into (or the old chaps still staying in) investment banking these days. I'm surprised that none of the sell-side analysts have questioned your reasons, but then, given how dependent the brokers have become on investment banking revenue after their commission pool was massacred by MIFID II, I shouldn't be so surprised.
Finally, I do not know what you even mean by 'potentially enhancing the equity base.'
If these were the reasons provided to you by your bankers, then I lament the quality of young chaps going into (or the old chaps still staying in) investment banking these days. I'm surprised that none of the sell-side analysts have questioned your reasons, but then, given how dependent the brokers have become on investment banking revenue after their commission pool was massacred by MIFID II, I shouldn't be so surprised.
Why would you throw away 3% of your equity forever?
I am curious about your choice of the financial instrument. The headline talks about it being a zero coupon bond maturing in 2025, issued at a premium of 40% over the last close. There is no fault with the timing of the fund raise (given the interest rates are so low), as well as the pricing (especially given the stellar performance of your stock price).
Let me illustrate that simplistically without going into too much of the underlying math, which I am sure your bankers have shown you. A convertible bond is a composite instrument, having an underlying 'strait bond' portion and an 'equity option' portion. A zero coupon bond offers no interest, therefore in this case the value is accruing to the investor only from the equity option. The pricing of equity option depends on the conversion premium, duration, and volatility in the stock price (as measured by standard deviation). Higher the volatility, higher the valuation. Given the relatively low volatility in your stock price in the past year (assuming this lower volatility continues in near future), the option is quite attractive for the issuer, in this case you.
However cheaper the funding source might be, I question your judgement: the conversion does result in over 3% dilution. You are potentially giving away 3% economic interest in the company forever, for raising the money that you do not really need? I really wonder why your existing investors should be fine with it.
This will only give an additional issue to your detractors to talk about
You have had your share of detractors, having been a target of a number of short-seller reports, the latest one by Muddy Waters Research, here, here, and here. Agreed that these reports have at best, created only a blip on your stellar stock price performance, but we believe that it has nonetheless created a skepticism among the investors about the veracity of your accounts, including your cash balance and the strength of your operating cashflow.
This is very evident from your shareholder base. For a company of your size, operating track record, your institutional shareholders base in our opinion is, at best, 'thin.' Four of the top ten funds that own your shares are exchange traded funds or ETFs, who have invested in your shares, let's say, not because they love you, but because you are part of an index that they track. Not a single investor owns more than 1% of your stock, which in Hong Kong market, for a company of your size and track record, is unusual.
...for instance, what are you doing with such high cash balance?
Resorting to irrational financing decisions such as the issuance of this convertible bond is only going to alienate potential investors further, who could question if the company indeed has the interests of its investors at heart.
More importantly, the skeptics could again raise questions about your extremely high and ballooning gross cash balance, or about your strong cashflow. You see, as of 1H19, you had a 'gross' cash balance of 8.2bn RMB, which will only go higher following this Convertible Bond.
Even the non-skeptics may perhaps be right in asking: Anta dear, what are you doing with a gross cash balance that is as high as 45% of your equity capital base? Are there things you'd like to explain about your operating cashflow?
Unless you have some readily available answers, I'd say good luck to you....and your existing investors!
(Note: This article is purely an exercise in extra-curricular academic interest. Neither I nor do the funds managed by my firm have any long or short interest in Anta sports. This article does not constitute any recommendation on the stock.)
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