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Yongye: To the Equity Well Again



June 02, 2011 – Comments (1) | RELATED TICKERS: YONG.DL

Board: Value Hounds

Author: LeKitKat

As predicted after a spending spree in 2010 of $46 million including PP&E and $33 million to acquire the rights to look for coal on 7,000 acres, Yongye has once more visited the equity well.

I predicted they would want to issue shares or take on some form of debt to cover these expenses and they have done both.

In Q1 the CEO guaranteed a $15 million loan from a local bank to ostensibly covering working capital needs. This was a company that had $42 million in cash at the end of 2010 and a record breaking Q1 with $50 million in revenue [consider the whole year's revenue in 2008 was $48 million.]

The debt was expensive at 8% interest.

Since the shares have been trading at $4 and below, issuing common shares as has been their modus operandi was out of the question.

The were able to court and win over Morgan Stanley's private equity Asia fund and get them to invest $50 million for around 6 million shares or $8.80 per share. This was generally greeted with wild enthusiasm by investors who bid the stock up around 42% the same day. Coincidentally, the CEO announced he would buy 3 million shares on the open market.

All this is by way of introduction as I am not an expert in preferred shares and have some questions I hope anyone who is [Rich are you there?] an expert can help clarify. Some of the covenants and privileges look a little different.

The adviser of Morgan Stanley Asia gets a seat on the board. Seems like a very non-independent choice.

The common stock was trading around $3.75 and the preferred was sold for $8.80. How do you arrive at a price for a preferred? How will the price be marked going forward if they are not on the market? This was a PIPE.

The yield is between 3% and 7% but the calculation looks like this:

Dividends will accrue on the Preferred Shares on an annual basis.
Dividends will be paid in the form of additional Preferred Shares at a rate of three to seven percent, according to the following formula:

7%-{VWAP-$8.80} * 2/310

VWAP is the average share price over 365 days.

It looks like if the price is below $8.80, you subtract a negative from 7% and increase the percent. There was no formula for 3% or is that implied as a variation. They won't get cash but get a percentage of shares every year.

S Morgan Asia gets a sweetener. This seemed highly unusual. If YONG hits certain target net incomes up until 2014, they can get as high as $15 per share for the shares in the trade to common--high profit.

here is the passage:

Additionally, the conversion price may be adjusted to the extent that the Company exceeds or falls below certain net income targets, provided that (i) the conversion price, as adjusted, shall not exceed $15.00 per share, and (ii) the sum of all shares of common stock issuable to the holders of Purchased Shares as a result of conversions, dividends, or distributions, or common stock acquired under the Stockholders’ Agreement described below shall not exceed 9,869,205, or 19.99% of the total number of shares of common stock outstanding on the date of execution of the Securities Purchase Agreement (the “Cap”).

It appears that the Morgan Stanley Asia board member will have a fairly significant conflict of interest here IMO. He has a strong motivation to see net go up--does not matter how. The share price of the common will be no issue for him. He gets $15 no matter what. I am guessing the difference between the common and the preferred will be paid in cash.

The dilution could be up to 20%! What are shareholders cheering?

The net income targets (the “Income Targets”) referenced above are: $84 million for fiscal 2011, $210 million for the cumulative period of fiscal 2011 through fiscal 2012, $399 million for the cumulative period of fiscal 2011 through fiscal 2013, and $682.5 million for the cumulative period of fiscal 2011 through fiscal 2014.

Net income in 2010 was $51 million--double 2009. The company is guiding to 50% increase in revenue this year so $84 million looks like a slam dunk. Good news for MS not so good for shareholders especially if YONG can keep hitting these numbers. Net income goes up every year but the company is under such a cloud of suspicion surrounding these numbers it has no impact on common shares. If that does not change, the little guy is getting worked over as always by YONG's free use of shares for its insatiable cash needs.

The preferred shares get voting rights--seems highly unusual.

For some reason their always biggest shareholder has had to pledge shares and abide by transfer restrictions. This person is a one woman that incorporated herself and has held around 17% of the shares recently. This seems weird.

So to recap questions:

How did they price these things? And how or will they be priced going forward since they are a PIPE?

Is it unusual to have the MS Asian manager on the board?

Is it unusual to have a sliding scale for these shares based on net income?

How often do preferreds end up being able to vote?

Why ban major shareholders from trading their shares?

How are they figuring the percentages to pay? Looks like the formula would give more than 7% under certain price conditions.

1 Comments – Post Your Own

#1) On June 02, 2011 at 11:20 PM, Dexter0860 (< 20) wrote:

While there are definitely some questions that need to be answered, the fact that MS Asia would put $50 Million into Yonge despite the pressure that the stock has been under and the negative articles written by Seeking Alpha etc, hopefully gives some credibility into the company as being legitimate. Assuming that MS Asia did their homework prior to making this investment, the shares would appear cheap at this price level. I hope that you guys post the responses to the unanswered questions raised in this article and I look forward to reading more about Yonge. Keep up the good work!!

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