Good analysis, tactician.
Ya.. the warrant is a backup for their loan, but provided the share price pushed beyond 25 c. agree the interest rate is a bit high, though justifiable.
besides some tax savings from bonds, the most rational thing they can do now to beat the bond interests is to do a share buyback. (which is my guess)
1) help save some money from the upcoming dividend payment in july/august
2) improve EPS, signal a confidence to the market and hence improve valuation closer to 25 c
3) the sharebuyback can be kept as treasury shares for employee rewards or to reward distributors (instead of cash incentives). alternatively, if they do not want warrant to be exercised after 2 yrs, possible to sell the treasury shares at higher price and make some profits to clear the loan interest.
But with the bond issue at such a high interest rate, my feel is that the dividend may be restricted to grow for the next 2 years. so, for Eratat, this will likely be a capital gain stock. but if u can hold beyond 2 yrs, at the rate its cash is growing, it can become a strong cash cow.
now tat bond issue deal is done... let's watch n see if they will do some share buyback over the next few weeks. now is a good time for them to buy back cheap when the market is still lao sai.
Tactician wrote: Hi all,
Been reading the posts and think that a few interesting questions and opinions have been made.
My own take is this:
1. The bond interest rate seems quite high at 12.5% per annum, but looking at the quantum, it's something that eratat should be able to handle quite easily. If they want to dig into their cash reserves, it's not an issue. If they want to fund it with the exercise price of the warrents, again that's a good option (as long as they can get share price to above 25 cents).
2. Going in with their own stores and seeking distributors is a tested strategy used by various firms. Starbucks, for example does this. The exposure and branding of their own stores create enough justification and proof for distributors to jump the wagon and sell the product. That's provided they do a good job and create the necessary buzz. Given their track record, I don't believe this would be too big of an issue, especially since they have been studying the market for some time.
3. The warrant price of 25 cents is not surprising in my opinion. It merely reflects what eratat lifestyle would deem as a reasonable price for their shares. In fact, warrants are typically priced below fair expectations - meaning that eratat would value their fair value as above 25 cents. An exercise price is that so out of the money would be worth little to the bondholders and so the bondholders should feel like the shares can hit above exercise price with a reasonable sense of comfort or confidence. The fact that the number of warrants issued is relatively small compared to share float is a confidence booster. To get a handle of this, it's often good to ask yourself what the bondholders are willing to get in exchange for the provision of capital and other aspects.
4. From point 3, we have to look at what the bondholders represent in terms of bargaining power. I believe they have a much stronger bargaining power than eratat. Would they be happy to risk their capital for 12.5% returns per year. To put it into perspective, how many investors would be willing to risk their money (for example - there were individuals who were very against eratat) for such a return? Many investors tend to want multi-bagger returns when investing in small caps - and they tend to think that it is achievable. Yet, these investors do not have the bargaining power, the resources to do due diligence, or the resources to conduct rigorous analysis. If you were the bondholders, what sort of returns would you want in order to entice you to invest in eratat and potentially contribute through other means? (e.g. eratat mentioned about being able to access to new investors). Personally, I think 12.5% return per year isn't enough. From the structure, the only other ways to profit would be through the warrants or through open market purchases.
5. Eratat's options to use the money seem reasonable, although a large chunk is conveniently left for working capital purposes. Yet, we do know that working capital has always been an area where they have had to manage in order to keep operations running smoothly. For me, it's a reasonable apportionment of capital... and I'm ok with them having the "get out of jail free" option of using the capital for uses which they deem fit. I do hope they will use it for some share repurchase or to develop the business further.
6. Eratat's has built up a couple of interesting resource types - like their training academy and using a concierge service to generate resources. I thin kthese will actually fit better with their own shops, when compared to other distributors. More importantly, the shanghai market do seem like it would be a good fit for implementing such resource components.
Overall, my view is that while the initial cost seems high at 12.5%... I believe that when one takes a holistic perspective, the benefits to be obtained outweigh the costs significantly.
Cheers,
Tactician
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