Hi all,
Full disclosure: I’m vested in Eratat.
I agree the interest on the bond is high and I don’t like it. However, if you were to dig further into the details, some points may prove interesting.
There are two possible scenarios: either Eratat is a dud or it’s not.
1) Eratat is a dud; it is a very risky coy, the cash is not there, it needs urgent cash infusion, hence the high interest rate.
If we assume this scenario is true, a few questions emerge.
From SHK’s point of view:
• Why would SHK even agree to lend?
o Didn’t they do their due diligence to ensure the cash is there?
• Why is the charged security so minimal?
o 121,500,000 shares * $0.135 * 5 = ~RMB82m, which is only 60% of the principal amount.
From Eratat’s point of view:
• Why didn’t Eratat opt for a convertible bond?
o If Eratat is really desperate for cash, why not opt for convertible, which will have a lower interest?
• Why is the bond only for two years?
o If the company is having cash problems, why are they so confident of paying it back within two years?
Which brings us to the second possible scenario.
2) Eratat doesn’t need the cash; it borrows for some other benefits.
• Eratat is paying for SHK’s stamp of approval and its network.
o Eratat hopes it will have “access to new contacts and opportunities through the Subscriber’s(SHK) network, thereby increasing exposure of the Company’s shares to new investor communities, funds and financial institutions in Hong Kong and the PRC.”
• Eratat, a perennially neglected stock, will finally enjoy greater investor prominence.
o Biggest beneficiary will be the CEO as the largest shareholder of the company.
To me, it appears that the bond is structured to aggressively participate in any upside, rather than protecting the downside, which is odd if SHK have serious doubts about Eratat. Warrant exercise price is 89% above the current price, and with an exercise period of only two years. Does SHK really think Eratat has a chance of hitting that? If not, why set such a high bar?
And if the price does reach that level, coincidentally, compounded annual return for current shareholders will be the same as that of SHK through its bond deal – 30%.
Given the drastic undervaluation as compared with the asset base and operating results, I’ll still be holding on to my Eratat shares, as I find that the rewards continue to outweigh the risks.
Any thoughts? I welcome feedback.
*Another point I would like to ask forummers here is how prestigious is SHK anyway? I find it difficult to quantify “a seal of approval”, if that is the purpose of the bond issue. However, if you look at Geo Energy, the “giver” of this approval can usually extract quite advantageous terms. Geo Energy has Jim Rogers on its board, and for that, the company has offered him a very deep in-the-money call option on 2 million shares with exercise period from 2015 to 2025.
More details on my blog:
http://sgvalueinvesting.wordpress.com/20...013-0-132/