SDTH and the convertible notes: a bit of follow up

I said that I would add some more on the convertible notes and I am remaining true to my word. Note that I updated my last post during the day on Thurs (at the end of the post) at the time I bought shares of SDTH.

When Shengda Tech offered the convertible notes this created uncertainty and share dilution which certainly warranted a sell-off. However, it also created opportunity because the sell-off was overdone. Why did this happen? First of all it shook off some of the weak hands. People who didn't have conviction (hadn't done the proper DD or didn't understand this company as well as they perhaps should have) sold off beyond where they should have. Additionally, there may have been some margin calls, and some short-selling. When an event like this happens the reaction is often overdone.

My initial reaction was not to buy the sell-off but to wait and see because there is some risk/uncertainty here until the exact details of the convertible notes, including share price and number of shares, is disclosed. Additionally if SDTH decides to acquire a company the profitability of this move will also cause uncertainty and may result in some selling. However when the share price held recent support around 8 the risk/reward was quite good.

Here are some follow up points to know and think about if you are interested in this company:
1. Convertible notes are not the same as simply offering more shares. Convertible notes are actually bonds... that is to say that SDTH plans to request loans from anyone wanting to offer them and will pay interest for this investment. The bonds will mature in 2018. Those that offer the cash will be able to convert their initial investment into SDTH stock, probably at a pre-determined price. This price will most likely be above the current price. This often offers those providing the loan (bonds) the best of both worlds: get a guaranteed rate of return from interest and have the right to change over the loan into shares at any time. If someone puts down 100,000 and they have the right to convert the shares at any time at $10.00 a share then as long as the stock is under $10.00 they will take the interest (let's say 3% annually... again remember the numbers have not been disclosed so this is just for exemplary purposes). If the share price turn into $12 or $15 for example the bond holder might opt to convert the investment into stock and forgo further interest payments. At that time share dilution occurs. However it most likely occurs at a higher price than the stock is trading at right now... unless the company goes bankrupt (unlikely... of course not certain) what do you think the share price will be that far away? Unless everyone sells right away the dilution should occur over a long period of time as the money provided in the bonds is used to grow the business and hence the share price...

Pretty good deal for everyone involved... depending upon the details of the offered notes... The risk of unknown details.. along with the fact that I think the market is due for a correction (leading up to Memorial Day or just after...?) prevented me from jumping in headlong at $8 and will keep me from adding more until the details are announced and/or another opportunity strikes...

One more point: a quick calculation on the dilution...
Worst case reasonable scenario: the convertible notes offered are at $10 a share (I suspect this is very low... so low I'm giving it a FAT CHANCE label) and everyone offering the notes sells off in the near term (also unlikely) but in this worst case scenario let's look at the dilution...

$115 M maximum loan requested by the company. Market cap at $10 a share is (10 x)54M shares = approx $540M. 115/540 = 21% dilution. This is the likely worst-case scenario and would still put the new fair share price around 80% of $10 which is... $8 a share!...

Of course these calculations are kind of bullshit because what really matters is the number of shares offered in terms of dilution and the share price but since no one has that information yet this at least points out a guesssstimate that shows things are reasonable to buy here...

Comments... feel free...

Let me emphasize one thing again... on the bottom of every post I have a disclaimer. I attempt to provide information and my opinions but they should never be substituted for your own DD.

Best,
Jon

This blog is for informational purposes only. It does not give investment advice.