The China automobile market is a great growth story for equity investors. Chinese people are now the world’s biggest buyers of vehicles – which led SinoSage to look into a company with the perfect name, AutoChina International (AUTC.NASDAQ).
AutoChina bills itself as "China’s largest one-stop commercial vehicle sales, leasing, and support network" with more than 150 stores across the country. But digging into its financials reveals a puzzling web of money flows, which point to significant downside potential.
Customers buy trucks from AutoChina by placing a 25% down payment and settling the balance over 26 months. AutoChina buys the trucks with money borrowed from an affiliate company, Beiguo Commercial Building. It is required to pay the money back to Beiguo within six months – 20 months before customers complete payments for their vehicles. The result, not surprisingly, is substantial negative cash flow.
The company was incorporated on October 2007 as Spring Creek Acquisition Corp. In April 2009, Spring Creek acquired ACG, a Cayman company owned by Honest Best, and changed its name to AutoChina International. ACG was formerly KYF, Inc, a holding company set up in 2007 by the CEO of AutoChina, Li Yong Hui. ACG operates three subsidiaries: Kaiyuan Logistics, Kaiyuan Auto Trade, and Hebei Xuhua Trading. All are owned by Hebei Kaiyuan Real Estate Development, a company founded in 2005 by Li.
Each truck financing subsidiary is held by a separate legal entity owned by Kaiyuan Auto Trade – which is owned by Li, not by AutoChina. So the CEO seems to own all the assets of the business. The public company also pays Li 5-20% of the shares outstanding annually as an “earnout,” which is a bit like paying a taxi driver a bonus by counting how many times his doors open and close, instead of, say, how much fare revenue he collects.
At the end of 2009, AutoChina paid Mr Li a stock bonus worth US$54 million and diluted the existing shareholders by 20%. This program is in place until 2013. It might be one of the most generous packages ever offered to an executive: Li in effect gave himself a bonus that was almost 400% of the company’s net income; the CEO of Goldman Sachs received US$9 million in 2009 after the company earned US$13 billion of net income.
AutoChina listed on NASDAQ in October 2009 and in March this year completed an additional offering of two million ordinary shares, but cancelled the overallotment option to place an additional 300,000 ordinary shares. In other words, the additional offering wasn’t so popular.
When a customer leases a truck, AutoChina’s subsidiary Chuangjie Trading places an order for the vehicle with Kaiyuan Auto Trade, which buys the vehicle and sells it to the local center.
In 2009, AutoChina leased (i.e. sold) 7,564 vehicles generating recognized revenue of US$308.8 million. However, it only received the 25% down payments on the vehicles, which came to US$77.2 million, plus lease payments – referred to as financing revenue – of US$16 million. So the total cash that came in was about US$93 million. AUTC reported positive earnings for 2008 and 2009, but net operating cash flow for both years was massively negative.
AutoChina has to pay for the vehicles over six months. The average cost of a vehicle is US$38,800, so the company purchased vehicles worth US$292 million. Assuming there is no down payment, it committed to paying US$48 million per month. As a result, AutoChina’s filings show that it owes affiliates about US$150 million.
The company appears to have survived so far by selling its dealership business for US$48 million net cash (the 10-K says the business was sold for US$67 million, but had US$19 million on the balance sheet, so the net cash proceeds presumably were US$48 million) and borrowing US$152 million from affiliates. And, of course, issuing stock.
The company plans to lease an additional 12,000 trucks this year. If it pays an average of US$38,000 per truck, it is going to have to incur a liability of US$456 million, and the negative cash flow will also increase. The faster the business grows, the more money it loses, but the way the company reports its financials, it actually looks like the company is going to make US$45 million.
SinoSage cautions AutoChina shareholders to beware of tricky roads ahead.