Commentary

Danger Under Sina's Stock

Tech Market WatchBy Perry Wu
Sina.com (NASDAQ:SINA) recently released its annual 10-K for 2003 and it should give you pause.

Usually, when you invest in an Internet company stock, you know about the inherent risks and vagaries of the business. You know that a search portal that is good today could easily get steamrolled by the next Chinese Google. You know that with all the smoke that Sohu puffs about it's most valuable asset being its "Sohu" brand, that the brand equity can be wiped away overnight with one PR blunder. But the good news is that these Internet companies often have little or no debt because they require few fixed assets (except for a few dedicated servers, etc). And because Internet companies (especially Chinese Internet companies) have only recently done their IPOs, they should be flush with cash.

This is the case with the Chinese portals Sohu.com and Netease.com, which have little debt (according to their most recent filings). So even if the business of Sohu and Netease goes bad, these companies would not suddenly explode like a supernova (it's hard to go bankrupt if you don't have debt–try it). More likely, they would just run out of all their cash and get acquired or just die a slow and predictable death.

However, if you take a look at Sina's recently released cash flow statement, it shows that Sina received $97.3 million of cash in the past year for the privilege of owing $100 million. The difference? Almost certainly the bulk of the $2.7 million difference went to those vultures, otherwise known as the investment bankers / lawyers / accountants, who executed the transaction. Evidently, some good-hearted investment bankers felt that Sina.com's business was not risky enough

and convinced the management of Sina.com that saddling the company with $100 million of debt was an intelligent idea. I'd like to see the pitch-book written by the bankers that led to this bright idea ( the other books in my bathroom stall are getting dated and I could use a little light-hearted reading).

The strange thing is that Sina.com didn't seem to need the money anyway. At year end of '02, they had over $100 million of current assets, of which $42 million was cash which was not being employed in the business. And they just now seem to be turning a corner and making a profit. So why do they need this money anyway?

Not just debt, but convertible debt. This means that in the future if Sina.com's bondholders decide to convert their bonds to stock, their stock would be diluted. Well-respected companies in the U.S. (remember, Sina.com has a U.S. listing) seldom, if ever, issue convertible debt and for good reason. It is usually a bad deal for their shareholders.

And for Sina too. Conversion would be at a conversion price of 39 shares per $1000 of debt so this would dilute Sina's ownership by 3.9 million shares or about 8% of the shares currently outstanding. If the bondholders think that Sina.com is a stinker and don't want to convert their bonds to stock, then Sina.com is still on the hook for the $100 million. So either Sina.com gets lucky and has their stock diluted by 8% or they don't and have to come up with $100 million sometime in the future.

But the future is where the real danger lurks. Unlike issuing other long-term debt, where Sina might have 10 or more years to pay back the principal of the loan, the terms of this debt may require that Sina pay back all the money in a mere three years from now. Here is what is buried in their recent SEC disclosure:

"On July 15 annually from 2007 to 2013, and on July 15, 2018, or upon a change of control, holders of the notes may require us to repurchase all or a portion of the notes for cash… We may not have enough cash on hand or have the ability to access cash to pay the notes if holders ask for repayment on the various put dates, or upon a change of control, or at maturity…"

Alarm bells should be going off. If bondholders want their cash back in 2007 and Sina manages to burn through enough of its cash so that it can't pay back the money, that would be a major problem. A fatal problem, perhaps.

About the author:
Perry Wu is a writer and correspondent for ChinaTechNews.com and can be reached here at the site. Perry Wu does not hold any positions, long or short, on any of the Chinese or American company securities mentioned in this article.

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