China Cord is an interesting company as it borrows money from related parties at extremely high interest rates (effectively above 12%).
Share price: $3.95
Market cap: $288M
There are four publicly-traded companies that are interrelated:
- Golden Meditech (0801.HK).
- China Cord (NYSE:CO).
- Cordlife Group Limited (P8A.SGX). I will refer to this company as CGL.
- Life Corporation Limited (ASX:LFC), formerly Cordlife Limited. I will refer to this company as LCL.
These companies own stock in one or more of the other companies:
- Golden Meditech owns a large stake in China Cord.
- China Cord owns shares in CGL and LCL.
- CGL owns shares in China Cord. There is a cross-holding of shares between the two companies.
All four publicly-traded vehicles share some of the same people, as shown in the diagram below.
Those “independent” directors
The China Cord 20-F filing states the following about Yee Pinh (Jeremy), who is supposedly an “independent” director:
Jeremy Yee, serves as one of our independent non-executive directors. He is the executive director and chief executive officer of Cordlife Singapore. Mr. Yee is responsible for identifying and implementing company-wide business growth strategies and organizational structures of Cordlife Singapore. He was previously the chief financial officer of Cordlife from 2004 to 2011. Prior to being the chief financial officer of Cordlife, Mr. Yee was a director of Corporate Development and the chief operating officer of Cordlife. Mr. Yee has worked at KPMG LLP, United Overseas Bank, Amex and other financial institutions in various audit, financial & management positions. He holds a BA (Econ) (Hons) from the University of Manchester and a BCom (Prof Acct) from Murdoch University. In addition, he also holds a MCom from the University of Sydney, MBA from NTU and The University of Chicago Booth School of Business.
Jeremy Yee serves as a China Cord director and is also the CEO of CGL. CGL and China Cord own shares in each other. This doesn’t seem very independent to me.
Related Party Transactions
Here is one transaction disclosed in the 20-F [emphasis mine]:
On October 3, 2012 we completed the sale of $50 million in aggregate principal amount of 7% senior unsecured convertible notes, which notes are convertible into ordinary shares at a conversion price of $2.838 per share, to Golden Meditech. The notes are senior unsecured obligations, mature on October 3, 2017 and are not redeemable prior to maturity at our option. The outstanding principal of the notes is convertible at any time or times on or after the issuance date, in whole or part, into ordinary shares at the conversion price, subject to customary anti-dilution adjustments for significant corporate events. Interest accrues on unconverted portion of the notes at the rate of 7% per annum. On the maturity date, we are obligated to pay a redemption amount calculated to provide a 12% internal rate of return (inclusive of interest) on the unconverted portion of the notes.
Here’s how I read this. The 7% interest rate is a red herring. On the maturity date, China Cord will pay at least 12% interest. The noteholder has an option between converting the note into shares or taking the 12% IRR. The effective interest rate is actually higher than 12%.
This cost of capital is extremely high. If a company is paying unusually high interest rates, I would ask the following questions:
- Is the company distressed? It is not unusual for distressed companies to pay very high interest rates.
- Is this a fraud?
- Is there a legitimate explanation for the high interest rate?
I would suggest that you do your own homework and come to your own conclusions.
According to the 20-F:
On July 11, 2012, the Group borrowed RMB50,000 (US$8,050) from Hangzhou Bank, a commercial bank in the PRC. The term of the loan is one year. The loan bears a floating interest rate equaling to 120% of the base lending rate quoted by the People’s Bank of China, which is adjusted on the 20th day of the third month of each quarter. As of March 31, 2013, the bank loan bears interest at 7.2% per annum. The bank loan has been repaid in full upon maturity on July 10, 2013.
Here’s what intrigues me. Normally companies will try to borrow as much as possible under conventional sources of capital such as bank loans. China Cord is borrowing a very small amount of money at 7.2%. It should be trying to borrow more money before resorting to paying more than 12% for capital.
Golden Meditech’s financials suggest that China Cord could be borrowing a lot more from the bank. Golden Meditech lent China Cord US$50M at over 12% via convertible notes. It has used these convertible notes as collateral for its own HKD$368M (or roughly US$47M) bank loan (PDF):
16 INTEREST-BEARING BORROWINGS (continued)
At 30 September 2013, the bank loans of certain subsidiaries of $201,944,000 (31 March 2013:
$185,597,000) are secured by interests in certain leasehold land and buildings.
The bank loan of the Company of $368,199,000 (31 March 2013: $362,749,000) is secured by the
convertible notes of a face value of US$50,000,000 issued by a subsidiary, China Cord Blood Corporation
(“CCBC”) and any ordinary shares of CCBC issued to the Company as a result of any conversion of the
convertible notes in accordance with the terms of the convertible notes. The loan is measured at amortised
cost net of transaction costs paid.
The bank loan of the Company of $12,887,000 (31 March 2013: $52,260,000) is secured by the trading
securities held by the Company.
Bank loan facilities of the Group and the Company of $368,199,000 (31 March 2013: $362,749,000)
are subject to the fulfilment of covenants relating to certain of the Group’s consolidated statement of
financial position ratios as are commonly found in lending arrangements with financial institutions. If the
Group were to breach the covenants, the drawn down facilities would become payable on demand. The
Group regularly monitors its compliance with these covenants. As at 30 September 2013 and 31 March
2013, none of the covenants relating to drawn down facilities had been breached.
I have a feeling that China Cord’s cost of capital could have been much lower.
A lot of things about these companies don’t make sense
Golden Meditech has its own set of related party transactions that strike me as extremely interesting.
LCL’s shareholder letter describes CGL as an “unrelated entity”. Personally, I would have described CGL as a related entity if I had served as the chairman of both companies.
LCL gave a $52K (presumably AUD) interest-free loan to Steven Fong to buy a car. It is not a good corporate governance practice.
A wrinkle in this unusual story
KKR China Healthcare Investment Limited (“KKRCHIL”) has also lent money to China Cord at high interest rates. It bought notes from China Cord with terms similar to Golden Meditech’s. Note that KKR bought notes before Golden Meditech did.
- KKR China Healthcare Investment Limited. Matures April 27, 2017. $65M. $2.838 conversion price.
- Golden Meditech. Matures Oct 3, 2017. $50M. $2.838 conversion price.
I don’t know if KKR is getting a really wonderful deal or if it is getting a really terrible deal.
*Disclosure: Short CO. No position in Golden Meditech (801.HK), P8A.SGX or ASX:LFC.