How to lower expectations and panicBelow is my take on Q1 results and what HF is up to. I believe this company will be taken private.
HF's management has done an excellent job lowering shareholder expectations. Q1 initially looks awful.
$3 million in sales?
Loss of $.22 a share?
Beidahuang situation not resolved since company is not private?
Unfortunately, it is all smoke and mirrors.
The CEO has a problem. He would like to buy this company for $2.25 even if it is with a partner. The book value is now $3.67 and consists principally of working capital. All the write-downs have been taken. So how do you get the shareholders to agree that $2.25 is a fair price?
Answer - You scare the hell out of them.
So in Q1, the company lost $13 million. Of this amount a net $12 million was taken as a provision against inventory. They did the same thing last year until the auditors forced them to reverse it all out in Q4 and they were left with $4 million at year end. So here we go again.
So what did they really make. A loss of $.01 is more likely.
In addition, Q1 is also the harvest season in China. Fertilizer use is very limited and shipments can be postponed to Q2, making the numbers seem so much worse.
Assuming this company stays public, you will see a large increase in revenue starting in Q2.
BEIDAHUANG
There is a lot of hyperbole related to their departure in HF's public documents. While management continues to warn shareholders that the company needs to be taken private and Beidahuang is only buying as needed, HF management is not acting in this manner.
First, if they did not believe their largest customer would stick around, why did they significantly increase the advances to suppliers +$14.2 million, and increase their inventory purchases by +$31.2 million (adjusted for provisions) in Q1. If Beidahuang can take down their purchases, why can't they? There are no purchase commitments/requirements. From a business perspective, this is illogical to do as you would focus on keeping the bare minimum in assets other than cash when faced with such high uncertainty. However, it is very logical if you know they are not really leaving.
Second, Beidahuang and a second customer accounted for 99.2% of the Trade Receivables at June 30th. At September 30th, there remained over $50 million to collect. HF is financing Beidahuang with terms in excess of 90 days and Beidahuang is more than happy to accept. Beidahuang is also in receipt of advances from HF as a supplier. Another reason to stay.
Third, while the information issued to shareholders speaks of Beidahuang's departure if this deal falls through, both companies are promoting their relationship within China. This can easily be found at each companies China site. Beidahuang went so far as telling us that HF was shipping to its many branches in a November 5th post on their site.
VALUATORS
In the February circular which includes Deloitte valuation, they deemed the $2.25 to be fair based on representations made by management. As part of those representations, significant impairments to Trade Receivables, Advances and Inventory were taken to get the price down. These impairments never materialized to the extent presented. I do not know how they will be able to justify it this time around, but it would be very difficult.
THE OTHER PARTY
It has been 2.5 months since another acquirer was disclosed. Any purchase would have to include the CEO as he is key to HF's long term success. While I fully agree that the deal has not closed, no one has walked out so far. Stay tuned.