Everyone’s least favorite electric car manufacturer, Nio Inc (NYSE: NIO), is at it again. Yesterday they announced their long-awaited capital partnership with the local Hefei government; the stock promptly rallied 20%, before fading to close +10%. A closer look at the terms of the transaction, however, suggest a horrible deal for current ADR owners. I added to my short yesterday and think, best case, this restructuring implies ~$1.3/share for ADR owners, along with imminent and significant dilution. Let’s look at the announced terms:

I’ve highlighted the key points, which are essentially:

• new investors are putting in 7bn CNY cash;
• Nio Inc (current holdco) is putting in 4.3bn CNY cash;
• Nio Inc is contributing ‘its core businesses and assets in China’ – ie substantially all its assets;
• Nio Inc keeps 76% of Nio China whilst new investors get 24% of it;
• Valuation of these assets is assumed to be 17.8bn CNY, based upon the Nio Inc stock price (ie a circular valuation method unrelated to fundamental asset value);
• Over half of Nio Inc’s cash contribution is due by June 30 (2.55bn out of 4.3bn total);
• The asset transfer may only happen much later (up to a year after closing).

So what actually happened? Prima facie, the new investors are ending up with 24% of Nio’s business – through Nio China – for an injection of 7bn…therefore implying a total valuation for Nio China of 29bn CNY, or $4.1bn. That doesn’t sound too bad…right?

But remember Nio Inc – the topco that ADR holders own – still needs to contribute 4.3bn CNY cash as well. In other words, the amount of new money being taken in is only 2.7bn…and for that the new investors receive a 24% stake in Nio China. On this basis, the implied Nio China valuation is thus only 11.3bn CNY ($1.6bn)…and Nio only owns 76% of this number (that is, $1.2bn). Not so great…

There is another, more aggressive (in Nio’s favor) way to slice the valuation. Instead of netting the cash injections against each other, let’s simply work out the total assets of new Nio China and see what Nio Inc owns of that. Here is how it looks:

Here I’ve simply given Nio credit for the circular valuation of the Asset Consideration – based as it is upon the Nio Inc share price, ie, very generous – but the key is because Nio Inc still needs to inject 4.3bn cash AND has 8.4bn of remaining financial debt (remember all those converts?) the implied valuation of Nio Inc stock, pro-forma for this transaction, is still only $1.3/share. Also note that this analysis does nothing with the working capital deficit (3.5bn CNY at year end, potentially higher now), which has to go somewhere. Whether it goes with the business into Nio China, or stays at Nio Inc, that will need to be funded as well – obviously lowering ultimate value per share to the ADR. If working capital deficit rolled up to the ADR level alone, the shares would be worth only 80c/share…

This of course raises the obvious problem with the restructuring plan as announced: what happens to the existing Nio Inc financial debt? The words ‘debt’ or ‘liabilities’ were notably absent from Nio Inc’s press release, but given the imperatives of the Hefei government – job creation, manufacturing plant creation, building R&D knowhow, etc – I highly doubt they would structure this transaction in such a way if they were willing to take the >$1bn USD financial debt that Nio Inc has amassed and assume it. Instead, the rather tortuous structuring of this deal – and the time it has taken to emerge – suggests they are explicitly avoiding taking this burden.

Essentially, the Nio assets – and only the assets – are being carved out, to be recapitalized probably in conjunction with Nio delivering on its obligations to move to Hefei and invest locally. Meanwhile the existing financial (and perhaps operational) liabilities of Nio Inc are stranded at the ADR level – meaning mostly foreign shareholders (and bondholders) take the pain. Such an obvious asset transfer is only possible because optically the equity stake being granted to the new investors – 25% – is much lower than 50% and thus doesn’t constitute a Change in Control (which would trigger par repayment of Nio Inc’s existing converts).

But in reality this is still an asset stripping exercise, to the benefit of new Chinese money coming in and the detriment of all existing stock and bondholders in Nio Inc. The fact that the market cannot see how obvious this is – yet – only means that Nio Inc will clearly monetize the temporarily high price, through large and dilutive offerings, as they still need to fund ~$600mm of investment into Nio China in the very near term (by June 30); have <$100mm cash on hand today; and still are burning ~$80-100mm cash per month in the business. ADR owners/buyers should be wary before jumping in the pool here…

Disclosure: short NIO stock