More on NIO: the devil is in the details

A month ago I broke down the Nio/Hefei transaction that purported to put a high valuation on Nio’s China business, suggesting that US investors and bondholders were probably being fleeced. With the release of Nio’s 20-F annual filing, we can now definitively conclude that the Hefei ‘Strategic Transaction’ is nothing more than an asset strip, plain and simple – but with even more adverse consequences for the existing holdco equity and bonds. There are two main takeaways coming out of an analysis of the document:

  1. all the key assets are going to the new entity but most all the debt is staying with the holdco – so both bondholders and ADR holders are being structurally subordinated in a massive way;
  2. despite the 76% remaining ownership interest at Nio Inc, new money is more akin to a convertible preferred, senior security that could easily foreclose on Nio China in the future.

All told, this rescue financing leaves the ADR and Cayman holdco debt on the outside looking in, and I still believe Nio ADR is worth very little.

  1. This is what an asset strip looks like

The 20-F for the first time clearly delineates how terrible new investment terms really are for existing Nio Inc holdco bondholders and stockholders. Firstly, its important to remember that the existing $750mm 2024 converts (puttable in 2022) were issued out of the Nio Inc Caymans holdco entity (that is, the same holdco that ADR shareholders own). Further, this recent 20-F filing made clear that all the recent convert transactions – $435mm in total through early 2020 – were issued out of the same holdco box:

That is to say, with regards to its financial liabilities, Nio is stuffing the empty Caymans holdco with a total of at least $1.23bn in debt, to fund the ongoing cash burn in the business.

However when it comes to the strategic transaction into Nio China, it appears very clear from the documents that assets – and only assets – are being transferred into the newco. Take a look at the language from the Investment Agreement (p.810 of the 20-F):

Nio Inc is clearly only injecting ‘assets’; there is no mention of ‘liabilities’ at all. More specifically, what does ‘Asset Contribution’ and ‘Restructure Assets’ mean and where are they coming from? Well, the Asset Contribution encompasses the following clauses:

That is, Nio Inc is injecting the three main operating entities in China – Nio Co Ltd, Shanghai NIO Sales and Service Co Ltd, and NIO Energy Investment (Hubei) Co Ltd – in addition to the Restructure Assets (see below). The additional clause is quite scary, too (circled above), because it gives the new investors the right to reduce Nio Inc’s residual share ownership in newco if the third-party appraisal of the injected assets comes in lower than the agreed amount here (ie, lower than 29bn CNY implied value for 100% of newco) – something that is entirely plausible given Nio China is a negative equity entity today and the 29bn CNY valuation is based purely on where NIO ADR traded, not based on hard asset value…

But that aside, what are the ‘Restructure Assets’? And do any liabilities, or at least any financial liabilities, leave Nio Inc balance sheet as part of this transaction?

The definition of ‘Restructure Assets’ tells us to look at Exhibit 3 to the Agreement:

The problem is, of course, when you go looking for Exhibit 3, it is somehow left out of the document (and it has not been redacted for confidentiality reasons, it is just missing):

Why would Nio Inc go to the trouble of including 900 pages of legal documents in their 20-F filing and leave out only the few pages that actually matter? Is there really an innocent explanation for this? Or do they simply intend to rely on opacity and obfuscation because…well, because they have dilutive securities they need to sell and nowhere apart from the US capital markets to sell them in?

Putting it all together, with the new debt all issued at the Caymans holdco; the clear language around ‘Assets’ being transferred from the core Chinese opcos; and no language at all around liabilities being transferred, I think its safe to conclude that the US equityholders/bondholders have been asset stripped. The new org chart thus looks something like this – slightly ‘edited’ by me 😛 :

2. New money is a minority shareholder (24% of Nio China) but structured more like a senior claim with an option to move to control

If the asset strip wasn’t enough, the new money coming in also appears to be effectively senior to Nio Inc’s residual 76% interest, in that the new investors have a whole host of rights that allow them to foreclose on much /all of the investment if they don’t get a guaranteed 8.5% return and an IPO exit in 4 years. Have a read of the description yourself:

In its own press release announcing the deal, of course Nio made no mention of this liquidation preference or 8.5% guaranteed return rights – they claimed this was simply a cash injection for a 24% stake of the new entity, and at generous valuations too:

In reality this ‘equity injection’ looks more like a convertible preferred: if Nio China somehow IPOs in 4+ years, the new money remains equity and no doubt they make a bundle; but in the more likely distressed scenario where Nio China limps along before running out of cash, the new investors sit on an 8.5% paying liquidation preference share that forecloses to 100% of newco equity if or when Nio Inc can’t make them whole.

All this is quite clearly pretty bad for Nio ADR – not least because there’s no way Nio holdco has the wherewithal to fund any of these commitments without simply turning on the equity/convert dilution machine. They need to fund the ~$600mm cash injection to Nio China (2.6bn RMB by June 30; and another 1.8bn by Mar21); another $100mm in maturing converts in September this year; and of course the ongoing operational burn in the business, since the capital injections from Inc and the new investors are being earmarked for capex/PP&E buildout, not maintaining the $50-100mm monthly burn. Oh, and there’s still ~$400mm of negative working capital that needs to be true-upped at some point too…

Suffice to say that post 20-F, there has never been more clarity in the documents. The Nio China transaction/Nio Inc subordination/disintermediation is perfectly ‘legal’ but still – for now – unbeknownst to the retail holders of the ADR (even though bondholders appear to get it, as Nio converts are back trading at 50c on the dollar). With the likely advent of substantial, and endless, dilution, however, I still expect that to change over the course of 2020…

Disclosure: short NIO

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