Summary
- Discussing Thursday's $27.5 million convertible notes offering.
- Toxic financing transaction incentivizing noteholders to short the company's common stock prior to conversions.
- Surprise offering provides further evidence for perceived liquidity issues.
- Speculative investors should put the stock on their short watchlist going into 2020.
Shares of controversial producer and distributor of Indian language films, Eros International (EROS) or "Eros", have been under severe pressure ever since India's second largest bond rating company, CARE Ratings, slashed bonds of the company's majority-owned subsidiary Eros International Media Limited ("EIML") by 10 notches from BBB- to D in early June, citing weaker accounts receivable collections as reason behind the company having failed to timely service its debt.
After the downgrade, the company admitted to EIML indeed having missed two interest payments of "less than 2 million" in aggregate for April and May 2019. In early July, Eros updated investors that the outstanding interest payments have been paid and that "the company is working with CARE in an attempt to restore its previous investment grade rating".
The company also announced a $20 million share repurchase program and review of strategic alternatives.
In FY2019 (ended March 31), the company generated $65.5 million in cash from operations but used almost $100 million to purchase additional film and content rights. Moreover, the company was required to restrict almost $50 million in cash as "security for overdraft facilities".
With credit facilities fully utilized, available cash was stated at $89.1 million at the end of FY2019.
As free cash flow continues to be negative, the company needs to raise capital in a more or less regular fashion. So far, Eros has relied on a mixture of short-term credit facilities provided by domestic banks and bond financing with a total outstanding debt of $281.5 million on March 31.
Last week, Eros' beaten down shares rallied close to 40% after announcing "a collaboration with Microsoft to build a next generation online video platform on Microsoft Azure targeted at its consumers across the globe".
On Thursday, the company took advantage of the material share price increase and sold $27.5 million in convertible notes in a registered, direct offering for estimated net proceeds of $24.5 million.
On the surface, the offering terms look reasonable for a company in Eros' financial position with the interest rate calculating to 10% and the $3.59 conversion price approximately 26.5% above Wednesday's closing price of $2.84, but after a deep dive into the respective SEC filing, a toxic financing transaction comes to light (emphasis added by author):
