ERATAT LIFESTYLE LTD 
By ERATAT LIFESTYLE has just raised RMB100.5 million via the issue of non-convertible bonds and warrants, a move that will pave the way for it to expand its business. But this has also drawn flak for the high cost of borrowing.
The matter was raised at a results briefing on Tuesday (Aug 6). Apart from the 2Q results, the CFO, Ken Ho, gave a run-down on the financing alternatives that the Singapore-listed, China-headquartered, company had considered:
Equity (placements, rights issue etc):
The amount that could be raised would be limited due to Eratat's depressed market share price (which currently is at below PE of 2.5x). Share placements also translate into shareholding dilution at too cheap a price for existing shareholders.
Convertible bonds:
The quantum would be limited to a maximum of 20% of the issued shares (based on the share issue mandate) at a conversion price which usually is set at a premium to the stock's current market price. The premium can be up to 30% or so.
The transaction costs are also high coupled with coupon interest.
A major disadvantage is that usually the timing of the redemption of convertible bonds is at the discretion of the bond holders, whomay redeem the bonds prematurely, especially in severe economic conditions.
Bank loans:
Again, the loan quantum may be limited to a fraction of the borrower's assets, and the bank lending is also highly subject to China's prevailing national credit policies.
The effective borrowing costs often far exceed the interest rates.
In addition, banks require collaterals such as mortgage of fixed assets, or personal guarantees, etc. The most risky collateral are cross-guarantees from unrelated third parties who, in return, require Eratat to guarantee their loans. "This is not uncommon in China and represents too high a risk for us to bear over and above the transaction costs," said Ken.
Ken Ho, CFO: "Is the cost high? On the surface, it looks to be. Do we have better alternatives? Probably no, considering the quantum raised. Do we need to do this? We have a clear purpose..."
Photo by Leong Chan TeikEratat could continue to grow organically using its internal funds (it had RMB502 million cash as at end-June 2013) but it faces the risk of competitors catching up. For the past 1-2 years, amid uncertain market conditions, it had been seeking additional funds to enable it to grow faster.
Eratat worked on a deal with Sun Hung Kai Securities (SHK) over the last 1.5 years or so, during which SHK conducted extensive due diligence on Eratat.
SHK is viewed as a strategic partner who would "increase the exposure of Eratat shares to a new investor community, funds and financial institutions in HK and the PRC," said Ken.
SHK also has a business network which could open doors to new contacts and opportunities in HK and the PRC for Eratat.
In that case, the actions and contributions of SHK would be something that investors would look forward to hearing about in future.
A key feature of the unconvertible bonds subscribed by SHK is, Eratat has the sole option to redeem them in full before they mature in two years' time.
And Eratat stands to enjoy significant upside if the 82.5 million warrants also issued to the bond holders are exercised at any time over the next two years. This would happen only if the stock rises above the exercise price of 25 cents (which is a premium of 85% over the recent price of 13.5 cents.)
A full exercise of the warrants will haul in RMB103 million for Eratat.
Another key feature of the bond issue is that the principal amount of RMB 134 million comes with a coupon rate of 12.5% per annum (or RMB16.75 million in interest payment a year) over a 2-year tenure.
"Is the cost high? On the surface, it looks to be. Do we have better alternatives? Probably no, considering the quantum raised," said Ken. "Do we need to do this? We have a clear purpose, which is to equip ourselves for the next growth phase --- and to sustain the business going forward and make sure the company does well in the years to come."
Use of proceeds - for growth
A distributor's shop in bustling Bai Lian Shopping Centre on Nanjing East Road, Shanghai, which opened in 2011. NextInsight file photo.
About RMB6.5million will be for setting up Eratat's Shanghai HQ Office to manage a network of new distributors; RMB50 million will be for opening self-owned flagship and up to 10 retail shops in Shanghai by year-end; and RMB44 million will be for working capital, substantially to secure the supply of apparel products for all its self-owned and new distributors' retail shops.
The new distributors will open shops in new untapped territories and are described as being of "more experienced in high-end apparel business." They are more accustomed to shorter credit terms of below 60 days, which is the norm in high-end apparel industry (as compared to current distributor credit terms of up to 120 days given to the existing pool of distributorswho were converted from sportswear industry players).
With new distributors on board, and a new relationship-sales marketing strategy added to conventional selling to walk-in shoppers, the topline and bottomline of Eratat could see further improvement in the years ahead.
For Eratat's 2Q results, check out the official release on the SGX website.
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