SMARTPHONES: Coolpad Sends Out SOS with Rights Issue Plan

Bottom line: Coolpad’s shares are likely to come under pressure for the rest of 2016 due to stiff competition in China’s smartphone market, and it could be forced to raise more money last this year following its newly-announced rights issue plan.

Coolpad taps stakeholders for more funds

It seems like $700 million and 2 major new alliances weren’t enough to prop up financially challenged smartphone maker Coolpad (HKEx: 2369), which has just announced a new share rights offer to raise up to HK$736 million ($95 million). The deal marks the latest distress signal coming from China’s overheated smartphone sector, which has seen Coolpad and a vibrant field of other domestic brands engage in a fierce game of price wars over the last 2 years.

What’s somewhat revealing about this new capital raising plan is its relatively paltry size, and also the large discount that Coolpad had to offer to sell the new shares. Even worse, one of the main buyers of the new shares is Chinese online video giant LeTV (Shenzhen: 300104), which should have been willing to pay closer to market levels for the new shares after becoming one of Coolpad’s largest stakeholders last year.

That kind of no-confidence vote by one of your biggest stakeholders certainly isn’t a good sign, and minority shareholders took note by dumping Coolpad shares in Hong Kong. At their current levels the stock now trades at a 2-year low, extending a sell-off that has seen the shares tumble 28 percent since the start of the year. And the stock could fall further still, since the rights offer price is still a bit below current trading levels.

According to its newly announced plan, Coolpad will issue 653-669 million rights shares, carrying a price of HK$1.10 per share. (company announcement; Chinese article) That compares with a Coolpad closing price of HK$1.29 the day before the announcement, and HK$1.55 at the start of this year.

The rights issue would allow Coolpad to raise HK$719-$736 million, and would boost its current share count by 15 percent. LeTV and Data Dreamland, Coolpad’s 2 largest shareholders, would be the 2 largest buyers of the new stock, along with 2 other individuals with connections to the company.

This particular fund-raising comes within a year of 2 other major cash-raising exercises by Coolpad, even as the company says it’s still operating profitably. The first of those came about a year ago, when Coolpad got $420 million after forming a smartphone-making joint venture with security software specialist Qihoo 360 (NYSE: QIHU). Later in the year it raised more money when controlling Coolpad shareholder Data Dreamland sold 18 percent of its stake to LeTV for $280 million. (previous post)

In both instances, Qihoo and LeTV wanted to launch their own smartphone brands and saw Coolpad as a good manufacturing partner. Qihoo was the first to form a tie-up, but wasn’t too happy when Coolpad signed its deal with LeTV later in the year, and threatened to end its joint venture. The 2 sides eventually reached a settlement, and I suspect that deal cost Coolpad both in terms of money and also in production assets it lost as Qihoo took control of the joint venture.

Profit Under Pressure

Coolpad has yet to release its annual earnings for 2015, but it admitted in its interim report that operating profit fell in the first half of last year compared with 2014. It didn’t provide an actual figure, but I suspect it was close to a breakeven scenario at best, and quite possibly was even losing money from its core operations. Last year’s big cash infusions may yet helped it to report an overall net profit for all of last year, but this latest rights issue probably tells a more accurate story of what’s happening behind the scenes.

That story is that competition in China’s smartphone market may be intensifying, as sales in the broader marketplace start to slow and even contract after several years of breakneck growth. The signs of strain have shown up in the broader industry supply chain, with growing reports of component makers and contract manufacturers closing shop and declaring bankruptcy. (previous post)

Coolpad is one of China’s older and better known domestic smartphone brands, and its relative wealth of experience was a major factor attracting Qihoo and later LeTV. But its already-strained resources were probably further strained by the Qihoo joint venture settlement, and its loss of manufacturing assets in that settlement is probably what’s driving this latest capital raising exercise.

LeTV looks quite opportunistic in this latest fund raising, since it will increase its stake in Coolpad at a big discount. What’s more, the new funds will probably be used to buy new equipment to manufacture LeTV’s own line of smartphones which it launched a year ago. But LeTV is also taking a relatively big risk, since it’s quite likely that Coolpad’s shares will continue to sink. And if Coolpad hits a cash crunch later this year, which looks like a strong possibility, it’s also quite possible that LeTV may have to provide even more funds.

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