"A123 says unsecured creditors to get 65 pct of claims"

"Unsecured creditors of A123 Systems Inc, a bankrupt maker of batteries for electric cars that had U.S. government backing, will likely collect around 65 cents for each dollar they are owed"

"A123 confirms Wanxiang wins bid for bankrupt battery maker" ($AONE)

"Wanxiang's bid of $256.6 million topped a joint bid from Johnson Controls Inc of Milwaukee and Japan's NEC Corp for the maker of lithium-ion batteries. The sale did not include A123's Michigan-based government business that works with the U.S. Defense Department, which was instead sold to Navitas Systems for $2.25 million"

"Chinese auto parts maker vows to top Johnson deal for A123" ($AONE)

This is so strange:

"My client feels it has been left at the altar a couple of times," Guzina, a lawyer for law firm Sidley Austin, which represents Wanxiang, said in U.S. Bankruptcy Court in Wilmington.

Why did AONE go BK? They could have done the Johnson Controls deal, settled with noteholders for cash and a majority of the equity, and stayed alive.

"Longtime VC investor bails just one month before battery maker's bankruptcy filing." ($AONE)

I wonder why this A123 investor held on for so long?

"[When] A123 went public in September 2009[,] North Bridge held a 9% equity position [which] was valued at nearly $120 million at the time of IPO, and $228 million just a few days later.

Over the intervening three years, North Bridge didn't sell a single share. Not when lockups originally expired. Not when the stock price steadily declined. Not when it was forced to recall defective electric car batteries last December. Not when the company signed a $465 million bail-out of sorts in early August with Chinese auto parts maker Wanxiang Group. Not a few days later when U.S. Congressmen began objecting to the deal, or when NASDAQ issue[d] a delisting notice on August 22 [...] No, North Bridge didn't unload its first share until August 28..."

"A123 Systems Reaches Agreement To Sell Automotive Business Assets To Johnson Controls" ($AONE)

Latest press release:

A123 Systems, Inc. (AONE) ("A123" or "the Company"), a developer and manufacturer of advanced Nanophosphate® lithium iron phosphate batteries and systems, today announced that it has entered into an asset purchase agreement with Johnson Controls, Inc. (JCI) in a transaction valued at $125 million. Under the terms of the agreement, Johnson Controls plans to acquire A123's automotive business assets, including all of its automotive technology, products and customer contracts; its facilities in Livonia and Romulus, Michigan; its cathode powder manufacturing facilities in China, and A123's equity interest in Shanghai Advanced Traction Battery Systems Co., A123's joint venture with Shanghai Automotive. The asset purchase agreement also includes provisions through which Johnson Controls intends to license back to A123 certain technology for its grid, commercial and government businesses. A123 also continues to engage in active discussions regarding strategic alternatives for its grid, commercial, government and other operations, and has received several indications of interest for these businesses.

To facilitate the transaction process, A123 and all of its U.S. subsidiaries today filed voluntary petitions for reorganization under Chapter 11 of the U.S. Bankruptcy Code in the U.S. Bankruptcy Court for the District of Delaware. The Company's subsidiaries located outside the U.S. were not included in the filings. This action is expected to allow the Company to provide for an orderly sale of the automotive business assets and all other assets and business units under Section 363 of the Bankruptcy Code

A123 Systems Files Chapter 11 in Delaware ($AONE)

A123 Systems Announces it Will Miss Two Interest Payments Due Today ($AONE)

From an 8-K filing released after the close on Monday:

On October 16, 2012, the Company expects to be in default under certain of its material debt agreements. The Company does not expect to timely pay the October Interest Payment due today, October 15, 2012, under the 2016 Notes which non-payment will result in a default under the indenture governing the 2016 Notes, $143,750,000 in aggregate principal amount of which are currently outstanding. Similarly, the Company does not intend to timely pay a 6% P&I Payment due today, October 15, 2012, under the 6% Notes, $2,759,118.69 in aggregate principal amount of which are currently outstanding, which non-payment will result in an event of default under the 6% Notes and will permit the holders of the 6% Notes to require them to be redeemed. The failure to pay the October Interest Payment and the 6% P&I Payment will also result in events of default under the Loan Agreement, but those events of default are temporarily waived under the First Loan Consent and Waiver Agreement and Second Loan Consent and Waiver Agreement, respectively, as described in Item 1.01 of this Current Report on Form 8-K. 

The Company is considering a broad set of strategic alternatives to address its liquidity constraints including one or more potential transactions and is preparing for all contingencies as part of that process. However, there is no assurance that the Company will be able to pursue a strategic alternative that will allow it to continue to operate its business as a going concern.

Stock was down ten cents (40%) after hours. [I'm surprised there's any bid.]

Very interesting to hear that the 6% Notes have been reduced to $2.76 million in aggregate principal amount outstanding. That's because the company was able to make principal and interest payments in shares of stock, at a discount to the market price. That's good news - it means that the share count is now probably bigger (and the market cap therefore higher) than people realize. Also, there's less debt in front of the sub notes than we thought.

It looks like the notes may be fairly priced at the current level of 33, while the common stock is looking like a zero.

Here's the real question: why did the company announce that it would miss these interest payments? Do they really not have $3 million in cash?

Remember, the deal with Weixang has a requirement that the company "convert or repurchase" the 2016 notes before Weixang will inject new money. My theory was that the company would do an exchange offer and basically wipe out the existing equity.

Perhaps the noteholders were being recalcitrant, and/or the company was worried about diluting the existing equity? Well, with this announcement the noteholders are going to be spooked and the existing equity is going to get crushed. Maybe it's a calculated move to get everyone to the negotiating table? Why else have such a fuss over a small coupon payment?

"A123 Systems triggers short-sale curbs" ($AONE)

"A123 Systems triggered the market short-sale rule Wednesday morning when shares dropped below 10% of Tuesday's closing price."

More About the A123 Systems Requirement for "Conversion or Repurchase" of the 3.75% Convertible Notes ($AONE)

I mentioned this requirement in my previous AONE post about the definitive documentation relating to the bridge loan facility and the sale of the 8.00% Convertible Notes. Here is the more detailed language (from the 8-K) regarding contingencies for the issuance of the new convertible notes,

"The issuance of the 8.00% Convertible Notes and the Convertible Note Warrants is subject to certain closing conditions, including obtaining the Shareholder Approval, receipt of a favorable determination from CFIUS and receipt of Chinese government approvals on terms satisfactory to the Purchaser in its sole discretion; the expiration or termination of any waiting periods under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended, and any other antitrust or competition laws; the continued listing of the Common Stock on NASDAQ; the concurrent appointment or election of four individuals designated or nominated by the Purchaser to the Company’s Board of Directors; the Purchaser’s receipt of reasonable assurances that certain government grants and tax credits will remain available for specified periods; the conversion or redemption of all of the outstanding 6.00% Convertible Notes and the related warrants; and the conversion or repurchase of at least 90% of the outstanding 3.75% Convertible Notes on terms satisfactory to the Purchaser in its sole discretion. This significant reduction in the outstanding amount of our existing debt may be difficult to accomplish."

OK, that sounds like more clues that my interpretation - the current equity is going to get massively diluted by the exchange/conversion/retirement of the current notes, before it has a chance to get diluted by the new warrants and convertible notes - may be correct.

I wonder if the company is in the market right now buying back some of the 3.75 convertible notes? The price of these has rallied substantially - from low 20s to almost 40 - since this new deal was announced. So, either the company is buying them back at a discount in the open market, or other people have read this deal the same way I have: good for bonds bad for stock.

However, the company probably won't be able to retire 90% of them through open market purchases. I would imagine that they then announce an exchange offer for these. However, I think it would need to be a really generous offer, like a cash payment, almost all of the existing equity, and maybe even a bond due after the new convertible notes will be due.

In light of this, it does not seem that the current equity (pre-dilution, pre-warrants) should be worth anything; certainly not the current $70 million market cap. I could actually see the sub notes being worth slightly more than the current level and the current equity being worth e.g. 80% less. If I'm right that there is going to be an exchange offer for the current notes, then that would be the catalyst for the revaluation.

A123 Systems Enters Into Definitive Documentation Relating to Bridge Loan facility and 8.00% Convertible Notes ($AONE)

"On August 16, 2012, the Company and Wanxiang entered into definitive documentation relating to the bridge loan facility and the sale of the 8.00% Convertible Notes, all as more specifically described in this Current Report on Form 8-K." The terms appear to be consistent with what was in the MOU filed earlier. My primary point of curiosity was any update regarding the sub notes. Here is the summary in this filing:

"3.75% Convertible Subordinated Notes . At least 90% of the initial principal amount of the Company’s 3.75% Convertible Subordinated Notes (the '3.75% Notes') shall have been converted into shares of Common Stock and/or purchased and cancelled by the Company on terms satisfactory to Purchaser in its sole discretion."

The wording in the MOU was a requirement for the "conversion or repurchase of at least 90% of the Company’s outstanding 3.75% Convertible Notes".

The writing on the wall still seems to be clear that the current equity is going to get massively diluted by the exchange/conversion/retirement of the current notes, before it has a chance to get diluted by the new warrants and convertible notes. 

Part of the rationale for that must be that the sub notes are due before the new convertible notes would be, which would hurt the value of the new notes. So, they need to be taken care of.

More A123 Systems Stuff ($AONE)

The company put out an 8-K today describing an amendment to the 6.00% Senior Convertible Notes due 2013, which changes certain terms of the Notes in connection with the WX financing deal.

Among other things, the Consent and Amendment increased the conversion price of a portion of the Notes at all times on or after August 21, 2012 from 85% of the market price thereof (as was previously provided for such the Notes under their original terms) to 87% of the market price thereof. In consideration of the foregoing, the Consent and Amendment changed the first date on which the holders of the Notes may convert up to $30 million of the Notes into shares of Common Stock at a 15% discount to the market price thereof from August 15, 2012 to August 10, 2012.

That was the worthless summary from the 8-K. One of the changes is as follows:

The Holder may, at any time and from time to time on or after August 10, 2012, notify the Company by so indicating in one or more Conversion Notices of its election to convert all or any portion of the outstanding and unpaid Conversion Amount using a floating rate conversion price equal to (a) for each Trading Day from and including August 10, 2012 to and including August 20, 2012, 85%, and (b) for each Trading on or after August 21, 2012, 87%, of the Closing Sale Price of the Common Stock on the Trading Day immediately preceding the applicable Conversion Date (the “Floating Rate Conversion Price ”) in lieu of the Conversion Price then in effect.

The difference appears to be that in the previous version the conversion could take place only after August 15. So, for some reason, they've made it possible for the holders to convert five days earlier. And encouraged them to do so, because the discount to market price (15%) goes down slightly on Aug 21. Interestingly, an enormous number of shares traded today. If $50 million of debt is converted to stock at a 15% discount to  current prices, that will mean issuing close to 100 million new shares. That will be really good for the long bond/short stock trade. The other major change was to add this provision:

REDEMPTION AT THE OPTION OF THE COMPANY. At any time on or after the date the Company consummates the transactions contemplated by the Bridge Facility and the New Convertible Notes, whereby the Company receives proceeds of at least $225,000,000 (the “ Requisite Financings ”), the Company shall have the right, upon not less than twenty (20) Business Days’ nor more than thirty (30) Business Days’ prior written notice via facsimile and overnight courier, which notice shall be irrevocable (a “ Voluntary Redemption Notice ”), to redeem all (but not less than all) of the outstanding Notes; provided that no such redemption shall be consummated prior to the date on which the New Convertible Notes are issued (but, for absence of doubt, the Voluntary Redemption Notice may be provided (on an irrevocable basis) prior to the consummation of the Requisite Financings for a redemption being completed no earlier than the consummation of the Requisite Financings). Each Note subject to redemption by the Company pursuant to this Section 32 shall be redeemed by the Company in cash by wire transfer of immediately available funds at a price equal to the sum of (a) the aggregate principal amount of the Note, (b) the aggregate principal amount of the Note multiplied by the Voluntary Redemption Premium and (c) accrued but unpaid interest on such aggregate principal amount of Notes (the “ Voluntary Redemption Price ”). The “ Voluntary Redemption Premium ” is equal to 10.00%. Redemptions required by this Section 32 shall be made in accordance with the provisions of Section 12. Notwithstanding anything to the contrary in this Section 32, but subject to Section 3(d), until the Voluntary Redemption Price (together with any interest thereon) is paid in full, the Conversion Amount subject to redemption under this Section 32 (together with any interest thereon) may be converted, in whole or in part, by the Holder into Common Stock pursuant to Section 3.

It's not clear why the company would want to redeem this debt in cash - at a 10 percent premium - rather than having it converted into stock. But maybe they just wanted to leave themselves the option. If the holders don't convert to stock (it's not clear why they wouldn't, since they make an instant 15%), then this allows the company to redeem the remaining debt.

What's funny is that none of the discussions of this deal - even the ones that are close to being accurate - are addressing these issues. For example, he says that "a substantial portion of the cash [from the WX deal] will be used to redeem or repurchase A123's other debt securities." I highly doubt that.

It seems much more likely that the existing debt will be converted to stock. That would explain why the WX deal is very clear about provisions to protect them from dilutive transactions.

Summary of A123 Systems News ($AONE)

The total revenue for the second quarter was $17.0 million, which was a decrease of 53% from the previous year. AONE talks about its "gross loss" because it has a consistently negative gross margin, and the gross loss for the quarter was $29 million, compared with $17.5 million the previous year.

The share count is currently 172 million, so the market cap is actually $86 million not the $74 million shown on various websites.

The much vaunted deal has two major components, first is the Bridge Loan Facility and Bridge Warrants. There's a strike price of $0.425 on those warrants that come with the 10% interest, 2-year senior secured loan. And how about the "subject to reduction to $0.17" feature, if the certain government grants go away? Is there maybe a chance that the DOE grant will go away now that the company is in the clutches of a Chinese company? Much of the value of this company is the future DOE money, and WX cleverly insisted on provisions protecting them in case those grants are cancelled.

This looks more like a hard money convertible loan where the lender can short the stock at the money (thanks to the conversion options and warrants) to protect its position.

The second part of the deal is the Senior Secured Convertible Notes and Warrants. So the new convertible notes wouldn't mature until 2017 and the old sub notes are due in 2016. That's why they have to retire the old notes. The 90% requirement and all the anti-dilution provisions regarding the warrants are dead giveaways that this is going to be an exchange offer.

The major question is how the sub notes are going to be repurchased/retired to satisfy that part of the MOU. Obviously, AONE isn't going to be calling them at par! They could do open market purchases at the current distressed price. However, that would still cost about $50 million, and cashing out other creditors presumably is not what WX signed up for. That leaves a distressed exchange / debt for equity swap. A big clue is that the MOU calls for 90% of the subs to be retired, which is a common threshold in exchange offers. I could see these notes being given something like 10 cents of cash plus stock to induce them to tender.

The stock component of the distressed exchange would need to basically wipe out the existing equity, though. If the entire WX deal needs to happen by the end of the year, than the distressed exchange needs to happen really soon. This could be why the stock tanked at the end of the day and the subs rallied from low 20s to 31.

Conclusion: the relative valuations of the subs and stock are still inconsistent. In order to bring in the new capital, the subs need to be given a tip to go away, and the current equity needs to get totally shafted. At a $50 million market value of the bonds and $75 million market cap, the market prices don't reflect this.

Q2 2012 Results for A123 Systems ($AONE)

Highlights (lowlights) from the earnings release:

• Total revenue for the second quarter of 2012 was $17.0 million, a decrease of 53% from $36.4 million in the second quarter of 2011.
• Gross loss was ($29.2) million in the second quarter of 2012, compared to a gross loss of ($17.5) million in the second quarter of 2011.
• A123 Systems had cash and cash equivalents of $47.7 million as of June 30, 2012. This balance does not reflect $6.8 million in net proceeds from the Company’s registered direct offering of common stock and warrants announced on July 6, 2012, $30.0 million from the Company’s 6.00% senior convertible notes offering that was restricted as of June 30, 2012, or the bridge facility, and convertible notes and warrants offering announced today. Cash and cash equivalents were $113.1 million as of March 31, 2012.

Super bearish, of course. Which is why so many financing deals plus today's big dilutive announcement have been necessary.

Notes from A123 Systems Earnings Call

The transcript (via Seeking Alpha) and slides (useless) are both available.

The share count is currently 172 million, so the market cap is actually $86 million not the $74 million shown on various websites.

Otherwise the analyst questions were pretty useless. Nobody thought to ask, for example, how they are going to retire the 2016 notes as mandated by the MOU.

First Opposition to Chinese-backed A123 Systems Deal Surfaces ($AONE)

I asked in my previous post whether there's a chance that the DOE grant to AONE will go away now that the company is in the clutches of a Chinese company? The first article attacking the deal on these grounds is already out, from Forbes.

"The recipient of a $249 million 'green technology' grant from our federal government, A123, believing their own (and everyone else’s) hype about the millions of electric vehicles that would soon be filling the nation’s highways (it will happen, but not soon) set about proving an old adage: stupidity and waste increase with the amount of money available. Production capacity was set at a level that was way overly optimistic, and the headquarters complex, with its magnificent office suites and marbled lobbies, was something only a company with tons of money would dream of. [...]

If the U.S. can’t find a way back to self-accountability, to the abnegation of the 'entitlement' philosophy, to hard work, to a focus on exports, an emphasis on value-added production rather than import-driving consumption, the A123 example will be repeated many times. If we can’t get our act together soon, the country will 'go Chinese' company by company, institution by institution, industry after industry.

Much of the value of this company is the future DOE money, and WX cleverly insisted on provisions protecting them in case those grants are cancelled. The risk is all on AONE shareholders.

The Actual Non-binding Memorandum of Understanding Between A123 Systems and Wanxiang ($AONE)

Not many of the people talking about this morning's AONE announcement have read the actual "non-binding Memorandum of Understanding" between A123 Systems and Wanxiang. The deal has two major components, first is the Bridge Loan Facility and Bridge Warrants.

A senior secured bridge loan facility in an amount of up to $75 million, to be provided by one or more of affiliates of Wanxiang, providing for an initial cash advance of $15 million and a letter of credit facility that will result in an additional $10 million of liquidity for the Company. The Bridge Loan Facility also provides for up to $50 million of subsequent cash advances, subject to the satisfaction of certain conditions, including the receipt of necessary governmental and other approvals, including (i) receipt of a favorable determination from the Committee on Foreign Investment in the United States (“CFIUS”), (ii) receipt of Chinese government approvals on terms satisfactory to the Lender in its sole discretion, (iii) the accuracy of representations and warranties, (iv) the absence of any default, , (v) the absence of a material diminishment of the Company’s research and development and engineering teams by reason of resignations or departures and (vi) certain other conditions. Borrowings under the Bridge Loan Facility would bear interest at an annual rate of 10 percent and mature in August 2014.

Upon each advance or other extension of credit made under the Bridge Loan Facility, the Company will issue warrants to the Lender exercisable (subject to the restrictions on exercisability described below) for a number of shares of the Company’s common stock resulting in warrant coverage equal to 100% of the outstanding amount of such advance or extension of credit. For purposes of calculating warrant coverage,the exercise price of the Bridge Warrants will initially be set at $0.425, subject to reduction to $0.17 in the event that certain government grants or tax credits cease to be available to the Company. The Bridge Warrants will expire on the fifth anniversary of their issue date. The exercise price of the Bridge Warrants will be appropriately adjusted for stock splits, stock dividends and similar events and will be subject to full-ratchet anti-dilution protection (which would increase the number of shares issuable under the warrant). Because the anti-dilution provisions are intended to protect the Lender from dilutive issuances occurring from and after the date of the Bridge Loan Facility, the effective initial exercise price of Bridge Warrants may be less than the Initial Exercise Price and the number of shares into which the Bridge Warrants are initially exerciseable may increase. Bridge Warrants may be exercised for cash or in exchange for outstanding Bridge Warrants on a cashless basis or by offset of amounts payable under the Bridge Loan Facility. None of the Bridge Warrants will be exercisable until the earlier of (i) the time the Company’s shareholders vote on the proposed issuances of Common Stock pursuant to exercise of the Bridge Warrants and the Convertible Note Warrants and the conversion of the 8.00% Convertible Notes and (ii) the termination of the Company’s obligation to seek the approval of its shareholder. After such vote has occurred, the exercise of the Bridge Warrants will be subject to the limitations set forth below. The exercise of the Bridge Warrants in an amount greater than 9.99% of the issued and outstanding Common Stock after giving effect to such issue will be conditioned on receipt of CFIUS approval. Additionally, before the shareholder approval has been obtained, the Bridge Warrants may only be exercised to the extent such issuance would not require shareholder approval. The failure to obtain shareholder approval within 120 days after the will be an event of default under the Bridge Loan Facility.

Wow! Strike price of $0.425 on those warrants that come with the 10% interest, 2-year senior secured loan. Somehow, none of that made it into the company's morning press release, did it? Maybe the price tanked once people read the 8-K? And how about the "subject to reduction to $0.17" feature, if the certain government grants go away. Is there a chance that the DOE grant will go away now that the company is in the clutches of a Chinese company? Another exciting alternative energy story for the Obama DOE.

The second part of the deal is the Senior Secured Convertible Notes and Warrants.

Subject to the satisfaction of certain conditions within 180 days after the date of first advance under the Bridge Loan Facility, an affiliate of Wanxiang would agree to purchase $200,000,000 in aggregate principal amount of the Company’s 8.00% Senior Secured Convertible Notes from the Company. The 8.00% Convertible Notes would mature on the fifth anniversary of their issue date. [...]

Holders of the 8.00% Convertible Notes will have the option, at any time and from time to time, to convert principal of and interest accrued on the 8.00% Convertible Notes into shares of Common Stock at a conversion price equal to $0.60 per share, subject to reduction to $0.24 per share in the event that certain government grants or tax credits cease to be available to the Company. The conversion price will be appropriately adjusted for stock splits, stock dividends and similar events and will be subject to full-ratchet anti-dilution protection. Because the anti-dilution provisions are intended to protect the Holders from dilutive issuances occurring from and after the date of the Bridge Loan Facility, the effective initial conversion price upon issuance of the 8.00% Convertible Notes may be less than $0.60 or $0.24 per share, as applicable. [...]

Concurrently with the issuance of the 8.00% Convertible Notes, the Company would issue warrants to the Purchaser to purchase shares of Common Stock equal to 50% of the shares of Common Stock underlying the 8.00% Convertible Notes issued, assuming conversion at the initial conversion price. The Convertible Note Warrants would expire on the fifth anniversary of their issue date. Each Convertible Note Warrant would have an exercise price equal to the conversion price of the 8.00% Convertible Notes. [...]

The issuance of the 8.00% Convertible Notes and the Convertible Note Warrants will be subject to certain closing conditions, including obtaining the shareholder approval, CFIUS approval and Chinese regulatory approval; the expiration or termination of any waiting periods under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended, and any other antitrust or competition laws; the continued listing of the Common Stock on Nasdaq; the increase of the number of members on the Company’s board of directors from seven to nine and the concurrent election or appointment of 4 individuals designated by the Purchaser to the Company’s board of directors; the Purchaser’s receipt of reasonable assurances that certain government grants and tax credits will remain available for specified periods; the conversion or redemption of all of the outstanding 6.00% Convertible Notes and the related warrants; and the conversion or repurchase of at least 90% of the Company’s outstanding 3.75% Convertible Notes on terms satisfactory to the Lender in its sole discretion.

So the new convertible notes wouldn't mature until 2017 and the old sub notes are due in 2016. That's why they have to retire the old notes. The 90% requirement and all the anti-dilution provisions regarding the warrants are dead giveaways that this is going to be an exchange offer. I wonder if they have the S-4 draft done already?

A123 Systems Announces Dilutive New Financing to Distract from Horrible Earnings ($AONE)

This morning, AONE started before announcing earnings by announcing a "Non-Binding Memorandum of Understanding With Wanxiang Group Corporation". These are the terms which were disclosed:

"Under the proposed terms of the strategic agreement outlined in the MOU, Wanxiang would provide A123 with up to $75 million in initial debt financing under a Senior Secured Bridge Facility, with an initial credit extension of $25 million and $50 million to be funded after the satisfaction of certain closing conditions, and, subsequently, upon satisfaction of certain closing conditions, purchase $200 million aggregate principal amount of A123's Senior Secured Convertible Notes. The agreement would also include the potential for Wanxiang to invest up to an additional $175 million if it exercises the warrants that would be issued in connection with the Bridge Facility and the Convertible Notes for cash. Incurrence of the remaining $50 million of loans under the Senior Secured Bridge Facility would be subject to the satisfaction of certain approvals and conditions, including receipt of favorable determination from CFIUS and receipt of Chinese government approvals. Issuance of the Convertible Notes and the related warrants would also be subject to additional conditions, including approval from A123's shareholders, termination of the Hart-Scott-Rodino waiting period, the conversion or redemption of all the outstanding six percent Convertible Notes and relevant warrants and the repurchase or retirement of at least 90 percent of A123's outstanding 3.75 percent convertible subordinated notes due 2016.

According to the proposed terms of the strategic agreement, if the entire amount of the initial debt financing is provided to A123 and the full amount of the warrants and Convertible Notes are issued and exercised for cash, Wanxiang's total capital investment in A123 from these agreements would total approximately $450 million. The total amount of shares of A123's common stock issuable upon exercise and conversion of the warrants and Convertible Notes would represent approximately 80 percent of the then outstanding common stock of A123. While the MOU is non-binding and the execution of definitive documentation is subject to negotiation and, among other items, the amendment of agreements with certain of A123's existing lenders, A123 and Wanxiang are currently negotiating definitive documentation and intend to close the full transaction by the end of 2012."

This disclosure is light on terms and heavy on headline numbers. Because of this, the initial market reaction was to incorrectly interpret this as bullish. Notice that there is no disclosure of the conversion price of the new notes or of the strike price of the warrants.

By the way, the news articles claiming that WX is paying $450 million for a majority stake are completely out of their minds. This looks more like a hard money convertible loan where the lender can short the stock at the money (thanks to the conversion options and warrants) to protect its position.

But the most amazing part is that it is contingent on redeeming the existing subordinated notes! These are the ones we own (paired against the equity) that have been trading in the low 20s.

That raises two questions: why and how. Why does WX care about having these be redeemed? Their new financing will be senior to the sub notes, so they could conceivably just ignore them. On the other hand, it is nice to have a cleaner capital structure, and it has always been embarrassing that AONE is trying to sell expensive capital goods when its debt trades at a 50 percent yield.

Second major question is how the sub notes are going to be repurchased/retired to satisfy that part of the MOU. Obviously, AONE isn't going to be calling them at par! They could do open market purchases at the current distressed price. However, that would still cost about $50 million, and cashing out other creditors presumably is not what WX signed up for. That leaves a distressed exchange / debt for equity swap. A big clue is that the MOU calls for 90% of the subs to be retired, which is a common threshold in exchange offers. I could see these notes being given something like 10 cents of cash plus stock to induce them to tender.

The stock component of the distressed exchange would need to basically wipe out the existing equity, though. If the entire WX deal needs to happen by the end of the year, than the distressed exchange needs to happen really soon. This could be why the stock tanked at the end of the day and the subs rallied from low 20s to 31.

Conclusion: the relative valuations of the subs and stock are still inconsistent. In order to bring in the new capital, the subs need to be given a tip to go away, and the current equity needs to get totally shafted. At a $50 million market value of the bonds and $75 million market cap, the market prices don't reflect this.

Latest and Greatest ($KV $AONE $GMXR $HOV)

KV said in its lawsuit that unless it is able to "immediately generate significantly higher market share and revenues from Makena than the current levels, the company will not be able to meet its cash obligations, and will run out of cash in less than three months from the date of this Complaint," which would be the first week of October. That even seems optimistic, and anyway they would be likely to file BK sometime before they literally ran out of cash. The FDA lawsuit that KV is banking on is not the clear winner that they need judging by the response by the FDA (e.g. "more time spent on pharmacies compounding 17-HPC means less time spent pursuing enforcement actions in other areas"). I would obviously expect the stock to collapse to ~0 in the event of a BK filing.

The AONE bonds are down to 20 cents (and they have issued new "debt" where the payments are made with stock), and the company had previously said that "as of May 31, 2012, the Company expects to have approximately four to five months of cash to support its ongoing operations." That suggests that sometime around August/September the company will need to do something dramatic, which would be good for the debt/equity trade. I continue to wonder how the $163 million of 2016 notes only be worth $35 million according to the bond market - yet the company has a market cap of over $100 million? Aren't both the notes worth significantly more and the stock worth significantly less? I think they should be looking at a debt/equity swap right now for all their existing unsecured debt. They would be in a much better position to survive with less leverage. Ultimately though, they are probably a goner no matter what as Vinod Khosla has said. The best outcome would be for the company to liquidate and distribute proceeds to bondholders, as ENER did.

The big catalyst for GMXR is the bond maturity in February. That bond is trading at 69 and the 2015 unsecured is trading around 40. The well results in the Bakken have continued to come in poorly. They tend to be pretty opportunistic about debt/equity swaps and I'm sure they would rather spend money on drilling than on principal repayments to bondholders. The market cap is $60 million, which is more than the market value of the debt due in February. I would look for them to try to repay the February maturity in stock (via swaps) rather than cash. That will obviously be good for the long debt/short equity trade. Also, the company announced that they will release 2012 second quarter financial and operational results after the close of trading on the New York Stock Exchange on Wednesday, August 8, 2012.

Last is HOV, which has been trading stock for the bond that we own. It's nice to know that the company agrees that the bonds are a better value than the stock. I'm looking for continued swaps to put a ceiling on the share price while increasing the price/expected recovery of our bond. I've previously mentioned "impediments [which] will affect the home builders going forward (significantly higher-than-average vacancy rates, legacy land positions with subpar gross margins, competitive land market in attractive locations, rising labor/material costs, potential new home-builder entities with stronger balance sheets...)." Today I see a smart observation, that "the market may come to the realization that a sizeable portion of the land left on the balance sheet is: 1) Not in a desirable area despite the uptick in new-home demand; 2) Land that needs major improvement but does not yield an adequate gross margin at today's home prices after the necessary development spend."

"A123 Surges on 2-Megawatt China Grid-Stabilization Order"

After not gaining much traction with yesterday's announcement, they decided to just... announce it again plus a 2 MW sale to China.

A123 Systems Inc. (AONE), a U.S. maker of lithium-ion batteries for electric cars, surged the most in a month after winning a contract to supply a 2-megawatt system to China’s Ray Power Systems Co. to help regulate grid frequency. [...]

"This is an application A123 has been chasing for some time and it’s good to see they’re making progress," said Michael Lew, a senior analyst at Needham & Co. in New York who has a hold on the stock.

First, it's interesting that you would have a "hold" on the stock in a company with bonds trading at 24 to yield over 50 percent.

Second, 2 MW is a puny order. I think it may only be a couple million in total revenue, with the profit margin naturally not being discussed. In the past they were putting out press releases for sales of 44 MW of grid stabilization. This reminds me of when the bulls on PV solar firm ENER were talking about that product being used for "solar powered Kindle covers" - which really meant that it had been sold as scrap.

Third, why does China place a teeny tiny order for 2 MW? Less than the output of one wind turbine? Starting with a small trial order, or planning to examine and knock off the technology?

Fourth, AONE increasingly shifts its attention to "ancillary" uses of batteries like grid stabilization. That might be a sign of defeat in the electric vehicle market.

"A123 Systems to Supply Lithium Ion Battery Packs to BAE Systems for HybriDrive(R) Series Hybrid Electric Propulsion System" ($AONE)

From the press release this morning:

"A123 Systems (AONE), a developer and manufacturer of advanced Nanophosphate(R) lithium ion phosphate batteries and systems, today announced an agreement with BAE Systems, a leading provider and developer of hybrid electric technologies, that expands the companies' long-standing relationship. Under the terms of the new agreement, A123 will supply lithium ion battery packs based on the company's prismatic cells to BAE for its HybriDrive(R) Series propulsion system. The new design is initially expected to be deployed on city transit busses, and as part of the new agreement, A123 will also supply lithium ion battery packs for additional versions of BAE's HybriDrive system for other commercial applications.

A123's battery packs are currently deployed in BAE HybriDrive systems on nearly 3,000 buses globally that have amassed more than 300 million service miles to date. The current HybriDrive system utilizes battery packs based on A123's cylindrical cells, but under the new agreement, A123 will deliver packs featuring the company's prismatic cells to satisfy BAE's requirements for a more compact and economical solution. The agreement also formalizes the terms of a previously announced customer warranty campaign through which A123 and BAE Systems are sharing in a program to retrofit and upgrade battery packs on hybrid busses in the field."

Very light on specifics. Notice the bonds did not even trade today - last trade I see was @ 22.5 on Tuesday, for a 54% yield to maturity.