KUALA LUMPUR: Kanger International Bhd’s recent proposal to issue redeemable convertible medium term notes (RCMTN) to raise up to RM100 million raises the question of why the ACE Market-listed outfit would employ a potentially share dilutive method of raising cash, just one year after its listing.

The proposed amount to be raised is also considered huge, as it equals to half its market capitalisation of RM198.66 million, based on its closing price of 38.5 sen last Friday. Meanwhile, Kanger’s nine-month net profit ended Sept 30, 2014 amounted to only RM5.1 million.

While the RCMTN, to be issued over four tranches with a five-year tenure, carries a low interest of 2%, the obvious downside to employing this method is that it is potentially shares dilutive, thus capping the upside in the company’s share price.

Kanger, while listed on Bursa Malaysia, has its operation based in China. The company manufactures bamboo flooring products mainly for mainland China and the export market.

According to the term sheet, the noteholders have the discretion to convert the RCMTN in two scenarios.

The first is a fixed conversion price based on 135% of the average daily traded volume weighted average price (VWAP) of Kanger shares for 45 market days prior to the date of the subscription agreement in respect of Tranche 1 Notes, being 49 sen, and 45 market days before the closing date of the subscription to the first sub-tranche in respect of Tranche 2 Notes, Tranche 3 Notes and Tranche 4 Notes, which has yet to be determined.

The second is a floating conversion price based on 85% of the average closing price of Kanger shares on any three consecutive market days during the 45 market days before the conversion date of Tranche 1 Notes and 90% of the average closing price per Kanger share on any three consecutive market days during the 45 market days before the conversion date in respect of Tranche 2 Notes, Tranche 3 Notes and Tranche 4 Notes.

 The proposed RCMTN issue is expected to raise up to RM15 million through the issuance of Tranche 1 Notes. Further amounts of up to RM85 million may be raised through the issuance of the remaining three tranches at the option of Kanger, subject to the terms and conditions as set out in the subscription agreement.

It could be argued that this method carries no immediate impact to Kanger’s balance sheet, as it does not increase the company’s gearing ratio, which stood at 0% as at Sept 30, 2014, according to theedgemarkets.com. Kanger’s short-term bank borrowings at the end of its third quarter ended Sept 30 last year was RM10.2 million, and its cash and cash equivalents stood at RM14.4 million.

Meanwhile, the company need not put its assets under collateral, as noteholders can convert the notes into shares in the company on default of payment.

However, the obvious downside to employing this method is that it is potentially shares dilutive to existing shareholders. Kanger’s current issued and paid-up share capital is 516 million shares. If all the RCMTNs are converted, the company will have an enlarged share capital of 827.4 million shares.

Under such a scenario, the major shareholders of Kanger, Leng Xingmin and Lim Lai Choy @ Lim Aun Nee, would see their shareholding pared down to 34.39% and 7.83%, from 55.17% and 12.55% respectively. The noteholders, on the other hand, will emerge with a direct 37.63% stake upon full conversion of the notes.

It should be noted, however, that Kanger said it expects no change in the company’s controlling shareholders pursuant to the proposed notes issue, and that the conversion shares are expected to be sold down via the open market on a progressive basis.

To recap, on Jan 2, Kanger said it would be issuing the RCMTN in four tranches, with multiple sub-trances in each tranche, convertible at the option of the holders into new Kanger shares of 10 sen each. The RCMTNs will mature in five years from the closing date of the first sub-tranche for the first tranche.

The company entered into a conditional subscription agreement with Advance Opportunities Fund and Advance Capital Partners Pte Ltd for the proposed notes issue.

Market observers say the timing in carrying out this exercise may appear a little too soon, given that Kanger was just listed on Bursa’s ACE Market on Dec 23, 2013, and had raised RM20 million to grow its business.

What’s more, it is puzzling that Kanger is planning to utilise some RM22.5 million of the RM100 million from the proposed RCMTN for its diversification into the property development and management business. At the same time, the estimated expenses for the proposals on RCMTN issues came up to RM6.6 million, which is expected to be utilised within one month.

On the diversification into the property business, Kanger’s subsidiary, Ganzhou Kanger Industrial Co Ltd, entered into a lease contract with Ganzhou Detong Technology Development Co Ltd in relation to the lease of a commercial building to be built by Ganzhou Kanger on a portion of  the vacant land owned by Ganzhou Kanger.

According to Kanger, the commercial building will generate an annual gross rental of approximately 5.60 million yuan (RM3.2 million) which is expected to contribute to more than 25% of the group’s net profit for a five-year period. It also said that the location of Ganzhou Kanger’s commercial building within the Ganzhou Economic and Technology Development Zone — close to an expressway and surrounded by ongoing developments — was strategic.

On the remaining proceeds to be raised, Kanger said it plans to spend RM13.5 million on expanding the dealership of its bamboo flooring products, RM30 million to acquire land for bamboo plantation, and RM27.4 million for working capital purposes.

However, given that bamboo plantation could require a gestation period and is deemed a long-term venture, wouldn’t it be better off making a rights issue, alongside a smaller RCMTN issue, that would also allow the company’s shareholders a chance to participate in the growth of the company?

This article first appeared in The Edge Financial Daily, on January 12, 2015.