"SPLAT!" That was the sound of a swarm of shorts, who've been bugging Yongye International (Nasdaq: YONG ) for the past few months, slamming against the windshield of an onrushing Mack Truck.
For weeks, investors in the little Chinese fertilizer maker have gnashed teeth, torn hair, and thrown towels, as a series of "reports" by the likes of Richard X Roe, Ian Bezek, and Absaroka Capital devastated the market value of their company. But this morning, it's the shorts doing the wailing and lamenting. Why? Because in answer to investors' insistent demands that management do something about the stock price, management … did something.
Actually, three somethings:
Step 1: Put your money Wu your mouth is.
First, CEO Zishen Wu announced his intent to set up a 10b5-1 plan to spend $3 million on shares of Yongye on the open market. Yongye's been hinting since April that it had something in the works to support its assertion that the stock was undervalued. Some Fools argued we would see a share buyback. Others argued that if Yongye wants to close the gap with bigger international fertilizer makers like Potash (NYSE: POT ) and Mosaic (NYSE: MOS ) , it must deploy all the cash it has to expand production, and will have to find some other way to "fix" the stock price. Now we see the alternative -- Wu using his personal cash stash to demonstrate confidence in his business.
Step 2: Bring a high roller to the table.
Second, Wu managed to secure a big vote of confidence from an international investor, in the form of Morgan Stanley's (NYSE: MS ) Asian private equity unit. MS is matching Wu's bet -- then doing him 15 times better, taking a $50 million stake in the company. Today's leap in share price suggests a 20% stake in the company -- but if priced at Friday's close ($3.75), MS could own as much as 27% of Yongye.
And it gets better. MS' investment comes in the form of preferred shares, convertible to common at the strike price of … (better sit down for this) … $8.80. That's about 66% more than what the shares fetch today. Also worth noting: when MS gets paid dividends for its investment, these dividends will not be in the form of cash … but in the form of additional preferred shares. Let me say that again: MS is so eager to own Yongye that it's passing up an immediate payback for the prospect of owning even more shares.
Step 3: Hire a watchdog.
Perhaps the best news of all came almost as an afterthought: In defense of its investment, MS is placing the managing director of Morgan Stanley Private Equity Asia on Yongye's board of directors. I'd argue this is the most significant news of the day.
Why? Look at it this way: Anybody can invest money in Yongye. (Why, I've bought a few shares myself.) It doesn't seem to help the stock price much, though. Because no matter how cheap Yongye's financials appear, there's still that nagging worry: What if the numbers aren't real? What if Yongye is lying?
This is why putting a major investor on the board is so crucial. In recent weeks, investors have begun worrying about the integrity of Yongye's managers. Alerted by Absaroka to allegations that the "Big Four" auditors missed frauds at China MediaExpress, China Agritech, Wonder Auto (Nasdaq: WATG ) , and China Integrated Energy (Nasdaq: CBEH ) , investors questioned whether KPMG was competent enough to ensure their company is honest. But now they've got a watchdog on the board. At the risk of mixing a metaphor, you know that with $50 million of its own money on the line, Morgan Stanley will be watching this company like a hawk.
Does this dog (hawk?) hunt?
As you can probably tell, I'm pretty pleased with Yongye's triple-pronged response to the short attack. They've done a lot right -- but don't expect everyone to be convinced. To quality-check my read on the situation, I rang up Absaroka Capital this morning for the "short view" of today's news. Here's how it reads, in brief:
- First, Morgan Stanley is putting money into the company, but in so doing, it dilutes the ownership of existing shareholders.
- Second, by taking a "preferred" stake in Yongye, MS protects itself if the common stock declines in value. If the stock price falls, MS' stake in Yongye grows.
- Third, and most importantly, Absaroka argues that MS' putting a director on the board isn't necessarily good news for common stock holders. Says Absaroka, MS' man will protect MS' interests only. These interests may not align with those of common shareholders like you and me.
Make no mistake -- while Absaroka's arguments have a distinct "grasping at straws" feel, there's a grain of truth to each. Morgan Stanley isn't in business to make money for other people, but for itself. It is creating a potential for stock dilution (albeit, only after Yongye hits $8.80). It is negotiating to limit its downside risk. And there may be other risks to the transaction that I haven't yet uncovered.
My advice: If you already own, or plan to buy shares of Yongye, but you haven't yet signed up for Motley Fool Global Gains, now would an excellent time to take a free trial. As we speak, our dedicated team of analysts is poring over the details of Yongye's 8-K filing. If you want clear, unbiased advice on what this deal means to investors, Global Gains is the place to get it. Click here now.