Investors punished NIO Inc. (NYSE: NIO) Monday after it announced it was raising $1 billion to refinance existing debt and shore up operating capital.
NIO traded down 12 cents, or 1.15% on the day Monday and dropped a further 6% after hours ending at $9.69. Tuesday morning the stock was faring no better. Those moves reverse all of 2023's gains in the Chinese luxury EV maker and put the stock at half its price this time one year ago.
Beyond the announcement of the debt issuance in two tranches, there were scant details of the other particulars, so the question is: why is the company issuing this extra debt and is the stock market warranted in selling NIO right now?
Returning To Double-Digit Margins?
The $1 billion convertible note that NIO announced it is issuing in two long-dated tranches was hinted at on the company's second quarter earnings conference call at the end of August.
A closer look at that discussion reveals how talk about refinancing was closely tied with a discussion about improvements in operating cashflows and proposed increases in product margins. As for market incumbents Tesla Inc (NASDAQ: TSLA) and BYD Co. Ltd. (OTC: BYDDF), NIO has experienced downward pressure on profit margins recently.
On the August call Citi's Jeff Chung asked the company's management if a combination of refinancing and increased sales of inventory would result in increased cash-flow for the company.
"First question is our refinancing plan going forward. And the second question is our cash flow projection into the third quarter and fourth quarter. So, why I am asking this is because we saw the first quarter, the net cash outflow was RMB10.6 billion [$1.5 billion], but improved to a cash outflow of RMB5.9 billion in the second quarter. And within the second quarter, we also saw the inventory Q-on-Q delta of around RMB2 billion, while the account payable -- account receivable remained stable," Chung said.
"So that said, if the third quarter inventory came down plus the operating leverage with a volume hike, whether we should see the cash outflow should be significantly narrowing further?" asked Chung.
Chung followed up with a direct question as to whether the company could consequently return to double digit percentage point operating margins in the near future.
"When can we return to a 10% or double-digit level as well as the third quarter, fourth quarter SG&A as a percentage of the revenue guidance?" he asked.
In answer to those questions, NIO's Senior VP of Finance Stanley Qu said that "regarding the ... refinancing plan, we will disclose our plan accordingly if there is any capital market-related updates," and indicated that the company had already secured $750 million in off-balance-sheet asset-backed debt financing for Q3.
Qu then went on to say that "our target is to achieve the double-digit gross profit margin and Q4 is 15%. And for SG&A guidance, I think the absolute value will grow along with our delivery volume and sales growth, but the percentage of total revenue will decrease."
SG&A stands for Selling general and administrative expenses and is a term used to describe the percentage of a company's income that is spent on achieving sales.
In other words, the $1 billion convertible debt package that NIO announced in mid-September is part of the company's stated strategy to increase net income and shore profit margins back up by an additional 50% plus before year-end.
Refinancing For Sales Growth
Q2 sales were disappointing, representing a revenue decline of 14.8% year-on-year. During the second quarter, NIO made sales of 23,520 EVs.
On the second quarter earnings call, NIO's management articulated how they anticipate a return to growth in the third and fourth quarters. Specifically, they said they will bolster sales to up to 20,000 EVs per month while increasing its capacity to sell up to 30,000 EVs per month, it said on the call. Sales guidance for the entire third quarter was for 50,000-55,000 EVs.
Part of the reason for these increases was due to NIO's hiring of dealers from competing luxury vehicle makers such as BMW, Mercedes Benz Group AG (OTC: MBGAF) and Audi during the first half of 2023, said the company's Chairman William Li. Those dealers have existing sales "networks" in place all over China, he said, which would help the company achieve the anticipated higher sales volumes from September onwards.
Monday's proposed $1 billion loan issuance doesn't come out of the blue, then, but rather it appears to be part of an effort by NIO's management to fortify its new sales infrastructure and refinance existing debt covenants on a longer-term horizon in order to boost margins back to growth.