Thursday, October 16, 2014

Nu Skin's capital structure makeover

Yesterday Nu Skin announced that they had a new loan to replace the old loan. This was essential because the old loan was about to breach its covenants and an event of default would not be a good thing for Nu Skin shareholders or their management.

So prima-facie the new loan was good news.

The stock however dropped almost 10 percent (and was briefly down more).

The loan terms are onerous and complicated and there are some bizarre disclosures in the attachments to the loan document.

The first bizarre thing about the loan is the disclosure as to how much is drawn immediately. Here it is:
The Credit Agreement provides for a $127,500,000 term loan facility, a ¥6,593,406,594 term loan facility and a $187,500,000 revolving credit facility, each with a term of five years.  The term loan facilities were drawn in full on October 10, 2014, and $112,500,000 of the revolving credit facility was also drawn on October 10, 2014.

They immediately drew $127.5 million dollars of term loan, ¥6.59 billion and a further $112.5 million on the revolver.  That is $309.4 million USD.

This is way more debt than they had at the end of the previous quarter. Here is the balance sheet from the last 10-Q.

NU SKIN ENTERPRISES, INC.
Consolidated Balance Sheets (Unaudited)
(U.S. dollars in thousands)

June 30, 2014
December 31, 2013
ASSETS
Current assets:
Cash and cash equivalents
$
219,501
$
525,153
Current investments
14,227
21,974
Accounts receivable
41,712
68,652
Inventories, net
389,650
339,669
Prepaid expenses and other
180,957
162,886
846,047
1,118,334
Property and equipment, net
429,332
396,042
Goodwill
112,446
112,446
Other intangible assets, net
79,258
83,168
Other assets
136,531
111,072
Total assets
$
1,603,614
$
1,821,062
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable
$
35,836
$
82,684
Accrued expenses
383,012
626,284
Current portion of debt
99,828
67,824
518,676
776,792
Long-term debt
111,621
113,852
Other liabilities
81,559
71,799
Total liabilities
711,856
962,443
Commitments and contingencies (Note 9)
Stockholders' equity:
Class A common stock – 500 million shares authorized, $.001 par value, 90.6 million  shares issued
91
91
Additional paid-in capital
410,440
397,383
Treasury stock, at cost – 31.3 million and 31.6 million shares, respectively
(844,615)
(826,904)
Accumulated other comprehensive loss
(42,284)
(46,228)
Retained earnings
1,368,126
1,334,277
891,758
858,619
Total liabilities and stockholders' equity
$
1,603,614
$
1,821,062



In the last quarter they had $219.5 million in cash and another $14.2 million in current investments. Against this they had $99.8 million in current debt and another $111.6 million in long term debt.

Total debt was $211.4 and net debt was zero.

Despite this they drew $302 million at moderately high interest rates.

But it is worse than that... the old debt numbers included some debt in Japan and Korea. Some of that is being left in place as per the loan covenant. In quantity:

Indebtedness
Debt
Borrower
Lender
Currency
Amount
Nu Skin Japan Co., Ltd.
Mizuho Bank
Japan Yen
  1,000,000,000
NSE Korea Ltd.
Shinhan Bank
US Dollar
      20,000,000
That is another $30.5 million of debt.

So now - suddenly - the company has $339.9 million in debt - way more than the $211.4 they used to have. The rise is inexplicable because their last accounts showed net cash.

The company has rapidly - and at what was to them a penal interest rate - borrowed a huge amount of money they didn't seem to need a quarter ago and when they had net cash.

And it can't be for an acquisition because the loan covenants prohibit that.

If you have any good idea what the sink-hole that absorbed this much cash is let me know. However if this cash were needed during the last quarter the whole thing is diabolical. Bluntly if it were needed the company is presumably and somehow massively loss making. I simply do not know how. I am a bear on this stock but that is worse than I would have dared to guess.

Two hypotheses:

(a) the company is secretly massively cash consumptive and we do not know (in which case short) or
(b) the company is drawing a huge amount of debt for which it has no obvious use and which it is prohibited to use for an acquisition [that might include buy-backs as discussed below].

But remember this: Nu Skin drew the revolvers. And it drew them hard. Drawing the revolvers has precedent. It is seldom something that makes credit providers happy. There may be a good explanation (truly). The market has not been provided with it.

Dividend restrictions

The story from yesterday was that the debt covenants involved dividend restrictions. This came from slightly ambiguous wording in the press release.

The press release states:

The Credit Agreement requires the Company to maintain a consolidated leverage ratio not exceeding 2.25 to 1.00 and a consolidated interest coverage ratio of no less than 3.00 to 1.00. The Credit Agreement also includes other covenants, including covenants that, subject to certain exceptions, restrict the ability of the Company and its subsidiaries (i) to create, incur, assume or permit to exist any liens, (ii) to incur additional indebtedness, (iii) to make investments and acquisitions, (iv) to enter into mergers, consolidations or similar transactions, (v) to make certain dispositions of assets, (vi) to make dividends, distributions and prepayments of certain indebtedness, (vii) to change the nature of the Company's business, (viii) to enter into certain transactions with affiliates, (ix) to enter into certain burdensome agreements, (x) to make certain amendments to certain agreements and organizational documents and (xi) to make certain accounting changes.

The highlighted section makes it clear that the company may not pay dividends subject to certain exceptions, which means provided they meet these exceptions they may pay dividends.

Indeed the loan documents allow the following use of proceeds:
Section 6.11.   Use of Proceeds.  Use the proceeds of the Credit Extensions (i) for working capital, capital expenditures, and other lawful corporate purposes, including (without limitation) investments, acquisitions, stock repurchases and dividends not prohibited by the Loan Documents and (ii) to consummate the Refinancing
So they may buy back stock and pay dividends provided they meet a fairly burdensome list of possible events of default.

An event of default is disastrous under the new documents because it involves immediate acceleration. You do not want immediate acceleration ever.

That said - and it is a clear positive for Nu Skin - the default based on trailing operating cash flow has been removed. As indicated in past blog posts Nu Skin is peculiar - it generates substantial earnings and huge negative operating cash flows. Nu Skin breaches its cash flow based covenants - and these have been removed.

The only explanation (that is not truly nasty) that I have for drawing the revolvers is a deep desire to use the cash (whilst it is available) to buy back stock. However given the nasty taste that drawing revolvers gives to credit providers this is an aggressive thing to do. [But it is possible. I am not dismissing it.]

Receiveables from offshore entities

The disclosure that caused most amazement amongst Nu Skin watchers was a disclosure at the back of the credit agreement about how much money their offshore subsidiaries own them. This is a list:


Intercompany Receivables
Nu Skin Enterprises United States, Inc.
Nu Skin Canada, Inc.
           146,199
Nu Skin Enterprises, Inc.
Nu Skin Enterprises New Zealand, Inc.
           175,787
Nu Skin Enterprises Hong Kong, LLC
         7,675,959
Nu Skin Japan Co., Ltd.
           620,350
NSE Korea Ltd.
         5,824,767
Nu Skin Enterprises Singapore, Pte. Ltd.
           230,681
Nu Skin Israel, Inc.
           165,000
Nu Skin Taiwan, LLC
               1,363
Jixi Nu Skin Vitameal Co., Ltd.
           430,500
Pharmanex (Huzhou) Health Products Co., Ltd.
         5,432,400
NSE Asia Products, Pte. Ltd.
         8,035,931
Nu Skin International, Inc.
Nu Skin International Management Group, Inc.
       44,301,819
Nu Skin Mexico, S.A. de C.V
         5,672,930
Nu Skin Guatemala, S.A.
         3,488,701
Nu Skin El Salvador S. A. de C.V.
           104,543
Nu Skin Honduras, S.A.
           131,853
Nu Skin Costa Rica
           377,841
Nu Skin Venezuela, C.A.
         6,421,303
Nu Skin Colombia, Inc.
           128,188
Nu Skin Argentina, Inc.
           759,321
Nu Skin Enterprises New Zealand, Inc.
           436,748
Nu Skin Enterprises (Thailand) Limited
           627,077
Nu Skin Enterprises Philippines, LLC
           159,190
Nu Skin (Malaysia) Sdn. Bhd.
         1,321,469
Nu Skin Pharmanex (B) Sdn. Bhd.
             30,366
Nu Skin Israel, Inc.
         2,725,815
PT Nu Skin Distribution Indonesia
         6,427,129
PT Nu Selaras Indonesia
           924,291
Nu Skin Enterprises Viet Nam Limited Liability Company
           520,580
Nu Skin Enterprises RS, Ltd.
           283,453
Nu Skin Enterprises South Africa (Proprietary) Limited
         1,163,340
Nu Skin (China) Daily-Use & Health Products Co., Ltd.
         2,207,202
NSE Asia Products, Pte. Ltd.
       53,477,483
NSE Products, Inc.
Nu Skin Netherlands, B.V.
             86,794
Nu Skin Germany, GmbH
           101,827
Nu Skin France, SARL
             27,185
Nu Skin Italy, Srl
           177,788
Nu Skin Enterprise SRL
       12,164,682
Nu Skin Eastern Europe Ltd.
             74,974
Nu Skin Enterprises Poland Sp. Z.o.o.
               8,814
Nu Skin Turkey Cilt Bakimi Ve Besleyici Uranleri Ticarel Limited Sirketi
           597,032
Nu Skin Islandi ehf.
           849,996
Nu Skin Czech Republic, S.r.o.
           217,724
Nu Skin Slovakia
             98,394
Nu Skin Israel, Inc.
           599,956
Nu Skin Enterprises South Africa (Proprietary) Limited
             71,231
Nu Skin International Management Group, Inc.
         2,272,938
Nu Skin Mexico, S.A. de C.V
           969,970
Nu Skin Guatemala, S.A.
           960,774
Nu Skin El Salvador S. A. de C.V.
                 265
Nu Skin Costa Rica
         2,194,916
Nu Skin Canada, Inc.
         4,446,848
Nu Skin Venezuela, C.A.
       23,896,815
Nu Skin Colombia, Inc.
         7,811,575
Nu Skin Argentina, Inc.
           414,677
Nu Skin Enterprises New Zealand, Inc.
         4,010,293
Nu Skin Enterprises Australia, Inc.
         1,316,560
NSE Korea Ltd.
       18,651,855
Nu Skin Enterprises Philippines, LLC
           319,735


Nu Skin Enterprises Viet Nam Limited Liability Company
           224,177
Nu Skin Enterprises Ukraine, LLC
           377,261
Nu Skin Enterprises RS, Ltd.
         4,998,951
Nu Skin (China) Daily-Use & Health Products Co., Ltd.
     133,465,866
NSE Asia Products, Pte. Ltd.
       23,849,660
Total
     405,689,111


The total is almost $406 million. This is large - about half the stockholders equity and the bulk of tangible stockholders equity.

If the foreign subsidiaries have the cash (and it is presumed they do) then they should - subject to payment restrictions - just pay it.

There is $24 million owed to head office by Venezuela. Good luck collecting that. But outside that the amounts should be collectable if the foreign subsidiaries are good for it. There is $133 million owed by China. This might be difficult to collect based on the amount of activity we have seen in China. However if they own the very large office complex we saw (see the post) they could collect some of it by selling up.

But the more pertinent question is why haven't all those subsidiaries been able to pay the money they owe to head office? Inquiring minds are asking. Especially as the company drew the revolvers.

--

Venezuela

The Venezuela amounts are irrelevant in Nu Skin (and Herbalife for that matter) but there is a contradiction between what the table above shows and the management says. According to recent presentation at the Wedbush conference they only had $10-15 million of sales in Venezuela.

It is hard to see how they are owed $24 million by a subsidiary that only has half that in sales. I can't square it. A clearer explanation of Venezuela exposure would be nice.






John

6 comments:

Anonymous said...

Leaving money offshore is not tax related?

Anonymous said...

Sir,

I am a big fan of your blog, and enjoy your unique take on individual stocks. I am a high yield analyst in the States, and very interested in studying changes in capital structures of heavily indebted issues of companies not under my coverage hoping this will shed light on actions taken my management teams that I follow.

Thus, I took great interest in your Nu Skin analysis, given the increased debt load is perplexing given the state of the company. I think the interesting question is not why they are borrowing more than they reportedly need, but why the banks are lending that amount? Also, how do those banks ensure protection? Here are just some quick overall thoughts:

· The new loan is essentially done to take out Pru. It is apparent the private lending side wants no more exposure to Nu Skin following the restrictive payments covenant violation. They entered into an amendment to avoid acceleration of the debt and allowed the dividends. But clearly this amendment was a short term arrangement until Pru could be taken out (see note 15 in last 10Q). In essence, the loan DID breach its covenants, and required a waiver. More important, Pru wanted out.
· I think your pro forma debt numbers are slightly off. As you stated, there is $309MM of new debt from the term loans. In note 15 of the 10-Q, it states that the company borrowed $50mm through the Japanese and Korean facility. So there should be $359mm outstanding.
· It looks like the company borrowed the $50mm from the two facilities to repay a $35MM payment on its 2010 term loan (listed at end of 2q).
· So, according to my math, the company raised $359mm of new debt (309+50) and paid off $211.5mm in debt and a $7.5mm termination fee to Pru for net $140mm net proceeds.
· From a birds-eye view, it seems strange Pru wants out. The overall leverage is not so bad $359mm debt/607mm ltm ebitda implies a 0.6x leverage ratio. For someone who regularly deals with 7x levered entities, I would think that’s a solid credit. So, your instincts that not all is right is the correct one.
· The collateral for the loan is interesting. It only includes domestic subs and 65% of the equity in foreign subsidiaries. Given that most of the sales are derived in foreign companies, it doesn’t seem like a lot. The company does not need to report condensed financials, so it’s not clear how much of the business sits outside the guarantee group. But we do know that approximately $206mm of $219mm in cash sits in foreign subs. Except for Venezuela, the company claims that most of this cash is readily convertible to cash and can be repatriated. We also know that China is a partial issue also. So could it be that the ability to repatriate cash to fund US ops, including dividends and share repurchases are complicated by the timing and potential leakage of taxes from repatriation. I think this has something to do with it.
· Attached is a quick analysis just looking at the components of FCF. It may be a little off but close. The Funds from operations foot (including working capital). What is interesting is that the entity has gone FCF negative mostly due to working capital changes. Something tells me the key is here. The payments out in 1H14 are well in excess of the buildup in all of 2013. Not sure why this is the case. But dividend restriction looks ok, so my sense is that the excess cash will be used for either working capital purposes and/or potential acquisitions.


In the end, I try to focus on cash flow and the movement of cash among subsidiaries, particularly where there can be restrictions. Large swings in working capital, while not an issue outright, needs to be understood. Further, I am always concerned about cash tied up in foreign subs that are needed to fund domestic cash needs.

Best of luck with your work.
JK

Anonymous said...

Sir,

I am a big fan of your blog, and enjoy your unique take on individual stocks. I am a high yield analyst in the States, and very interested in studying changes in capital structures of heavily indebted issues of companies not under my coverage hoping this will shed light on actions taken my management teams that I follow.

Thus, I took great interest in your Nu Skin analysis, given the increased debt load is perplexing given the state of the company. I think the interesting question is not why they are borrowing more than they reportedly need, but why the banks are lending that amount? Also, how do those banks ensure protection? Here are just some quick overall thoughts:

· The new loan is essentially done to take out Pru. It is apparent the private lending side wants no more exposure to Nu Skin following the restrictive payments covenant violation. They entered into an amendment to avoid acceleration of the debt and allowed the dividends. But clearly this amendment was a short term arrangement until Pru could be taken out (see note 15 in last 10Q). In essence, the loan DID breach its covenants, and required a waiver. More important, Pru wanted out.
· I think your pro forma debt numbers are slightly off. As you stated, there is $309MM of new debt from the term loans. In note 15 of the 10-Q, it states that the company borrowed $50mm through the Japanese and Korean facility. So there should be $359mm outstanding.
· It looks like the company borrowed the $50mm from the two facilities to repay a $35MM payment on its 2010 term loan (listed at end of 2q).
· So, according to my math, the company raised $359mm of new debt (309+50) and paid off $211.5mm in debt and a $7.5mm termination fee to Pru for net $140mm net proceeds.
· From a birds-eye view, it seems strange Pru wants out. The overall leverage is not so bad $359mm debt/607mm ltm ebitda implies a 0.6x leverage ratio. For someone who regularly deals with 7x levered entities, I would think that’s a solid credit. So, your instincts that not all is right is the correct one.
· The collateral for the loan is interesting. It only includes domestic subs and 65% of the equity in foreign subsidiaries. Given that most of the sales are derived in foreign companies, it doesn’t seem like a lot. The company does not need to report condensed financials, so it’s not clear how much of the business sits outside the guarantee group. But we do know that approximately $206mm of $219mm in cash sits in foreign subs. Except for Venezuela, the company claims that most of this cash is readily convertible to cash and can be repatriated. We also know that China is a partial issue also. So could it be that the ability to repatriate cash to fund US ops, including dividends and share repurchases are complicated by the timing and potential leakage of taxes from repatriation. I think this has something to do with it.
· Attached is a quick analysis just looking at the components of FCF. It may be a little off but close. The Funds from operations foot (including working capital). What is interesting is that the entity has gone FCF negative mostly due to working capital changes. Something tells me the key is here. The payments out in 1H14 are well in excess of the buildup in all of 2013. Not sure why this is the case. But dividend restriction looks ok, so my sense is that the excess cash will be used for either working capital purposes and/or potential acquisitions.


In the end, I try to focus on cash flow and the movement of cash among subsidiaries, particularly where there can be restrictions. Large swings in working capital, while not an issue outright, needs to be understood. Further, I am always concerned about cash tied up in foreign subs that are needed to fund domestic cash needs.

Best of luck with your work.
JK

Anonymous said...

John, perhaps all the NUS cash is held outside of US and cannot be brought onshore without a tax hit (US tax code hits repatriated cash)....the US operation may need cash and hence the heavy borrowing

Jeremy Raper said...

John - thanks for writing up your thoughts on the NUS refi; I also found it perplexing. Great find on the intercompany receivables. My hypothesis (which you alluded to and perhaps considered without explicitly stating): the net increase in debt - about $120mm - is most all the amount the China sub owes head office ($133mm); company management cannot access that cash and so needs to replenish however they can, despite the poor optics on the immediate revolver drawdown.

The question, of course, is why can't they access the cash. This could be because the earnings (and cash generated) in China never existed, as you previously conjectured; or it could have been embezzled, etc. Either way I am struggling, like you, with how much cash this business supposedly consumed in the last couple of quarters...

Additional yellow flag (I guess not quite red but still concerning): long-time lenders JPM and Prudential were taken out in this refi (and aren't involved in the new lending facility that I can see)

Anonymous said...

Why not go long Nu Skin's travel agent as an offset to your short?

First, we had a significant amount of accrued expenses at the end of December 2013, following record sales and a record number of sales representatives who
qualified for incentive trips. The selling expenses and incentive trip expenses, although accrued in 2013, were paid in 2014.

This to your question where the money is going! As an aside, these must be quite the trips if one works out the cost (233m in H1 for how many representatives!?).

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The content contained in this blog represents the opinions of Mr. Hempton. Mr. Hempton may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Hempton's recommendations. The commentary in this blog in no way constitutes a solicitation of business or investment advice. In fact, it should not be relied upon in making investment decisions, ever. It is intended solely for the entertainment of the reader, and the author.  In particular this blog is not directed for investment purposes at US Persons.