Telestone Technologies (TSTC) is another Chinese reverse merger company that took a hit to its stock price this last week. Whereas accounting issues surrounded companies like Rino International (RINO) and China Education Alliance (CEU); Telestone Tech’s drop was due to a secondary stock offering at $12 per share. The $12 price was well below the $14.96 mark put in by the stock after a recently strong quarterly earnings report. While it may not appear so, Telestone Tech’s secondary offering does have to do with its accounting.
Most of Telestone’s revenue and subsequently cash flow is tied up in their large accounts receivables and to get the cash necessary to fund its operations Telestone Tech needed to access the capital markets via a secondary offering.
Currently, Telestone Technologies (TSTC) has $136.014 million in receivables on its balance sheet, which is more than its trailing twelve-month revenue of $103.814 million. Such high receivable levels indicate a company that can sell but can’t collect on payments or is too aggressive in recording revenue.
The bulk of Telestone’s revenue, over 95%, and receivables come from its three biggest customers: China Mobile (CHL), China Telecom (CHA), and China Unicom (CHU).The accounts payable and the duration on each balance sheet for the three companies listed above does not match the duration on Telestone’s accounts receivable. Telestone’s receivables have a longer time frame for receipt of payment than how quickly the three major China Telecom companies are paying their accounts payable. For more on the accounts payable and accounts receivable disconnect I highly recommend reading the article “Chinese Company has Growing Receivables Issues” by Sharesleuth. As always, double-check the numbers for yourself.
Telestone Tech’s large receivables balance and inability to collect on them is affecting their cash flow or to put it another way, it is not producing any cash flow. Below is a copy of Telestone Technologies’ (TSTC) latest cash flow statement from their Q3 10Q.
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For the nine months ending in 2010 and 2009 Telestone Technologies (TSTC) produced negative cash from operations with the bulk of the cash drain coming from accounts receivable. To help offset the cash drain from operations Telestone Tech has relied on short-term bank loans to funds its operations and to pay-off previous bank loans.
With revenue not being converted into cash, Telestone Technologies cannot fund its operations let alone any future growth. Telestone Tech needs to access the capital market by either issuing debt or selling stock. This time Telestone Tech decided to sell stock, diluting shareholders and EPS.
While some will tout the offering as a good thing, I, on the other hand, am more inclined to view this as a caution sign. Telestone Tech’s lack of cash flow is affecting their business. They are unable to fund their operations and growth through their own cash flow. The capital markets may be receptive now but how long will it remain open to a business that is cash flow negative?
An interesting side note, the main underwriter of the secondary offering is Roth Capital, a major player in the underwriting of Chinese reverse mergers.
AT THE END OF THE reverse-merger supply chain are the U.S. bankers, which include Roth Capital, Rodman & Renshaw and William Blair, among others.
The pre-eminent banker for China reverse mergers is Roth, the Newport Beach, Calif., firm whose promotional materials say that it pioneered the practice of PIPE financing and has helped raise more than $2.8 billion for 67 U.S.-listed Chinese companies. Roth works closely with hedge funds like Kitt’s Pinnacle. Indeed, Kitt’s son is an investment banker in Roth’s Shanghai office.
…
Of the 28 Roth client companies with at least three years of trading post-merger, the median among them underperformed the Halter Index by one third over a three-year period.
You can read more about this in the Barron’s article “Beware this Chinese Export” by Bill Alpert & Leslie P. Norton.
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