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The Convertible Note broken down, page-12

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wombat777

11,249 Posts.

29638

05/10/17

23:29

Post #: 27698412
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Originally posted by ozemania ↑

General Convertible Note basics

A Convertible Note (CN) is a fancy way of securing finance. Essentially you borrow a sum of money, and repay the loan by issuing shares. The terms of the arrangement typically involve layers of discounts and other incentives in the fine print which tend to make the deal very lucrative for the lender (or Note Holder).

CN's are often a 'last resort' option for the borrower, usually taken when other options are not feasible (eg: bank loans, CR's etc). In most cases, the lender is lending money to a high risk borrower who has limited options, so they are able to ensure the terms of the deal cover them nicely for taking on that risk.

When the lender hands you the money, you give them a 'Convertible Note' which they can then convert into shares as per the terms of the agreement. In most cases, they will then sell the shares on market and recover their profit.

In some cases this can prove to be a crippling blow for a company that is already struggling. Relentless selling after each conversion pushing the price further and further down, and every time converting at lower and lower prices they receive more and more shares for the same money resulting ever increasing dilution which gets sold on market and the vicious cycle continues until the loan is repaid.. A SP can take a long time to recover from such an ordeal!

The devil is in the detail though, and properly understanding the terms of each CN you come across can save you a lot of headache (and money) in the long run.

Mustang's Convertible Note

Background

In the lead up to the auction, Mustang needed to secure funds to continue expanding operations and maximise the inventory to ensure the auction later this month is one that puts Mustang on the map. At the time sentiment was generally low, the SP at the 4c level and plenty of holders were stuck with entries at higher prices. A CR to retail investors was unlikely to be successful and a raising to SI's had proved to be a 'dump and run' earlier in the year.

Personally I was concerned when a CN deal with Arena was announced as the finance option. There were a few key redeeming factors with this deal though:

While MUS may not have had too many better options, they were not 'desperate' in the sense of the typical CN customer (or 'victim'). Holding millions of dollars of ruby inventory, and being only a few months away from their first auction, they were in a much stronger position than most CN customers.

We were told Arena had and 'investment' perspective, and sent people to review the inventory we already held at the time.

Apparently Arena have a desire to win more CN business in Australia, so hopefully they would be less likely to destroy the SP with ruthless selling

The Deal Structure

The total deal was to provide up to $8.5mil in cash. The first 'catch' to be aware of is that the loan itself totals $10mil but Arena receive a 15% discount, as a kind of 'interest' up front. Basically we receive $8.5mil in cash but we have to repay the full $10mil.

The total loan is split into 4 'tranches' which we can 'draw down' separately as required. Tranche 1 was drawn down upfront, but Tranches 2,3&4 were not able to be drawn down until shareholder approval was received at the EGM last month. (All 4 tranches received shareholder approval, though to date tranche 4 has not been drawn down.

There are two separate sets of options which are included with the deal. (These are unlisted options, they are not MUSOA). "A" options were defined as a fixed number of options with a fixed exercise price, while the number and price for the "B" options is calculated at the time of drawdown (40% of the value of the note issued-at the previous close price, exercisable at 130% of the previous close price). While this ends up being even more 'profit' for Arena, it also serves to protect our own interests as the fine print does set an exercise price which provides an incentive for Arena to avoid crashing the SP. (Assuming these options are all exercised in the future, this will mean additional capital for Mustang)

As each tranche is drawn down, we receive the cash (minus the 15% discount) and we issue a Convertible Note for the full value to Arena, and any options which are applicable to that tranche. Every time Arena convert part of a note into shares, the conversion price used is the lowest VWAP of the previous 20 trading days.

Tranche 1 - Issued

Face value of note issued: $2mil

Cash received (Face value - 15%): $1.7mil

"A" options: 38.7mil options exercisable for 6.2c

Tranche 2 - Issued

Face value of note issued: $2mil

Cash received (Face value - 15%): $1.7mil

Tranche 3 - Issued

Face value of note issued: $3mil

Cash received (Face value - 15%): $2.55mil

"B" options: 13.33mil options exercisable for 11.7c

Tranche 4 - Not Issued (may not be required)

Face value of note issued: $3mil

Cash to received (Face value - 15%): $2.55mil

"B" options: calculated at time of drawdown

If all goes well, we may not need to drawdown Tranche 4. Cancellation of unused tranches comes at a cost of 25% of the 'face value' of the unused tranches. If we do not use tranche 4, we will have to pay the cancelation fee of $750K in either cash or shares.

The Verdict

Borrowing money is always going to come at a price. This deal might be very profitable for Arena, but it is much fairer than some I have seen. While it was hoped Arena would hold into the auction, that was always a bit of a long shot, and we have seen them selling some/all of what they have converted to date. The great news is, this has not ruined the SP, in fact far from it.. It took us a few days to click that they were even selling. In the short term it may be frustrating some days to see the SP have to wade through a lot of supply, but we are 60% of the way through the conversions and the SP is double what it was when the CN was announced.. That’s actually an impressive result!

In hindsight this may even end up proving to be a superior finance option compared to a CR to SI's. A SI (or even retail) CR would have been done at a discount to the prevailing SP (low 4's) resulting in significant dilution. As the SP goes up, Arena's conversion price goes up too. Today we issued their shares at 8c, and the remainder will probably be issued at even higher prices resulting is much less dilution than a CR at 4c or below.

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A fabulous rational explanation of why the CN facility was logical for Mustang. Too many people here seem to be getting worked up by the selling activity of arena. That storm will pass. Just give it time.
MUS Price at posting: 9.4¢ Sentiment: Buy Disclosure: Held
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