Business Context and Reporting Period
Company: Kaixin Auto Holdings (formerly CM Seven Star Acquisition Corporation)
Filing Type: Form 8-K (Current Report)
Date of Report: April 30, 2019
Event: Completion of a Business Combination (Reverse Merger) with Kaixin Auto Group ("Kaixin"). Kaixin is the largest premium used auto dealership group in China by number of cities and locations, and the second largest by revenue (2017). As of December 31, 2018, Kaixin operated 14 dealerships across 12 provinces in China, focusing on premium brands (Audi, BMW, Mercedes-Benz, etc.) and offering financing and value-added services.
Key Financial Metrics
Note: Financial data below reflects Kaixin's historical results for the years ended December 31, 2016, 2017, and 2018, which are now the historical statements of the combined company (KAH) due to the reverse acquisition accounting treatment.
Income Statement Highlights (in thousands USD)
| Item | 2016 | 2017 | 2018 |
|---|---|---|---|
| Total Net Revenues | $20,846 | $116,586 | $431,404 |
| Gross Profit | $6,775 | $3,528 | $17,433 |
| Loss from Operations | $(13,965) | $(26,123) | $(34,075) |
| Net Loss | $(24,054) | $(28,695) | $(89,532) |
| Adjusted EBITDA (Non-GAAP) | $(18,612) | $(19,347) | $(23,884) |
Balance Sheet Highlights (in thousands USD)
| Item | 2016 | 2017 | 2018 |
|---|---|---|---|
| Cash and Cash Equivalents | $34,697 | $17,061 | $7,950 |
| Restricted Cash | $288 | $47,253 | $5,818 |
| Total Assets | $349,506 | $410,095 | $191,232 |
| Total Liabilities | $371,153 | $408,664 | $260,952 |
| Shareholders' Deficit | $(21,647) | $(33,222) | $(102,126) |
Cash Flow Highlights (in thousands USD)
| Item | 2016 | 2017 | 2018 |
|---|---|---|---|
| Net Cash Used in Operating Activities | $(8,537) | $(73,684) | $(9,749) |
| Net Cash Provided by Investing Activities | $(172,642) | $162,411 | $98,982 |
| Net Cash Provided by (Used in) Financing Activities | $205,863 | $(59,734) | $(138,637) |
Material Changes vs. Prior Period
- Revenue Growth: Total net revenues surged 270% from $116.6 million in 2017 to $431.4 million in 2018. This was driven primarily by the expansion of the used car sales business (revenue grew from $88.2M to $420.0M) and the launch of new dealerships.
- Profitability: Despite revenue growth, the company reported a significant increase in Net Loss, rising from $28.7 million in 2017 to $89.5 million in 2018. This was largely due to a $49.5 million non-cash fair value change in contingent consideration related to dealership acquisitions and increased operating expenses ($51.5M in 2018 vs. $29.7M in 2017).
- Business Model Shift: Financing income revenue dropped significantly from $26.4 million in 2017 to $2.3 million in 2018 as the company shifted focus from third-party floor financing to direct used car sales.
- Liquidity: Cash and cash equivalents decreased from $64.4 million (including restricted cash) in 2017 to $13.8 million in 2018, reflecting heavy investment in inventory and operations.
Guidance, Outlook, Risks, and Unusual Items
Transaction Structure and Earnouts
Upon closing, KAH acquired 100% of Kaixin. Renren Inc. (the former parent) received approximately 71.7% of KAH's outstanding shares. Renren is entitled to up to 19.5 million earnout shares based on 2019 and 2020 performance targets:
- 2019 Revenue Target: RMB 5.0 billion (approx. $720M) for 1.95M shares.
- 2019 Adjusted EBITDA Target: RMB 150M - 200M for 3.9M - 7.8M shares.
- 2020 Adjusted EBITDA Target: RMB 340M - 480M for 4.875M - 9.75M shares.
- Stock Price Trigger: Earnouts may be triggered if KAH stock trades above $13.00 or $13.50 for specific periods, regardless of financial performance.
Outlook and Capital Resources
Management believes anticipated cash flows will meet working capital needs for the next 12 months. However, future growth may require additional debt or equity financing. Renren has provided a letter of financial support for 12 months. The company plans to continue expanding its dealership network and after-sales service centers.
Risks and Contingencies
- Internal Control Material Weakness: Kaixin identified a material weakness in internal controls over financial reporting as of December 31, 2018, specifically regarding the accounting of complex transactions (e.g., purchase accounting for acquisitions) due to a lack of personnel with U.S. GAAP expertise.
- Regulatory Environment: The company operates through Variable Interest Entities (VIEs) in China. There is uncertainty regarding the interpretation of PRC laws governing these structures.
- Market Risk: Significant exposure to foreign exchange risk (RMB vs. USD) and interest rate fluctuations.
- Discontinued Operations: The company discontinued its "Renren Fenqi" student financing business and transferred its Ji'nan Dealership (new car sales) to Renren in 2018.
Investor Verification Checklist
- Earnout Feasibility: Verify the likelihood of meeting the aggressive 2019 revenue (RMB 5B) and EBITDA targets required for Renren to receive additional shares.
- Internal Control Remediation: Monitor the progress of hiring qualified financial personnel and implementing controls to address the identified material weakness.
- Liquidity Position: Assess the sufficiency of the $13.8M cash balance against the company's expansion plans and potential need for further capital raises.
- Revenue Quality: Analyze the sustainability of the 270% revenue growth and the shift from financing income to auto sales margins.
- VIE Structure Risks: Review the legal opinions regarding the enforceability of the contractual arrangements with Chinese subsidiaries.