Hikvision has secured nearly $4 billion USD in debt this year ($3.1 billion here and $760 million here).
Now, Hikvision's arch rival and #2 Dahua has authorized 3/4 of a billion of its own.
In this note, we examine what Dahua has done, how it will impact their competitive positioning and what this means for the global market.
Dahua *****
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Benefits ** ***** **** ****
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China ***** ***** **** ****
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******* - **************
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Short-term debt is cheap and flexible in contrast to equity which is far more expensive. Building a company with maximal short term debt provides greater financial benefits to the smaller amount of equity held.
More expensive in what way? Do you mean the cost of preparing an equity offering vs issuing bonds?
I am not saying anything profound here, this is college corporate finance 101.
The 'cost' is not simply preparation / transaction.
The 'cost' is mostly how much the business needs to spend on the form of financing. With debt, it's a fixed percentage (relatively low) only during the time you need it. With equity, it a fraction of the profits you generate forever.
What do people mean when they say debt is a relatively cheaper form of finance than equity?
Sure, debt may be cheaper to the original stockholders, but it's not cheaper to Dahua (the company) as a going concern...
And I am more concerned with the Dahua company's well-being, not with how much the pre-issue shareholders stand to gain.
For instance, Dahua (the company), has a far better balance sheet and financial outlook if they are to raise 1 billion via equity, vs. Dahua (the company) borrowing 1 billion (which must be repaid).
It matters to the industry, because, the equity infused Dahua would be more competitive than the debt laden one.
Before you claim straw, let be clear that I'm not saying that you actually disagree with this, but it's a subtlety that some might miss otherwise.
For instance, Dahua (the company), has a far better balance sheet and financial outlook if they are to raise 1 billion via equity, vs. Dahua (the company) borrowing 1 billion (which must be repaid).
I think what you are getting at is that debt is cheaper than equity but also riskier.
And I agree, that is my other point in the post. With equity, that $760 million is yours, regardless of what happens to the economy or industry. With short term debt, that $760 million can be called and, if that happens, the downside is significant.
I think what you are getting at is that debt is cheaper than equity but also riskier.
Yes, the irony that it's the cheap money can make you broke, not the expensive money.
Get ready for the Billion Dollar BBQ!
The interest rate may be not high for Dahua to issue bonds, which means it is a good time. If they get loan from bank, the interest rate will be much higher.
Dahua has not announced this interest rate to the bond, but another company LongYuan (00916.HK) issued 270 days RMB bond for 2 billion RMB a week ago, the rate is 2.77%. quite low.
because loan rate from bank on average for big companies with high rating is about 6%.
which means, Dahua can do nothing but just loan the 5 billion RMB out for 6% to market and gets 3.23% interest in return ( assume zero cost).
So this news just means Dahua gets cheap money from bubble economy.
The interest rate for the "Ultra Short-term Loan" is determined by the credit rating of the borrower. LongYuan has a credit rating of "AAA".
What does Dahua have?
And in terms of bank loan, what types of bank loan are you referring to?
Unsecured line of credit? Asset-based lending? Secured loan? They all have different rates.
In plain English, this bond should be called the "inter bank short-term bond". It is not for the public, and can only be purchased by banks, insurance companies and institutions that are permitted to trade in the inter bank market in China.
Typically, the interest rate would look better than the rate from the bank loan. The rate is primarily based on SHIBOR and the credit rating of that company.
Dahua does not have a credit rating from a 3rd party credit rating agency before. So they will have to do it for this bond. Based on Dahua's financials, it is likely to get something above "AA". That means the interest rate for the inter bank short-term loan would be at least 100 basic points lower than the bank loan rate for the same duration. Somewhat savings for Dahua. On average, it is 200 basic points lower than the bank loan rate.
In terms of cons of pros of this type of debt financing, well obviously, it is a kind of direct debt financing in the currency market, since it often connects the buy-side players, such as the insurance companies and the pension funds with the borrower. And yes, on average, it is cheaper than the bank loan. Fast approval and flexibility of terms are other benefits.
Comparing to the cost of equity financing, many factors come into play. Essentially, we are comparing the cost of equity (calculated from the CAPM model or the dividend model) and the after-tax cost of debt (weighted average or a specific debt; it is after tax, since interest expense decreases pre-tax income).
We don't really know the cost of equity for Dahua. So, can't draw any conclusion about whether this bond is a cheaper deal then equity offering. But we do know that the board and the independent board directors approved this bond.
