Discussion on Convertible Notes with Floating Rates

 

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Private a nd Co Confidential  nfidential 

Background ACP Asia has advised several public companies as to options for raising capital which can be classified as challenging for companies with a market capitalization of less than $2 billion. KKR’s Henry Kravis summ summarized arized the g global lobal issue for S SME’ ME’s in a recent interview offering, “Smaller and midsize companies are telling us, “I don’t have the banks covering me anymore.” The banks today today are pulling p ulling away from a lot of these thes e companies, because the capital charges are are so high. hi gh. There’s not enough margin in it for them.” This leads companies back to the equity markets. Howeve Howeverr, the equity equ ity markets tend to look look less favorably on companies having trouble trouble acc accessin essing g credit and not surprisin surprisingly gly valuat valuations ions take a hit as a result. result. This fforces orces the capital capital markets version of a ’prisoners dilemma’. dilem ma’. Do a placementt aatt a less than favorable d placemen dilution ilution to current shareholders or or borro borrow w at high teens or via way out money m oney CB and hope it all works w orks out. out. ACP beli believes eves there is anot another optionissue by moderniz modernizing ingstructured a structured has a checkered checke red history history. . But theher h historical istorical issues s with this product proproduct duct canthat be structured away so as to protect protect shareholders and give Co Company’ mpany’ss a material better optio option. n. And utilization does not a distressed situation as a properly str structured uctured product p roduct can be useful source on on ongoing capital thus creating pricing ttension ension for other forms of capital. Regain control over your balance sheet. acpasia

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Private a nd Co Confidential  nfidential 

Assumptions Bread Br ead Fa False lse Flags

Redeemable Convertible Notes, Convertible Redeemable Conv ertible Bonds with Warrants, Warrants, Exchangeabl Exc hangeable e Loan Note, or what ever new or old name being used to describe a short sho rt term structured product intended intended to be converted into shares of a ListCo. A% 1** B#"/ '0% 0(.'"&C

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Private a nd Co Confidential  nfidential 

“Bad Actor” Act or” Structural Elements

 

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Indicate Ind icate iinten ntention tion o off investor to short th the e stock prior to conve conversion rsion price setting

Sizeable Upfront

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Reflective of deals where each party party’’s interest are not aligned

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Initial funding covers mostly fees thus not creating cr eating value for for Company

Stock Borrow

Fees

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Mandatory Warrants

Short look back period

‘Slight of of hand’ – detached warrants ca cash sh in the cheap wa warrants rrants for quick gain or retain cheap warrants to acquire acq uire oversized portion of Listco.

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Taken ttogethe ogetherr wi with th stock borrow iitt is pr probable obable that stock w will ill be unde underr pressur pressure e

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Can create c reate risk of ‘feeding’ into dow downward nward pressure

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typicall typ icallyy means conver conversion sion wil willl take t ake place no matte matterr the market conditions.

Be careful not to paint with a broad brush acpasia

Not all structures have have the same risk

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Private a nd Co Confidential  nfidential 

A “death “death spiral” Needs Structure tha thatt is alwa always ys in i n the t he money

So how can structure address dilution dilution risk (eg “death spiral”). spiral”). It cannot be a guessing game. Structural Point 1 - Greater of Conversion Prici Pricing ng N&%1'%& "9 F/ F/" " M"&L3*1.

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30 - 60 day lo look ok back usi using ng tthe he llowes owestt single day or lowest couple of days

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90% of 3 consecutive consec utive days wi within thin last 20 days

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80% of last 3 day VWAP

80% discount to that th at llook ook back price

Subsc riber is totally indifferent to Subscriber actual stock performance Willl alwa Wil always ys b be e in the money Could be out of money mone y if wa warrants rrants given which are then th en used to offset note loses loses thus retaining indiff indifferen erence ce

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Conversion price materially tracks ListCo

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Discount customary to an equity placement

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Not always in the money thus not feeding a ‘death spiral’

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Private a nd Co Confidential  nfidential 

Structura Stru cturall Point oint 1 – Analysis Analysis of a L ListCo istCo – Do Your Home Homewo work rk !

18 month look back analysis

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Daily closing price and daily VWAP for purposes of formula use @,A75 B7>C/ ?C @,A75 DE3F @,A75 D>76G/ &)!!!

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Private a nd Co Confidential  nfidential 

Structurall Point Structura Point 1 – Conversion Conversion Price for Each Formula Formula !

Using historical data, what would have been the conversion price on any one day

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Two formulas so two lines representing the daily conversion price for each

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The highest price of these two formulas is what would have been used as the conversion price on that day @!A <C 5<D-E: & F*3 *=-0*6- GH1I <=-0 5*E: $# F*3E =E J!A <C 5*E: & F*3 *=-0*6- GH1I

Major Maj or ‘up ‘upward’ ward’ move means

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Shorter formula will prevailterm this protecting shareholders from over dilution during such periods

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During ’flat’ stock performance performanc e the 20 day lo look ok back is is higher. The Shorte Shorterr better represents typical equity placement prici p ricing ng

Longer formula is greatest during down cycles cyc les

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Private a nd Co Confidential  nfidential 

Structurall Point Structura Point 1 – Daily Close versus Greater Greater of C Conversion onversion Price !

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Important to note that there will not be a conversion conversion event event every day. This is simply an i llustrat ion of conv conversion ersion price available on a day relati ve to price performance performance.. But one cannot cannot time the market

There may be divesting di vesting of shares already conv converted erted on any given day that iiss expos exposed ed to pricing ch changes anges as tho those se shares have alr already eady bee been n converted at a price, p rice, but conversion itsel itselff will more iincremen ncremental tal

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Stock moves down faster than conversion price

Movement down results resu lts in in

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’at the money’ conversion pricing which conversio means non conversions conver sions = no fee feeding ding a death spiral

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Big move up but no egregious returns for Subscriber or excessi ex cessive ve dilution to shareholders

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Private a nd Co Confidential  nfidential 

Structurall Point Structura Point 1 – Implied Implied Pe Percenta rcentage ge Discount !

Consistently within band thus proving thesis that product is simila similarr tto o equity placement placement,, ifif not better  bett er 

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Traditional CB that may ultimately be out of the money thus th us creating default risk. @.1:.+;*7. B=+>.1CD=+ @1D:. *>*D6*/6. =+ * E*4 1.6*; D>. ;= ;F*; E*4GC HI2@ HI2@ '%!"

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Private a nd Co Confidential  nfidential 

A “death “death spiral” Needs Structure T That hat Can Never N ever Be Stopped

If Issuer Iss uer has has no control over capital capital issuance that may create unexpected unexpec ted diluti dilution on then that risk grows materially materially Structural Point 2 – “Stop the Madness” Clause Option 1 F0% O,1- E4'"&; A1C !

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Once the transacti transaction on begins there are very few ways Issuer can prevent more notes from from being is issued sued no matter tthe he stock price

When combined with with a ’’friendly’ friendly’ conver sion price mechanism that is conversion always alwa ys in the money then let the “Death Spiral” begin Out of control process thus encouraging encour aging shareholders to sell

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Set a floor floor price below w which hich th the e Issuer can stop new convertible convert ible notes from being is issued sued at all 80% look look back at time first tranc tranche he of capital is made

Does what it says A material move down from when deal started the Issuer can simply decide the capital is too expensive expe nsive and stop issuing notes Bett er than large convert as there is materiall Better materiallyy less default risk on Issuer  10

 

Private a nd Co Confidential  nfidential 

Simulation: Floor Analysis !

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The Floor Floor is set at st start art of each main Tranche and surv survives ives until all subsub-tranch tranches es in that T Tranche ranche are drawn down. Example: if floor floor had been set at any time d during uring the labeled Period A then all sub-t sub-tranche ranche dr drawdown awdown notices during Period B would be at the discretion discre tion of of Issuer. @A2*9: <C ,5<<0 D0E9E+6 #

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Private a nd Co Confidential  nfidential 

A “death “death spiral” Needs Structure T That hat Can Never N ever Be Stopped At end of the day day,, it comes down to play betwe between en shar shares es used for pu purposes rposes of financ financing ing and the capital raised Structural Structur al Point Point 3 – “Stop “Stop the Madness” Madness” Clause Option Option 2 I&%$%#' P%/ P"'%. 9&"L )%(#6 J..3%-

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Again, program can run unabated concerned more about subscribers profits than shareholder impact

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Cap total tot al number of shares to issued Recall that the capital is issued incrementall increment allyy

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If the convert has prici pricing ng resets then shareholders get totall t otallyy destr destroyed oyed in a down cycle cyc le as it acts llike ike a make whole provisi pr ovision on Capping discount does not solve solve the problem as the notes will will not conver convertt once cap it reache reached d and is now replaced with with cred credit it ris riskk that can bring

down the company acpasia

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May result in less capital c apital raised than originall originallyy planned BUT shareholders shareholders have be been en protected against over dilution thus allowi allowing ng for reassessment of options Ability to anticipate when approaching share cap thus nearly eliminating eliminating any residual credit risk

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Private a nd Co Confidential  nfidential 

Historical Historic al Issues Issues Can Be Structured Struc tured Away Away !

Structured Product

Manage Dilution Risk

Aligned Interes t Aligned Interest

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Incremental conversions – 'pebbles make small ripple where a large Incremental rock creates creates waves' – can provide lower cost cost of capital ov over er time

allow company paceperformance process and stop process during periods of weaktostock

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Depending Dependi ng on liquidity, liqu idity, tighter conversion pricing p ricing mechanics

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No warr w arrants ants to “juice return” or to become ind indiffe ifferent rent to price

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Tighter conversion pricing and floor mechanisms

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Manage Leverage

Protect shareholders and offer company regular access to capital

Incremental capital means less risk of getting caught with sizeable debt deb t position position if notes are out of the money

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Private a nd Co Confidential  nfidential 

Execution Execu tion – Do Not Be Disruptive Disruptive !

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Stock moved in in lock step with Index RCN provided pr ovided material capital in a time all othe otherr forms of capital market marketss were closed Liquidity has materially improved thus thu s creating more options Notice the th e la lack ck of d disruptive isruptive beh behavior avior typ typical ical of “Bad Act Actors” ors” .,#,/0),1 3)0-*"4'54

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Private a nd Co Confidential  nfidential 

Execution Execu tion – Do Not Be Disruptive Disruptive !

Chart speaks for itself. Many tra tranches nches;; stock price mo moved ved side-ways and up

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Message : Not Not all str structures uctures ar are e “Death Spirals” and not all Subscribers are are “Ba “Bad d Actors” .,#,/0),1 3)0-*" 454 !(+ '%!#!!!#!!!

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Private a nd Co Confidential  nfidential 

Conclusion In our experience nearly all matters of financing can be structured to address specific risks that give rise to ‘bad actors’. actors’. The two decades de cades old adjustable convertible debt product product has been used and abused abused by the market in the past. We would consider these older older structures as ‘naked’. They had virt virtually ually no n o mechanis mechanisms ms in place to prot protect ect against unanticipated dilution events. We firmly believe beli eve there is an opport opportunity unity to revisit the value of a properly structured adjustable convertible note as a means by wh which ich a company can incrementally rraise aise capital efficiently effi ciently and with down si side de protection. protection. We believe believ e there is a platform ffor or real capital partners in the market place for SME’ss..

acpasia

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