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NIO: Punishing Dilution Inbound

NIO Inc. (NYSE:NIO), a Chinese electric vehicle company, has continued to limp along despite facing rapidly depleting cash, anemic demand and key management departures.

This week, Piper Jaffray became the latest Wall Street shop to chronicle the strange travails of the struggling company. Despite initiating coverage with a "Neutral" rating, Piper's analysts could find little cause for optimism.


Not enough revenue

NIO has pinned its hopes on a rapid growth story. It is betting it can increase revenue sufficiently by gaining market share in the luxury SUV market. Yet while this strategy might have some chance of paying off eventually, it does little for the company in the near term, as Piper Jaffray's research note explains:


"NIO's strategy differs from most Chinese EV suppliers. The company is focused on high-end premium SUVs with base retail prices of $45k-$60k USD. NIO may succeed in boosting its market share modestly in this elite segment - but in order to fund capex, R&D and administrative spending at current levels, the company would need to unseat some true luxury heavyweights."



NIO's strategy simply does not address the very immediate cash crisis gripping the company.

Running on empty

NIO needs cash. Badly. As I pointed out a month ago, the company is running out of time.

According to Piper Jaffray, NIO cannot extricate itself from its current predicament without raising significant amounts of fresh capital:


"With a bloated cost structure and a floundering macro backdrop, we think NIO will need to cut costs and raise capital - probably in excess of $1 billion - in order to keep selling its (inarguably differentiated) electric SUVs."



There is not likely to be much appetite among lenders or investors to stomach another debt offering. NIO's bonds are trading at such a steep discount that they seem to imply imminent bankruptcy and worthless equity.

Red knight, white knight or naught

Many NIO bulls have been praying for a government rescue. Their line of reasoning is, essentially, that the Chinese government would rather pump rescue financing into a moribund EV company than allow it to go belly up in a very public, not to mention embarrassing, fashion. Yet these hopes have largely been in vain. China has been injecting an increasingly heavy dose of market forces into its domestic EV market, cutting a number of generous subsidies and consumer tax credits. China appears content to allow its homegrown EV makers to sink or swim, and NIO offers no particular exception.

Even if a China "red knight" rescue is probably off the table, hopes for a rescue of some kind have not fully dissipated. However, as Piper Jaffray explained, it may be difficult to find a white knight that is sufficiently charitable and patient:


"Wanted: patient (and/or philanthropic) investors. Building cars is expensive - even when you have a manufacturing partner to help shoulder the burden...NIO is aggressively cutting headcount and working to boost revenue, but in the end, additional equity will probably be required."



Punishing dilution imminent

A dilutive equity offering now seems all but inevitable, as debt markets have soured on the company's prospects. Fortunately for NIO, it still has considerable equity value to work with.

NIO's stock has managed to hold up remarkably well despite its obvious financial woes. After plummeting 60% in the wake of a disastrous September earnings report, shares have climbed more than 70%. With a market capitalization currently standing at nearly $2.4 billion, the company's equity implies considerable value remains. While that does not comport with what the debt market is saying about the name, it does provide some flexibility. Unfortunately, as Piper Jaffray acknowledged, "Finding valuation support is a challenge." NIO needs upward of $1 billion to stay in the game, which means equity dilution of 50% or more is very likely.

The walls appear to be closing in on NIO.

Disclosure: Author is short NIO.

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This article first appeared on GuruFocus.