Today I will cover Xhibit Corp. (OTCPK:XBTC), a $290 million "cloud" company with numerous red flags that indicate it may be being used as a tool to execute a sophisticated Pump and Dump scheme. This article will outline these red flags in detail, and why I believe the stock is destined to lose the majority of its current market value in the months to come.
Investing in small cap companies can be risky; this is all the more evident investing in small caps that go public via reverse takeover transactions ("RTO"). Also called a reverse merger, this is a type of going-public transaction in which a publicly traded shell company issues shares in order to acquire the operating business or assets of a private company. There is little oversight into the quality and accounting treatment of assets or businesses acquired by shell companies in an RTO. The SEC has even gone as far as issuing a bulletin, available here, outlining the risks to investors of investing in RTOs. RTOs are subject to very little scrutiny from legitimate bankers, accountants and regulators, far less than an IPO; because of this, although IPOs are often overvalued and can make for poor investments, they are far less likely to be complete scams, as RTOs often prove to be.
Some of the major red flags to avoid if investing at all in small caps generally and in RTOs specifically are: Management with a past history of corruption or dubious corporate associations; major corporate transactions that prejudice shareholders to the benefit of insiders or cronies; minimal assets and/or business activity; and a history of paid stock promotion.
Since 2010, I have exposed 8 RTO companies, all with market caps initially above $70 million and all of which have been disastrous for ordinary investors. On average, these stocks have declined by 90% since my original articles. My track record of exposing companies on Seeking Alpha is shown below (RTOs highlighted):
XBTC shares a number of characteristics and red flags with the companies that I have already exposed and this article will specifically detail how:
- The individuals behind XBTC's RTO spent only $350K in August 2011 to buy a shell company and then printed themselves shares today worth over $40 million on paper.
- The figures who engineered XBTC's RTO and hold the majority of XBTC's free-trading shares have direct associations to multiple dubious and defunct penny stocks.
- XBTC's CFO and director Michael Schifsky has direct ties to multiple questionable penny stocks, one of which was the subject of a thoroughly investigated and documented Pump and Dump scheme.
- XBTC is radically overvalued within a peer universe that already sports sky-high valuation multiples and therefore fundamentally the stock is unlikely to appreciate any further in value.
Because of these points, I am comfortable adding XBTC to my list of "Strong Sell" candidates, and I predict that it will burn common shareholders badly and lose in excess of 80% of its value in the days ahead.
Xhibit Corp is a technology company which according to this company press release describes its activities as follows:
"Xhibit is a cloud based marketing and technology development company focused on digital advertising, online and mobile social media, CRM (customer relationship management) solutions. Xhibit offers a total solution for digital advertising that is integrated throughout its divisions and shares technology and resources across all of its services. Through its subsidiaries, Xhibit utilizes its branded products and services to provide digital marketing and advertising solutions."
Looking past the "cloud," "mobile social media," etc. buzzwords of the corporate description, closer examination reveals that the company went public in 2012 via an RTO transaction. As is explained on page 5 of their most recent 10-Q, the company went public on June 4, 2012, via an RTO with a shell company called NB Manufacturing ("the NBMF shell").
According to the 10-Q, in the 9 months ended Sept. 30, 2012, the company's subsidiaries generated $7.4 million in sales and a profit from operations of $249K. Looking at the balance sheet, the company has $159K of cash and the largest item among its $5.4 million in total assets is $2.9 million in "intangibles." The company has $3.1 million in net book equity, although subtracting the intangibles reduces this amount to a mere $200K. Xhibit has 67.3 million shares outstanding, which based on a closing price of $4.30 on January 4, 2013 gives the company a total market capitalization of $289.4 million.
Because the company went public via an RTO, additional due diligence should be conducted into the history and circumstances surrounding that transaction. The result of such diligence is highly concerning.
How the Figures Behind XBTC's RTO Spent $350K in August 2011 to Buy a Shell Company and Then Printed Themselves Shares Today Worth Over $40 Million on Paper
Information regarding the initial transfer of ownership of the NMBF shell can be seen in this 8-K. According to the 8-K, ownership of 1,007,300 shares representing 72% stake in the shell was transferred for a total consideration of $300K to four parties:
Larry D. Eiteljorg
Azul Dia - owned 100% by Fabia Daniele, signed by Bobby D. Perry as Secretary.
Beaux Beaux Partnership - owned 99.9% by the IRA of Tracy McKittrick, signed by Bobby D. Perry as President of the General Partner.
Rocky Global Enterprise, Ltd. - Signed by Bobby D. Perry as President.
On the basis of this 8-K, we can calculate the cost-per-share basis for these individuals was $0.298/share ($300K/1007.3K shares). The 4 parties each owned a 25% stake or 251,825 shares each. It turns out that the four parties decided to acquire even more cheap shares. This 8-K/A amends the amount of shares purchased from the original filing and states that 1,189,190 shares representing an 85% stake in the shell were transferred in equal amounts. This amended filing doesn't list a total price for the shell, but we can be pretty sure it wasn't any more than $0.29/share on the basis of these subsequent 4/A filings here and here that show a much lower average transfer price per share of $0.16. Piecing it all together, we can see that four parties bought 1,189,190 shares for a total amount likely not exceeding $345K ($0.29/share x 1189.2K shares).
While these four parties then had a controlling stake in the shell, they approved an 8-for-1 stock split, increasing the number of shares they owned and lowering the cost base per share. Background on the 8-for-1 stock split and the subsequent RTO with Xhibit can be seen in this 8-K. Item 2.01 states:
"Immediately prior to the Merger and following its recent 8:1 forward stock split (which was completed effective March 1, 2012), the Registrant had approximately 11,200,224 shares of common stock outstanding.
Following the Merger, the Registrant has 66,583,676 shares of common stock outstanding and no derivative securities outstanding. Following the Merger, the former members of Xhibit own 83.2% of the Registrant's outstanding securities, and the Registrant's shareholders own 16.8% of the Registrant's outstanding securities."
The four parties together now owned 9,513,520 shares in total, or 2,378,380 each. Because of the split, these new shares only had a cost basis which was 1/8 of the original ~$0.29 per share. This equates to a mere $0.037/share.
So, post-RTO, we had four parties owning around 9.5 million shares which were purchased for around $345K. These shares now have a nominal value of $40.85 million or $4.30 per share based on the closing price on January 4, 2013. Interestingly, none of the four parties have filed a Form 3 filing declaring their share ownership or any subsequent transactional filings on an individual basis, so we can't know how many shares they continue to own. Regardless, based on the volume of shares traded since the RTO, it's a certainty that the four still own many millions of their ultra-low cost base shares. These shares are also the majority of the company's "free-trading" shares, since the shares created in the RTO should be restricted stock. For these reasons, it makes sense to examine some of the individuals behind these four parties.
The Figures Who Engineered XBTC's RTO and Hold the Majority of Free-Trading Shares Have Associations to Multiple Dubious Penny Stocks
Bobby D. Perry
Three of the parties listed above have direct associations with Bobby D. Perry in the capacity of Secretary, General Partner or President. Perry also has ties to several defunct microcaps which resulted in major losses to shareholders. Here is a list of filings documenting Bobby D. Perry's links to defunct penny stocks Defi Global (OTC:LCHL) and Opexa Therapeutics (NASDAQ:OPXA).
Although it might not look like a penny stock, Opexa Therapeutics, which began its life as an RTO on the OTCBB called Pharmafrontiers (PFTR.ob) has undergone both 10-for-1 and 4-for-1 reverse splits since 2006 (i.e. 40-for-1) and although as of today it continues to trade on the Nasdaq at ~$1.30 (~$0.03 per pre-reverse split share), this represents a loss of over 95% vs. when Bobby Perry first shows up as a major selling shareholder in 2005.
Larry D. Eiteljorg
Perhaps more interesting to piecing together the overall story is the involvement of Larry D. Eiteljorg. As shown in that company's last 10-K filing with the SEC, Larry D. Eiteljorg has ties to defunct penny stock Clear Choice Financial (CLCI.pk was CLRC.pk) where he served on the company's board of directors. Additional documentation of Eiteljorg's various filings in connection with both XBTC and CLRC can be found here.
Clear Choice Financial, which recently had its registration revoked by the SEC, described its major business activities as mortgage banking as outlined on page 3 of their final 10-K. The company filed its last financials with the SEC in November 2006 and the company's auditor resigned in 2007 as shown in this 8-K. Among other concerns from the auditor was that Clear Choice
"did not have a documented system of internal controls over the processing of information, the recording of transactions or the reporting of financial results."
This is both highly unusual and troubling from the standpoint that Clear Choice was at least operating under the pretence of being a banking company. For such a company not to possess these kinds of controls is startling and leads one to wonder how much of its $26 million in assets reported in its final 10-Q truly existed or if the whole company were an elaborate financial asset inflation scam.
But XBTC's connections to Clear Choice Financial do not end with Larry D. Eiteljorg, in fact one of XBTC's management and directors was also closely tied to the company.
XBTC's CFO and Director Michael Schifsky Has Direct Ties to Multiple Questionable Penny Stocks, One of Which Was the Subject of a Thoroughly Investigated and Documented Pump and Dump Scheme
Based on the disclosure in the 8-K surrounding the RTO, we can see that CFO Michael Schifsky has a number of past corporate associations. Greater examination of these associations reveals that a number of them are suspicious penny stocks, at least one of which also appears to have been used as a vehicle for a Pump and Dump scheme. Here is a list of the public company filings associated with Michael Schifsky.
Clear Choice Financial
According to this 8-K, Michael Schifsky was named CFO of Clear Choice Financial (CLCI.pk was CLRC.pk) on November 26, 2006. However, as can be seen by this December 2007 8-K regarding the resignation notice from their auditors, after Schifsky's appointment as CFO, the company became delinquent in filing their 10-Qs and 10-Ks. In fact, despite Schifsky's annual base salary of $150,000 and grant of 200,000 shares of company stock, he never filed a single 10-Q or 10-K for the company. Beyond their filing delinquency, the banking company had a number of other questionable characteristics including, as mentioned by their resigning auditors, a lack of
"internal controls over the processing of information, the recording of transactions or the reporting of financial results."
Schifsky clearly must have either known Eiteljorg before joining Clear Choice, or the two of them became acquainted as a result of his work at Clear Choice Financial, where Eiteljorg was a director.
Big Bear Mining
Big Bear Mining is a company which although is ostensibly a mineral exploration company, was actually the subject of one of the biggest Pump and Dump schemes of 2010. The story behind the BGBR Pump and Dump is well documented by Melissa Davis of the Street Sweeper and also the Vancouver Sun here, here, and here. To summarize:
- BGBR held a variety of "Mineral Properties" with no proven deposits of significant or economically recoverable minerals.
- BGBR also conducted a large forward stock split in early 2010.
- BGBR's market capitalization reached almost $170 million in April 2010.
- BGBR was the subject of a paid stock promotion campaign with one promoter receiving $900,000 for "advertising" services on BGBR stock.
- The company appears to have ties to infamous Vancouver stock promoter Shane Whittle, also the figure suspected of being behind the Jammin' Java (OTCQB:JAMN) Pump and Dump.
- BGBR had several figures who apparently held positions of power and large share positions, but were not the controlling forces behind the company
Based on Schifsky's position on the board of directors and the level of financial sophistication apparent in his resume, it seems unreasonable to believe that Schifsky did not know what was going on at BGBR, if he was not in fact directly involved in the Pump and Dump scheme itself. Shares of BGBR declined from a high of $1.75 reached on April 9, 2010 to $0.18 on June 7, 2010, a loss of 90% in a time period of less than 2 months. They now trade at $0.01/share, a loss of over 99%.
Based on the disclosure on page 62 of the 8-K covering XBTC's RTO, we can see that Michael Schifsky's involvement in XBTC began when he was appointed as CFO of Xhibit LLC, the main operating subsidiary of XBTC in July 2011. The date is just weeks before Eiteljorg and company closed their purchase of the controlling stake in the NBMF shell.
For his involvement in XBTC, to-date Schifsky has been well rewarded. The 8-K states that he received 1.2 million shares of XBTC in the RTO, after working there for 11 months, an amount now worth over $5 million on paper. Page 64 of the RTO 8-K also reveals that subsequent to the RTO, Schifsky is additionally entitled to a $204K annual salary. He is also eligible to receive an unspecified number of the 13 million shares reserved for issue under the company's stock-based compensation plan, viewable here.
XBTC is Radically Overvalued Within a Peer Universe That Already Sports Sky-high Valuation Multiples
Unlike some of the RTO's that I have covered, XBTC does actually have some business activities and is not likely to have an intrinsic value of zero, as of today. This makes it more sophisticated than many of these schemes which operated out of an essentially worthless shell. This situation is akin to that at Legend Oil and Gas (LOGL.pk), (OTCPK:LOGL), a company which I exposed here, here, here and here. Much like XBTC, Legend actually had an operating business producing revenues, in that case from oil and gas. I analyzed that their business seemed to intrinsically be worth perhaps $11 million to equity holders. The problem for shareholders was that this figure was significantly below the $100+ million market capitalization of the company when I first wrote about it. Legend has since declined by over 95% since my articles and recently traded as low as $0.03 per share.
Based on the information contained within XBTC's most recent 10-Q, we can see that in the 9 months ended September 30, 2012, the company's subsidiaries generated $7.42 million in revenue and a profit from operations of $249.4K. Based on the disclosures within that 10-Q regarding the financial results from the first 9 months of 2011, and also the full year 2011 results for Xhibit disclosed in the RTO 8-K, we can extrapolate the revenue and operating results for Q4 2011, in order to arrive at trailing 12-month figures as well.
Revenue: $6,351,384 (FY 2011) minus $4,251,262 (9 mos 2011) = $2,100,122 for Q4 2011
Operating Profit: Negative $329,424 (FY 2011) minus $1,197,398 (9 mos 2011) = Operating Loss of $1,526,822 for Q4 2011
Based on these figures we can see that for the trailing 12-month period ended September 30, 2012. XBTC had TTM revenues of $9.52 million and a loss from operations of $1.28 million.
Contrasting XBTC's valuation against comparable companies in the Social/Mobile advertising and marketing space reveals that the company is starkly overvalued relative to these comps. For my analysis, I have used following comparable companies:
Constant Contact Inc. (NASDAQ:CTCT) - Constant Contact Inc. provides on-demand email marketing, social media marketing, event marketing, and online survey products primarily in the United States. The company's shares are listed on the Nasdaq.
Millennial Media Inc. (NYSE:MM) - Millennial Media Inc. provides mobile advertising solutions worldwide. It operates MYDAS, a mobile advertising technology platform for developers and advertisers. The company's shares are listed on the NYSE.
ExactTarget Inc. (NYSE:ET) - ExactTarget Inc. provides cross-channel, interactive marketing software-as-a-service ("SAAS") solutions that enable organizations to communicate with their customers through the interactive channels, including email, mobile, social media, and websites. The company's solutions provide marketers with a suite of integrated applications to plan, automate, deliver, and optimize data-driven interactive marketing campaigns and real-time communications. The company's shares are listed on the NYSE.
Since XBTC is a loss-making business, it doesn't make sense to try to value it on the basis of a price-to-earnings ratio, since the earnings are negative. Therefore, I am opting for the use of several other metrics to gauge XBTC's valuation relative to comparables. The following table compares financial results for XBTC next to the three comparable companies in terms of price-to-sales ratio.
As we can see, XBTC is substantially smaller than the comparable companies in terms of its overall revenues. The company has grown its sales during the trailing 12 months at approximately the same rate as Millennial Media, and faster than the other 2 companies. Despite the fact that XBTC is a company listed on the OTCBB, has a very limited operating history and a plethora of red flags, the company has a Price to TTM Sales Ratio more than 24x higher than the next nearest comp, Millennial Media . Another startling comparison is XBTC has a market capitalization that is already approximately 65% of Constant Contact while generating less than 4% of CTCT's sales figure. On the basis of price-to-sales ratio, XBTC appears drastically overvalued.
Another metric that clearly demonstrates the irrationality of XBTC's current valuation is looking at its market capitalization in comparison to its number of employees. In order for a company to grow successfully, it needs to add qualified and competent employees. This is not always an easy process, to which many in human resources departments will attest. Although XBTC does not disclose its employee count in its most recent 10-Q, we can see a recent figure from Page 25 of the RTO 8-K which states that as of June 7, 2012, XBTC had 22 employees. A chart comparing XBTC to the comps is included below:
XBTC is valued at $13.2 million per employee, a figure which is more than 4 times that of the next highest comp, Millennial Media . One should also not forget that included in XBTC's employee count are highly suspect individuals such as CFO Michael Schifsky.
On the basis of price-to-book value, XBTC's valuation also appears completely out of line with the peer group. Readers should take note that other than XBTC, Constant Contact has the highest ratio intangibles and goodwill to assets and also trades at a lower price-to-book ratio than Millennial Media and ExactTarget, this is no coincidence as investors are less likely to pay up for what are often viewed as lower quality assets such as intangibles and goodwill. XBTC is valued at a 92.2x price-to-book ratio, a figure which is almost 86x larger that of the next highest comp, Millennial Media ; meanwhile the company has the highest ratio of intangibles and goodwill to assets in the peer group, indicative of a lower quality balance sheet.
Based on any rational valuation standard, XBTC appears to be highly overvalued relative to its comparables. Further, XBTC appears to deserve a discounted valuations next to such comparables on the basis of its listing on the OTCBB vs. large national exchange; limited operating history; small scale; poor corporate governance with a board of directors consisting of only 2 individuals (one of whom is Michael Schifsky); and host of other red flags. Although XBTC does appear to operate a real business, the stock is clearly outrageously overvalued.
We also shouldn't forget that XBTC, which is a much smaller company with next to no resources in terms of cash, liquid assets, etc. is actually competing with these peer companies. The market may be developing fast but it isn't as though this market is an uncompetitive one. In light of all of the above, a highly generous valuation would be to value XBTC at a price-to-sales ratio equal to that of Millennial Media , or 6.0x price-to-sales. On the basis of this extremely generous valuation, XBTC has an implied valuation of $57.12 million or $0.85 per share; this represents an implied downside of over 80% vs. the current price.
Despite operating a real business in a hot sector, XBTC appears both highly suspicious and absurdly overvalued. We know that the individuals behind XBTC's RTO spent only $350K in August 2011 to buy a shell company and then printed themselves shares today worth over $40 million on paper. We also know that the figures that engineered XBTC's RTO and today hold the majority of XBTC's free-trading shares have direct associations to multiple dubious and defunct penny stocks. Moreover, we know that XBTC's CFO and director Michael Schifsky has direct ties to multiple questionable penny stocks, one of which was the subject of a thoroughly investigated and documented Pump and Dump scheme. Analysis of comparable companies shows that XBTC is radically overvalued relative to a peer universe that already sports sky-high valuation multiples.
I believe that the real business of XBTC is likely being used as part of sophisticated RTO Pump and Dump scheme involving XBTC's CFO and Director Michael Schifsky, Larry D. Eiteljorg, Bobby D. Perry, and potentially others. At the very least it represents one of the most ridiculously overvalued companies in the tech space and is destined for a sharp move down to fall in line with its true value. Based on all of these factors, I am comfortable to add XBTC to my list of "Strong Sell" candidates. I believe that buyers or holders at the current price are likely to be badly burned and lose in excess of 80% of their investment in the days ahead.
Additional disclosure: General Disclaimer: I am short XBTC.ob and/or hold derivative positions which will benefit from a decline in the stock price.