Editors' Note: This article covers a micro-cap stock. Please be aware of the risks associated with these stocks.
Management of Biolase (BIOL) has repeatedly tried to mask bad news through the use of euphemistic and creative wording in disclosures and press releases. Biolase has also tried to create a false boogeyman of "illegal naked short sellers" even though there is demonstrably no naked short selling going on with the stock. I will demonstrate this clearly below. The continued weakness in the share price is not due to short selling. Instead it is the result of a complete loss of confidence by long investors who are not being fooled by the continued shenanigans of management.
The continued driver of the share price will be Biolase's liquidity position along with the upcoming stock offering at a discount.
There is nothing illegal or immoral about shorting the stock of a company. Companies who deliver on performance will see their share prices rise. Those which do not will see their share prices fall.
Shorts have done far less selling than longs
I recently wrote two articles on Biolase. At the time of both articles, the share price was around $1.80 and had already plunged by 50% following a moderate earnings miss announced on August 7th after the close. I did not cause this plunge. Instead I was writing about it after it already happened.
The moderate earnings miss was certainly not justification for the steep plunge. Instead it was solvency concerns and the expectation of an equity offering at a discount. As soon as earnings were announced, the stock fell by more than 20%.
The share price continued its steep dive nearly every day and within a week was down by more than 50%. The falling share price triggered a short sale restriction, such that short sellers could only sell upon an uptick. This means that one could only sell short when a buyer chose to lift the price and buy at the ask. Short sellers could not hit the bid.
This means that short selling would not have been able to put any pressure on the share price whatsoever. Instead, it was a rush for the exits by long holders of Biolase stock.
Biolase continues to take the same action over and over again, but each time expects different results. When bad news hits, Biolase has tried to use creative wording and euphemisms to smooth over the issues with shareholders. Judging by the share price, it clearly isn't working.
When disclosing the violation of bank covenants (a loan default) in its 10Q, Biolase chose to trumpet the fact that is was still in "compliance" with its loans covenants … with the exception of just one little default. The market was not fooled and the stock price plunged.
Biolase then re-released identical information in a press release but positioned the news as a very positive statement that Comerica bank had "waived" the default. In fact, Comerica had really given Biolase just a one month deadline to renegotiate the loan and fix the problem. Again, the market was not fooled and the stock price dropped sharply.
Despite the failures of this strategy, Biolase continues to try to spin the facts with creative interpretations. The strategy continues to fail.
In its latest press release, Biolase makes a number of statements which are clearly inaccurate. It also makes a clear attempt to create a false boogeyman out of "illegal naked short sellers" which do not even exist.
A subsequent article on Seeking Alpha entitled "Biolase CEO Takes Dead Aim at Naked Short Sellers - Main Street Cheers" attempts to highlight the wisdom and effectiveness of the Biolase strategy against naked shorts. The author predicted that there would be a "stampede" of buying due to Biolase's savvy strategy.
The only problem is that there is no naked shorting of Biolase going on. As I will show below, author RS Analytics did nothing more than conveniently quote a press release from Biolase. Had the author even bothered to check any data on short sales or fails to deliver (as I have included below), he would have known that there is no naked shorting here. As a result, the notion of a short squeeze is downright wrong.
But it is a very convenient misconception just ahead of Biolase's upcoming stock offering.
These continued efforts at PR spin have only aggravated the frustrations of shareholders. As a result, Biolase shareholders have continued to sell.
What is "naked" short selling ?
In order to legally short a stock, one must obtain shares by borrowing them. One then sells the borrowed shares with the intention of buying them back at a lower price. At that time they will be returned to the lender and the short seller will profit. If there are no shares available to borrow, then the stock cannot be sold short.
In some cases, less reputable brokers might allow the short sale to go through, with the hopes that the shares to borrow could be located before settlement. If the shares were unable to be located by that time, there would be a "fail to deliver."
We can see from data released by the SEC in August that there have been fails to deliver on just 5,022 shares of Biolase. It is almost nothing. For historical data, the SEC doesn't even bother to track the data if the number is below 10,000 because such small numbers are de minimis.
This should not be surprising to anyone who follows Biolase. When there are borrowable shares, there can be no naked shorting, except when a broker makes a brief oversight. It is often the case that many retail oriented brokerages do not maintain an inventory of shares. For Biolase stock, this typically includes ScottTrade and Ameritrade. It is typically impossible to short Biolase at those firms. But on any given day, Interactive Brokers has had several hundred thousand shares available to short. Fidelity tends to have even more at over 600,000 over the past week. These are just the numbers that are automatically displayed. When these firms run low, it is possible to call them and simply ask for more.
This battle against "illegal naked short sellers" is therefore 100% bogus because there continues to be more than ample supply of shares to short.
I repeat: "Stock dividends have no value to investors"
When Biolase stock plunged to $1.20, the company quickly halted its own stock as it sought to counter the drop with positive news. Biolase needs to imminently issue stock to raise money, so it is important for Biolase to prop up the share price.
One of the measures announced by Biolase was a stock dividend. We can see from message boards and comments that many small investors mistook this for a cash dividend. On the day of that announcement, shares of Biolase soared by over 60% and ended back at $1.81.
Instead, we can see that this is a stock dividend. Biolase has first attempted to make the statement that this stock dividend in some way "rewards" investors. It does not. Period.
Any undergraduate student in Corporate Finance 101 can tell you that from the point of view of an investor, a stock dividend is identical to a stock split. An investor who owns 1% of the company prior to the "dividend" will continue to own precisely 1% of the company after the dividend. Each investor receives a small number of new shares, but the total share count increases by just as much. There is simply no economic benefit or "reward" to shareholders. Anyone who needs further convincing on this subject can simply Google "stock dividend vs. stock split" to find extensive examples and explanations.
Biolase's second attempt at explaining this "dividend" is that the stock dividend creates an audit of shares which helps to prevent illegal naked shorting. But as we can see from the above, there is no naked shorting going on because there is ample stock borrow.
Despite the obvious evidence to the contrary, Mr. Pignatelli has hitched his wagon to the "illegal naked short selling" theory, stating
It is my belief that a large amount of naked shorting is currently in existence in our stock, and therefore by August 30, 2013, such illegal trading will be forced to be covered by purchases in the open market.
Mr. Pignatelli has now made a bold prediction with a very near term deadline. The findings I presented above should serve to demonstrate that this is entirely incorrect. But within 9 more days (August 30th), we will all be able to judge for ourselves.
Mr. Pignatelli made this bold prediction about "a large amount of naked shorting" on Monday August 19th. This is actually a very easy thing to disprove.
The NASDAQ Reg SHO Threshold List posts the names of all stocks which had a fail to deliver of greater than 10,000 shares. There are only 24 NASDAQ stocks listed. Biolase is not one of them. There is no naked shorting of Biolase's stock.
Mr. Pignatelli's statements regarding naked short selling are therefore entirely without any factual basis whatsoever. The data which proves that there is no naked shorting is easy for anyone (including Mr. Pignatelli) to find.
His prediction of an imminent short squeeze is based on nothing at all other than his desire to inflate the share price immediately ahead of a much needed stock offering.
There are already two shareholder investigations underway by two separate law firms. These firms are investigating misleading statements and omissions by Biolase management. Judging by the comments posted on recent articles and the postings on message boards, it is clear that there are numerous investors who have relied upon the predictions of Mr. Pignatelli when buying the stock.
Likewise, Biolase recently ran a paid "infomercial" describing its products on several TV channels. But these ads are targeted towards Fox Business, CNBC and Bloomberg TV. These are all stock market channels, not channels which would boost product sales by targeting dentists. The purpose of the infomercials is to boost the share price in advance of the stock offering. But so far, like the other efforts, it does not seem to be working.
Biolase had previously announced two stock dividends in the first two quarters of 2013. At both times, the share price was under no pressure at all and sat at around $4.00. In the past, there was no mention of issuing a stock dividend in order to thwart "illegal naked short sellers." Therefore there does not appear to be any correlation with short selling in the past.
Biolase's Chairman and CEO Federico Pignatelli stated
I advise management of all small cap companies that are subject to attacks from naked short sellers to uncover such illegal activities and protect their shareholders by issuing stock dividends on a quarterly, or even monthly, basis.
But given the continued plunge in Biolase shares this week, it is unlikely that many management teams will be stampeding to follow any advice from Mr. Pignatelli. What Pignatelli doesn't understand is that there is no naked shorting. The selling going on at Biolase is continued selling by long investors who have lost all confidence in management. The valueless stock dividend will do nothing to bring investors back into the stock.
As management continues to waste time and effort tilting at windmills, the clock continues to tick down towards the September deadline imposed by Comerica bank in regards to the defaulted loan.
For the first 6 months of 2013, Biolase has now burned over $5 million in cash. This is a statement of fact. Yet Biolase management continues to direct investors' attention to what it burned last year ($1.7 million) and what it hopes it will burn for 2013 in total (approximately $4 million).
The fact is that Biolase now has a habit of failing to hit guidance, such that its recent realized performance is very relevant. In addition, the fact remains that Biolase has now confirmed that it will log in yet another year of losing money and burning cash. This also reconfirms that Biolase needs to raise money by selling stock at a discount. Biolase needs to do this within a limited number of days due to the default on its loans. So once again, with Biolase the "good news" is still just more bad news.
In regards to my articles, Mr. Pignatelli also stated that
As the Chairman of BIOLASE, it is my duty to protect the interests of our shareholders as well as the Company's credibility and we will be doing all that we can to thwart these injurious efforts
Mr. Pignatelli clearly believes that his recent PR campaign and a valueless stock dividend is the best use of his time and effort. But the share price is proving that shareholders do not agree.
Rather than wasting time and blaming false scapegoats. Mr. Pignatelli should be focused on finally turning an annual profit and resolving the solvency crisis.
Yet Mr. Pignatelli continues to deny that there are even any concerns over solvency.
Shareholders have now had ample time to evaluate the statements from Biolase management and they have clearly come to a different conclusion. I am not fabricating this crisis to "create anxiety" among shareholders. Instead, I am explaining the crisis even after it is already in midstream.
Biolase's shareholders equity is now down to just $8 million but it owes the bank $6 million. As of June 30th (1 ½ months ago) the company was already down to just $2 million in cash after burning $5 million in the past 6 months. We don't know what the cash balance is down to as of today.
The bank has already taken as collateral all of Biolase's assets. The bank has also taken the dramatic step of placing all of Biolase's receivables in a "lock box" such that Biolase cannot even touch the cash from its own sales until that cash is released by the bank. Biolase now has a limited number of days in which to rectify the situation and renegotiate with its bank. These are not normal operating conditions. It appears that the only ones who are not worried about this situation are the members of management at Biolase.
As an investment banker, I helped numerous companies raise money when they had fallen into a state of distress. My job was to advise them on how to ensure the survival of their company.
In times of distress, investors need to see that a company recognizes and takes responsibility for problems. They also need to see a clear and overwhelming plan to eliminate even the remotest possibility of failure (bankruptcy).
Biolase has refused to even acknowledge the severity of its liquidity position. Management has also refused to acknowledge its own role in directly creating this crisis. Instead, Biolase has wasted time and effort in blaming the false scapegoat of "illegal naked short sellers" when there is not even any naked short selling happening whatsoever.
Biolase management has made this inaccurate statements, predicting a sudden rise in the share price due to a "naked short seller" short squeeze, at just the time when it plans on issuing equity and needs a higher share price. Investors should view these statements within that context.
Futile gestures such as a stock dividend do nothing to add value or change the company's situation. Cutting the size of the S3 filing to just $5 million helped to boost the stock for a day, but leaves substantial uncertainty about Biolase's ability to fund itself to the end of the year. This is the exact opposite of what investors need to see during a crisis. And this is why the share price continues to fall.
It is clear that short sellers are not the ones causing these declines. It is even more clear that "illegal naked short selling" has precisely nothing to do with the declines. The current selling is the result of continued disappointment by long shareholders and it will continue until Biolase begins to take steps to fix the company's very obvious problems.
The next significant leg down for the stock will occur when Biolase attempts to raise $5 million from new investors. Given the continued declines in the stock, I now expect that this offering could come at a price of below $1.00 and would require the issuance of at least 5 million new shares. Given the September deadline from Comerica, we will all know for sure in a very short time.