Warnings about reverse merger stock promotions
Over the past few months, I have written a series of articles describing promotional activity which often precedes equity offerings by small cap, reverse merger companies. Such promotions often take the form of "transformational" press releases from the companies along with hyper bullish articles by independent authors. The stock price surges accordingly. Following my articles, and the predictable equity offerings described, these stocks have often declined by more than 50% over the course of just a few weeks. I have included a number of reference examples below and I strongly encourage readers to take note of these repeated precedents.
Over the past six months, shares of Neonode (NEON) have risen by as much as 60% during a very well executed promotional campaign. This rise in share price has occurred even as Neonode's revenues have plunged following the loss of its largest customer. Yesterday the stock fell by as much as 13% in after hours trading due to the announcement of an equity offering. Insider selling represented a rather large 50% of the offering. The insider selling came from a wide range of executives (including both the CEO and CFO) and directors and raised $7 million for them personally. This follows $2 million of insider selling in August. Just after the offering was announced, Wellington also filed a 13G filing stating that it had cut its stake in Neonode in half. Wellington is now below the 10% threshold and will not need to report further sales.
There are four reasons why this offering is perceived by investors as being notably abusive:
First, Neonode had just recently indicated that "we believe that our existing balance sheet can carry us to breakeven". Clearly this was interpreted by investors to mean that there would not be an equity offering.
Second, the large insider sales are coming directly on the heels of what appeared to be major and "transformative" business announcements. The fact that insiders are selling heavily casts doubt on the real impact expected from these recent press releases.
Third, the "greenshoe" over-allotment option of nearly 300,000 extra shares in the offering is coming exclusively from selling insiders. Typically the greenshoe comes from the company itself, allowing the company to raise greater proceeds. But these insiders wanted to sell all of the extra shares for themselves. This is extremely unusual and abusive for a greenshoe option.
Fourth, buried in the disclosure are clues that the insider selling is going to keep increasing in the next few months. Insiders are not nearly done selling. First was the sale of $2 million in stock in August. Then came an additional $7 million in September. Then is the $1.5 million greenshoe. But now we can see buried in the disclosure that the Executive Chairman intends to sell at least $1 million in additional stock within the next 60 days as part of a personal loan swap. The selling is not nearly done for insiders of Neonode and this will be done regardless of price.
As I will show below, shares of Neonode are likely to fall by a further 40-60% in the next few weeks.
There has been a well-executed promotional campaign on Neonode which caused the stock to soar, just in time for insiders to cash out. The recent design and licensing wins announced by Neonode (and which caused the price spike) are virtually identical to more than 100 other announcements by the company over the past 4 years. Yet these recent identical releases have been trumpeted as the source of truly unprecedented and transformational revenue growth which is supposedly going to begin within months.
The past wins for Neonode were consistently from the biggest names in the tech space, including Sony (SNE), Texas Instruments (TXN), Amazon (AMZN), and others. Despite the regular appearance of massive wins, Neonode has been unable to generate consistent revenues from these agreements and has never made any profit whatsoever. Total revenue so far in 2013 is just $1.7 million, even after more than 70 major design wins announced in 2012 alone. Predictions of any surge in revenues for Neonode are entirely unfounded and simply helped the stock to rise in time for an equity offering.
Background to the promotion
Last Wednesday, Neonode announced that "it has entered a new worldwide license agreement with a second undisclosed Tier-One Consumer Electronics OEM in South Korea". However, it was quite notable that the stock barely budged on the news.
On Thursday (the very next day), Seeking Alpha author Tech Guru drew attention to this development in his 11th bullish Neonode article since March. The shares immediately soared by nearly 20%. Part of the reason for this was that the author identified both Samsung and LG as the partners for Neonode. Neonode had left the parties anonymous. Another reason was likely that the author mapped out a very clear $27 share price target for the company based on the news.
However, despite the now familiar hyper enthusiasm from Tech Guru, we can see that the stock quickly gave back almost all of these strong gains, fading from just under $8.00 to around $6.90.
The latest "license agreement" announcement from Neonode follows multiple consecutive years with over 100 nearly identical announcements and partnerships with global technology giants. Past announcements have included: Texas Instruments, Sony, Amazon, Sony Ericsson Mobile, Barnes & Noble (BKS), Alpine, LG Display and many others.
As with the recent wins by Neonode, the past names of the giant customers were often not released at the time of the announcement. In each case, the unnamed customer is a "global" or "tier one" OEM giant who is a leader in their product class.
Past examples (just like the recent ones) have included manufacturers of "white goods", PCs, consumer electronics, mobile phones and others. Sometime later it is occasionally uncovered that the identity of the customer is one of the largest tech giants in the world, such as Sony.
The latest wins from Neonode once again fit this pattern precisely. The customer is unnamed, but it is (as always) a "leading" global giant. Tech Guru then filled in the blanks for who the counter party was, naming both Samsung and LG.
But in each case over the past 4 years, we can see one of two outcomes after these announcements. First, in many cases, the much anticipated revenue simply never materializes, despite the unbridled enthusiasm in the press release. This is why Neonode has been careful to include the following disclosure at the bottom of these frequent mega announcements:
Even if the customer or partner always has the intention to actually launch a commercial product or product line in high volume, there is no guarantee that this will be the case.
In other words, announcements such as the one last week are in fact just preliminary indications which may never be realized. In fact, on most occasions, the revenues are not realized. Yet Tech Guru has presented the latest news as if the revenues were in fact guaranteed.
Readers should note that just in the first half of 2012 alone, Neonode announced 40 individual design wins and 7 licensing agreements! It was clearly a very busy and promising 6 months in 1H2012. By year end, the number surged to 72 design wins and 12 licensing wins for 2012. These agreements often came from the biggest of the global technology behemoths in the industry.
Yet after 12-18 months, revenues are still sitting at around just $1 million per quarter - almost nothing, despite the marquee nature of the dozens of signed global counter parties. Revenues in Q1 were even worse at just $500,000.
As a second problem, even when some revenues did materialize, the amounts from these global technology giants ended up being so tiny (despite huge volumes) that Neonode has never been able to generate a profit in its entire history.
Despite the high profile nature of over 100 such announced agreements, total revenue across these 4 years has amounted to just $15 million cumulatively. As we will see below, Tech Guru has justified his "4 bagger" target by stating that these identical press releases will suddenly result in revenue surging to $58 million in just 2014 alone.
Net losses over the past 4 years have amounted to $72 million, with $9 million in losses last year alone. But in justifying his $27 target, Tech Guru has stated that Neonode's first ever profit will suddenly amount to a staggering $32 million.
Neonode's best year ever was 2012. The reason for the "record" revenues that year was that Neonode was successfully selling to Amazon/Kindle, Sony, Sony Ericsson Mobile and Barnes & Noble as current customers. Yet even when successfully doing business with the biggest names in the business and on huge volume, Neonode only generated a mere $7 million in total revenues that year.
Last year Morgan Stanley estimated that Amazon sold between $3-4 billion in Kindles. From this huge volume, Neonode realized a tiny $3 million in total revenues from Amazon. As a result, Neonode reported a net loss of $9 million for the year despite recording its best ever revenues.
Both Amazon and Barnes & Noble have discontinued the use of Neonode products, which explains the dramatic plunge in revenues in 2013 (even though Sony and Sony Ericsson are still sources of revenue).
The point is that Neonode already has a long and established history of signing new agreements and winning design wins with the absolute biggest technology giants in the business. Neonode has had tech titan Texas Instruments as a customer/partner since 2010. Likewise Sony and Sony Ericsson Mobile have been customers for years. Amazon was their largest customer in both 2011 and 2012.
If Neonode cannot manage to report a profit when supplying to that type of volume and to the biggest tech clients on the planet, then it is hard to imagine what will be required before we finally might see a profit. Likewise, when investors calibrate their expectations about what to expect from recent wins (such as Samsung and LG), they need to keep in mind that $7 million was a spectacular year in which Neonode was partnered with the largest names in the tech business.
The fact that we are now adding Samsung (GM:SSNLF) and LG into the mix does not change the fact that Neonode cannot transform these wins into meaningful revenues or profits. Nor does it even ensure that these agreements will actually result in any revenues AT ALL. Most of the past big name agreements resulted in little or no eventual revenue (see below).
It isn't the lack of big name design and licensing wins that has limited the prospects for Neonode. Instead it is the fact that Neonode's technology is already encountering a functional and competitive disadvantage. This is just the reality of the business and it is being reflected in Neonode's financials.
We know that last year Amazon discontinued the use of Neonode's infrared touch sensor because it wanted to go with a capacitive touch sensor. Capacitive touch sensors are lighter, thinner and more responsive, making this a very intuitive decision in the competitive e-reader market.
This "functional obsolescence" does not mean that Neonode will suddenly lose 100% of its customers. Instead, Neonode will end up serving markets which have a less demanding set of requirements and which are willing to compromise quality in exchange for a rock bottom, commodity price.
For example, instead of being used in e-readers and tablets for adults, Neonode's sensor is now being used in the $150 LeapFrog Leap Pad. This is a children's learning device which is sold at Toys R Us. It is clearly more of a toy than a computer. If there is long latency after touching the screen or if it is less responsive, this is less of a concern in a children's toy which is purchased for them by their parents as a learning toy. Unlike an e-reader or tablet, a heavy emphasis on small size and light weight are not really competitive considerations at all. As a result, LeapFrog is willing to use the fatter, heavier and less responsive Neonode sensor simply because it costs almost nothing.
As soon as the e-toy was launched, author Tech Guru was quick to highlight its significance for Neonode. He notes that last year LeapFrog sold 2.5 million units, and he projects that it will sell 4.5 million units this year. He is predicting that Neonode will somehow realize greater revenues from this small scale children's toy than they did from $3-4 billion in Amazon Kindle volume. This is simply unfounded.
Likewise, Neonode recently announced that it had introduced "the world's first one dollar touch solution", saying:
With an unsurpassed ultra-low BOM cost of only $1 (US) in high volumes, it is specifically designed to meet the aggressive price requirements in super cost-sensitive product segments.
Once again, it is clear that as the price continues to fall, Neonode's ability to generate meaningful revenue falls even further - even at huge Kindle-like volumes which might be realized from a Samsung or LG. This is why their product is more appropriate as an alternative to simple physical buttons on "white goods" (appliances). It quite literally costs almost nothing.
But fast money day traders have figured out one thing for certain: when news of a big design win is properly trumpeted, the stock will briefly rise. Buying on the rumor has been a consistently winning short-term trading strategy with Neonode shares.
On August 6th (notably just one day before earnings) Neonode announced that
Neonode Lands PC Design Win With Tier One PC OEM
Once again, this language is nearly identical to the language used in no-name Neonode press releases over the past 4 years. As expected, the stock immediately jumped by as much as 13% to a new high of $8.84. But by the end of the day, the stock had closed just about flat at $7.90. Buy on the rumor, sell on the news. Again.
Following earnings (the very next day), investors quickly realized that adding yet another one of dozens of similar wins was clearly not translating into any meaningful revenues (and certainly not profits). Neonode announced revenues of just $1.2 million (down by 40% from a year earlier) and the stock quickly sank to as low as $6.80 - nearly 25% below the previous highs.
In the weeks that followed, Neonode then traded down to around $6.30, and only rallied again following the most recent press releases.
In short, the usual "design win" boost was (as always) very short lived. This is what we have seen time and time again with Neonode. Massive design and licensing wins are very common. In each case they are described as "transformative" or even "disruptive". But in each quarter we can see that material revenues always fail to materialize.
This explains why the share price always gives back its gains even after very short and explosive rallies.
But now that insiders have sold and Neonode has issued stock, there is little incentive to continue the promotional campaign. Furthermore, by selling large chunks of stock just after announcing such bullish news, management has shown its hand that the news isn't so big after all. This fact alone will cause many former bulls to quickly sell.
Looking at Tech Guru's articles
Seeking Alpha author Tech Guru has certainly been a boon to Neonode. The company consistently refrains from disclosing the names of its customers and licensees. In the vast majority of cases, it simply describes its counter parties as being anonymous "Tier One" players in their given industry.
When the names of the giant potential customers are unknown, the effect of the announcements on the share price is often muted. Fortunately, Tech Guru has been able to uncover the likely identity in each case by relying on very obscurely disclosed technical information in hard to find locations.
If one didn't know where to look in advance, one would certainly wonder how such information could be found for such a wide variety of industries and applications - and all presumably without the help and guidance of management.
Yet Tech Guru always knows exactly where to find the information that allows one to deduce the names of each major new win.
By revealing the name of the likely partners, Tech Guru has repeatedly caused a tremendous surge in the share price of Neonode which otherwise would not be possible. The simple headline association of tiny, micro-cap Neonode with giants such as Apple (AAPL), Nvidia (NVDA), Sony, Microsoft (MSFT) and others is enough to cause a knee jerk share price jump on most occasions.
Given that Neonode insiders were able to sell nearly $2 million in stock in August alone at prices of $7.49, they should certainly be thanking the anonymous author for publishing the names of their "anonymous" partners. Prior to his first article on Neonode, the stock was trading at just over $5.00. It jumped by more than 20% in 2 days following that article. His more recent articles managed to push the stock into the $7-8 range. The latest article alone delivered a brief 1 day surge of 20%.
The share price began fading every day, but management was quick to cash in with an equity offering at a time when the stock had just closed at $6.99.
Since March, Tech Guru has written bullish articles on Neonode 11 times - approximately once every 3 weeks. Tech Guru has set a $27 share price target for Neonode, meaning that it will roughly quadruple according to his estimate. Yet oddly he appears to be the only author to have discovered this 4 bagger gem. No one else has felt the need to write about Neonode even a single time since he began in March.
In arriving at the $27 share price target, Tech Guru has attributed $9 of value to a spin-off of Neonode's IP assets alone. The impetus for this was an announcement that Neonode would "Explore Strategic Alternatives for Its User-Interface Patent and Licensing Subsidiary".
In this release, there was no mention from Neonode of any litigation or of the scope or size of any of these IP assets. It should also be noted that the total value of ALL of the non-cash assets on Neonode's balance sheet is less than $2 million! This includes ALL intellectual property (which is valued at near zero) as well as property, plant and equipment, receivables, intangibles - everything.
Despite these facts, Tech Guru has oddly predicted that Neonode will be able to sue for patent infringement on the sale of a whopping 2.4 billion smartphone sales by Apple and Samsung (among others).
Tech Guru is therefore telling us that these patents (valued at zero on the books) are in fact worth billions. But no one else has figured this out, and supposedly management would rather just place the patents into a separate company (which it would generously spin-off and give to Neonode shareholders as a gift).
The $9 per share estimate from Tech Guru values just the spin-off at over $300 million. This is more than the $240 million value of the entire company as it stands at present - for just an ambiguous spin-off which potentially has zero value. Tech Guru notes that he feels that this value is conservative.
The remaining $18 of his $27 share price target is due to the colossal revenue potential which he feels that Neonode will realize in 2014. The source of these revenues will be what it has always been in the past: printers, PCs, Automobiles, Children's Tablets, Handsets, White Goods, E Readers and NRE fees.
According to his estimates, the total will be a staggering $58 million in 2014 revenues.
A chart of Neonode's revenues (as forecast by Tech Guru) would therefore look as shown below. Six-month revenues will apparently leap from less than $2 million to almost $30 million - an immediate increase of 15x.
This chart is very important, so I strongly suggest that readers click to enlarge it and have a close look.
The notations on the chart above highlight the historical announcements from Neonode about "global" and "tier one" design wins and licensing agreements.
As shown, these past wins included LG Display, Sony, Texas Instruments, Alpine and a host of unnamed leaders in consumer electronics, e-readers, and consumer and business products.
The effect of these dozens of identical announcements on revenues during those 4 years is quite obvious. It is almost none. Yet somehow we are to believe that a series of identical announcements in 2013 is going to cause revenue to increase by a truly staggering 15x in the next few months. A more realistic view is that this is clearly a substantially inflated estimate.
Another way to look at this is that despite the huge number of identical announcements over the past 4 years, total revenues over the 4 years was just $15.6 million. Tech Guru is therefore predicting that Neonode will bring in almost 4x the total revenues of the past 4 years COMBINED in just 2014 alone. And the reason for this explosion in revenues is simply that Neonode has put out several press releases which are identical to over 100 similar press releases during the past 4 years. Again, such predictions are entirely unfounded.
The 72 design wins and 12 licensing agreements in 2012 were in fact far more than has been announced in 2013. But because the majority of these did not have a marquee company name attached to them, they generated much less excitement at the time. When looking at the anonymous releases as they have been made by Neonode (as opposed to the named releases by Tech Guru), they are far less exciting because they are anonymous.
Had Tech Guru been releasing the names of the 72 "anonymous" wins in 2012, there would have been massive excitement because many of these were clearly with the biggest names in tech. These were disclosed as "Tier One", "World Leading" and "Global Leaders". There is no doubt that many of these 72 wins in 2012 were with names that were just as impressive as LG or Samsung.
This explains one part of why the stock refuses to hold its gains after soaring to around $8.00 on these announcements. There are some investors who now have sky-high expectations for near-term revenues based on new announcements. But the smarter money knows that we have seen identical announcements hundreds of times in the past without any effect on revenues.
Yesterday's equity offering should be reason for any investor to look with strong suspicion on the stream of press releases and the hyper promotional articles which caused the stock to surge. IF the stock were about to quadruple over the next 6 months, then management willingly left nearly $30 million in easy profits on the table by cashing out. A more likely explanation is that management expects the share price to decline from the current peak.
What did we learn from Uni-Pixel?
Neonode's shares have been promoted on the research side by small-cap investment bank Craig Hallum. Anyone who follows the activities of Craig Hallum should have expected an equity offering in the works. This is especially true given that the last upgrade occurred in August, despite an earnings disaster.
Towards the end of 2012, shares of Neonode were trading for just $3-4. On December 12th, Craig Hallum initiated Neonode with a $7.50 target. This aggressive target was puzzling because Neonode had just recently lost its largest customer, Amazon, which accounted for 40% of revenues.
When Neonode released Q2 results in August, the stock quickly sold off by more than 20% due to investor disappointment with deepening losses and almost no revenues. But Hallum took this opportunity to actually raise its target on Neonode to $10.00 based on little more than the press releases from the company. This upgrade appears just as puzzling as the initial target following the loss of Amazon.
In December, the shares immediately jumped to $5.00 and have seldom traded below that level since then. In August, the upgrade helped to support the stock, allowing management to sell shares.
Hallum should be distinctly remembered for a very similar performance with Uni-Pixel (UNXL), which also happens to be in the same touch sensor business as Neonode.
Upgrades from Hallum repeatedly helped to drive Uni-Pixel to new highs. Each time the stock rose to a new high, Hallum simply upgraded the stock again and raised the target to an even higher level. It was notable that sequential upgrades often occurred despite no material new developments which would boost revenues or profits. When the stock hit $35.00 (up 4x in 4 months), Hallum still did not suggest that it was time to take any profits. Instead, Hallum simply upgraded the stock to $58.00. It was still the case that the only contract that Uni-Pixel had won had been announced back in December (at which time Hallum had assigned a target of just $22).
Almost immediately thereafter, Uni-Pixel took advantage of the spike in the share price and issued $44 million in an equity offering. As expected, it was priced at a 20% discount. As should have been expected, Hallum was the underwriter and raked in millions in fees.
The stock quickly plunged after the offering and never recovered. With the equity offering out of the way, Hallum became more realistic about the share price prospects of Uni-Pixel. Hallum quickly downgraded the stock to $40 based on nothing more than a "production delay". After peaking out at $42, Uni-Pixel subsequently traded down to around $12.00.
The point is that no matter how high a stock rises, these micro-cap investment banks will never suggest that it is time to sell. Instead, each new rise is just an excuse to set an even higher price target.
Such gratuitous upgrades just in advance of a lucrative equity offering are par for the course for Hallum and other micro-cap investment banks. Both of the Hallum upgrades occurred when a downgrade would have been more expected due to setbacks at Neonode.
As with Uni-Pixel, the $10 target placed on Neonode by Hallum (just after last quarter's earnings disappointment) will become transparently ridiculous once the stock starts trading in the $3-4 range. This is where Neonode was trading last year when it was still doing $7 million in revenues and had a large Amazon contract.
Lately I have done quite well by predicting the sell-offs of small-cap reverse mergers in anticipation of a predictable financing. This performance should be clear based on the last few articles I have written. Many of these stocks have fallen by 40-60% following the article and/or the financing.
It is often the case that these companies see a surge of promotional activity which boosts the stock at just the time they need to raise money. The promotions typically come in the form of press releases and bullish articles. This means that the share price spikes up a bit too high just before the equity raise, but then crashes far lower when stock is issued.
When I wrote about Kandi Technologies (KNDI), it was clear that the company was down to just a few million in cash but had over $20 million in debt coming due in June. The stock had recently traded over $8.00 following a string of positive press releases and hyper bullish articles. I predicted that a large financing was imminent. Within days of my article, Kandi raised $26 million and the share price quickly began its descent from around $6.50 to $4.50 - a very steep drop from its $8.00 peak. Like Neonode, many investors and authors had been predicting that the stock would see multi-bagger returns, above and beyond its $8.00 peak.
When I wrote about Organovo (ONVO), I made it clear that the stock had spiked to $8.50 for all the wrong reasons, including a non-event uplisting and several hyper bullish articles. The spike made it a compelling time to raise new money and the company clearly needed it. On the very next day after my second article, Organovo raised $46 million and the share price fell as low as $4.44 - also a very steep drop from $8.50. Prior to the drop, many small investors were predicting returns of 3-5x (instead of the 50% drop which materialized).
Other companies I have highlighted still need to complete their offerings. But the need to finance is now very visible and the share prices have already begun to decline as investors increasingly expect an offering in the near term.
MiMedx (MDXG) has already filed to raise $100 million in a stock sale. Following an unpleasant letter from the FDA, it is likely that MiMedx will be raising equity at around $3.00 vs. $6.50 when I highlighted the upcoming financing.
When I wrote about the upcoming financing at Biolase, the stock quickly declined by 30% and management was quickly forced to cut the size of their offering to just $5 million down from $30 million.
Conclusion - what's the point?
The point from each of these examples is that when an equity offering follows an extended effort to promote the stock, the stock will quickly begin a substantial decline. Many less experienced investors try to hope that the offering will "set a floor" under the share price or that the capital raise will "support the stock". This is almost never the case.
The advance promotional activity raises the price of the stock to an unwarranted level. Once the companies and individuals have the cash in the bank, there is little remaining incentive to continue to run a time intensive promotional campaign. Moreover, many smarter investors quickly figure out what is going on and make a hasty move for the exits.
As a result, the offering is typically just the beginning for the descent, as opposed to the end. Investors who ignore the alarm bells are often punished severely with steep losses within days or weeks.
Over the past 12 months, Neonode has lost its largest customer and revenues have shriveled to just $1.2 million per quarter. Despite this, the share price more than doubled based on an aggressive promotional campaign. The basis for the promotion is the notion that Neonode will secure explosive new revenues from new contracts. But by looking at 4 years of nearly identical press releases, we can see that this is clearly a deeply misguided notion.
Neonode follows a licensing model not a sales model. As a result, it is not cash intensive at all. The cash raised by Neonode was clearly more of an excuse to conduct an offering in which management could sell a large chunk of personal holdings. This should be quite evident given that insider sales comprised 50% of the offering and that management took 100% of the greenshoe to sell an additional 300,000 shares instead of providing cash to the company.
As the promotion ends and as investors realize what has happened, it is likely that we will see Neonode decline by around 40-60% from current levels within the next few weeks. This would place Neonode back at around $3.50, where it was last year prior to the loss of Amazon.