Fresh Healthy Vending (OTCQB:VEND), a niche vending company aimed at providing healthier snack options, commands a lofty $200 million market cap that is, in our opinion, primarily driven by a multi-million dollar stock promotion campaign. After its recent meteoric rise from $1 to $10 over a period of less than six months, we believe VEND.OB is one of the most overvalued stocks on Wall Street. Based on the company's fundamentals, an eventual 60-85 percent collapse in share price is likely.
We urge investors to beware of the promotional propaganda that is fueling this massive run. We also advise the general public that this penny stock is at risk for an SEC suspension because its relative volume spike and price movement is eerily similar to that of recently suspended stocks Centor Energy, Inc. (OTCPK:CNTO), Imogo Mobile Technologies Corp. (OTC:IMTC) and Makism 3D Corp., Inc. (OTCPK:MDDD).
This report will focus on the following:
- Fundamentals that no rational investor would assign to a $200 million "going concern" penny stock;
- A significant number of skeletons in the closet for past and present affiliates of the company, including "deceptive conduct";
- Increasing competition, low barriers to entry and the lack of any significant differentiation between Fresh Healthy Vending and competitors;
- The current stock-promotion balloon, which has sent shares of VEND.OB soaring, definitely will pop because there has been little to no change in the intrinsic value of shares.
To date, we have expressed a number of these concerns with the company via email, but have not received a response.
Not A Financially Sound Company
In later sections, we will focus on the main elephants in the room - including VEND.OB's most recent penny stock promotional campaign and misleading and deceptive conduct by the company's founder, Mr. Nicholas Yates. For now, we will highlight some of the more important numbers taken from the latest quarterly report for the period ending Dec. 31 2013:
- Revenues for the three months ending Dec. 31, 2013, were 64 percent lower than those of the same period in 2012;
- The company incurred a $503,887 net loss, compared to a net profit of $441,934 for the same three months of 2012;
- Gross margins decreased from 52.6 percent to 41.8 percent, representing a 20 percent decrease;
- Cash on the balance sheet did increase, but is less than $500,000.
There is no denying that Fresh Healthy Vending does have sales and an operational business. However, it is absurd to place a valuation in excess of $200 million on a business with increasing competition, few barriers to entry and a very limited marketing budget.
The fundamentals alone give us reason to believe that VEND.OB presents one of the best opportunities in the market for short sellers, but the background of the players involved and the most recent promotional campaign lead us to believe it is almost certain VEND.OB will trade below $2 sometime during the next 12-24 months.
Misleading and Deceptive Conduct
Fresh Healthy Vending generates most of its revenue from vending machine sales. According to a representative of the company, low-end agreements are typically in the range of $100,000-$120,000. Although payment terms vary on a case-by-case basis, approximately 40 percent cash consideration is due at the time of signing.
Any seasoned entrepreneur giving consideration to an up-front payment of $40,000 or more would reasonably be expected to perform proper due diligence on the company and its employees. In doing so, that entrepreneur quickly would discover numerous red flags. A simple Google search for: fresh healthy vending llc, legal yields some disturbing results.
California Commissioner of Corporations Settlement
Item 3 - Legal Proceedings from the company's most recent annual report outlines a March 2013 settlement agreement with the State of California regarding "allegations of inaccurate and incomplete disclosures" in the company's Franchise Disclosure Documents during 2010 and 2011. As part of the settlement agreement, a number of California franchisees were entitled to a refund of their initial franchise fees and the depreciated market value of the vending machines.
Franchise Investment Protection Act of Washington
Fresh Healthy Vending, LLC entered into Consent No.: S-11-0712-12-CO01 to determine whether there were any violations of the Franchise Investment Protection Act of Washington. Fresh Healthy Vending neither admitted nor denied the findings in the Consent Order.
That is a major red flag, so we conducted background checks of all individuals either associated or previously associated with Fresh Healthy Vending. We believe the inaccurate or incomplete disclosure relates to company founder, Nicholas Yates, former principal and manager, Mark Trotter, or possibly both, perhaps in an effort to hide their past wrongdoings. Based on an article published on unhappyfranchisee.com, our concerns appear valid:
In an unrelated case, the Federal Court of Australia found that Yates "engaged in misleading and deceptive conduct in the operation of a vending machine business."
ACCC Chairman, Graeme Samuel states:
"Small business investments and franchises have the potential to attract unscrupulous operators [and] this makes it one of the areas that the ACCC targets. Operators who make false claims about the profitability of small business opportunities risk civil or criminal action by the ACCC."
Even more disturbing reports about the checkered pasts of Trotter and Yates, reports that go into more detail about "vending industry scams," have been published by consumers on RipoffReport.com.
Trust: The Most Valuable Business Commodity
The external business environment for Fresh Healthy Vending is enormous and will continue to grow. New legislation, such as Section 4205 of the Patient Protection and Affordable Care Act, continues to be put in place and will dramatically alter the marketplace for vending-machine businesses by requiring "clear and conspicuous statements" disclosing the number of calories on specific items sold.
An article published on VendingMarketWatch.com further validates the business model Fresh Healthy Vending is seeking to execute. While the market likely will grow, there are few barriers to entry. So few, in fact, that if the "fresh healthy" concept gains widespread consumer acceptance, billion-dollar multi-national corporations will completely decimate Fresh Healthy Vending, whose marketing budget, relatively speaking, is virtually nonexistent.
The biggest problem that VEND.OB faces, in our opinion, will be an inability to acquire new franchisees in the wake of past legal problems surrounding individuals either involved or previously involved with the company. Vending machine sales historically have accounted for roughly 90 percent of total sales, and during the past two years, those numbers have been slashed in half. Unfortunately for VEND.OB, we believe the drop is partially due to a lack of trust among potential franchisees.
A Stock Promotion Bubble Waiting to Burst
A color brochure touting Fresh Healthy Vending, Inc. as a "$42,000,000,000 opportunity" that could "make investors a fortune" due to new Federal legislation has made its way into physical mailboxes across the country. We have already debunked the notion that VEND.OB will be a market leader in this space in previous sections, so we will focus on the primary reason for the recent rise in share price - the promotional propaganda designed to lure naive investors into buying shares of VEND.OB:
Zoom in on the VEND.OB brochure legal disclaimer published on timlento.blogspot.com, and you will discover one very important sentence:
Brown Dog Marketing, Inc. paid one million three hundred thousand dollars to marketing vendors to pay for all the costs of creating and distributing this advertisement.
Risk vs. Reward: Accounting For Multiple Halt Risks
The SEC has become very proactive in halting penny stocks such as VEND.OB for a variety of reasons, and it appears that a common trait is that most halted OTC stocks use color brochures and convincing online ads costing millions of dollars to produce. Millions of dollars are spent by advertisers in order to sell millions and sometimes tens of millions of dollars of worth of stock that was acquired for pennies on the dollar.
The use of color brochures and online ads make it easy for the SEC to identify potential investigations, so while the probability of any one particular penny stock being halted on a given day is low, VEND.OB is one of the most active penny stocks in the murky OTC market, due in large part to its stock promotional advertising campaigns.
The magnitude of the SEC's recent effort to curb penny stock promotions has taken many by surprise. It can affect any company actively being promoted, including operational businesses like VEND.OB, due to the vague response typically given by the SEC that can be open to much interpretation:
While VEND.OB, like all actively promoted stocks, is at risk for a trading suspension, we believe there is much more going on behind the scenes in an effort to curb unscrupulous career promoters. In our opinion, efforts to cease stock promotions will come from a number of angles.
On May 9, 2013, the Financial Industry Regulatory Authority (FINRA) was granted authority under Rule 6440 to halt trading in OTC equity securities if it determines an extraordinary event has occurred, which has a material effect on the market for the OTC equity security. Some would argue penny stock promotion is one of those extraordinary events, because it certainly has a material effect on the marketplace. To date, FINRA has utilized the Rule 6440 "extraordinary event" halt once on April 17, 2013, when it halted trading in Eco-Trade Corp. (OTC:BOPT).
It is our opinion that promoted penny stocks such as VEND.OB may also begin to run afoul of the Federal Trade Commission. Color brochures like the one shown above are highly deceptive marketing materials that are subject to interstate commerce laws and the Federal Trade Commission Act.
To date, the FTC has not pursued cases of false advertising relating to promotional penny stock brochures similar to the one designed for Fresh Healthy Vending. But to a reasonable person, it would seem that truth-in-advertising rules clearly are being broken and that the color brochure advertisements are incredibly misleading.
Every savvy trader and investor should attempt to measure risk vs. reward prior to entering a trade. There was a time when OTC traders neglected to consider SEC trading suspensions, but that time has passed. When measuring risk-to-reward with promoted penny stocks like VEND.OB, it is a necessity that investors consider SEC suspension and FINRA halt risks even to the slightest degree, along with the very small possibility that the Federal Trade Commission begins taking an interest in these misleading and deceptive advertisements.
The Current Stock Movement and What the Future Holds
Part A depicts the illiquid market for VEND.OB shares trading in the fall of 2013 around $1. Due to the lack of liquidity, large VEND.OB shareholders would be unable to favorably liquidate the millions of shares they purchased at less than a penny in private transactions.
Part B begins in mid-November, when a $1.3 million stock promotion campaign launched and volume picked up. Then, in February, it is apparent more ad dollars were spent, and thus more volume was created for large early shareholders to sell stock to the naive public.
After Part B is completed and large shareholders have finished liquidating stock, promotion spending stops, and with fewer buyers in the marketplace, the result is always the same:
We believe that an eventual 60-85 percent collapse in share price is likely. As our track record shows, Part C above is almost fail-proof. Sometimes, the share price of promoted penny stocks declines more than 99 percent, but as we pointed out earlier, Fresh Healthy Vending has an operating business with existing revenues, so a 60-85 percent correction is more reasonable.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.