- PHOT shares are highly likely to be down 60-90% when trading resumes; with the potential for a permanent drop..
- There has been a variety of questionable insider share sales in the past few weeks..
- Two members of management received compensation which represented ~24% of 2013 revenues, despite the company’s profitability deteriorating year-over-year..
- One director has resigned from the board..
- FINRA had previously warned investors about scams in the marijuana space; PHOT is the fifth marijuana stock to be halted this year..
The purpose of this post is to set out relevant facts that should be considered in advance of the Growlife Inc's (OTC:OTC:PHOT) resumption of trading on Apr 24, 2014. On Apr 10, 2014, PHOT was halted by the SEC for two weeks as a result of "questions that have been raised about the accuracy and adequacy of information in the marketplace and potentially manipulative transactions in PHOT's common stock". This is only 15 days after Advanced Cannabis Solutions (OTC:OTC:CANN) was halted on Mar 27, 2014 "due to a lack of current and accurate information concerning the securities of Advanced Cannabis". It is my view that PHOT may fall 60-90% when trading resumes and thereafter. This post further highlights that given questions with its financials, poor capital allocation decisions and lost partnerships - that PHOT has concerns above and beyond the SEC halt. The halt simply foreshadows greater underlying business issues.
This article is important in the context of PHOT but also in the context of the broader comp space. Recall that FINRA warned investors about potential stock scams in the marijuana space in January 2014. PHOT's underlying business issues will hurt the momentum that has been rich for cannabis players over the past few months. Given the shareholder base of PHOT, on resumption of trading, there may be a significant amount of retail investors that will be turned off from the marijuana industry. Consider the impact on PHOT's comps whom may also be negatively impacted: Terra Tech (OTC:OTCQB:TRTC), Greengro Technologies Inc (OTC:OTCPK:GRNH), Full Circle Capital Corp (NASDAQ:FULL), Medbox Inc (OTC:OTCQB:MDBX), Nuvilex Inc (OTC:OTCQB:NVLX) and Advanced Cannabis Solutions .
PHOT shares are expected to drop between 60% and 90% once trading resumes
There have been at least four halts since the beginning of March 2014 in the marijuana industry which include Advanced Cannabis Solutions , Citadel EFT Inc (OTC: OTC:CDFT), Petrotech Oil & Gas Inc (OTC:OTC:PTOG) and Aventura Equities Inc (OTC:OTC:AVNE).
It appears that a drop of between 60% and 90% is likely on Friday. Although, it is my view that shares will trade at a 90% discount to its last trading price. This is because PHOT's halt was the result of potentially manipulative transactions which is above and beyond the accuracy and adequacy issues that its peers (CDFT, PTOG and AVNE) were halted for. CANN's trading resumption (that resulted in a 38% drop in share price) is not as relevant given the softer language used by the SEC compared to CDFT, PTOG and AVNE ("due to a lack of current and accurate information"). PHOT specifically acknowledges a drop is likely with its response to the halt "If history is any guide, there is likely to be a negative impact to GrowLife shares when trading is allowed to resume".
These halts also hurt the potential of the industry and its players as aforementioned.
There are a variety of "potentially manipulative transactions" that the SEC may have scrutinized
In the last few weeks, there have been many questionable moves made by PHOT and its management. The company paid select directors in shares at a significant discount to trading prices. Two members of management received compensation which represented ~24% of 2013 revenues. To top it all off, insiders sold material amounts of shares and major partners have walked away from PHOT. These underlying business concerns not only highlight the potential reason for the halt but also put into question the long-term potential of PHOT.
On March 31, 2014, in conjunction with the release of its 2013 10-k filing, directors (Tony Ciabatonni, Eric Shevin, Alan Hammer and Jeff Giarraputo) were paid two million shares at a price of $0.02 per share which constitutes a ~97% discount to the then trading price (of $0.58). How was a valuation that is over 90% below trading value established? How can the company continue to grant shares to insiders at the same price for over a year with material changes in the market and trading value of the underlying equity?
Tony Ciabatonni (Director), Eric Shevin (Former Director), Alan Hammer (Director), and Jeff Giarraputo (Director) were the recipients of 500,000 shares each. Prior to receiving these shares, Tony and Jeff had only 72k shares each. I note that the majority have these shares were granted at $0.02 per share.
There is also questionability with regards to compensation and the health of the company's financials. How appropriate is it that the CEO (Sterling Scott) and CFO (John Genesi, who was only appointed mid-year in July 2013) were paid compensation of $1.1 million when the company only had $4.9 million of sales? This implies that two members of the company were compensated ~24% of total revenue alone. Moving on to the financials, the company lost $21 million in 2013 which is ten times its loss from 2012. I note that warrant expense (of $7.0 million) and interest expense (of $5.3 million) were both individually greater than 2013 revenues. With the company's financials deteriorating, this hardly seems like a company with good capital allocation decisions or sound financials. It is my view that these concerns will lead to a long-term negative drag for PHOT and its business.
With a valuation of over $430 million (based on 865.1 million fully diluted shares outstanding - from its 2013 10k), PHOT trades at just under ~90x 2013 sales. This is just one of the many reasons that I think that the drop in PHOT's price on April 24th will be justified, SEC halt or not.
Within the PHOT 2013 10-k, the company highlighted that four insiders had not filed form 3's on a timely basis. In addition, 11 of 15 insiders had not filed form 4's on a timely basis.
Only a few days later on Apr 1, 2014, Eric Shevin (Director) resigned from the Board. Perhaps he was waiting to receive these shares before he departed? His resignation also afforded him the ability to liquidate his holdings without any requirement to file insider transactions. A director exiting the business is often a sign of bigger problems at play within the business.
On Apr 4, 2014, the president of the company Robert Hunt sold 1.8 million shares:
Not surprising that the CEO, Sterling Scott, filed the sale of 5.7 million shares for his wife (Wedam Elisabeth) on Apr 9, 2014. Along with the recent director resignation, the sales by Robert Hunt (President) and Sterling Scott (NYSE:CEO) may be signs of little long-term value in the business.
One of the key aspects of PHOT's future potential related to its agreement with CEN Biotech and RXNB. CEN had been approved to build a medical marijuana growing facility in Canada which could produce 1.3 million pounds of dried marijuana annually. It is noted that CEN is a subsidiary of Creative Edge Nutrition (OTC:OTCPK:FITX). On Apr 11, 2014, both CEN Biotech and RXNB rescinded all agreements and terminated their relationship with PHOT further hampering Growlife's potential at becoming a seasoned marijuana player. PHOT's potential partners (CEN Biotech and RXNB) obviously realized, that the shares they were to receive in consideration for the transaction (over 500 million shares were to be issued in total), would be close to worthless when PHOT's shares resume trading. The loss of this deal is a hard blow for PHOT in the medium-term.
On Apr 21, 2014, if PHOT did not have enough issues on its plate, Tripp Levy PLLC announced a class action lawsuit on behalf of purchasers of PHOT securities between Nov 14, 2013 and Apr 9, 2014.
Despite responding to "thousands of investor inquiries by phone and email arising from the trading halt", PHOT did not respond to a draft version of this post.
Based on current information, PHOT is likely to trade at a fraction of its valuation in the medium to long-term. In terms of its comps, they will also be hurt with a less euphoric retail investor base.
With all this potential adverse activity in close proximity, an SEC halt is starting to make sense and PHOT's long-term potential is seriously in question. What was PHOT's response to the SEC halt? "The answer is that we simply do not know". My response is that once trading resumes, it is highly likely that the stock is going down…big.
Editor's Note: This article covers a stock trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.