6 Overvalued Short Candidates

by: Edward Schneider, CFA

The following six stocks have enterprise values of around $200M or more, have zero or nominal revenues, are losing a lot of money, and questionable business models. Fundamentally, they should go to zero or close to it.

Name Ticker Price Ent Val Revs EV/Revs Net Loss
Carview Communic.


$1.55 $188M $0.4M 459X -$27.3M
Green Automotive (OTCPK:GACR) $1.35 $324M none NA -$1.4M
Hoku (HOKU) $1.61 $360M $3.2M 112X -$19.4M
Max Sound (OTCPK:MAXD) $0.88 $225M none NA -$5.7M
Mytrah Energy MYT (London) £0.95
$360M none NA -£0.3Me
St. Elias Mines SLI (Toronto)
$270M none NA -C$10.8M

St. Elias Mines (SLI, TSXV) (OTCPK:SELSF) is a gold exploration company that has yet to report any revenues or show significant gold deposits. I attended a St. Elias Mines presentation a few years ago when they were raising money at C$1.50 per share, after previously doing a financing round at C$0.75. They raised more money this summer at C$1.80. Management is still hyping the farflung potential of its Peruvian Tesoro property with no results three years later.

Management brags about attractive gold samples from veins near the surface (strangely none was shipped in FY 2011 which could open up a whole can of worms). Management still hypes the ovoid, a potential huge gold deposit below these veins. Until this month, very little money was spent on drilling. But stock marketing expenses went through the roof. For the fiscal year ended May 2011, promotional, travel and telephone expenses increased three-fold to $1.5M.

The short-selling catalyst is that the company recently began drilling at Tesoro. Even after all these years and advanced surveys, the company does not have the confidence to undertake deep drilling where the ovoid deposit supposedly exists. Instead, the company is initially doing shallow drilling amongst already established veins;and may try to use this insignificant data to prolong the ovoid myth a bit longer. But this stalling tactic is running out of time. By definition, a drilling program is used to find major gold deposits, not veins. Investors and the marketplace expect to see substantial deep drilling results. If the company avoids or comes up empty on deep drilling at Tesoro, then the stock will crash towards zero. This distinctly possible negative event is quickly approaching.

Management has some credibility issues. Director Duncan Bain was disciplined by his professional association for writing reports for a US exploration company that did not comply with national standards for mineral disclosure. Bain's reports provided an overly optimistic view of US Canadian Minerals, Inc's gold-silver project in Arizona that was used to pump this stock that was traded on the OTCBB (source: see here). Exploration Manager, Lloyd Brewer, was implicated for insider trading in the past. He delayed the release of negative drill results from St. Elias, while selling St. Elias shares at a much higher price in between the time the results were known and were released (source: see Settlement Agreement with British Columbia authorities - see here). The CEO and wife of Lloyd Brewer, Lori McClenahan, has no mining experience. Neither Ms. McClenahan nor most of the top managers and directors have visited the infamous Tesoro property that has been propping up the company's stock price. Ms. McClenahan puts a lot of time and effort into fund raising.

St. Elias strategy is to acquire properties, and then hope that a large gold mining firm buys them out. So far, there have been no takers. This strategy was feasible when St. Elias had $50M market cap, but not at $279M. St. Elias is the ultimate promotional company - see here and decide for yourself. Their expensive promo campaign has effectively spread the shares amongst many retail investors including Europeans. The stock was cracked last year by a large short-seller (before covering at around C$1.20), and is susceptible to another short-selling attack at today's bloated valuation, especially now that management is reaching the end of the line of delaying real deep-drilling Tesoro results.

Mytrah Energy (MYT, LSE-AIM), formerly known as Caparo, is an aspiring India-based wind farm operator. Wind power, including Mytrah, have potential. The problem is that they plan to incur $825M in additional straight debt over the next two years to purchase the wind turbines. This amount of leverage for any start-up company is a recipe for disaster for early equity investors. Current debt stands at $112M and equity is only $72M. The interest cost alone would be about $100M per annum. This is project financing.

The terms for the first phase of the project for 1GW of capacity were set with its wind turbine supplier (Suzlon). There were delays, but management hopes that deliveries will start in Q4 2011 and finish in 2013 for this initial phase. Mytrah, however, still has not raised the $189M tranche of debt needed to pay for the complete first-phase purchase commitment.

If everything goes right under very rosy sell-side analyst assumptions, Mytrah would be cash flow positive by 2013-2014 time frame. Assuming an additional 4GW of capacity (1/2 from Suzlon, 1/2 from another supplier) and average feed-in tariffs of about 3.75 Rs/KWh, revenues would cap out at around $1.1B in 2018. Taken the PV of those discounted cash flows, maybe the stock can reach £4. So why am I short the stock? Because the probability of this actually occurring is 1-out-of-100.

First of all, there is only a 50/50 chance that they will even be able to complete the $189M tranche given the risk tsunami that is now hitting emerging markets. The chances of getting timely financing on the remainder of their $825M debt requirement is even worse. Suzlon, their primary supplier, has a leveraged balance sheet, was not profitable in FY 2010 or FY 2011, and can easily default in a difficult business environment. A sample of other issues include monsoon wind dependency / unreliable wind power source, land purchase limits, and electricity pricing uncertainty.

Some of these sell-side projections are just plain naive in projecting revenues with barely any operating costs, and interest expense as the largest outflow. Do you think that the Indian government will allow a company to earn outlandish profits from now until infinity without adding much real value? I have been to India, and the level of required payoffs there are large in both the private and public sector. In this situation, I highly doubt that residual foreign equity investors would realize a large portion of this pie-in-the-sky windfall, even if it did occur. So, the bottom-line is that Mytrah has a 50/50 chance of being wiped out, and only a small chance of ever exceeding the current price on a fundamental basis.

As a side note, one of the sell-side analyst that supports Mytrah, also covers Pursuit Dynamics (PDX, London). Pursuit Dynamics still sports a $247M market cap without any revenues despite totally missing sell-side analyst projections.

I would like to point out that I am not negative on wind power. Today, wind energy has the lowest cost per watt of all major alternative power sources. It has power variability and aesthetic issues, but definitely has a place in the future energy landscape. The issue that I have is with hyped / debt-laden companies with enormous market caps that still have not even proven themselves. Venture capitalist invest in these companies at $5M valuations initially, not $293M like Mytrah or $1.9B in the case of bio-fuel start-up KiOR (NASDAQ:KIOR) - see here. In fact, I may invest in an interesting wind power company with a much simpler business model and lower breakeven point than Mytrah, but it only has a market cap of $3M.

Max Sound (OTCPK:MAXD), formerly known as So Act Network, is your typical pump-and-dump OTCBB stock. The recent eight-fold jump in the stock price since a private placement took place at just $0.10 per share in August 2011, puts Max Sound at a perilous market value of $225M without any revenues. There has been no substantive news to support this monumental price spike - no revenues or orders, or paid downloads of its software. News before and during this price spike consisted of just very early stage developments like developing an app for Android phones, Akamai (NASDAQ:AKAM) customers having the ability to download Max Sound's software, and adding people to the advisory board. While this is welcoming news, it does not justify a 8x spike in the stock price nor even a small fraction of its $225M market valuation.

Management claims that its high-definition (HD) Audio can convert any audio file into HD quality while reducing the file size. My son and I listened to a demo country song on Max Sound's web site. Yes, the quality was slightly higher than a music web download if you had good headphones. But would anyone pay extra for it? Internet and mobile consumers traditionally do not pay extra for these features.

For argument's sake, let's believe the super-optimistic Max Sound sell-side research report on Max Sound's web site claiming that 10M mobile users will download Max Sound's HD Audio app for $7.99. The report also adds 10B music downloads (why 10B, because that is how many Apple (NASDAQ:AAPL) iTunes have been downloaded says this analyst) using Max Sound's HD Audio, providing a premium of $0.10 to $0.20 per download. After different royalty and other assumptions, the report envisions a total recurring revenue stream of at least $50M annually.

There are no financial projections in this sell-side report, as the company is too early-stage to know if and when these "potential revenues" will occur or what the costs will be. So, let's try and finish this sell-side report. Let's use $60M in revenues five years from now and a net margin of 30% based on peer Dolby (NYSE:DLB) with the same royalty business model (albeit Dolby has $940M in revenues, but we'll give Max Sound a break). This leaves us with a net profit of $18M in 2016. The two closest peers, Dolby and Avid Technology (NASDAQ:AVID), currently have forward P/Es of 11x and 12x, and EV/Revenues of 2.5x and 0.4x, respectively.

So based on peer group valuations, Max Sound's valuation in this upbeat sell-side scenario would be: 11.5 x $18M detract 20% for share dilution discounted back to the present at a 15% rate yielding a market value of $82M, and only $36M on a EV/Revenue basis, well below today's $225M market cap. Even if you believe the sell-side claims that Max Sound is superior to Dolby and can grow faster, one still cannot justify a valuation close to the current market cap - and this is the rosy scenario with a low probability. In the more likely scenario, this stock is worth $5M to $10M. This happens to be what a venture capitalist would pay for a Series A or B round of an early-stage company, if they would fund it at all.

Hoku (HOKU) has been trying for years to build a polysilicon solar cell manufacturing plant in Idaho. The company also has a small solar panel installation unit in Hawaii. This company is basically broken. Hoku has a tremendous $270M net debt burden that is not being met currently, and is unlikely to be met in the future. Last 12-month EBITDA was -$19M. The Idaho facility will never be able to compete with low-cost Asian competitors. So it will be a money-loser from the get-go (future protectionist policies could create a subsidized profit, but this is not sustainable). The solar panel installation business is a low-margin service business that merits a low valuation multiple. So, there is little fundamental support for Hoku's current $360M enterprise value.

The one savior for the company has been Chinese majority owner Tianwei New Energy Holdings. Tianwei, has financed much of Hoku's capital investment in recent years. But Tianwei has been asking for more and more compensation from minority shareholders for undertaking that risk in the form of warrants. Moreover, Tianwei along with certain suppliers, have been asking for Hoku to repay their loans. It would not be surprising that other creditors are also becoming more aggressive.

Another bearish sign is that the borrow rate on shorting Hoku shares has exceeded 100% during the last few months. My personal experience has been that nervous lenders demanding record-breaking high borrow rates forewarns of a pending financial collapse or SEC investigation for that stock.

Green Automotive Company (OTCPK:GACR) plans to import ecologically-friendly vehicles from China, and distribute them in the US starting in 2012. Management is planning to import two models - an all-electric SUV and an all-electric MUV. Management is also trying to sign up US dealerships that would then buy these Eco-friendly cars from Green Automotive. There are a lot of ifs and unanswered questions. Has management bought the cars from China yet? Do they have the money to do so? How many dealers have they signed up?

I am skeptical because there is no cash or assets to implement this plan. According to the latest balance sheet: cash was only $12k, total assets were $1.6M, half of which were intangibles. With very little resources, the company managed to lose $1.4M over the last twelve months and incur debt of $0.8M. It is incomprehensible that this stock has a market value of $324M. It is hard to give it any value at all.

Let's take the ultra-bull case and assume that money falls from the sky so there is no dilution to shareholders, they import the cars, sign up the US dealers, and there are some first-adopter consumers that will buy an Eco-friendly car. There is one problem; the US infrastructure for all-electric consumer vehicles is not ready, and will take many years to build out. Apart from novelty sales to passionate first adopters, Green Automotive sales in the US will be limited.

How much money will Green Automotive make even if they achieve revenues? Middleman distribution is a low-margin, non-scalable business. Margins will always be razor thin, as there are no barriers to entry for other competitors and there is little value-add from a distributor. So, limited sales x razor-thin margins = very little profit in the 1-out-of-100 best-case scenario (the company and the web site provide so little information that I cannot credibly plug-in any numbers). In addition, distributors have very low valuation multiples with single-digit P/E's. So even this remote best-case scenario does not get us close to the current market value of $324M. And the most likely scenario is that this company is worth close to zero.

Careview Communications (OTCQB:CRVW) is a company that I have written about previously - see here. Since this last article in August 2010, the stock has fallen from $2.04 to $1.50 currently. But the stock still maintains a bloated enterprise value of $188M. This enterprise value excludes several million warrants and a $20M recently-obtained revolving credit line they should fully utilize to cover an enormous cash burn. Careview burned through $21M of cash over the last twelve months, while generating only $0.4M in revenues.

Careview provides video monitoring of hospital patients, that can then be linked into local area networks or internet feeds with medical staff and patients' families. There is not any real proprietary technology. A service business model plans to charge a monthly service fee of $60 per month to the hospital and $13 per day to the patient plus a transaction fee. But no real revenues have been generated yet.

It is mind-boggling that investors continue to pay so much for a stock with no fundamental value. I can't even fathom writing a bull-case scenario for this stock. The bull-case has been a bunch of vapor-ware news releases that never panned-out (e.g. JV in China) or had no significance whatsoever. In the meantime, Carview reported a loss of $15.5M in just their last-reported quarter. The company has to issue shares and warrants like candy and now incur debt that they will unlikely to be able to repay, in order to cover these huge losses. While I give kudos to management for their persistence, I pity the holders of Careview shares.

Debt and share dilution are the final death knell for these OTCBB and Pink Sheet stocks. The steady price decline over the last 18 months should accelerate. The actual rate of that decline will depend on how much longer Careview's backers will try to support a sinking ship.

Disclosure: I am short SLI.V, MYT.L, MAXD.OB, HOKU, GACR.PK, CRVW.PK, PDX.L, KIOR.