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John is a lawyer and accountant with over three decades of corporate finance, due diligence, M&A advisory and related legal services for manufacturers, innovators and investors in the energy storage and renewable energy sectors. Over the last eight years John has earned a global following for... More
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  • A Deeper Dive Into My FINRA Short Report Analysis 11 comments
    Jul 27, 2014 1:23 PM | about stocks: AXPW

    Most of my readers know that I keep close tabs on FINRA's Daily Short Sale Volume reports for Axion Power International (NASDAQ:AXPW) but they don't know why I think the statistics matter. Today I'll try to explain how I use the FINRA short volume reports to track the flow of shares into the market from investors who originally bought their shares in unregistered transactions. The legal distinctions in the following discussion are a bit arcane, but they're very important.

    The Securities Act of 1933 is an extraordinary law because it prohibits any sale of securities that is not:

    • Covered by an effective registration statement; or
    • Exempt from registration.

    It's the only major law I know of that begins with a absolute prohibition "thou shalt not sell investment securities" and then carves out a series of narrowly defined exceptions to the rule. The more typical structure presumes conduct is legal unless it's specifically prohibited.

    Because of the general prohibition in the Securities Act, the public stock markets could not exist without a sweeping exemption in Section 4(1) for transactions by persons who are not "an issuer, underwriter, or dealer". Investors rely on this exemption every time they hit the sell button and most of them don't realize that the mere act of selling shares would be illegal without the Section 4(1) exemption.

    While buying and selling shares doesn't pose any regulatory risks for investors who only trade shares that they bought in the open market, the Securities Act provides that any person who buys securities from an issuer with a view to redistributing those securities is an "underwriter." While normal investors can buy and sell in the open market with impunity, underwriters can only resell shares into the public market under an effective registration statement.

    In an IPO, an issuer files a registration statement with the SEC and professional underwriters buy the securities from the issuer and redistribute them to the public in a single day. Issuers can also file a registration statement with the SEC for a "registered direct transaction" and then sell the securities to the public. In both cases, the purchasers are not classified as underwriters and they can rely on the Section 4(1) exemption like everyone else.

    In an unregistered transaction, an issuer sells stock to a group of investors and then files a resale registration statement that allows those investors to redistribute their securities to the public over time. It's a slow-motion version of an IPO that can take weeks, months or even years to unfold. From a regulatory perspective, however, all investors in an unregistered transaction stand in the same shoes as the underwriters of an IPO. As long as the securities remain in the hands of the investors who bought them from the issuer, the securities are restricted and resale transactions can only be effected pursuant to a registration statement or an available exemption.

    While most investors will never need to understand the intricacies of securities registration and resale transactions, all investors should know that exempt open market transactions do not give rise to any special back-office procedures but resale transactions by underwriters do. That extra paperwork makes it very hard for an underwriter to comply with T+3 delivery requirements and usually means the transaction will be flagged as a "short-sale" for FINRA reporting purposes.

    If we scrutinize Axion's history, there was only one financing transaction in 2012 where an SEC registration statement was filed and declared effective before the stock was sold to investors. While the 2012 investors ended up in the same regulatory position as open market purchasers, all of the other investors who bought stock from Axion in 2004 through 2011 and in the 2013 PIPE fell into the "extra paperwork" class, which means that resales by those investors ought to show up as short sales in the daily FINRA reports.

    The following is an enhanced version of the FINRA graph that I send the Axion Power Host every week. The blue and red columns are keyed to the left-hand axis and show total reported trading and short sale volumes on a monthly basis since January 2010. The green line is keyed to the right-hand axis and shows the monthly short percentages since January 2010.

    (click to enlarge)

    Over the last couple years I've written several detailed analyses of who the principal sellers have been since January 2010. Prior to the 2013 PIPE transaction, I was able to identify holders who bought a total of 61.5 million shares from Axion in unregistered transactions and subsequently resold them into the public market before the spring of 2013 when the monthly short percentage bottomed out at about 6.8% for two consecutive months. During that 40-month period, the cumulative daily short sales reported by FINRA aggregated 59.6 million shares. By the time I make allowances for the quirkiness associated with a couple million shares that were resold in connection with bankruptcy proceedings, it's the closest thing to a perfect match I've ever seen. It also meshes perfectly with my experience that OTC market makers never take a long or short position in a stock unless they're forced to.

    Since May 2013 there has been a sea change in the FINRA short sale reporting dynamic that I don't have enough information to explain. During that period 110 million shares were issued to the PIPE investors but only 72 million shares flowed through the FINRA daily short reports. The most reasonable explanation for the discrepancy is that one of the four PIPE investors found a way to expedite back-office processing or otherwise avoid having their trades flagged as FINRA short sales. I don't know how the magic was done, but experience tells me there's no such thing as loophole free regulation.

    If I assume that the selling behavior that flowed through the FINRA short sale data mirrors the selling behavior that avoided being tagged as short sales, it looks like the PIPE investors as a group have resold between 96 million and 100 million shares and continue to hold small stock inventories that they'll sell into the market over time. That being said I don't foresee a lot of pushing and shoving around the pay window because the PIPE investors no longer have a chance to sell at depressed prices and recoup their losses in the next scheduled payment.

    The bottom line of this new analysis is that we have passed "ZRPSOD," zero remaining PIPE share overhang day, but we have not yet arrived at "ZRPSID," zero remaining PIPE share inventory day. I think the PIPErs continue to represent 60% to 70% of daily sell-side trading activity, but they've throttled back enough to avoid crushing the price. When I first started talking about the supply and demand inflection point I said I wanted to see two things happen:

    • A collapse in the daily trading volume; and
    • A sustained collapse of the FINRA short percentages into single digits.

    The first half of the test has been met. I'm still waiting for the second. My conviction that there have been no substantial defections from the retail stockholder base remains unshaken.

    In any stock market, the most motivated seller always sets the price. We've long known that the PIPErs were highly motivated sellers and the FINRA data tells me they're not out of stock yet. Their inventories are running low but they're not exhausted. Unfortunately I can't offer a more detailed estimate of the size of their remaining PIPE investor holdings or the time required to take them completely out of the picture.

    For now, I'm simply waiting for the FINRA data to tell me ZRPSID has arrived.

    Disclosure: The author is long AXPW.

    Stocks: AXPW
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Comments (11)
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  • Fancy Pants
    , contributor
    Comments (36) | Send Message
    Thanks JP. I am patiently waiting for some news that will create a more equal buy/sell ratio which will create a 'real' market cap.
    27 Jul 2014, 02:14 PM Reply Like
  • Nikunj Gupta
    , contributor
    Comments (6) | Send Message
    This is excellent. But then why are you long, will not the price drop before it will rise? and should you not be long then! When inventories run out?


    27 Jul 2014, 03:57 PM Reply Like
  • John Petersen
    , contributor
    Comments (30632) | Send Message
    Author’s reply » While the PIPE debt was outstanding the investors didn't care whether the price went down because they got an estimated payment a month before the installment due date and a true up payment on the due date. So if the price declined during the month, it merely increased the number of true up shares. The last payment date was the first trading day of May, which means the PIPE investors got their last block of shares in early April. There is no mechanism for future adjustments.


    The PIPE investors can make a small profit if they sell at or above the current price, but they'll leave money on the table or potentially suffer a loss if they drive the price any lower. Since these particular investors are all about squeezing every penny out of a deal I don't see any motivation to drive the price lower.
    27 Jul 2014, 04:07 PM Reply Like
  • JamesBBecker
    , contributor
    Comments (494) | Send Message
    How much you want to bet that the PIPErs have everything timed so that they sell the last of their stock 3 days before the next financing is announced?
    28 Jul 2014, 10:56 AM Reply Like
  • John Petersen
    , contributor
    Comments (30632) | Send Message
    Author’s reply » That plan might make sense if the PIPErs thought Axion would come back to them for a second round, but given their barbaric behavior over the last year I have a hard time believing that any sane manager would sign up for second pass through the value shredder.
    28 Jul 2014, 11:12 AM Reply Like
  • JamesBBecker
    , contributor
    Comments (494) | Send Message
    Maybe I'm reading too much into this, but it seems to me that the PIPErs can read Axion's balance sheet and cash burn rate just as well as I can.


    Which means that unless something good (and unexpected) happens, the PIPErs can pretty much tell when the next dilution will occur, though my statement about "3 days" was obviously an exaggeration.
    28 Jul 2014, 11:26 AM Reply Like
  • John Petersen
    , contributor
    Comments (30632) | Send Message
    Author’s reply » Finance professionals are nowhere near as fearful of the dilution bogeyman as retail investors. Every bartender in the world know you can't dilute a beer by adding a shot of whiskey. For reasons I can't begin to understand, retail investors seem to overlook that critical fact and think that new capital is a bad thing because it "dilutes" the upside potential they might have if additional capital wasn't needed.


    Corporations grow and prosper by selling shares and using the resulting cash to build the underlying value. Sometimes the additional value doesn't show up on the balance sheet, but it's always there unless management blows it all on futile spending.


    In late 2009 I owned a couple percent of Axion. Today it's closer to 0.5%. Without the money that Axion raised in 2009, 2012 and 2013, I would have had 2% of an idea. With the money and the dilution I have 0.5% of a very valuable new technology that's proving its worth to some of the toughest critics on the planet. I'm far better off today than I was in the fall of 2009.
    28 Jul 2014, 12:13 PM Reply Like
  • robert barry
    , contributor
    Comments (76) | Send Message
    as a casual observer (and long axpw) I believe you're reading too much into this. It strikes me as nonsense. The company is just not showing anything in spite of a superior product. That's it, plain and simple.
    28 Jul 2014, 12:04 PM Reply Like
  • slfnflctd
    , contributor
    Comments (9) | Send Message
    After the last report on issues with the test truck, I'm having trouble forgetting the homely image of Mario the sweaty driver, tooling around in a half-baked experiment with no air conditioning. I mean, I know how this stuff goes sometimes, but these are supposed to be professionals, not college students.


    How hard is it, really, to properly test a few simpler applications of this battery (i.e. not trains, trucks or trailer-sized cubes), get through the regulatory hoops and start selling? I'm honestly curious.


    If it was me, I would put the PbC battery in front of as many damn people as I could, ASAP, and let them prove for themselves that it works better than the competition. I understand market positioning, but bringing nothing to the table for this long starts to look like someone's hiding something.


    I'm still long (in a small way) because, I don't know, it would be a neat comeback story. I do feel, however, that the odds are decreasing. This isn't the only tech being developed with a comparable level of performance for certain applications, and I truly believe it is only a matter of time before another one starts shipping product to John Q. Public in suburbia... there may still be niches left for Axion when that's all said and done, but my gut tells me opportunities are being missed.
    31 Jul 2014, 12:36 PM Reply Like
  • bazooooka
    , contributor
    Comments (3688) | Send Message
    John any recent insights from the FINRA data? Do you have a theory why the stock went down another 40% since the June/July highs; was it because we never got to ZRPSID?
    18 Sep 2014, 01:48 AM Reply Like
  • John Petersen
    , contributor
    Comments (30632) | Send Message
    Author’s reply » We arrived at ZRPSOD at a time of maximum discontent. Instead of continuing the accumulation patterns of the last four years the stockholder base decided to sit on their collective hands and let the stock price wallow until there was more clarity on the reverse split and financing. As soon as the reverse split proxy was filed, volume fell through the floor.


    The dynamics are still in place and the underwritten offering shouldn't have an impact one way or the other. When the behavior of the stockholder base changes so will the price.
    18 Sep 2014, 07:12 AM Reply Like
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