Real Goods Solar Is About To Collapse Under A Mountain Of Toxic Financing

| About: RGS Energy, (RGSE)


RGSE's recent increase in price on very heavy volume appears to be nothing more than an opportunity for preferred shareholders to exit their position at a profit.

Noteholders holding $10 million worth of debt will start converting into shares next week according to the company.

Noteholders floating conversion clauses give them great incentive to mercilessly short the stock and convert more and more shares at ever-lower prices.

RGSE has weak financials and no apparent near-term catalysts that would support a strong stock price.

I have a policy of not shorting stocks as I don't like the idea of potentially losing more than 100% on a position. I didn't even request shorting capability on my brokerage account when I opened it and stories like KaloBios Pharmaceuticals, Inc. (NASDAQ:KBIO) makes me glad that I didn't. I open bearish positions through put options so when a stock like Real Goods Solar, Inc. (RGS Energy) (NASDAQ:RGSE) which is devoid of options comes to my attention, my choice is to either go long the stock or stay neutral. If I was able to short, this stock would be as it sits on a mountain of convertible debt and preferred shares that are destined to cause the stock price to collapse in a blaze of glory that rivals Great Basin Scientific, Inc. (NASDAQ:GBSN). RGSE has bounced from a low of $1.83 a week ago to as high as $8 before settling at $4.84 on Wednesday. This temporary bump on tens of millions of shares traded can only be explained by market makers wishing to push the stock to a certain price level for the pending conversion of warrants and debt.

So while I don't have a position in RGSE, my only personal stake in this is writing an article on a trending stock and collecting easy credibility points as the stock price is about to get demolished and the share count skyrockets to infinity before the next reverse split. This article can serve as a public service announcement to those people who are too lazy to read SEC filings before diving headfirst into a doomed position just because it looks like a fun day trade.

This 8-K filed on September 23 should be a huge red flag for anyone considering a long position in RGSE and music to the ears of shorts:

Summarizing the major points of this filing:

1. We know that preferred stock is going to be converted.

2. We know that $10 million of convertible notes are expected by the company to be converted into shares starting as early as next week.

3. The company expects so much dilution that it has set up a URL on its website to provide daily updates to its share count.

4. Shares outstanding as of September 21 was 1,226,342. Shares outstanding according to the company's website has already doubled to 2,400,807 as of September 27 and the real dilution hasn't even begun.

First, let's review the prospectus of the recent preferred stock financing:

Offering: 2,800 Units, representing $2,800,000 of Units, each consisting of [i] one share of our Preferred Stock and [ii] a Series H Warrant to purchase approximately 181.8181 shares of our Common Stock.

Conversion Price: The Preferred Stock is convertible into shares of Common Stock by dividing the stated value of the Preferred Stock by the conversion price. The conversion price is equal to the lesser of: [i] $5.50 per share of Common Stock, referred to as the "Set Price;" and [ii] 87.5% of the lowest volume weighted average trading price of the Common Stock during the five trading days ending on, and including the date of delivery of a notice of conversion, subject to adjustment as provided for in the Certificate of Designation. The conversion price is subject to a reset, as described herein and a floor of $1.10.

Mandatory Conversion Price: On September 29, 2016, if we meet certain equity conditions, the Preferred Stock is subject to mandatory conversion into shares of our Common Stock at a conversion price equal to the lesser of the [i] then-Set Price, or [ii]75% of the lowest volume weighted average trading price of the Common Stock during the five trading days ending on, and including September 29, 2016, upon written demand from us.

Series H Warrant Conversion Price: The initial exercise price per share of Common Stock purchasable upon exercise of the Series H Warrants is $5.50 per share of Common Stock. The exercise price of the Series H Warrants is subject to adjustments for stock splits or similar events. Further, the exercise price is subject to a reset. If on the earlier of the date of repayment in full of our convertible notes due on [i] April 1, 2019 and (ii) the maturity date of such note, the exercise price exceeds 85% of the lowest volume weighted average price of our Common Stock during the five consecutive trading day period ending on, and including, such date, the exercise price will be reset to such lower price.

At the preferred conversion price of $5.50 and full exercise of the warrants, we should expect 1,018,182 shares to be issued (2,800 x 181.8181 each for warrants and preferred shares). The company has disclosed that at the lowest possible conversion price of 1.10, 3,054,545 shares could be issued (1,000/1.10 x 2,800 = 2,545,455 plus the warrants exercised at $5.50). This assumes that the warrant exercise price doesn't get reset, but that issue won't arise until after the convertible notes are dealt with.

Let's take a look at RGSE's price history:

Isn't it funny that in the days leading up to September 26 when conversion really started to pick up, that the stock price has walked down from over $6 to under $2 on very light volume before moving up this week? It looks as though someone is toying with the stock price. First, to get as low of a conversion rate (whether voluntary or forced through the mandatory conversion clause) as possible, which looks to be around $2. Second, to be able to sell at a nice profit by pushing the stock price back to where it was at the start of the month, but on much higher volume to ensure that the converted shares are absorbed by the market. At least the conversions aren't happening at the floor rate so shareholders can expect less than 3 million shares in dilution.

What do you think will happen once all the preferred shares are converted and the profit seekers behind the deal lose interest in keeping RGSE inflated? Will the stock tank to new lows on decreased volume? Improved company performance could always turn it around; however, that doesn't seem to be in the works for RGSE in the near term. The company's income statement shows revenue in steep decline with deep net losses:

If there was any doubt that RGSE is headed down, the final nail in the coffin would be the conversion of the $10 million in notes, which the company openly admits that it expects it to happen starting October 1, as early as next week. The conversion terms of the notes are as follows:

The Notes are convertible at any time, at the option of the holders, into shares of Common Stock at the lower of a fixed and floating conversion price. The initial fixed conversion price is $0.7941 per share, subject to adjustment for stock splits and similar events. The floating conversion price is equal to the lowest of [i] 85% of the arithmetic average of the five lowest volume-weighted average prices of the Common Stock during the 20 consecutive trading day period ending on the trading day immediately preceding the delivery of the applicable conversion notice by such holder of Notes, [ii] 85% of the volume-weighted average price of the Common Stock on the trading day immediately preceding the delivery of the applicable conversion notice by such holder of Notes, and [iii] 85% of the volume-weighted average price of the Common Stock on the trading day of the delivery of the applicable conversion notice by such holder of Notes.

The fixed conversion price after adjusting for the 1-for-20 reverse split in June is $15.88 so that will not factor into the equation. It looks like clause [i] results in the lowest floating conversion price at this time, with the five trading days between September 19 and September 23 resulting in a price of around $2. 85% of that is $1.70. $10 million worth of convertible notes at $1.70 results in 5.9 million shares being issued to the noteholders. That results in immediate selling pressure as the noteholders could achieve in excess of a 100% return by dumping their shares down to $3.40. If you were in their position and had the opportunity to take an easy double on a money-losing company with weak financials, would you not take it? So expect a lot of selling pressure on RGSE next week.

However, clause [ii] and [iii] provide the noteholders an incentive to short RGSE into oblivion. The noteholders are expected to start converting next week, but don't HAVE to convert. With clause [i], that allows them a safety net. The noteholders can freely short up to 5.9 million shares with absolutely no fear of repercussions. Should the stock price rise to, say, $20 on a short squeeze, they are no worse for wear as they can cover by converting the notes at around $1.70 and close the position.

However, if the stock slides downward, they have an incentive to short, and short it mercilessly. As day traders lose interest, existing longs start to sell and short selling picks up, the stock price might dip under $1.70. Let's say it drops to $1. The new floating conversion price using either clause [ii] or clause [iii] is $0.85 and the noteholders can now exchange $10 million for 11.8 million shares. Instead of making profits by shorting 5.9 million shares and covering with converted notes at $1.70, they stand to make even greater profits by shorting 11.8 million shares and covering with converted shares at $0.85. If they can convert at $0.50, that's 20 million shares. I think people can see where this is headed. As far as I can tell, there is no floor with respect to how low the floating rate can go.

Clause [i] always provides a safety net from short squeezes so that noteholders can short with a fair amount of confidence before deciding to convert and cover. Let's say that the noteholders successfully short RGSE down to 50 cents for a week next month. If there's a short squeeze to $1 or $2, there is nothing for them to worry about as the floating rate is still only $0.50.

RGSE is a perfect storm of preferred share dilution, convertible notes providing an incentive for noteholders to mercilessly short it and a company with weak financials that doesn't appear to have any positive near-term catalysts. RGSE looks like it will continue to need financing, usually in this toxic form. Stay away from this one unless you want to lose almost your entire investment in a relatively short time frame.

Disclosure: I/we 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.

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