It's been almost a year and a half since Mako Research fully and completely debunked every aspect of the Cellceutix (CTIX) story. CTIX shares at the time were trading near $2.50 and have fallen dramatically since then, currently languishing near a dollar on very low and decreasing volume. Since that time, nothing in our original report has been refuted. Astoundingly, however, CTIX continues to trade at an unsustainable market capitalization of $145 million for, as far as we can tell, essentially nothing. This report provides an update on the short case for CTIX, a financial analysis of the liquidity crunch CTIX faces now, and also includes highly relevant and concerning new information about CTIX's financing partners that recently came to light. Lastly, we revisit our valuation model for CTIX and show why the stock remains a compelling short even at the current "low" share price as CTIX faces an imminent liquidity crisis which we believe may finally result in the bankruptcy of CTIX, just like Leo Ehrlich's prior company StatSure Diagnostic Systems that went to ~$0.
Cellceutix "Death Spiral" Cash Crunch Underway and Updated Valuation: Downgrading Price Target to Zero
In our original report, we had this to say about CTIX's valuation:
I value shares of Cellceutix at $0.09 in a best-case scenario, which is 96% lower than the current price, and recommend that investors avoid this company entirely. It's clear to me that Cellceutix is very likely to end up as a complete wipeout for shareholders over time, and stands to continue declining significantly if we experience more near-term market volatility.
Our assessment of the value of CTIX was heavily dependent on the company's cash balance, its only meaningful asset to speak of, in our view. This cash balance has continued to decline to the point where near-term bankruptcy is now a real risk and CTIX has little hope of financing the expensive trials it touts without massive dilution, if the company can raise the necessary equity at all.
As a result, CTIX's only financing options available now is the Aspire Capital equity line, which puts the company into what is commonly known as a "death spiral" - in a worst-case outcome, this could result in CTIX insolvency and wipeout for equity holders. Even more importantly, by our estimates, given increasing delays in CTIX trial process and continued cash burn, the Aspire equity deal itself is also insufficient to keep CTIX from functional insolvency.
We will explain why the cash on hand appears insufficient, the multiple ways in which the Aspire Capital equity line can become instantly frozen, which would render CTIX insolvent virtually overnight, and how CTIX's reliance on this equity line of financing has put it in a "death spiral" position that could wipe out shareholders.
Based on CTIX's own SEC filings, we learned that the Aspire Capital equity line has limitations and could be frozen instantly if certain circumstances occur.
To start with, if CTIX is halted by the SEC or Principal Market, then the Aspire Capital agreement is frozen, which would mean certain bankruptcy:
"[T]rading in the Common Stock shall not have been within the last 365 days suspended by the SEC or the Principal Market"
Furthermore, if CTIX stock trades below $0.25, there is a floor price and Aspire Capital is then also no longer obligated to be involved with CTIX or provide any funding.
"The Company and the Buyer shall not effect any sales under this Agreement on any Purchase Date where the Closing Sale Price is less than the Floor Price. "Floor Price" means $0.25 per share"
In this situation, CTIX will also likely suddenly go bankrupt. While $0.25 per share may seem low, it is important to note that I estimate the median market cap of Aspire's current public holdings at $17.7m as most Aspire capital companies are disasters. Further, as we will see below, the Aspire deal is likely to put significant pressure on CTIX shares. Should CTIX receive a $17.7m market cap, consistent with Aspire's other companies, with the current 125m shares outstanding, this would result in a valuation of $0.1416 per share, well below the $0.25 Floor Price at which this financing agreement is frozen.
Lastly, we estimate the Aspire agreement is woefully insufficient to fund CTIX even if executed.
First, we can see that as of the September, 2016/9/30 balance sheet CTIX reported, we estimate the company only has ~$3.5m of cash net of the related party note and suffers from negative working capital ($6.17m of total current assets, including the cash minus $8.77m total current liabilities).
Source: Google Finance
This balance sheet is a sick puppy and the cash left is perilously low, which leaves no margin for error at CTIX, particularly in light of the company's ongoing operating cash burn, which is currently running over $2.6m per quarter and which is expected to accelerate if CTIX actually tries to ever complete its forecasted trials.
Source: Google Finance
CTIX itself has acknowledged its cash is low, and in September 2016, it forecasted it will need at least $19m over the next 12 months. We think this is clearly incorrect and too low as we explain below.
To be conservative, we will start with the old net cash number of $3.5m. Then, if we go back to past years of CTIX before the currently expanded purisol and other later stage and more expensive trials, we can see CTIX was burning an average of $2.37m per quarter excluding any capex or cash spent on infrastructure. We will conservatively round this down in CTIX's favor to $2m per quarter since it was probably spending a little each quarter previously on random small animal studies and other similar work. This means over the next 12 months, CTIX is estimated to burn $8m just for operations.
To show why CTIX will likely run out of cash and become insolvent, we start with the ~$3.5m of net cash CTIX had left as of the last financial statement three months ago 2016/9/30 and my estimate that CTIX will continue to lose at least $2.0m per quarter for another year (or ~$8m of annual cash burn) just in operations to keep the lights on independent of its expensive trials announced. Then if we add the $15m more cash it estimates it will burn for near-term trials, that puts CTIX at estimated total cash burn of $23m (15 + 8) over the next 12 months. Its past net cash balance of $3.5m plus the $19m Aspire deal only amounts to $22.5m. This means that within the next 12 months, assuming cash burn does not ramp up (which we expect it will if CTIX hopes to actually do anything new) CTIX will become functionally insolvent as its net cash position weakens and the liabilities then have the senior claim on any equity value as cash burn continues. This scenario is likely to occur even if it uses 100% of the Aspire deal, which is a questionable and generous assumption itself.
Note that CTIX has no revenue to speak of so there is no other cash coming into the company unless CTIX can raise equity. The way I see it, anyway you cut it, significant dilution and cash burn is coming to CTIX in the immediate future.
Furthermore, with the stock so low the, only remaining financing option is a "death spiral" type financing with Aspire capital which could be frozen at any time if some very possible outcomes occur, and even if it exhausts 100% of the Aspire capital line that is still not sufficient.
If CTIX stock continues its steady march lower on declining volumes, though, this type of financing can spiral out of control into theoretically infinite dilution or suddenly become impossible to use, potentially putting CTIX in a position of sudden bankruptcy, as previous companies with this type of financing have experienced. Let me explain:
The Aspire deal that CTIX agreed to is termed in "dollars raised" while that money will need to be raised by "number of shares" sold. The problem here occurs that the lower CTIX stock goes the more shares need to be sold to raise the same amount of money - this is simple math: if the share price declines, then to reach the same number of dollars raised, CTIX will need to issue a larger number of shares. Given that CTIX stock has already collapsed 75% off the latest high and now trades near $1, this is not a trivial concern. If CTIX stock were to continue declining as it has been, at a certain point the number of shares required to be sold to meet the dollar target CTIX seeks to raise would begin to expand exponentially. At that certain price point, share sales no longer become feasible for raising a substantial amount of equity and the company becomes backed into a corner of insolvency and bankruptcy. This is where the term "death spiral" comes from and it has happened to many other companies in the past.
This is the reason in my view that every one of Aspire Capital's current holdings I could find have been shareholder disasters and typically trade at tiny <$30m market caps, creating substantial shareholder losses.
Should CTIX not raise a tremendous amount of equity immediately, the company could face insolvency, similar to prior Platinum Partners efforts.
To value CTIX, we take this estimated net cash of ~$3.5m and divide by the company's fully diluted share count of 125.11m shares to reach a fair value estimate of $0.028 per share. Since this doesn't leave much for the bulls to play for, we simply round down to what we believe will be the inevitable trading price of CTIX and set a price target of $0.00.
The Platinum Partners Chronicles: Alleged Ponzi Scheme Financiers Arrested
In our original report, we detailed how CTIX was born through a financing agreement with the Nordlicht family. We outlined Cellceutix's deep and longstanding relationship with Nordlicht and his business partner Murray Huberfeld, both of whom have a dubious reputation for supporting extremely low-quality penny stocks that wipe out shareholders. Nearly a year after our original report, the hedge fund these two operated, Platinum Partners, went into receivership after it was alleged the firm is actually nothing more than a $1B+ Ponzi scheme, according to allegations from the United States government. Nordlicht and Huberfeld were both recently arrested and charged with fraud, facing hefty prison sentences if convicted. Pundits have begun to refer to Platinum as the greatest financial scandal since Bernie Madoff.
CTIX Financing Partners Mark Nordlicht (Left) and Murray Huberfeld (Right)
The implosion of Platinum Partners was well covered in the news but strangely was not mentioned at all by CTIX from what we can tell. I recommend you read the following links to form your own opinion of these key CTIX founding partners:
- Platinum Partners execs charged in $1B mini-Madoff fraud - USA Today
- U.S. charges Platinum Partners execs with $1 billion fraud - Reuters
- Several New York hedge funders have been arrested and charged with $1 billion fraud - Business Insider
- US charges hedge fund founder, others with $1 billion fraud - CNBC
These articles and others provide a shocking glimpse into the alleged house of cards that was Platinum Partners before its sudden demise. We won't rehash all the details here but suffice to say they would make an excellent script for the next James Bond movie, and that if that movie is made, we hope to see a Sean Connery cameo appearance. In Bond-esque fashion, recently revealed details include Platinum founders' plans to flee the country, as well as hilarious quotes from internal fund documents that hint at the founders' state of mind as Platinum faced a rapidly worsening liquidity situation and the alleged Ponzi scheme began to quickly unwind. One internal document detailed written correspondence between Platinum executives where they claimed, "It's Hail Mary time". Sadly, the pass was incomplete.
The market has missed the deep ties between the Platinum Founders and Cellceutix
Those wanting a refresher on this content can refer to our original report here which explains how crucial Platinum Partners, Huberfeld and Nordlicht are to CTIX.
We highlight a few specific bullet points:
CTIX was born through a financing arrangement with the Nordlicht family and pursued a number of deals with Huberfeld. Without these deals with Nordlicht, Huberfeld and Platinum I think it is clear CTIX would not exist in its current form or at all. This makes these people key partners of CTIX which CTIX has relied on heavily in the past. Nordlicht and Huberfeld now face what appears to be overwhelming allegations that Platinum Partners was a Ponzi scheme, and that Platinum allegedly was involved with dubious companies engaged in their own fraud. Amazingly, this was not the first alleged Ponzi scheme involvement for Nordlicht. Remember that Huberfeld and Nordlicht (and both their wives) were named in the scathing lawsuit surrounding the $1.2B Scott Rothstein Ponzi Scheme, for which Scott Rothstein is serving A 50-year prison sentence. Murray Huberfield was arrested several months ago. In our original report, we detailed Huberfeld's so called "knack for finding shady deals" and discussed the investments he made in CTIX. Huberfeld was originally part of an alleged "conspiracy to commit securities fraud by filing false documents." We believe CTIX has filed SEC documents that, from what we can tell, contain blatantly false information, which would be illegal. Specifically, we remind readers that CTIX executives signed SEC documents containing false biographical information for insider Krishna Menon which claimed that Menon received his PhD from Harvard. At least one of Platinum's portfolio companies (so far) was itself accused of fraud and went bankrupt.
Platinum Partners: Fraudception?
Many readers will no doubt be familiar with the award-winning movie Inception directed by Christopher Nolan and staring Leonardo DiCaprio. The plot of the movie is about a team of "extractors" who preform corporate espionage through a shared dream world. As the movie progresses, the protagonists travel through the subconscious of their targets by entering a dream within a dream. This process is called Inception.
While all of the bullet points above are unquestionably relevant and concerning for investors holding or considering purchasing CTIX shares, it is this last point that we find particularly concerning - that some of Platinum's portfolio companies were allegedly committing fraud themselves, independent of Platinum being an alleged "Ponzi scheme". If this proves true, it would not surprise us: low-quality stocks tend to attract low quality financing partners.
Specifically, Platinum portfolio company, Black Elk Energy, was itself the subject of fraud allegations before declaring bankruptcy, and at least one Black Elk executive allegedly helped Platinum illegally take assets owed to bondholders:
"The founder of New York hedge fund Platinum Partners and seven executives and affiliates were charged on Monday with engaging in a $1 billion securities fraud scheme wherein they allegedly inflated the value of investments and duped bondholders of defunct offshore driller Black Elk. According to Brooklyn's federal prosecutor, Platinum founder Mark Nordlicht and his colleagues had lied to investors since 2012 about the health of Platinum's portfolio company Black Elk Energy Offshore Operations LLC. Prosecutors said that as the investment faltered, Platinum relied on insider loans and new sales to repay increasingly worried investors. And in 2014, ex-Black Elk CEO Jeffrey Shulse allegedly helped Platinum usurp assets owed to bondholders."
If the evidence proves that Black Elk itself was a fraudulent endeavor as distinct from the Ponzi scheme fraud alleged to have occurred at Platinum (and the Black Elk case seems pretty clear at least to us), it would open up a pandora's box among Platinum's portfolio companies and companies that previously engaged in financing deals with the Platinum founders.
We see many similarities between Black Elk, and other Platinum companies like CTIX including confusing related party transactions and financial vulnerability. To see how these typically end up and now for everyone's favorite part (we strive to give the people what they want), wipeout charts of companies that received the "benefit" of Platinum's dubious financing efforts:
Source: Capital IQ
At this point, we can only speculate at how this will play out but it's hard to imagine that this ends well for Cellceutix. We know that CTIX has engaged in a host of opaque and self-enriching related party transactions. And we know the company was born out of a financing deal with the founders of Platinum. But just how deep does the CTIX rabbit hole go? We support and welcome a full SEC investigation into these and other matters at Cellceutix, which we believe is more timely now than ever before as the full impact of the Platinum scandal is just beginning to play out.
How to Play
We understand that some investors are reluctant to short sell penny stocks because these stocks can be volatile and potentially subject to large price swings. This is not an unreasonable point of view. However, given the overwhelming amount of value destruction that has occurred in prior Platinum Partners efforts, as well as at prior Ehrlich and Menon stocks, we submit two ways to capitalize on a likely CTIX convergence to fair value.
Method 1: Short CTIX in small enough size that you are insulated from the volatility and then simply wait
This is our preferred method. CTIX has an astoundingly high market capitalization for what it is, which provides a margin of safety to long-term short sellers who are not concerned about daily price volatility. Those inclined to pursue a short sale in CTIX stock may wish to do so in very small size, perhaps 20 to 50 basis points of fund capital. In the event that CTIX stock appreciates significantly - say, to $2 a share, which would be nearly a $300 million market cap (!) - it would be easy to simply double the bet and size this up to a core short position. In fact, that might even be a preferable outcome over the long-term because the short would have a tremendous margin of safety at a $300 million valuation.
One thing many investors fail to understand about Mako Research is that we take relatively small short positions - this allows us the luxury of waiting indefinitely for a convergence to fair value. We never, ever have to cover. Small positions also allow us to aggressively add to any positions that temporarily go up. All of which is to say this: We're going to be here. If one of our shorts goes up, that's great - now it's an even better risk/reward and we should add to our position. This approach has proven very effective over time and we recommend other short sellers consider the merits of small position sizing, particularly those similar to us who have very long duration capital commitments from their investors and the patient dispositions to capitalize on irrationally priced stocks such as Cellceutix.
Method 2: Wait for the next Ehrlich and Menon "special" to incubate
Many market participants may be unaware that yet another Ehrlich and Menon stock trades on the pink sheets: Nanoantibiotics (OTCQB:BIVI). According to Reuters, the company is run by Elliot Ehrlich and Rajah Menon, who we believe are likely related to Leo Ehrlich and Krishna Menon of Cellceutix. Although clearly shorting a $0.30 stock is problematic, we recommend investors keep a close eye on BIVI and revisit it in the event the shares ever trade to a higher price level. Mako Research certainly plans to do so.
Disclosure: I am/we are short CTIX.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
Editor's Note: This article covers one or more stocks 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.