5 Overvalued Short Candidates

by: Edward Schneider, CFA

The following five stocks have enterprise values of more than $175M, generate nominal revenues, lose a lot of money, and have broken business models. Fundamentally, they should go to zero.

Name Ticker Price Ent Val Revs EV/Revs Net Loss
Viggle VGGL.PK $4.60 $348M $0.6M 626X -$88.4M
TherapeuticsMD TXMD.OB $3.25 $324M $2.3M 139X -$25.4M
Careview CRVW.OB $1.35 $177M $0.9M 194X -$19.7M
SunGame SGMZ.OB $4.20 $747M $0.01M 57461X -$0.7M
Parabel PABL.OB $1.05 $187M $0.5M 374X -$23.0M

Viggle (VGGL.PK), formerly known as Function {X} (FNCX), is an interactive media company with nominal revenues, losing $27M in the last quarter alone, investors filing to sell over 7M shares, an employee leaving amidst a sexual harassment suit against the founder and the company (which was just settled according to a June 27th 8-K filing), the CEO recently leaving the company, but still maintaining a current market cap of $352M. Function {X} unsuccessfully tried other media businesses before embarking on Viggle over the past year.

Viggle is a loyalty program that rewards its users for watching television. Users receive points for interacting with their favorite TV shows, and can then redeem these points for items such as movie tickets and music. While the concept has attracted some users, there are a few problems. Viggle currently does not have any agreements with advertisers or vendors whereby the advertisers or vendors issue rewards when the users redeem their points. So the company is currently burning more cash to purchase gift cards from vendors so that users can redeem their points. Secondly, the company is running out of money again, and cannot continue much longer without incurring substantial debt or share dilution. Founder and majority owner, Robert Sillerman, just lent the company $2.5M at 9%, as part of a $10M line of credit (and even that will not last more than 3 to 4 months at Viggle's current cash burn rate). Finally, in case Viggle manages to survive at a lower-valuation, there is an egregious compensation scheme where Robert Sillerman receives $85M in stock compensation and a change-of-control pay-out of $64.4M inclusive of gross-up payments, according to a June 8th S-1/A filing.

Viggle was hyped to the market reaching a ridiculous peak-valuation of $1.4B in January, and has been falling ever since. Once these OTCBB/Pink Sheets flame-out, they usually go to zero. Given the huge overvaluation that still exists today, lack of revenues, high cash burn, dysfunctional business model, questionable management practices/departures, selling shareholders, etc. it is very likely that Viggle will spiral towards zero as well.

TherapeuticsMD (NYSEMKT:TXMD) has a volatile recent history. From mid-2009 to mid-2010, the company was known as America's Minority Health Network (AMHN) operating a digital signage system for waiting rooms. From mid-2010 to mid-2011, AMHN was disposed and the company did a reverse takeover (RTO) of Spectrum Health Networks under a different business model. As Spectrum also failed miserably, the company had another RTO of VitaMedMD in the second half of 2011. The company changed its name to TherapeuticsMD to reflect the company's new focus. The company currently provides vitamins and nutritional supplements for women. VitaMed itself only launched its first product in 2009, and has a long way to go before getting even close to revenue break-even.

TherapeuticsMD is in a low-margin business of distributing generic nutritional supplements. Life's DHA, one of its main products, is sourced by DSM's Martek Bioscience division, which is where the value-creation resides (even if it is now going off patent). The difficulty of this business model is evidenced by the fact that to generate a 49% y-o-y increase in Q1 revenues to a mere $722k required a 3x jump in SG&A expense to $2.8M. Distribution is only in 10 states and management stated it needs to expand substantially. Even if the company sticks to the business plan this time and somehow succeeds in its expensive mandate to achieve much wider geographical coverage, distribution companies normally trade at single-digit P/E multiples and at a fraction of revenues. So, how can TherapeuticsMD support a market cap of $320M, trading at 139x revenues while losing $25M in the last twelve months!

More worrying than even this outlandish valuation is the extreme two-tier pricing between insider prices and the quoted price retail investors pay. According to the SC13D filed July 20th, Steven Johnson (President of Careview Communications) through his 100%-owned investment vehicle, converted a $105k promissory note into 10M shares gross ($0.0105 per share), converted part of another promissory note at $0.038 per share. Furthermore, as part of a debt extinguishment agreement which cost the company $10M in Q1, Mr. Johnson converted debt into millions of shares at $0.38 per share. Thus, certain investors pay $0.01 to $0.38, while retail investors had to pay between $1 and $3.40 (mostly weighted towards the $3.40) since the latest RTO became effective in Q4 2011.

The icing on the cake is that after Mr. Johnson extracted his ton of flesh out of the company, management was desperate enough to borrow another $1M (6% interest) from him last month, with a cashless warrant exercise at $2 for 3M shares (plus another 0.5M shares at $3). Thus, Mr. Johnson can demand that the company pay him the difference between the market price and the warrant exercise price, which today would be a whopping $3.875M on a $1M loan. Even worse, the company recently approved the cashless exercise for all holders of the company's options. What a great source of future cash outflows from the company's coffers.

According to the above filing, Steven Johnson beneficially owns 9.4M shares (or 9.5% of fully-diluted shares outstanding) and sold/transferred 6.5M of the $0.0105 shares to unnamed parties. Recently, Tommy Thompson (Chairman of Careview, and now Chairman of TherapeuticsMD) and Samuel Greco (CEO of Careview, and now Director of TherapeuticsMD) joined the Board of TherapeuticsMD. Who is watching the store back at Careview?

Careview Communications (OTCQB:CRVW) is a company that I have written about previously (see our last in-depth article as well as this more recent article). One of my readers recently sent me a past government Cease and Desist Order against Steven Johnson for overpromoting his previous company to investors (see here). Moreover, certain Careview Board members' benefits from revocation of subscription rights, among other practices, wreak of bad corporate governance. The bottom line is if Careview Communications or TherapeuticsMD by some miracle do create any fundamental value, it is unlikely this value will be equally shared with outside investors.

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. A service business model plans to charge a monthly service fee of $60 per bed to the hospital and $13 per day to the patient plus a transaction fee. In the current health care cost crackdown, it is hard to imagine many hospitals paying this high fee for such a service. According to the latest 10-Q, a major customer, though its joint venture with Rockwell Holdings, cancelled its service this year. Thus, it is not surprising that Careview generated only $0.9M in last twelve month's sales, despite the expensive efforts of the company's staff and directors. Careview had a net loss of $20M over the last twelve months.

Careview stock has fallen from $2.34 in our initial article in April 2010 to $1.35 currently. But the stock still maintains a bloated enterprise value of $177M. This valuation requires Careview to be a profitable $100M+ revenue company, not a money-losing, sub-$10M revenue firm. The steady price decline over the last two years should accelerate. The actual rate of that decline will depend on how much longer Careview's backers will try to support a sinking ship.

SunGame Corporation (OTC:SGMZ) sports a sky-high market cap of $746M, with only $13k in revenues and a net loss of $0.7M over the last twelve months. SunGame supposedly provides virtual world communities and online games. If you go to its web site, there is nothing there except a game application form. The company lists six employees. The Outlook section of the latest 10Q gives an especially strong warning stating "We have been grossly undercapitalized in 2012 and unable to raise a significant amount of capital, other than receiving $167,627 in advances from our majority shareholder... our independent registered accounting firm has expressed substantial doubt as to our ability to continue as a going concern." The majority owner and CEO, Neil Chadran, is now owed over $1M by SunGame.

In an event that could only occur in the OTCBB world, SGMZ reached a market cap of $4B in May (or $23 per share). The stock subsequently fell back to $4.20 currently, but remains extremely overvalued. This is a difficult short to locate, but if you can find the shares, short it.

Parabel (OTC:PABL), previously known as Petroalgae (PALG.PK), is a company we have written about before (see here). Since publishing this article in June 2011, Parabel shares declined 94% from $16.50 to $1.05 today. So why do we continue to short these shares at current price levels? The market cap may no longer be $1.8B, but is still $112M. Moreover, net debt has increased to $74M, making bankruptcy all the more likely.

In the past year, management shifted focus from an algae-to-oil biofuel strategy to converting duckweed to animal feed. The company still only has two trials occurring worldwide, producing just $0.5M in non-cash revenue (via recognizing previously deferred license revenue) over the last twelve months, while losing $23M over that period. Total debt now stands at $81M, the bulk of which came due on June 30, 2012. The debt-holder is also the majority shareholder - Valens Capital Management. Valens has been valiantly supporting this very expensive, long-term project since 2008. The question is how long will it take for Valens to finally pull the plug?

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Additional disclosure: I am short VGGL.PK, TXMD.OB, CRVW.OB, SGMZ.OB, PABL.PK