Use & Abuse Of The IPO

How strong generally are companies having an initial public offering?

Consider the week of November 3^rd when 10 companies filed with the SEC signaling their intentions to IPO. Two have no forms available for review through SEC’s EDGAR, thus no visibility and no possibility for listing on any exchange. Either they’ve been pulled back, or they’ll show up on the OTC Bulletin Board or the Pink Sheets, neither of which is too particular about SEC filings. The first is ICOS Vision Systems Corp., a Belgian company which manufactures equipment for the semiconductor industry; it wants to round up $29.9 million. The other is Moores Retail Group, a Canadian chain of men’s clothing stores; it hopes to lasso in a whopping $73.8 million. These two companies are to be avoided like the plague.

Among the remaining 8 companies 1 or 2 others will be listed on the OTC Bulletin Board, the absolute bottom rung for those trying to extract money from the public. Within its dim recesses where accountability is limited and the trading, thin, are found companies with barely the beginnings of a track record. Usually their revenues are inconsequential, their income nonexistent, their capitalization by the market typically under $30 million, and they can be found promoting an untested product or service with untested management. They shuffle onto the OTC Bulletin Board, because they haven’t met the minimal requirements for listing as even a Nasdaq SmallCap stock.

Gulf Coast Bancorp, Inc.
Gulf Coast Bancorp, Inc. is one of the companies going onto the OTC Bulletin Board. It’s seeking $10 million on a 1 million share float to start a bank in Florida. It will use part of the money to buy land and another part to construct the bank building. While construction is underway it’ll fling open the doors to a "leased modular temporary facility," and start doing business. That, at any rate, is the plan. Currently there is no bank. There are no employees. There is no revenue on which they must rely to stanch their startup losses. There are no assurances it will happen. One must admire the entrepreneurial spirit required to start a bank from scratch and hope that it does well in the years to come. The cautious investor, however, should veer wide of any company at such an incipient stage of its development.

Castle Group, Inc.
Castle Group, Inc., formed in November ’93, is "in the business of hotel and resort management, sales and marketing" in Hawaii. Its contracts, a good percentage of which were gained through acquisition, cover over 3000 rooms, and its revenues for the last year reached $6.2 million. The company already appears on the OTC Bulletin Board and has now made an application to get upgraded to the "Nasdaq National Market System" where it will be taken more seriously by investors. By this they probably mean the Nasdaq SmallCaps, since their financials don’t meet the requirements for a full listing on the Nasdaq market.

The company will register 1.6 million shares with a selling price under $3 per share and try to get $4 million. If they fail at that amount, they’ll probably take what they can get. The underwriters are pursuing this task on a "best effort" basis, which is tentative on their part. It means they have doubts about their ability to get all the stock subscribed, and therefore they refuse to assume the risk of buying it from the company, as is always done with stronger issues.

The company will confront several obstacles in its quest for public funding. At bottom, hotel management is not an area of major interest to investors. It doesn’t seem to have much of a customer base, there isn’t a lot of money flowing within the industry, certainly not scores of billions, it doesn’t have a compelling story to tell, and the profit margins are at best average, which means mediocre earnings per share, if that. Although they may be excellent in what they do, quality service alone will not stir market interest. They must bring to the game something new, and they don’t.

Galacticomm Technologies, Inc.
Galacticomm Technologies, Inc. is a software company of 33 employees, which incorporated in December 1995. Their central product is an "integrated suite of five communications programs (E-mail, Polls and Questionnaires, Newsgroups, Shared File Libraries and Chat)," all focused on Internet usage. Unfortunately, aside from email the other 4 applications don’t have widespread utility. Worse, they’re up against some very major competitors in all these areas, such as Microsoft, Lotus, and Novell.

Since their inception they’ve been very busy raising money through the sale of stock, and there’s no end in sight. Already 4.4 million shares are outstanding, and with this offering, which is incomprehensible in its financial complexity, another 5.8 million shares will be registered. Based on their assumption of a $3.75 stock price they expect to raise through purchase warrants, underlying warrants, and bridge warrants, not to mention through units and representative unit purchase options, and most important, through the infinite stupidity of investors as much as $21.7 million. Not all the money will find its way into the coffers of the company, however. A goodly portion will be passed on to the numerous selling stockholders who have funded the company to date. The four principals apparently have no compunction about raking it in either. Even though the company’s total losses from ‘95 to mid ‘97 amounted to $2.1 million on a paltry $3.5 million in revenue, the principals too seem poised to sell an undetermined number of shares; the opportunity is just too good to miss. After the vultures have left, the company will end up with $6.9 million, perhaps even $10 million if the stock manages to sustain its value through the onslaught of dilution and growing debt.

The company has a tough row to hoe given that it depends on a product of unproved broad-scale interest in an industry of congenital weakness against competitors who are likely to crush them without even realizing they were there. This hasn’t deterred the CEO and president from having a good time. Despite its two year record of severe losses they’ve shown no hesitation in awarding themselves a starting annual salary, on the completion of the IPO, of $175,000 to be increased 10% a year for each future year of service and a $600 a month car allowance and a life insurance policy. Plus a prodigious quantity of stock options.

Galacticomm is trying to get listed on the Nasdaq SmallCap Market. Investors should note its name and give it a wide berth.

Comtelco International, Inc.
Comtelco International, Inc. is a Delaware company only in the loosest sense. Actually, they’re perched on Hechtackerstrasse in the no doubt picturesque village of St. Gallen, Switzerland. And you’ll have to go to Poland or Slovakia to find their products, because they don’t sell them here. They make a software system that monitors telephone usage and another system that does PC-based telephone dialing and faxing. Suffice to say such systems have been around for years and are quite thoroughly matured. Competitors trample over each other in an effort to make a sale and stay alive.

The company’s filial ties to the U.S. extend to the money it can suck from the Nasdaq SmallCap Market. In an exercise of European restraint it wants to shovel in only $10 million on this first go. None of it will ever reach the company, though. Not a solitary red cent. The $10 million is to get distributed among all the selling stockholders who should pad away with contented looks on their faces. That the company has hardly more than an 18-month track record, and within this frame of time has accumulated losses of nearly $1 million against minuscule revenues of $1.4 million, these sad figures are a secondary matter. It will struggle along until they come back to the trough and try to squeeze out more from the confused or unsuspecting or unconscious American investor. One gasps with incredulity at the gall.

C2i Solutions, Inc.
C2i Solutions, Inc. is a new company trying to make hay from the Year 2000 computer problem. It has been pointed out since the mid ‘80s that older computers use 2 digits to identify the year; for example, 97 means 1997. The problem arises when the year rolls from 1999 to 2000. The 2 digits now will contain 00, which to many computers will be interpreted as 1900, not 2000. Alarmists have predicted societal chaos if this were to occur. Vast governmental bureaucracies, like Social Security and the IRS in the view of the alarmist, will be dealt a blow to the fidelity of their operations. Some have claimed the damage done to companies and the government could amount to a trillion dollars unless the problem gets fixed and the beast expunged computer by computer. Calmer voices perceive the Year 2000 problem mainly as marketing hype generated over the last couple of years. Certainly it’s an issue. Companies with older computers are aware of it. The problem is being addressed. Planet Earth will stay in orbit.

Any concerns about its underlying validity has not deterred C2i Solutions with its 8 intrepid employees from trying to haul in as much money as possible from the Nasdaq SmallCap Market. They intend to issue a million shares of common stock and a million warrants to snag a cool $6 million. On what basis they justify a $6 stock price and expect such an infusion of money from the public is unclear.

The entire history of the company dates back a mere 14 months. It was formed as an LLC in September ’96 and reorganized as a Delaware corporation in September ’97. From its inception until June 30 of ’97 it made a total of $46,000. There’s a good reason for such limited revenues—nobody cares. The company is attempting to create an industry where none exists, or if it exists, will be finished in 3 years. The big corporations, which need modifications made to their software, will use major players like EDS or Ernst & Young. Those companies have the technical talent and the resources to address the problem on a large scale with exactitude. Midsized companies generally will do the job themselves, and small companies won’t have the problem at all.

At the same time they were putting together their $46,000 in revenue they were developing losses of $1.4 million, which they now want to foist onto the unsuspecting investor. How can so few people incur such enormous losses? There was "a non-recurring charge of approximately $1.2 million, as a result of sales of equity securities to key employees at less than deemed value for financial statement purposes." Aside from the impenetrability of that statement it’s clear the key employees have positioned themselves to reap the riches of the IPO.

The company acknowledges that "it will incur operating losses over at least the next year," and they forewarn the investor they’ll soon be back at the public trough. Their boldness in promoting a company so weak and so thin tends to leave one astonished, like a rabbit transfixed by headlights. Perhaps it’s a strategy with some potential.

American Medical Providers, Inc.
American Medical Providers, Inc. has been formed to address the needs of the podiatrist, that is, the foot doctor. There are 10,700 podiatrists in the country most of whom are sole proprietors working out of their own separate offices and not affiliated with clinics. This company will provide "management, marketing, expertise, equipment and facilities often unavailable to podiatrists with small practices." Furthermore, they will provide ancillary services on a regional basis to include "ambulatory surgical centers, anesthesiology, pathology, radiology, MRIs, EKGs, laboratory work, pharmacy, physical history and exams, physical therapy, orthotics, pain management, home care, diabetic wound care, specialty shoes and other retail products."

The company is taking an approach followed by hospitals with managed care. They believe that if many of the standard functions are centralized, including the purchasing of supplies and the performance of tests, then costs can be brought down, the overall management of the practice can be made more efficient, more capabilities can be provided to the doctors than they normally would have, and patient care ultimately would improve.

To this end the company is seeking $30 million. Of this amount $16 million will go to bring into their fold 45 practices consisting of 64 doctors who have 95 offices scattered among 57 different cities. These practices will be bound to the company in many of the ways mentioned above. It will then attempt to build on this core.

To its credit the plan of the company appears to have been conceptualized in depth. It’s clear the entrepreneur who is putting this effort together knows how to raise funds and how to implement. Still, there are several reasons why the investor should avoid this company.

It was formed in August, 1996 but won’t begin operation until the completion of the offering. Without even a single day of any track record it’s impossible to make an assessment of the company’s true viability. We don’t know whether its gross profit margins are 70% or 20%. We have no idea when or whether it can cover its costs. We can’t make a judgment about its growth rate and from that draw any conclusions about future revenues or earnings. Although it has described much that it intends to do, such as the ancillary services, many of these efforts will take considerable funds and time to piece together. Nobody knows the economic feasibility in moving forward on these activities. And nobody can say whether the company will have the management strength to make any of this a success. Finally, the stock market, which is never enthused about management services, will likely show a tepid response to the company. There are too many unknowns, such as the willingness of the customer base, which itself seems small, to align itself with the approach. In this highly preliminary stage where the idea remains very much unproved, investors will and should stay away.

Triumph Fuels Corp.
Triumph Fuels Corp. is a company with history, with revenue, and even with a bit of income. The company operates in the "wholesale distribution and marketing of refined petroleum products including gasoline, diesel fuel and lubricants." That is, they haul the petroleum by truck from the refinery to the gas stations. They are among the 10,000 independent petroleum distributors in the U.S., most of whom own and operate a single truck and use it within a specific region.

In 1995 it generated $93.6 million and by ’97 had pushed its revenues to $135.4 million mainly because of several acquisitions. Its strategy in this highly fragmented industry is to continue its growth through consolidation. It will enter a region of the country and attempt to acquire a leading distributor. If successful, it then has a strong position from which to pick up smaller operations.

Although the strategy has pumped the company’s revenues with 45% growth over the last 3 years there has been no corresponding increase in earnings. This is one of the fundamental concerns which will impose a drag on stock price. Their gross profit margins are razor thin, hardly more than 8.5%. Thin margins are a nature of the business, so there can be little expectation of improvement beyond a few points. For this company it has resulted in net profit margins just a hair above breakeven, from 0.7% in ’95 to 0.3% in ’97 giving them no room for error. They will likely be implementing their strategy of consolidation through the sale of equity. If so, we can expect a dilution of earnings and a burden placed on stock price. The companies they acquire cannot be expected to have margins much better than their own, so the mere act of revenue growth may not have a positive influence on the stock. Indeed, the cost of consolidation, the added overhead required to run a far-flung operation, and the need to increase their marketing and sales effort could further erode the margins. The cautious investor should monitor this opportunity from afar.

Dollar Thrifty Automotive Group
Finally, we come to Dollar Thrifty Automotive Group. Of the 10 companies, which filed with the SEC for the week of 11/3, this one alone deserves serious consideration from the investor.

The company, fully owned by the Chrysler Corporation, consists of two subsidiaries, Dollar Rent A Car Systems, Inc. and Thrifty Rent-A-Car System, Inc. Chrysler intends to divest itself completely of the operation by selling off all of its 22.5 million shares for $500 million. The stock will trade on the NYSE.

From ’94 through ’96 the company generated $2 billion in revenues. It has 833 locations across the U.S. and Canada and an established market presence. At the same time, it has taken an annual loss the total of which across those 3 years amounts to $198 million. Dollar Thrifty becomes the last major rental company to go public, and it’s doing so out of necessity. As they acknowledge, "The domestic vehicle rental industry is emerging from a period when rental rates, including those of Dollar, Thrifty and their franchisees, did not keep pace with rising fleet costs." They need an infusion of capital to sustain their current position against increased levels of competition. Major changes will have to be made to reinvigorate the company and move it toward serious earnings growth. It may be that independence from Chrysler is just the ticket. Deeper analysis is required to ferret out their potential for success.

Land Of Opportunity
So there you have it—a dismal picture indeed of 10 companies skulking after money. Six or 7 of the companies lapse well into the absurd in their reasons for seeking public funding, but they operate on a principal that works: People are born every day who are willing to invest in companies with no track record, no revenues, no income, no hope of survival, no useful product or service, no interest by the stock market, and no rhyme or reason except to enrich the selling stockholders who trot off praising the glories of American capitalism.