Briefing.com's response to EUO's "news"
Stock Brief
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Updated: 28-Dec-01
The Red Flags of Eurotech
Most investors don't partake of the development-stage, concept stocks that occasionally enjoy a day in the limelight. No doubt these investors occasionally marvel at the 100+% increases the shares of these stocks can record in a few hours. But along with those huge percentage rewards come huge risks. Most such stocks that emerge from obscurity to benefit from a hot momentum theme will eventually return to obscurity; sometimes quickly, sometimes over the course of months. Occasionally, one of these stocks will emerge for good and will have been a sound investment. To help in determining which stocks will face which outcomes, we take a closer look at the case of Eurotech (EUO 0.82).
EUO rallied 202% on Wednesday after issuing a press release which announced a BBC interview with the Eurotech CEO regarding the company's technology for detecting C-4 plastic explosives. Following the attempted bombing of the American Airlines flight from Miami to Paris, technology that could detect plastic explosives carried by passengers could indeed be quite profitable.
While no one can rule out that Eurotech might ultimately be quite successful in this business, there is a series of screaming red flags advising investor caution.
Executives From Unrelated Industries
It's always good to see that a company's executives have experience in the industry in which the company competes. In the Eurotech case, that is most certainly not the case, unless there is a link between poultry and nuclear waste that we're missing.
Eurotech defines itself as a leader in the development of emerging chemical and electronic technologies. For the past two years, its most prominently featured product has been EKOR, which the company claims is "a family of advanced materials for nuclear and hazardous waste containment." The company was formed in 1995 to "commercialize new, existing but previously unrecognized, and previously 'classified' technologies, with a particular emphasis on those developed by prominent research institutes and individual researchers in the former Soviet Union" and in particular from the I.V. Kurchatov Institute in Moscow.
Eurotech's Chairman is Chad Verdi, a 34-year old with this bio:
Worked in restaurants from the age of 15.
By 19, saved enough money to purchase an oceanfront condo and buy into a franchise business, TV Facts, a community-advertising circular.
In two years, he said his condo was worth twice as much as his purchase price. Soon, he was able to buy $25,000 worth of shares of the Coastal Foods, a wholesale foodservice company.
Verdi moved from being a minority owner to an equal partner. Later, he and his father bought out the other partners and gained control of the company.
He said he sold the company for several million dollars to concentrate on developing Eurotech.
He is also CEO of Premium Poultry and Coastal Sausage Company.
Unfulfilled Promise
A classic red flag is a company that consistently over-promises. Eurotech has been over-promising for years; always seeing revenues just ahead, though it still has yet to recognize any revenues from the sale of a product. The dated excerpts below are from the company's own press releases, with our follow-ups on the outcomes.
Jul 17, 1999: "Eurotech's hybrid non-isocyanate-based paint will undergo testing shortly at McPhee's prospective client's facilities. It is anticipated that after testing is complete, within 45 to 90 days, McPhee will be in a position to accept orders in excess of 50,000 gallons. Each 50,000-gallon order is in excess of $1 million."
No revenues have yet been recorded from this product.
Sep 27, 1999: "Following a letter of intent to apply the radiation-resistant EKOR material in nuclear waste and nuclear power projects, Eurotech and European representatives, and Euro-Asian Physical Society (EAPS) scientists met last week to finalize details of the agreements. The initial test demonstration of EKOR, which is a routine and essential process required by every nuclear country when introducing a new technology, is planned to commence in November. This period of several months will constitute the evaluation and licensing phase. Wider application of EKOR will commence immediately afterwards. The scope of the projects is expected to approach $100 million."
No revenues have yet been recorded from this product.
May 24, 2000: "Eurotech announced today that McPhee Environmental Supply headquartered in Phoenix, Arizona, has placed an order for $10 million for several of Eurotech's market-ready products."
No revenues have yet been recorded from these products.
Sep 20, 2000: "Early next year, the company will begin realizing revenue from the sale and application of EKOR™, its advanced composite for the containment of nuclear waste."
No revenues have yet been recorded from these product.
Dec 22, 2000: "Eurotech expects these efforts to generate contracts in the first quarter of 2001."
Announcement of two contracts with unnamed customers on Mar 30, 2001 but no revenues have yet been recorded from these contracts.
Mar 23, 2001: "Company's Nuclear and Environmental Business Unit which is marketing EKOR™ is expected to generate over $250 million annually within the next five years and turn profitable in 2002."
Jury still out.
Unusual Financing Arrangements
In investigating companies, it is reassuring to see that its financing sources are well-known and the deals are straight forward. In Eurotech's case, the investor is unknown, and the deal is subject to unusual repricings that have been continually diluting shareholders.
Eurotech's primary funding in recent years has come from Woodward LLC, a Cayman Islands company about which we have been unable to discover little. The firm has invested $20.25 mln in EUO by our count. The amount of shares it received for that amount is still being tallied, as this unusual deal involved many "repricings" at which its share count would go up as the stock price fell. In its latest 10Q, EUO says that if its share price holds at $0.45 (where it was until Wednesday's spike) for the next eight months, it would have to issue 22 mln new shares to Woodward, a full 43% increase from the total Sep 30 count of 51.6 mln. Convertible stock deals set up in this fashion are known as "death spiral converts" as the investor can short the shares, profit on the short sales, and then be reimbursed by receiving more shares. There's no evidence that this is happening in EUO's case, but there is at least a very real threat of substantial dilution.
Related Party Transactions
Any related party transactions raise suspicions, but they are particularly worrisome in this case as they involve the financing deals that already raised a red flag.
The brother of Eurotech CEO Don Hahnfeldt is the sole owner of Spinneret Financial Systems. Spinneret has been paid $965,790 in consulting fees in connection with the Woodward financing deals, and will get 5% of any future deals with Woodward.
Deception
It should go without saying that investors should demand total clarity from a company's executives. Yet there is little question that the following statement from Eurotech's Chairman was not entirely forthcoming. He boasts of the above-market price of the deal without mentioning the future repricing arrangements, leaving shareholders with a less than accurate picture of the deal.
In the company's own press release on May 4, 2000 in which it announced another $10 mln investment by Woodward, Chairman Chad Verdi stated that the company was "not diluting the Company at any discount to the market."
As subsequent SEC filings made clear, Woodward could afford to pay a premium because it was guaranteed more shares if the market price of the stock fell. It did indeed fall, and the price per share that Woodward ultimately paid was at a discount to the market.
Business Plan Changes
When you're considering an investment in a development stage company that has never recognized revenues from its primary business, it is critical that there is a clear business plan and that you can identify continual progress in carrying out that plan.
Since its inception, Eurotech has focussed primarily on nuclear waste-related products, but it has dabbled in many other products as well, including "automated parking technology." The latest addition to the product line appears to be the "Acoustic Core" technology that it acquired on Sep 25. When Eurotech announced the deal, it hailed its use in nuclear waste remediation projects, consistent with its focus. But on Oct 4, the company issued a press release claiming that Acoustic Core had an application for detecting C-4 plastic explosives on the person of airline passengers (the product is not yet for sale, however; the company notes that it is "currently in the process of submitting proposals and completing demonstrations"). Always beware companies that so easily alter their business plans.
Lessons
Few Briefing.com readers would have been drawn to invest in Eurotech, but its lessons have a broader application. Any investment in a development stage company is asking you to play venture capitalist. There is no proven product and no proven business model. In such a case, it becomes all the more important that the company's executives, past actions, and financing are beyond question. In Eurotech's case, questions arise at every step of the investigation.
Readers should not assume that they are safe from such investments if they simply avoid penny stocks. Eurotech itself traded over $10 in 1997 and over $5 in 2000, and other development stage companies such as Zixit (ZIXI) and Wave Systems (WAVX) have enjoyed substantial market caps and high stock prices even while prompting many of the same questions as Eurotech. Before investing in these "concept" stocks, be sure that you can answer these questions to your satisfaction and that the valuation offers the rewards of a venture capital investment.
Greg Jones - gjones@briefing.com
Fast Eddie
short at 1.25 Monday |
