SRCM FRAUDULENTLY REPORTS ASSETS, COVERS UP LOSS OF BUSINESS WHILE INSIDERS SELL STOCK
LAS VEGAS, Sept 25 -- Pluvia Securities Research reiterates a Strong Sell and Short Sell Recommendation of Source Media, Inc. (Nasdaq: SRCM). We feel the current price represents an excellent opportunity to short stock in a company we do not believe will be in business in 24 months, leaving the stock trading at pennies.
On October 30, 1997, SRCM purchased certain assets of two companies, Brite Voice, Inc. "Brite" and Voice News Network, Inc. "VNN", for a reported price of $44.6 million - cash. The purchase price was 3.8 times the combined, ($11.8 million), annual '96 revenue of the two companies.
During the takeover transition, certain key employees of these entities did not take employment with SRCM. Instead, they started a new company, Interactive Media Services, and began picking up customers who also chose not to transition to SRCM.
"The biggest assets in VNN and Brite were their customer bases. As it turns out, many of the customers preferred to work with Interactive Media Services - not SRCM. Some customers had already worked with SRCM and left them, reportedly unsatisfied with SRCM's performance," noted Steve Pluvia, founder of Pluvia Securities Research. "Within days of the $44.6M purchase, a significant number of these customers decided to terminated their contracts, refused assignment to SRCM, or gave notice of termination upon contract conclusion. The price SRCM paid for these companies was ridiculously high to begin with, so to lose these customers so quickly was staggering. The assets SRCM just purchased walked right out the door," Pluvia added.
Since the Oct. '97 acquisition, customers that have left or given notice of termination include: US West; Great Western Directories; TDI; Southern Directories; Tele Direct (Bell Canada); Telus; Feist Publishing; Sunshine Directories; and other smaller accounts.
As of today, the departure of these customers represents an annual loss of over $8 million to SRCM, and industry sources report the stampede of customers departing SRCM is not yet over. "I think about the way they blew $44 million bucks and I just shake my head," Pluvia commented, "typically one word come to mind - incompetence".
This loss of business was obviously a very significant event to SRCM shareholders. "For $44.6 million, SRCM shareholders bought a bunch of customer contracts and about $1 million dollars of equipment. Take away a majority of the customers and what's left?" Mr. Pluvia asks.
Well in SRCM's case, it looks like you get a cover-up thrown in for free. SRCM did not disclose the loss of these customers in their '97 10K, which covered a period when a number of these customers quit. Instead SRCM noted this: ('97 10K page 6):
"Many of the customer contracts acquired by the Company are either non-transferable, or terminable at will or with little or no notice and, while the Company has not experienced significant problems to date, there can be no assurance that the customers under such contracts will not terminate them or that the Company will be able to renew such contracts."
The company had another opportunity to disclose these problems in their March 31, '98 10Q, but again failed to do so, instead saying on (page 16):
"As a result of the October 1997 Brite and VNN Acquisitions, the Company has experienced growth in its revenues, gross margins, and operating expenses. The Company will continue to incur operating losses in 1998, although it expects that cash used in operations will decline as a result of the October 1997 Acquisitions discussed below."
We feel management's disclosure of this matter constitutes fraud. We believe these statements were knowingly false and intentionally misleading. We feel SRCM's '97 10K and the March 31,'98 10Q are inaccurate, and considering the departure of a majority of their recently acquired customers, customers that were just purchased for the lofty price of $44.6 million, we believe SRCM has significantly overstated the value of the company's assets in the last two reporting periods which will require SRCM to restate their 1997 10K and 1998 10Q.
Meanwhile, after failing to disclose these problems to shareholders, on May 19 & 20 1998, SRCM insiders, or partnerships and groups managed by, or, including SRCM insiders, sold over $20 million of SRCM stock. "I can hear the class action attorneys tripping over themselves to file on this case" Pluvia quipped.
We feel fraud and accounting discrepancies are just the 'tip of the iceberg' of reasons not to own this stock. The company has never earned a profit, has over $100M in historical losses and burns about $5M a quarter. After raising $120 million of debt in Oct. '97, a short six months later they had only $19.6M of working capital left. Now with $120M of debt, they have a heavy debt burden they can't escape. SRCM doesn't come close to earning enough income to cover the $12 million interest on their debt, and we don't see any product or service they have that will produce any significant new revenue. There is good reasoning to think the company will go broke within a few quarters.
In addition to SRCM's shaky financial picture, there's a great deal of stock from cheap warrants available to hit the market. According to the July 28, '98 S-3 filing, SRCM registered 4,775,857 shares of stock for sale from various warrants SRCM has issued, often exercisable at very low prices. As an example, 477,000 warrants were issued in Oct. '97 that are convertible to common stock for just one penny. Over 2,665,000 other warrants can convert to common for $6. "And those warrants are available to convert at any time," Pluvia noted.
This company has a history of being long on promotion and short on results. Their latest "Dog & Pony Shows" look to me, more like your common "Black Box" promotion designed to part investors from hard earned money, rather than a real product that will ever become marketable. SRCM claims they own patents and products that will allow them to provide internet access over cable TV, which sounds pretty sexy in a market giddy with internet stocks - unless you look at their product and research the activities taking place in the cable TV market.
SRCM's Black Box internet 'type' service requires you to use a TV channel changer to navigate web pages, that are really snapshot pictures of a webpage coming from a server that is accessing the net. Using your channel changer you are expected to punch in various numbers on your hand held TV control to navigate around the page. It is completely impractical for typing, e-mail, chatting, playing on-line games or sharing files. It reminds me of a an arm-less man trying to open a can of beans with a can opener. SRCM's Black Box TV internet service has never been market tested on a cable system, so we don't really know if it will work - and neither do they. Given their current questionable activities, we have our doubts.
Cable industry sources suggest SRCM is irrelevant in the cable TV market and always will be. Part of the reason stems from the direction the industry is moving. The world's leading software companies, cable networks and broadcasters, including CableLabs, MSFT, ORCL, INTC, GIC and others are 12 months away from rolling out a new cable settop platform that will include essentially a net-PC running on windows CE or Netscape, and a cable modem. GIC's Series 5000 settop box will provide true, fully functional cable internet access, as PC users expect, as well as true TV interactivity based on new standards proposed by ATVEF. The new series 5000 settop box will operate on an Internet Protocol, on a computer network which we believe makes SRCM's patents irrelevant to future cable internet access. The idea that anyone would purchase SRCM for the value of their patents has no logical basis. We believe rumors to this effect are an illegal attempt at manipulating the stock of SRCM.
The new products entering the market in 12 months will significantly leapfrog SRCM's proposed Black Box service. Thus, if SRCM had a cable internet product ready to sell today, due to these new products, we believe SRCM would only have a 12 month product life cycle. Since we think it will take SRCM 12 months or more to develop and test their current beta product, we doubt they will ever have a TV Cable product that is saleable.
SRCM's management come from a background of yellow page advertising sales - not technology. Given their current problems managing their yellow page business, we think the idea that SRCM could competing with MSFT, ORCL and other world leaders to develop software, is rather amusing.
Pluvia Securities Research is a securities research boutique specializing in corporate valuations, equity research and investigation of fraudulent stock promotions. This report should not be construed as an offer to sell or solicitation of an offer to buy any securities. Opinions expressed are subject to change without notice. This report has been prepared from original sources and data which we believe to be reliable but accuracy is not guaranteed. Certain matters described in this report are forward-looking statements and are subject to risks and uncertainties that could cause actual results to differ materially from those projected. This research report was prepared by Pluvia Securities Research whose stockholders, officers and employees may from time to time acquire, hold or sell a position in the securities mentioned herein. Mr. Pluvia and affiliates of Pluvia Securities Research currently hold positions consistent with the above rating.
e-mail Pluvia2@aol.com
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