INTERESTING ARTICLE ON REG S/ SHORTING
Best Regards, daaan
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To: daaan (1370 )
From: MonteChristo Tuesday, Nov 24 1998 8:30PM ET
Reply # of 1374
Great information my friend.
Here's another one for you all to ponder:
Pirates' Play?
Offshore dealsters have found a new way to beat U.S.
investors
Jaye Scholl
The offshore dealsters are at it again, and it looks like they've been
reaping tidy profits
at the expense of unsuspecting U.S. investors. In three deals that
Barron's has learned
about, offshore investors have been getting cheap shares of U.S.
companies through
special convertible debenture offerings. As the charts below show, the
share prices of
the companies involved have a mysterious habit of dipping just before
the debentures
are converted, giving the offshore buyers that much more of a bargain.
The convertible debentures involved are cousins to securities sold under
Regulation S,
the controversial 1990 amendment to the federal securities laws that
allows U.S.
companies to sell unregistered stock to foreigners, usually at big
discounts to the
prevailing market price. After 40 days, foreign investors can sell these
securities back
into American stock markets. The flood of new shares often results in
much lower
stock prices (Barron's, April 29).
If anything, the Reg S convertible debentures can hurt existing
shareholders even more
than Reg S stock sales because of the greater potential for massive
dilution. Editek, a
North Carolina company that sells diagnostic kits to test on-site for
drug abuse and for
toxins in agricultural products, actually ran out of shares during a
convertible debenture
conversion in April. The process sent Editek's stock reeling, and the
company, with 18
million shares outstanding, was faced with having to issue a further 32
million shares.
Thanks to new SEC disclosure requirements that took effect in November,
shareholders can find out if a company has sold Reg S convertible
debentures. If it has,
watch out, because, based on the evidence so far, a plummeting stock
price is likely to
follow.
Offshore investors have been converting their debentures into common
stock at just the
right moment: when the common's price is depressed. A mere coincidence?
Don't bet
on it.
Reg S convertible debentures work the opposite way from your garden
variety
convertibles. Most investors buy convertible bonds expecting to receive
interest
payments while waiting for the stock price to appreciate. They convert
after the stock
price has risen above the agreed-upon conversion price. But in Reg S
convertible
debentures, the conversion price is typically set by taking the average
price of the
stock over the five days leading up to the conversion date. For a
kicker, the company
gives investors a further discount from that final
conversion price. Obviously, the lower the price of the stock, the
better the deal for the
convertible debenture investors.
As the charts show, at Editek, Chantal Pharmaceutical and Ponders
Industries steep dips occurred in the days leading up to conversion, and
trading volume
soared as sellers unloaded the stock.
Last January, Editek, which trades on the American Stock Exchange under
the symbol
EDI, relied on Reg S convertibles to raise $20 million for its
acquisition of Medtox, a
St. Paul, Minn., company that makes medical diagnostic kits. Editek's
stock began a
long descent in January, falling from $3 a share to around 53 cents in
April, the point at
which the conversion took place.
Too Many Shares
At that bargain-basement price, investors were able to convert their
holdings into
millions more shares than the company was authorized to issue, and the
company
stopped converting. Investors sued Editek for the additional shares.
Editek's
management, at least one of whom had participated in a Reg S convertible
debenture
deal at another company, resigned. New management says it intends to
honor the
conversions to those investors whose trading records prove they weren't
part of an
organized effort to drive down Editek's stock price in the days before
the conversion.
Another player in the new Reg S convertible debenture game is Chantal
Pharmaceutical, a name familiar to Barron's readers (Jan. 8, 1996). This
cosmetics
manufacturer claimed it had sold $10 million worth of an anti-aging
cream from July
through September 1995. But investors reacted negatively when they
learned that one
entity, Chantal's distributor, was virtually the company's only
customer. Moreover, the
distributor had the right to sell his entire company - lock, stock and
$10 million worth
of unsold Chantal inventory back to Chantal, an exit strategy that made
the sales data
highly questionable.
Chantal subsequently restated its financial results, revealing a
substantial loss. The
stock, which had traded as high as 28 1/8 a share in Dec. 1995, fell in
subsequent
months. It hit a new yearly low of 2 1/2 in August when its auditors
resigned.
Now Chantal has disclosed in its most recent financial statements that
it raised $5.2
million in a Reg S convertible debentures deal that took place Oct. 30.
The terms
called for conversion of one-third of the debentures into common stock
shares 45 days
later, on Dec. 14. The price set in October was to be the lesser of
$3.91 a share or
80% of the average closing price in the five days immediately preceding
the conversion
date.
Lo and behold, Chantal's stock sank to new lows in the days leading up
to conversion,
averaging 1 7/8 a share between Dec. 9 and 13. With the 20% discount,
the
December conversion appears to have resulted in an additional 1.1
million shares
outstanding.
Another case in point is Ponder Industries, an oilfield-service company.
It halted
conversion of its 8% Reg S convertible debentures in July. That's when
its stock, which
had traded at $6 a share in April, slid to 1 1/2 - just before requests
to convert came
pouring in.
A debenture holder sued Ponder in the U.S. District Court for the
Western District of
New York for failing to honor the conversion agreement. Ponder has filed
a
counterclaim in the same district court against the debenture holders.
The suspicion is
that the purchasers of the convertible debentures shorted Ponder shares,
expecting to
cover their shorts with cheap stock they received from the conversion.
Ponder Chief
Executive Larry Armstrong says he received guarantees from the dealmaker
involved
that Ponder's stock price would be protected from a bear raid. The
guarantee fell
apart, he says, which is why Ponder halted the conversion.
So far, the SEC has not commented on Reg S convertible debenture deals.
But based
on a review of filings with the SEC, the incidence of these deals is on
the rise. And, no
surprise, the companies relying on them aren't portraits of financial
health.
Solv-Ex, for example, has a $13 million Reg S convertible debenture deal
under way.
As Barron's readers may recall, federal authorities are reportedly
investigating trading
in Solv-Ex stock to determine whether convicted stock swindlers Arnold
Kimmes and
Thomas Quinn are involved. The Albuquerque company, which claims to have
a
method of extracting oil and other minerals from oil sands in Canada,
has denied
knowledge of an investigation.
Why were Reg S debentures invented? They appeal to offshore dealsters
because they
can be converted into common stock quickly and that stock can be sold in
the U.S.
market almost immediately. This eliminates some of the risk associated
with traditional
Reg S common shares, which must be held offshore for at least 40 days.
Ironically, by
forcing companies to disclose traditional Reg S deals within 15 days,
the SEC may
have promoted the increased use of these rapid-fire Reg S debentures.
Close a door,
they crawl through a window. |
