Tracking and Analyzing Trading Activity

From time to time, every public small company encounters market conditions where trading activity spikes dramatically and the makret price reacts negatively. Shortly thereafter I begin to get concerned calls from management asking about potential short selling or other manipulative conduct. Most of the time, I simply explain that stockholder relationships are by nature transitory and stockholders sell for a host of reasons that have nothing to do with the issuer's performance. In those cases, the issuer is simply facing a situation where there are more sellers than buyers and it needs to do a better job of telling its story to the market. But every once in a while trading patterns justify more detailed investigation and it's important for issuers to understand the available analytical tools.

In addition to the Short Interest Reports that are published for OTC and Exchange listed securities, there are three types of collateral documents that can give issuers important information on who the buyers and sellers have been during a particular period of time. None of these documents provides a complete picture, but if all three are used properly and regularly updated, careful analysis can provide a surprisingly clear picture.

The first useful document is a complete stockholders list prepared by the issuer's transfer agent. This list identifies everybody who holds stock in physical certificate form. Since people who hold stock in certificate form will usually move their shares into a brokerage account before they start selling, a shareholders list can give an issuer a very solid idea of the people who can be excluded from the universe of potential sellers. An issuer can also do side-by-side comparisons from one list to the next and use that process to identify holders who have moved stock out of certificated form and into brokerage accounts.

The second useful document is a list of "non-objecting beneficial owners," which is commonly referred to as a NOBO list and can be requested from Broadridge Financial Solutions. The NOBO list identifies all people who hold an issuer's stock in a brokerage account and have not specifically asked that their identities be kept secret. While confidentiality requests used to be fairly common, they have fallen out of favor in recent years and most NOBO lists are pretty complete. So if an issuer requests a NOBO list at regular intervals and then prepares detailed side-by-side comparisons, it can readily identify individuals who have added to or reduced their ownership positions between the list dates.

The third useful document is a "Securities Position Report" that can be requested from The Depository Trust Company, or DTC, and specifies the number of shares that individual brokerage firms hold in customer accounts. While the SPR is the least useful of the three documents, it can be helpful in tracking the movement of shares into and out of brokerage firms who have customers that are either accumulating or disposing of shares.

In combination, shareholders lists, NOBO lists and SPRs can usually provide fairly clear answers to an issuer's concerns. Even if they don't, they can give an issuer a very clear idea of whether the market activity is normal. Since manipulative trading is always bad for a small public company and its stockholders, we typically advise issuers to use all the tools at their disposal to maintain reasonable oversight and insure that any questionable trading patterns are promptly evaluated and understood, and referred to market oversight authorities when appropriate.

The Mega-C Trust and the Road Forward

Over the last couple of years, there have been many questions about the integrity of the Second Amended Trust for the Benefit of the Shareholders of Mega-C Power Corporation and whether the Trust would have any real value for individuals who invested in Mega-C, a company that turned out to be a complete scam. Since I drafted the original agreements and much of the structural work survived with modest changes in the bankruptcy court, I thought it might be useful to offer an author's perspective. I have not had any contact with the shareholders trust or its trustee since late 2006, so my discussion will be general in nature and involve some speculation. But I don't think the following discussion is too far off the mark. 

This post does not constitute legal advice to any creditor or shareholder of Mega-C Power Corporation and I encourage each interested party to consult with his own lawyers about his specific circumstances. This post has not been reviewed, authorized or endorsed by the U.S. Bankruptcy Court, Mega-C's Chapter 11 Trustee, the Liquidation Trust, the Shareholders Trust, Axion Power International, Inc. or their respective management and attorneys. The commentary, opinions, interpretations, evaluations and estimates set forth herein are mine alone and others may strenuously disagree. I have no obligation to update this post for subsequent events. My only goal is to provide an analytical framework that interested parties can use to evaluate the range of possible outcomes. 

Subject to all of the foregoing, my key observations and thoughts are: 

• Mega-C's promoters filed the bulk of the creditor claims in its bankruptcy case and all of those claims have been eliminated. While Axion and its founders originally had $1.3 million in creditor claims, those claims were reduced to $100 in the 2006 settlement agreement. There is one large unresolved creditor claim, but I do not believe the claim has substantial merit. If that claim is resolved on favorable terms, the surviving creditor claims should be less than $1 million. While it's too early to predict timing with any certainty, I think the liquidation trust is close to resolving all creditor claims and its trustee should be in a position to finalize his cash requirements and stock sale plans within 3 to 6 months. 

• After giving effect to the settlement agreement with Axion that paved the way for confirmation of the Chapter 11 plan, the shareholders trust held 5.7 million Axion shares. Under the terms of the plan, 1,000,000 of those shares were set-aside in a separate liquidation trust for the purpose of paying creditor claims and the administrative costs. The balance remained in the shareholders trust; provided that if the liquidation trust needs more resources, it can request additional shares from the shareholders trust. When the bankruptcy case is closed, any shares that remain in the shareholders trust will be available for distribution among the individuals who personally filed valid shareholder claims in the bankruptcy case. 

• Of the 1,000,000 shares that originally went to the liquidation trust, 685,000 shares were pledged as collateral for $2,055,000 in loans that were used to pay pre-confirmation administrative costs. The remaining 315,000 shares will eventually be sold to pay creditor claims and additional administrative costs. In their joint report for the quarter ended June 30, 2008, the trustees of the liquidation and shareholders trust (a) reported that 750,000 additional shares were being transferred to the liquidation trust from the shareholders trust, and (b) stated that the trustees believed the anticipated proceeds from the sale of the 1,065,000 shares would be sufficient to pay creditor claims and administrative costs and permit closing of the bankruptcy case. 

• When the trustees filed their joint report, Axion's stock price was approximately $1.75, which leads me to conclude that the liquidation trust anticipated a budget of roughly $2 million for creditor claims and administrative costs. Since Axion's stock price subsequently declined into the $1.30 range, I think there is a fair chance that the liquidation trust will need up to 500,000 additional shares to make up the shortfall resulting from a lower stock price. 

• The shareholders trust currently holds 3,950,000 Axion shares. If I assume the liquidation trust will need 500,000 additional shares to generate $2 million in proceeds, then the shareholders trust will be left with 3,450,000 shares to pay its own administrative costs and make distributions to shareholders. Depending on the cost and complexity of shareholders trust administration, I think it would be reasonable to assume that roughly 3 million Axion shares will ultimately be distributed to Mega-C's shareholders. 

• I don't have a precise tally of the claims that were filed with the Bankruptcy Court, but the Chapter 11 trustee counted approximately 24.5 million voting shares for purposes of the plan the confirmation hearing. Of that total, 900,000 shares were canceled in a settlement with C&T's scientists, 3 million shares were canceled in a settlement with Taylor and another 200,000 shares were canceled in a settlement with Usling. In addition, Pardo has previously stated his intent to abandon his claims for 14.5 million shares. In total, the cancellations and claim abandonments should reduce the number of outstanding Mega-C shares from 24.5 million to roughly 6 million. 

• Two shareholder groups own the remaining Mega-C shares. The first group is people who actually bought Mega-C shares from that company or one of its promoters. The second group is people who received shares from a Mega-C promoter because of some pre-existing relationship. As near as I can tell, the two groups are evenly balanced and each is group owns roughly 3 million Mega-C shares. I think the most difficult issue facing the shareholders trustee will be resolving the competing interests of these two groups. 

• If the shareholders trust decides that distributions should be limited to people who invested in Mega-C, the share distribution ratio will approach 1 for 1. If it decides to leave all remaining shareholder claims intact, the share distribution ratio will be closer to 1 for 2. While the legal issues facing the shareholder's trust are complex, I think its trustee should be in a position to finalize his distribution plan within 6 to 9 months. 

Despite the vigorous propaganda and disinformation campaigns that Mega-C's promoters have waged for the last five years, the simple fact is that Mega-C was broke and its promoters were the subjects of an OSC investigation before Axion's founders met each other for the first time. The iceberg had already breached the Titanic's hull and the stern was slipping beneath the waves. Instead of simply abandoning ship, Axion's founders built a new lifeboat for all of the stranded passengers and paid for it with their own funds.

Over the years, I've seen a lot of small companies fail. Sometimes the failures were due to bad behavior and sometimes they were due to bad luck. This is the first time I've ever seen a group of stockholders salvage the wreckage of a failed business, start over again from scratch, provide all the necessary capital and preserve a substantial interest in the new company for the equity investors in the failed company. 

Overall, the administrative costs of the Mega-C bankruptcy will probably be in the $4 million to $6 million range and the bulk of those costs will be directly attributable to litigation instituted, inspired or supported by Mega-C's promoters who cynically used the litigation to build support among the people they had cheated. I think it tragic that the individuals who were responsible for Mega-C's failure have increased the cost of bankruptcy administration by millions of dollars and decreased the ultimate distribution from the shareholders trust by millions of shares. While my opinion really doesn't matter in the overall scheme of things, I'm saddened that more Mega-C shareholders have not actively supported Axion and its founders who went to extraordinary lengths to leave no investor behind. 

I would have preferred a speedier resolution. I would have preferred a resolution that did not waste millions of dollars in administrative costs on frivolous litigation with Mega-C's promoters who never won a substantive hearing based on evidence. But I derive a great deal of satisfaction and comfort from knowing that Axion's founders insisted on protecting the innocent Mega-C shareholders and the trust structure we jointly established in December 2003 will ultimately serve the purpose it was designed to serve. 

I will do my best to respond to reasonable and factually accurate comments and questions. But I have no intention of letting my blog be used as a forum for disinformation.

Stockholm Syndrome and Stock Promoters

Stockholm Syndrome is a psychological disorder where a kidnap victim develops intense feelings of loyalty to his kidnapper. A similar pathology is common in domestic abuse cases where a battered wife or child will staunchly defend an abusive husband or father. A lesser-known pathology is one that I like to refer to as Battered Investor Syndrome, or BIS, a disorder where defrauded investors continue toxic relationships with stock promoters who repeatedly lie to them while stealing or wasting their hard-earned money. I can't claim to understand the root causes of BIS, but I know that until BIS victims acknowledge and accept the facts and decide "I'm mad as hell and I'm not going to take it any more" the cycle will continue and the promoters will keep going back to the same victims for more money and more forgiveness.

 

Over the last five years, I've had a once in a lifetime opportunity to watch the life cycle of a major stock fraud and study BIS in detail. The events I've witnessed still amaze me and they would make for a fascinating business or law school case study. But I'm far too tired to even try my hand at writing a detailed summary of the convoluted history.

 

The basic story is simple. A group of promoters agreed to join forces to create a new company that would finance R&D work on a new technology. Their business structure was doomed from the start but the details didn't matter because the inevitable failure could always be blamed on bad R&D results. Besides, these promoters were not ones to let the facts get in the way of a good story. Over a period of 18 months, the promoters sold stock to about 1,400 unwary investors in transactions that were never registered under applicable law. As one might expect, none of the investors received anything that remotely resembled a disclosure document. Overall, the promoters raised between $10 and $15 million. Some of the money went to R&D but the bulk the cash simply disappeared. The house of cards collapsed when securities regulators started asking questions about illegal stock sales.

 

Unlike most scams that abruptly end when the securities investigation begins, this company was different because the last round of investors included a handful of businessmen who were unwilling to accept a complete loss. So the investors banded together as allies, forged a new relationship with the owners of the patents, formed and financed a new company and then put a mechanism in place to protect the innocent investors who were defrauded by the scam. By the time the investor group was finished with its work, the new company owned the patents outright, a majority of the stock had been set aside in trust for the scam victims and the new company was adequately financed and fully compliant with applicable securities laws.

 

It didn't take long before the promoters of the original scam saw substantial value in the new company and decided that they wanted a big interest in the new company as compensation for their valuable contribution in causing the original train wreck. Predictably, the organizers of the new company didn't want anything to do with the promoters who had already skimmed millions of dollars from their original scam. So what started as a silly greenmail demand from the promoters quickly degenerated into an outright war.

 

Over the next four years, the promoters engaged in a non-stop campaign of historical revisionism, disinformation, Orwellian double-speak and scorched-earth litigation. Their arguments distorted the history of the old company and misconstrued the goals of the new company and its organizers. But as I noted earlier, the promoters were not ones to let facts stand in the way of a good story. In 20/20 hindsight, I don't believe the promoters ever believed they could win their lawsuits. Nevertheless, I'm convinced they believed they could make the litigation so expensive and time consuming that the new company would be forced to capitulate and offer a huge settlement. Thankfully, the new company was able to rise to the challenge, continue in operation and defend its position honorably and honestly.

 

While the promoters won the occasional procedural victory, they never won a court hearing based on facts and evidence. Even so, they were able to create enough fear that the BIS victims reportedly financed the bulk of their litigation costs. The litigation has finally been resolved. The promoters have no claims against or interests in the new company and all the money and time spent on litigation has been wasted.

 

Overall, the BIS costs have been staggering. The BIS victims lost between $10 and $15 million when they invested in the original scam. The frivolous litigation against the new company impeded its financing activities, reduced the price it could have gotten for its stock and forced the new company to divert substantial money and energy from technology development to litigation. The net effect of the litigation was to reduce the ultimate benefit to the BIS victims by more than 50% and disqualify a large number of BIS victims from participating in the payout at all. As the final insult, rumor has it that the promoters were able to shift the burden of financing their frivolous litigation to the shoulders of BIS victims and new pigeons who never got adequate disclosure. By the time the dust settled, BIS was responsible for at least three levels of economic loss and intense fear among the BIS victims who have never understood the simple truth that the promoters are pathological liars who will happily squander vast amounts of investor money if it advances their personal interests.

 

The promoters' hearing before the securities regulators is scheduled to begin soon and I have no doubt that they will be severely sanctioned because there is no defense against the alleged securities law violations. I remain hopeful that this final nail in the promoters' coffins will be enough to instill a little confidence that the new company has always been a steadfast defender of the BIS victims. I also hope that BIS victims' interest in the new company will be enough to offset some substantial part of the injuries they suffered at the hands of the promoters.

 

I'm an eternal optimist and believe that sooner or later the BIS victims will realize who their enemies were and who their friends are. The BIS victims and the new company both deserve a break. I suppose time will tell.

My first post to Seeking Alpha

On July 17th, a blog entry I wrote was published on Seeking Alpha. Since this was my first foray outside the friendly confines of my own website, I've decided to add a copy to my blog after giving Seeking Alpha a few days of priority. The original entry drew a number of angry responses from people with interests in Ener1 and Altair, but I stand by my conclusions that:

1. Li-ion technology has a long way to go before it is safe enough to use in automobiles because it takes thousands of cells to make a battery pack and one failure can start a catastrophic chain reaction. I've been exposed to a number of trial lawyers over the years and have no doubt that they'll have a field day when catastrophic battery failures start injuring families;

2. Substantially all of the world's lithium currently comes from Argentina and Chile. While China also appears to have significant lithium reserves, I don't believe for a minute that the Chinese will export raw materials to American manufacturing companies when they can export batteries instead; and

3. The market rarely buys the "best available technology" if a suitable alternative is available at a lower cost. For over 20 years, I've paid a premium to work on Macintosh computers. While the Mac OS is and always has been objectively better, 95% of the market has not been willing to pay the price when a cheaper alternative was available elsewhere.

The full text of my Seeking Alpha blog entry follows:

Lithium-Ion Batteries and Centerfolds

They're glamorous, sleek, sexy and hot; the building blocks of pubescent dreams and mid-life crises. But they're expensive, temperamental, potentially dangerous and scarce.

For the last few years, news from the battery sector has been dominated by stories about advances in Li-ion batteries that hype performance while downplaying system costs and safety risks. As a result, U.S. companies operating in the Li-ion space like Ener1 (HEV) and Altair Nanotechnologies (ALTI) have attained nosebleed market capitalizations based on little more than dreams. While some recent articles have noted that global lithium supplies are limited, nobody has come to grips with the fact that it is prohibitively expensive to recycle used Li-ion batteries to a point where you can use the lithium in new batteries. So much like the oil industry, the Li-ion battery industry will have to come to grips with raw material shortages far sooner than anyone imagines.

In comparison, major lead-acid battery manufacturers including Johnson Controls (JCI), Exide (XIDE), Enersys (ENS) and C&D Technologies (CHP) have established product lines and rust-belt market capitalizations. Lead-acid innovators like Axion Power (AXPW.PK) and Firefly Energy are currently manufacturing commercial prototypes of advanced lead-acid batteries that promise huge leaps in performance at modest prices. To top it off, over 98% of used lead-acid batteries in the U.S. are recycled into new batteries; minimizing resource waste and pollution.

Size, weight and energy density are critical in cell phones and laptops, but far less important in transportation and alternative power applications: and despite all the safety talk, catastrophic failure rates of one cell in 10 million, or even one cell in100 million, are not comforting when it takes thousands of cells to make an automotive battery pack and a single failure can start a chain reaction (remember the Pinto).

History shows that two key factors determine whether a technology will be widely adopted: bottom line cost and proven product safety. I believe Li-ion fails on both counts because the technology is neither cheap nor safe.

There is growing consensus that energy storage is the next big investment opportunity because cost-efficient storage can significantly improve the profit potential and reliability of every alternative power technology. Transportation applications are an important part of the picture. But the market potential in transportation pales in comparison to bulk energy storage for wind, solar, and utility applications.

When you get real about issues like cost, safety and materials availability, I believe advanced lead-acid batteries offer an attractive alternative to their sexier but more problem prone cousins. In energy storage as in life, the plain and reliable girl next door is probably a far better bet than the airbrushed centerfold.

 

The Case For Registered Reverse Mergers

I spent a couple days at Deal-Flow Media's Reverse Merger Conference in Los Angeles last week and left Thursday afternoon with the firm conviction that while competitors and colleagues are working diligently to develop new reverse merger structures that accommodate recent regulatory changes, most of the emerging structures are too complicated, contingent, time-consuming and expensive for the real world.

After listening to hours of presentations on APOs, WRASPS, Virgin Shells, direct filings and other emerging structures, I'm more convinced than ever that there are only two rational IPO alternatives. The first is a reverse merger with a legacy shell that will be registered with the SEC on Form S-4. The second is a reverse merger with a Rule 419 shell that will use a post-effective amendment to an existing SEC registration statement to achieve the same result.

Over 28 years of practice in the small company finance space have taught me four great truths:

• No sane management team even considers going public unless they need money and their investors demand the liquidity of a public market;
• Our clients never believe that OTCBB or Pink OTC quotations represent fair markets that reasonably value their stock;
• Institutional investors avoid OTCBB and Pink OTC companies like the plague unless their investment will serve as a spring-board to a national exchange listing; and
• Companies that begin trading on the OTCBB or Pink OTC markets often find it very difficult to develop the corporate bulk and shareholder base required to upgrade to a national exchange.

While there are rare exceptions, we believe private companies should not go public without a clearly defined short-term plan to list their shares on a national exchange like the Amex or Nasdaq. Anything less is the self-inflicted pain of OTCBB purgatory or Pink OTC hell.

If a private company has ready access to adequate capital, the documentation for an SEC registered reverse merger is not much more complicated than the "Super 8-K" filing required for every reverse merger. The big difference is that an SEC registered reverse merger is a one-step process that does not entail the time and expense of:

• filing a Form 10 or Super 8-K and clearing SEC comments;
• filing a Form 211 quotation application and clearing FINRA comments;
• filing a resale registration statement and clearing SEC comments; and
• working to develop a stable market on the OTCBB or Pink Sheets.

Instead you file a registration statement on Form S-4 (or a post-effective amendment for a Rule 419 offering) and concurrently file a listing application with a national exchange. Once you clear SEC and exchange comments, you can close the reverse merger and immediately begin working to develop a credible trading market on a national exchange.

Unlike the more convoluted emerging structures, an SEC registered reverse merger puts all shareholders of the combined companies (other than directors, officers and affiliates) on an equal footing because they all end up holding shares that can be resold in the public markets. There is no discrimination between new money and old money, and the potential for market manipulation that invariably arises when a small group of shareholders control the bulk of the public float effectively disappears.

I cannot overemphasize the difference between a back-door reverse merger, which invariably gives rise to substantial regulatory and market skepticism, and a front-door reverse merger that simply follows the SEC's rules and takes the shortest path from point A to point B. Full SEC registration is difficult, time consuming and expensive, but so are all of the common reverse merger alternatives. In the final analysis, the securities markets are no place for on the job training and it's always better to learn the rules before you begin playing the game.

Reverse Mergers - revised resale rules

The SEC has just revised Rule 144, the regulation that provides a safe harbor exemption for the public resale of stock that was purchased in a private placement transaction. The rule change became effective on the 15th of this month. Today's entry will provide an overview of the rule change. This discussion is general in nature, does not constitute legal advice to any person, and does not apply to directors, officers and other corporate insiders who can be classified as "affiliates."  If you own restricted stock that you want to sell, you should consult your own attorney before taking any action.

The SEC's goal in adopting the rule change was to make it easier for investors to sell restricted stock, while maintaining the bulk of the current restrictions for affiliates. While the changes are beneficial for most investors, they have complicated the analytical matrix and made it far more difficult for an average investor to understand what the changes mean to him.

The Old Rule 144

Most investors understood what the old Rule 144 required. If the issuer was registered under the Exchange Act and current in its reporting, and you were not an affiliate:

• During the first year of ownership you were not allowed to sell any stock;
  
• During the second year of ownership you were allowed to sell up to 1% of the company's outstanding stock in any rolling 90-day period; and
  
• After two years of ownership, the restrictive legends could be removed and your stock could be deposited in a brokerage account.
  

The old Rule 144 also included manner of sale restrictions and required the seller to report sale transactions on Form 144.

New Rule 144 - Reporting Issuers That Have Never Been Shells

The new Rule 144 is most beneficial for investors that hold stock issued by companies that have never been shell companies, are registered under the Exchange Act and are current in their SEC reports. If those three requirements are satisfied and you are not an affiliate of the issuer:

• During the first six months of ownership you can't sell any stock;
  
• After six months you can engage in unlimited public resales; and
  
• After one year restrictive legends can be removed and your stock can be deposited in a brokerage account.
  

New Rule 144 - Nonreporting Issuers That Have Never Been Shells

The new Rule 144 also provides rules for the resale of stock issued by companies that have never been shell companies and are not registered under the Exchange Act. If you are not an affiliate of a non-reporting issuer:

• During the first year of ownership you can't sell any stock; and
  
• After one year you can engage in unlimited public resales.
  

New Rule 144 - Current and Former Shell Companies

While the new Rule 144 is beneficial for the stockholders of issuers that have never been shell companies, it imposes harsh restrictions on the shareholders of current and former shell companies. The basic rule is that stockholders of issuers that are now or have ever been shell companies cannot rely on the safe harbor unless:

• The issuer is no longer a shell company;
  
• The issuer has registered under the Exchange Act;
  
• The issuer is current in its Exchange Act reporting; and
  
• At least one year has elapsed since the issuer filed Form 10 type information with the SEC reflecting its status as an operating entity.
  

We view the shell company limitations of the new Rule 144 as a potential minefield for investors and their lawyers, and will be curious to see how the SEC's staff interprets those limitations in the future. 

Until the staff's interpretive position is clarified, we will advise our clients to regard non-reporting shells and companies that have merged with non-reporting shells as toxic waste. We will also advise that the risks of a reverse merger with a reporting shell are far greater than they were before the rule change.

Reverse Mergers - ownership percentages

The percentage of public stock ownership is probably the most poorly understood aspect of reverse mergers. Shareholders of private companies that are negotiating reverse mergers always want to maximize the value of their interest in the combined companies. Unfortunately, they frequently attempt to do so by minimizing the ownership interest of the existing shareholders. While many shell promoters are all too happy to accommodate, experience shows that squeezing those last few points out of a reverse merger usually does far more harm than good.

Reverse mergers that give the owners of the private company 90%, 95% or even 98% of the combined companies are not uncommon in today's market. But to modestly increase the percentage ownership of the private company's shareholders, the number of outstanding shares has to increase dramatically. As a simple example, if a shell has 1,000,000 shares outstanding before a reverse merger:

• It takes 4,000,000 shares to give the private company shareholders an 80% interest;
  
• It takes 9,000,000 shares to give them a 90% interest; 
  
• It takes 19,000,000 shares to give them a 95% interest; and
  
• It takes 49,000,000 shares to give them a 98% interest.
  

Many small public companies can and do support a reasonable trading price with 5 million or even 10 million outstanding shares. But as the number of shares passes the 10 million mark, the number of companies that can support a reasonable trading price drops off precipitously. So the stockholders of a private company that is negotiating a reverse merger will ultimately have to choose between getting a small number of reasonably priced shares or a large number of very cheap shares.

We have never seen a good result when the shareholders of a private company demand too large a stake in connection with a reverse merger. Stock market investors are not always rational, but they can all multiply and divide. If a small public company has a sustainable market value of $25 million, it will be priced in the $5 range if there are 5 million shares outstanding and it will be priced in the $0.25 range if there are 100 million shares outstanding.

Low stock prices make it very difficult for small public companies to obtain additional financing on reasonable terms because investor confidence in the sustainability of market prices bears an inverse relationship to market prices. While a relatively high market price does not guarantee a high level of investor confidence, a relatively low market price will almost never give rise to a high level of investor confidence. Moreover, as the relative market price per share declines, the profit margin or "spread" that market makers charge buyers and sellers can and usually does increase rapidly as a percentage of the share price.

We believe the principal value of a public company lies in its inherent ability to issue additional shares in connection with future financing, property acquisition and compensation transactions. Initial ownership is important from a control perspective, but placing undue importance on initial ownership percentages can seriously impair a small public company's future.

While it is not a perfect analogy, we frequently compare public shells to printing presses. When the press is delivered to the buyer there are a limited number of stock certificates that were printed while the press was being built. Those shares are the initial public float. In connection with the sale of the press to the buyer, an additional pile of stock certificates is printed for the reverse merger transaction. The number of stock certificates that need to be printed in connection with the reverse merger is wholly dependent on the percentage ownership that the shareholders of the private company demand. Once the press is turned over to the buyer, he owns it and can print as many or as few additional stock certificates as he chooses.

If the press is used judiciously, substantial value is received in the reverse merger and substantial value is received every time a new stock certificate is printed, the market value of all outstanding shares will increase over time. If too many stock certificates are printed for the reverse merger or the press is used indiscriminately to print new stock certificates for dubious value, the market value of all outstanding shares will decline over time.

In the final analysis, there is no way to repeal the laws of supply and demand.

We once heard a Vancouver promoter quip "As long as a tree stands in British Columbia we will never run out of stock." This is a great truth and a real and present danger. A public company that indiscriminately issues stock in a reverse merger will permanently impair its ability to obtain new value in the future by issuing additional shares. If management lacks the discipline to maximize value per share from the outset, then their venture into the public markets is in grave peril before it starts.