The Microcap Speculator

1. China 3C Group: CHCG.OB shares dropped after the company announced that it had sold $11.74 M worth of common shares in a private placement at an enormous discount. Although shares traded for over $8 as recently as yesterday morning, China 3C Group only charged the private investors $5.60 per share. That’s a 30+% haircut! CEO Zhenggang Wang said “We believe this new sale of China 3C’s equity will enhance shareholder value by providing the company with a cash infusion that will enable it to pursue certain business opportunities in China that are currently being considered by management. Although the sale price of the shares was at a discount to the current trading price of the company’s common stock, we believe that management’s ability to act swiftly to negotiate this transaction without the assistance and associated fees of a placement agent demonstrates the company’s desire to maximize the benefits of the capital investment in light of a discounted sale price.” I disagree. The action, in my opinion, can only mean one of three things: (1) that management was not savvy enough to negotiate a better deal; (2) that management feared it could not sustain the stock price long enough to lock in financing at a more reasonable discount; or (3) that management does not have shareholders’ best interests in mind. I am currently long CHCG, and do not like this move at all.
2. Another ticker change — Air Industries is now: AIRI.OB. Makes sense. The archives on this site have been adjusted, so you can access all of the former Gales Industries articles under the AIRI.OB tag by clicking on the “Navigate” button above.
3. AIRI.OB and Paragon Technologies: PTG were both up big today. I didn’t see any news or SEC filings to explain either move. If you know why, please comment or drop me a note.
4. Paul Kedrosky is calling the Answers.com: ANSW purchase of Lexico a land grab for the generic domain names dictionary.com, reference.com and thesaurus.com. I agree that the names have value, but by any metric Answers.com overpaid.

DISCLOSURE: I am long CHCG.OB, AIRI.OB, and PTG. I have no position in ANSW.

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Internet reference content site Answers.com: ANSW announced after the bell today that it would buy Lexico Publishing Group, owner of Dictionary.com, Thesaurus.com and Reference.com, for $100 million in cash.   The transaction is subject to financing (which may be tough given that Answers.com’s market cap is only $101.3M as of today’s close).

According to the press release, Lexico had revenues of $7 million, EBITDA of $2.9 million and net income of $2.8 million in 2006.  Answers.com calls Lexico “highly profitable,” but like everything else, that phrase is relative.  The transaction price values Lexico at almost 15x trailing sales, over 33x trailing EBITDA, and over 34x trailing income.  That’s not cheap at all in my book, and financing costs will only make the transaction more expensive.

Answers.com CEO Robert Rosenschein calls the deal “a transformative event.”  He stated, “Post-transaction, we estimate that over 70% of our total traffic will now be direct from end users or people searching specifically for the term ‘dictionary’ in search engines.”  Ask yourself: is that really the audience that advertisers are striving to reach?

I don’t think investors in the chronically underperforming Answers.com should find solace in today’s news.  At best, the company has paid a very dear price to double its revenues.  At worst, the company has bought a property that will cannibalize its core operations and burden the combined company with significant debt.  Also, the deal makes Answers.com even more leveraged to a downturn in cost-per-click advertising.  This must read article from TheStreet.com’s James Altucher shows why a drop in CPC prices may be on the horizon.

Bottom line:  For a firm that calls itself Answers.com, management really should have a better solution to poor performance than overpaying for another third-tier content company.

DISCLOSURE:  No position.

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