R/S "tainted history" article
Posted on Mon, Mar. 20, 2006
Page's brother uses tactic with tainted history
By Mike Langberg Mercury News. CA
Carl Page became an Internet success story before his younger brother, billionaire Google co-founder Larry Page.
Which makes it surprising that Carl Page and his colleagues have just raised money for their newest company with a financing tactic tainted by a long history of scams.
Handheld Entertainment of San Francisco, which makes a portable device for playing digital audio and video, was co-founded -- and funded -- three years ago by Carl Page. Earlier this month, the company raised $7.6 million by going public through a reverse merger.
Instead of slogging through the lengthy process of a conventional initial public stock offering, or IPO, Handheld purchased a dormant or ``shell'' public company and merged into it.
Such reverse mergers are quick and inexpensive, but lack careful scrutiny from investment banks as well as some of the regulatory oversight of a conventional IPO.
Until a crackdown by the Securities and Exchange Commission two years ago, oversight was so lax that reverse mergers were a favorite tool of ``pump and dump'' con artists.
The con artists would take control of a private company of dubious value on the cheap, take it public through a reverse merger into a shell that they acquire, and then sell stock to gullible investors. Many of these companies collapsed once the con artists sold all the stock.
However, the SEC clean-up is now luring some established and legitimate businesses -- such as Handheld -- to consider reverse mergers, even though the bad smell is far from dissipated.
An academic study in the December issue of the Journal of Corporate Finance showed just how risky reverse mergers, also known as reverse takeovers, can be for investors: The authors reviewed 121 reverse mergers from 1987 to 2001 and found 54 percent failed within two years.
``Over half of reverse takeovers end in delisting or bankruptcy,'' the study concluded.
Such deals, the study's authors said, ``tend to be speculative in nature and fail to generate long-term wealth gains.''
Jeff Oscodar, Handheld's chief executive officer, conceded during an interview last week that, ``Historically, there has been a taint'' surrounding reverse mergers. ``But,'' he added, ``the taint curve is coming down.''
That may be true, although it seems unlikely Handheld could have raised money through a regular IPO.
The company is a mouse going up against a lion. Its hugely ambitious plan is to grab a chunk of the downloadable digital music and video market from Apple, which has a virtual lock on the world's ear canals with its phenomenally popular iPods and the iTunes Music Store.
Handheld introduced its first product, a portable player called the Zvue, in late 2003.
Wal-Mart agreed to carry Zvue last year. But sales were under 20,000 units for the first nine months of 2005, the most recent period reported by Handheld. The company lost $2.3 million on sales of just $937,100 in those nine months -- hardly a shining performance after more than two years in one of the fastest-growing areas of consumer electronics.
Apple, by comparison, is now selling about 150,000 iPods a day.
Handheld is hoping for a turnaround by introducing a new generation of products, due later this year, with bigger color screens at prices below equivalent iPods.
The reverse merger gave Handheld the opportunity to finance its turnaround plan, in this case by selling shares to private investment funds that specialize in small public companies. These investors got their shares just before the start of public trading.
``They're excited to get into this deal that had a kind of Silicon Valley, venture capital spin to it,'' Oscodar said.
Certainly, Carl Page knows about start-ups with spin.
In 1997, he co-founded eGroups in San Francisco, at about the same time his brother was launching Google in his Stanford University dorm room with partner Sergey Brin.
EGroups was sold to Yahoo in 2000 for $420 million worth of Yahoo stock.
According to several accounts of Google's early days, Larry and Carl inspired each other and often turned to each other for advice. They even shared a venture capitalist -- Michael Moritz of Sequoia Capital in Menlo Park provided early funding and took board seats at both eGroups and Google.
Larry, who turns 33 on Sunday, and Carl, 41, have also invested together in Nanosolar, a private company in Palo Alto working on ultra-efficient solar panels for generating electricity.
Carl Page, whose title at Handheld is chief technology officer, provided most of the company's funding prior to this month's reverse merger -- a total of $3.7 million. He is now the largest shareholder of the newly public company, with a 23 percent stake.
``I was extremely skeptical at first,'' Carl Page said last week of the reverse merger. ``We had a bunch of other good options on the table.''
But he became convinced it could work if Handheld avoided any impropriety. And, as far as I can tell, there are none of the red flags in Handheld's offering that flutter around illegitimate reverse mergers.
At the same time, it's worth noting that the private investors in Handheld got their shares at $2 each. The stock started trading March 6 at $5 on Nasdaq's over-the-counter market, and closed Friday at $6.55 a share.
Public investors buying Handheld now, in other words, are paying more than triple what private investors were asked to fork over less than a month ago. And it's for a company that took a shortcut in going public.
