Replies to post #340 on Money 101 (Money)

[Stock Lobster]

fyi: Structured PIPE Transactions Take Hold as Convertibles Deemed Risky


To raise money for operations, companies usually must raise it on the open market through privately placed convertible securities that have a floating conversion ratio. These conversions are more often than not priced at some discount to the company's closing bid price over a period of days and have very dilutive effects on the company's stock.

The dangers of this method of financing can be found from the craze of the dot-com bubble, when death spiral or toxic conversions torched stocks like Micro Strategy Inc. (NASDAQ: MSTR), Log On America, eToys, Sedona Corporation (OTCBB: SDNA) and many others that lost up to 90% of their value. With the lessons of the last decade, Allegheny Energy Inc. (NYSE: AYE) and Owens and Minor Inc. (NYSE: OMI) learned that an alternative method could be used much more effectively than death spiral and toxic conversion financing.

As these corporations soon realized that they had another option due to the evolving investment marketplace, they turned to what is called a structured PIPE (private investment in public equity) transaction. PIPE's are any placement of securities for a public company to accredited investors that agree to a purchase agreement in order to purchase those securities. Securities often sold in these types of transactions are common stock, convertible preferred stock, convertible debentures, warrants or other equity securities.

These structured PIPE transactions, without floorless convertibles, are often used as an alternative for other means of financing company operations, such as toxic converts, that are usually very dilutive. Investors in this particular PIPE transaction purchase a specific number of shares at a fixed price, with the closing becoming effective upon the Securities and Exchange Commission's ability to approve the resale registration statement covering the resale of the shares sold in the private placement.

There is one very important benefit to PIPE transactions, including the ability for investors to commit to purchasing a fixed number of securities at a fixed price, avoiding the risks of changes in the market prices or rapidly varying conversion ratios. This fixed price allows considerable protection for the issuing company to limit their risk to the number of shares it has to issue. However, there should always be a concern that PIPE transactions may pose risks or could even be tampered. In the past years of PIPE deals, the SEC has been requesting information from broker-dealers about short sales in connection with particular PIPE transactions. In one highlighted case back in February of 2003, the SEC sued Rhino Advisors for manipulating the price of Sedona Corporation's common stock by selling the stock short for the client that had participated in the floorless PIPE transaction.

Overall, well crafted PIPE transactions that do not use floorless convertible ratios create the incentive of limited risk on market value and shareholder dilution. This has made it a safe bet for many technology and biotechnology companies that have significant capital requirements that need to be fulfilled. However, due to the rise in popularity of PIPE transactions, the variety of companies who complete PIPE offerings has increased dramatically, especially due to the liquidity it provides to the issuer's current shareholders.

In the latest year, it was expected that proceeds generated from PIPE transactions would reach over $14 billion. With hundreds to possibly thousands of PIPE deals in the works, there is no reason to believe the phenomenal movement into private investment in public equity will stop anytime soon.

[Stock Lobster]

fyi: Private Investment in Public Equity - PIPE

A private investment firm's, mutual fund's or other qualified investors' purchase of stock in a company at a discount to the current market value per share for the purpose of raising capital. There are two main types of PIPEs - traditional and structured. A traditional PIPE is one in which stock, either common or preferred, is issued at a set price to raise capital for the issuer. A structured PIPE, on the other hand, issues convertible debt (common or preferred shares).

This financing technique is popular due to the relative efficiency in time and cost of PIPEs, compared to more traditional forms of financing such as secondary offerings. In a PIPE offering there are less regulatory issues with the SEC and there is also no need for an expensive roadshow, lowering both the costs and time it takes to receive capital. PIPEs are great for small- to medium-sized public companies, which have a hard time accessing more traditional forms of equity financing.

[Stock Lobster]

fyi:Basic Intro to 'PIPE' funding

(note that the increase of PIPE financings began around 2004)

THESE PIPE ARE SMOKING
Investor Information
April 23 2004

For the past several years, since the tech bubble burst, companies have struggled to find sources of financing. Initial public offerings virtually disappeared from the scene, frustrating private companies that hoped to solve their financial needs by becoming public. But being public is no panacea, and public companies have found funding equally elusive.

That could be changing. Private investors, who have spent recent years sitting on the sidelines waiting for a sign that the economic tide has turned, have decided to open the spigot on their pipeline of funds. Make that PIPEline, since much of the latest funding is being packaged as PIPES, private investments in public companies.

PIPES provide almost instant access to funds, for those companies willing to pay the price, which can be considerable. Still, companies must be prepared to hand over a significant block of stock in exchange for the financing, and what flows through these PIPES can prove murky indeed. The structure of the PIPE may well spell problems down the road for a company struggling to obtain credibility and pave the way for future, more substantial funding.

According to a recent report from PlacementTracker, a division of Sagient Research (itself an OTC Bulletin Board company trading under the symbol PCSR) 209 PIPE transactions, involving $2.7 billion in proceeds to public companies, concluded during the first two months of 2004. This represented a 200% increase in transactions, and a 150% increase in proceeds from the same period a year earlier. The numbers may be even more striking - the PlacementTracker report excluded equity based financings under $1 million and transactions placed by non-U.S. issuers.

Perhaps it is a sign of the revived economy, or of restless private investors who have been waiting on the sidelines for the right opportunity and environment. In any event, PIPES share a common rationale with other forms of financing; the individuals providing the funding see an opportunity to profit. While that does not mean that the public company cannot also benefit from the PIPE, that benefit must be carefully weighed against the price to be paid, in stock, cash or reputation.

PIPES often provide a short term solution for the company, while resulting in a handsome profit for the financiers. In a sense that seems fair. After all, the people funding the PIPES are theoretically putting their money at risk. In reality, however, those risks are carefully calculated, and in many cases, merely theoretical.

Consider how PIPES generally work. One or more investors - often including offshore companies - agree to buy unregistered shares of a public company, at a substantial discount from their market price. The investors may also receive warrants entitling them to purchase additional shares at a fixed below-market price.

The shares are issued at a discount because, in theory at least, the PIPE financiers will have their funds at risk until their stock has been registered. Those risks appear to be particularly acute when the PIPE is made available to a smaller public company, as is often the case. In fact, so-called emerging growth companies traded on the OTC Bulletin Board, and that would include many up and coming biotech firms, have proven to be particularly receptive to the calling of the PIPES. They need cash, whether for working capital or research and development, and are willing to part with shares - lots of them - to become more liquid. And, unlike more established companies with institutional shareholders, they are less uneasy with the concept of dilution, and therefore far more likely to continue printing shares to feed those PIPES.

PIPE investors recognize that these undercapitalized companies are hungry for capital, and consequently prepared to issue even more shares, at a greater discount. Even then, the investors find ways to reduce their potential risk. In some cases, they insist that the public company file a Registration Statement for their shares before any of the funding is delivered. In that scenario of equity-based financing, the company notifies the investor that it wishes to draw down funds from a financing, and files a registration statement for the corresponding shares that it is obligated to deliver. Once the Registration Statement is declared effective, the investor exchanges the funds for the registered shares.

The investor's risk is limited because he can immediately sell the stock- at a profit since it was issued at a discount to the market. Particularly shrewd investors can hedge their bets even further by shorting the company's shares before the funds are delivered, then using the money received from selling short to fulfill the financing commitment, delivering the newly registered stock to cover the short position, and pocketing any difference.

Even more dangerous are PIPES that involve "death spiral" financing. In this scenario the number of shares issued to the investor is keyed to the market price of shares, and increases as the market price descends. Unfortunately, that means the PIPE investor stands to profit from lower stock prices. Consequently, the investor has an incentive to short shares, thereby depressing prices, and guaranteeing the receipt of more shares.

Consider a PIPE investor who provides $1 million in financing in exchange for a debenture that is convertible into $1 million worth of stock. The number of shares to be issued is based upon the price of the stock on the date of conversion. Say the investor begins to sell the company's shares short when the stock is trading at $5, eventually sells 1 million shares, receiving $5 million and successfully depressing the share price to $1. He then converts the debenture into common stock at a rate of $1 a share and receives 1 million shares which he delivers to cover the short position. He has earned a $ million profit in exchange for $1 million in short term financing.

Death spirals are, however, the worst case scenario, and one to be avoided even if it means foregoing a PIPE. That does not mean that PIPE investors are willing to allow their shares to remain unregistered. Most insist upon speedy registration following the delivery of funds. In some instances, the investors will not receive common stock, but in =stead are issued a debenture or interest bearing preferred shares, ach of which can be converted into common stock once the underlying common shares have been registered. That way the PIPE investors receive interest while awaiting the day when they can convert and sell their shares- again at a discount to the market.

PIPES have one other attractive feature; they provide speedy access to cash without regulatory scrutiny. In a public financing the company would be required to file registration documents with the Securities and Exchange Commission, disclosing material details about the identity and nature of the investors. PIPES remain private - and so do the people who fund them. On the positive side that allows the public company to move quickly. On the flip side, it means investors and regulators are deprived of meaningful information about those investors, many of which may simply be offshore companies with nominee directors and officers.

PIPES provide an appealing mechanism, provided they are utilized judiciously. On the other hand, when companies issue PIPES repeatedly they leave shareholders diluted and disgruntled, and create a public float that may cause them to drown in their own shares.

Money is flowing again, but the individuals who are providing it are sophisticated, shrewd, and dedicated to profit. In order to be treated fairly in these transactions, public companies should be equally focused on their goals and set reasonable limits on the price they are willing to pay for an infusion of capital.

Put that one in your PIPE and smoke it.


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http://www.stockpatrol.com/article/key/pipes

[Stock Lobster]

fyi: Ant & Sons on PIPE Transactions:

Structured PIPE Transactions Take Hold as Convertibles Deemed Risky

To raise money for operations, companies usually must raise it on the open market through privately placed convertible securities that have a floating conversion ratio. These conversions are more often than not priced at some discount to the company's closing bid price over a period of days and have very dilutive effects on the company's stock.

The dangers of this method of financing can be found from the craze of the dot-com bubble, when death spiral or toxic conversions torched stocks like Micro Strategy Inc. (NASDAQ: MSTR), Log On America, eToys, Sedona Corporation (OTCBB: SDNA) and many others that lost up to 90% of their value. With the lessons of the last decade, Allegheny Energy Inc. (NYSE: AYE) and Owens and Minor Inc. (NYSE: OMI) learned that an alternative method could be used much more effectively than death spiral and toxic conversion financing.

As these corporations soon realized that they had another option due to the evolving investment marketplace, they turned to what is called a structured PIPE (private investment in public equity) transaction. PIPE's are any placement of securities for a public company to accredited investors that agree to a purchase agreement in order to purchase those securities. Securities often sold in these types of transactions are common stock, convertible preferred stock, convertible debentures, warrants or other equity securities.

These structured PIPE transactions, without floorless convertibles, are often used as an alternative for other means of financing company operations, such as toxic converts, that are usually very dilutive. Investors in this particular PIPE transaction purchase a specific number of shares at a fixed price, with the closing becoming effective upon the Securities and Exchange Commission's ability to approve the resale registration statement covering the resale of the shares sold in the private placement.

There is one very important benefit to PIPE transactions, including the ability for investors to commit to purchasing a fixed number of securities at a fixed price, avoiding the risks of changes in the market prices or rapidly varying conversion ratios. This fixed price allows considerable protection for the issuing company to limit their risk to the number of shares it has to issue. However, there should always be a concern that PIPE transactions may pose risks or could even be tampered. In the past years of PIPE deals, the SEC has been requesting information from broker-dealers about short sales in connection with particular PIPE transactions. In one highlighted case back in February of 2003, the SEC sued Rhino Advisors for manipulating the price of Sedona Corporation's common stock by selling the stock short for the client that had participated in the floorless PIPE transaction.

Overall, well crafted PIPE transactions that do not use floorless convertible ratios create the incentive of limited risk on market value and shareholder dilution. This has made it a safe bet for many technology and biotechnology companies that have significant capital requirements that need to be fulfilled. However, due to the rise in popularity of PIPE transactions, the variety of companies who complete PIPE offerings has increased dramatically, especially due to the liquidity it provides to the issuer's current shareholders.

In the latest year, it was expected that proceeds generated from PIPE transactions would reach over $14 billion. With hundreds to possibly thousands of PIPE deals in the works, there is no reason to believe the phenomenal movement into private investment in public equity will stop anytime soon.

http://www.antandsons.com/takesalook/pipetransactions/

[Stock Lobster]

I've posted extensively on PIPE financing on my board:

http://www.investorshub.com/boards/read_msg.asp?Message_id=15238319&txt2find=pipe

http://www.investorshub.com/boards/read_msg.asp?Message_id=15238319&txt2find=pipe

[Stock Lobster]

fyi: Death Spiral Convertible Just Refuses to Die

Brokerages/Wall Street
Death Spiral Convertible Just Refuses to Die
By Matthew Goldstein
Senior Writer
5/11/2006 7:13 AM EDT

URL: http://www.thestreet.com/stocks/brokerages/10284937.html

The "death spiral convertible" might sound like your last car, but it's a bond -- and it's making an unlikely comeback on Wall Street.

These much-maligned securities, whose conversion into common shares can be triggered by precipitous drops in a company's stock, all but disappeared from the market three years ago. The near extinction occurred as investors got wise to the deleterious impact an endless flood of new shares can have on price.

Subsequent allegations of manipulative trading by some of the hedge funds that invested in these deals looked to be the death knell of the death spiral convertible. Those allegations ultimately spawned a regulatory investigation that led to a number of enforcement actions against hedge funds accused of illegally profiting from declines in stock.

Over the past year, however, there's been a surprising revival in the market for death spiral convertibles -- known officially on Wall Street as "floating convertibles.'

In particular, small, cash-strapped companies with market capitalizations often under $100 million are selling these bonds to hedge funds in deals covered by the Wall Street acronym PIPEs, or private investments in public equity. The resurgence in death spiral deals may be an indication that tiny, cash-strapped companies are finding fewer options for raising money.

This year, 10% of the 478 completed PIPE deals brought to market have been death spiral transactions. By comparison, just 1.9% of all PIPE deals in 2003 were categorized as death spirals, according to research firm PlacementTracker. (PlacementTracker officially calls them floating convertibles).

Last year, death spirals accounted for 6.4% of the $20 billion-a-year PIPEs market. Death spiral deals peaked in 1999, when they represented 20% of all PIPE transactions.

Some of the companies that have done death spiral PIPE deals with floating conversion prices this past year include Generex (GNBT:Nasdaq) and Vasomedical (VASO:Nasdaq) , according to PlacementTracker.

So far, two hedge funds are leading the way in investing in death spiral deals. Over the past 12 months, Cornell Capital Partners has emerged as the top investor in death spiral transactions, sinking $175 million into 42 deals. In second place is NIR Group, which has invested $77 million in 40 transactions.

No other hedge fund comes close to Cornell Capital or NIR, says Robert Kyle, executive vice president of Sagient Research, the parent company of PlacementTracker.

Mark Angelo, the founder and president of Cornell Capital, a $500 million fund located in Jersey City, N.J., declined to comment. Corey Ribotsky, the manager of Roslyn, N.Y.-based NIR Group, did not return several phone calls. NIR Group has $486 million in assets under management.

PIPE deals, of course, come in all shapes and fashion. But almost every deal involves the sale of discounted shares to a group of hedge funds.

Death spiral PIPEs got their unsavory reputation because, unlike typical convertible bonds, which get converted into shares only when a stock rises to a fixed price, the conversion price for these notes keeps getting adjusted downward whenever the underlying stock falls. The drop in the stock price also means the buyers are entitled to receive more shares when the conversion occurs.

The floating convertible feature is intended to be an embedded hedge to protect investors in the event the stock doesn't rise in price after the deal. But, in the past, some unscrupulous hedge funds that bought the bonds saw the floating conversion feature as an invitation to make money by literally shorting the stocks to death. In many cases, those hedge funds violated contract provisions forbidding any shorting of the company's stock. (Nobody has lodged such allegations about Cornell or NIR.)

A short sale is a market bet that a stock will fall in price.

To some degree, every PIPE deal, not just death spirals, is a bit of a Faustian bargain for a company. In selling discounted stock or a bond that converts into discounted shares, the company hopes all the extra shares coming into the market won't depress the price of its stock.

PlacementTracker reports that six months after a death spiral convertible is placed, the stock of the issuing company is down, on average, 7%. Yet, ironically, death spirals are not the worst-performing PIPE deals.

PlacementTracker says companies that sell bonds with a so-called "convertible reset' conversion provision often see their shares plunge by 26% six months after doing a deal. A convertible reset PIPE is a modified death spiral that doesn't have an endless conversion feature.

Indeed, the NIR Group, which mainly invests in death spiral PIPEs, reports having some stellar annual returns. The NIR Group's AJW Offhore hedge fund is up 6% this year, after rising 17% last year, according to a report sent to the hedge fund's investors.

One hedge fund manager who didn't want to be identified says most investors in death spiral deals want a company's stock to go up. He says the floating convertible is intended to provide protection to investors. He says there's more money to be made from a company's stock rising than falling.

The hedge fund manager says death spirals unfairly got a bad reputation because of abusive short-selling by some rogue hedge funds.

Casper Hallas, a portfolio manager with Denmark's Scandium Asset Management, agrees with that sentiment. He says his fund invested with the NIR Group because he likes PIPE deals with a floating-conversion feature. He says the downward-conversion feature provides added protection for investors.

"If the market goes down, you convert at the lower rate,' says Hallas. "Having a floating rate is a little bit like riding a put.'


--------------------------------------------------------------

As originally published, this story contained an error. Please see Corrections and Clarifications

[Stock Lobster]

Basically, a company resorting to PIPE financing is like a couple going to a loan shark to finance their mortgage payments.

PIPE financing is the number one reason why most pink sheet companies implode, imho.

There are several reasons for this. Partly it's the "death spiral convertibles", partly, the fact that the very companies financing the Pinksheets are also shorting the stock (and covering cheap with the shares they're getting as a result of the PIPE deal) and lastly, the terms of the financing are enough to doom the company to an impossible-to-meet payment plan.

Just think of a $50K a year couple, already saddled by debt, buying a $500K house with an adjustable rate mortgage, interest only, no money down!

No matter how impressive their credentials, or income potential, the debt burden would be enough to bury them. Imagine then that the very bank that lent them the money were then in a position to add an additional $5K a month in debt to their monthly burden...

However, worse still, is the fact that some cynical CEOs enter into an agreement with a PIPE financer, knowing full well that the company will never survive. The company is a sham, never designed to survive, but merely an excuse for the CEO to collect a nice bonus check, in full cooperation with the PIPE financiers.

[Stock Lobster]

Bidwacking. This is when a seller chooses to sell his/her position 'at market', instead of 'at ask'.

Depending on the size of the position, the shares will 'hit the bid' and usually have the effect of causing the bid to drop quickly. Buyers suddenly realize that sellers are anxious to sell, and as a result, they drop their "bid" price even further. Buying and selling is all a matter of creating a market perception. most people want a stock that is in high demand, where sellers are reluctant to sell except at a higher price. Similarly, Most buyers will get spooked when many sellers suddenly are willing to drop their price just to get out of the stock.

This playing out of market psychology is easy to watch on the L2s.

On a high volume momentum stock, 'bid wacking' isn't as destructive. But if the stock is a low volume play just getting started, someone dumping a large position 'at market', could drop the bid as much as 30%, depending on the market makers involved.

Sadly, many newbies don't realize that during a high volume run on a popular stock, it's entirely possible to set a price and one's shares sell 'at the ask'. Not only is this possible, but it's preferable!

Not only is selling at "the ask" better for the seller, (assuring him of a higher PPS selling price) selling 'at the ask' is better for the stock's future performance as well.

That may explain why veteran traders will say "friends don't let other friends bidwack!"