Friday, September 24, 2010

Making Money The Wrong Way

Last year, we discussed a small-cap company called Daxor (DRX) that claimed to be a medical device manufacturer. Unfortunately, it made no profits from this operation, but it did generate profits from trading securities, including millions of dollars worth of short positions! By marketing itself to investors as a medical device firm, the company was not being very up-front with investors, which is why we originally discussed the company. Apparently, the SEC agrees.

Last week, the SEC issued cease-and-desist enforcement proceedings against Daxor for illegally operating as an unregistered investment company. Investment companies must provide disclosures to increase transparency for investors. Daxor skipped that process by purporting to be in the medical device industry. The SEC notes that Daxor's investment income has amounted to 750% of Daxor's gross operating revenues over the last five years. Furthermore, 90%+ of the company's assets are investment securities, rather than assets related to medical device manufacture.

When we first looked at the company last year, it traded at a 50% premium to its book value, which mainly consisted of the aforementioned short-term investments. In other words, there was no discount to be had. Since then, however, the price has fallen significantly, while the book value has been relatively stable. As a result, investors are now offered the opportunity to buy this company's short-term investments at book value, with the company's regular operations thrown in for free.

But are those regular operations worth anything? Perhaps not. As the SEC explains:

"Although it claims to be a medical device manufacturing company and its principal product has been developed and available for sale since at least 1998, Daxor has never realized an operating profit or even significant operating revenue."

Furthermore, there may even be material penalties or costs to pay associated with the SEC allegations should a hearing go against the company. As such, investors are not offered much of a margin of safety on this stock. If investors can take anything away from this situation it's that they must understand the sources of a company's profits. Otherwise, they are buying assets they don't understand.

Disclosure: None


Ankit Gupta said...

I'd like to know what they've been investing in - looks like some of their investments worked well. If they are decent at this at all, why don't they just register as an investment company?

Any idea what they were invested in?

Saj Karsan said...

I believe they are rather short on details. But I do know they had a significant "short" portfolio! I think they don't have to disclose much in their current form, so this is a change that would occur if they registered as an investment company