Monday, May 30, 2016

Data Group Dilutes Shareholders...Again

Shareholders of Data Group should not be surprised that they are getting poor treatment from the company's insiders, because this is consistent with the company's recent behaviour. Just a few months ago, the company essentially bankrupted its equity holders by converting debt to equity, rather than shore up the company's capital situation with a rights offering that CEO Michael Sifton originally agreed to backstop and then backed out of.

Now, the company has decided to do a private placement for 20% of the company's shares at a price of just 1.4 cents per share. This is about 30 *times* cheaper than the price Sifton originally agreed to (before backing out as referred to above) when he took the reigns as the company's CEO.

I was pretty upset when I read the press release and so I called Sifton to discuss it. He told me he has wanted to do a private placement since the beginning, but has gotten push back on it. I can only speculate that this is the reason he resigned. However, he did such a good job turning the company around that I suspect the company went back to him hat in hand and now this is the result. Sifton said it would be a good assumption to make that if the placement goes through, that he would take back his resignation.

I can understand a successful CEO wanting to have upside and an ownership stake in the company he runs. I still don't really understand why it needs to be done at the shareholders' expense though. The equity position for Sifton could have been done in the open market, or through a backstopped rights offering where every shareholder is offered a chance to buy in at the advantageous price. I also don't understand why the dilution has to occur at 20% of the company's shares when Sifton is only buying in for 10%. The answers I got did not really satisfy me. Sifton argued that the company is looking to raise a certain amount of working capital to help pay off the converts due in a year. But this could have been done with all shareholders through a rights offering. I'm also surprised at this need to raise capital considering the company got to decide how much of the debt to convert to shares and did not convert all of it. I offered to participate in the private placement as an investor but was turned down.

Regarding the rights offering that he backed out of at a much higher share price, Sifton agreed that "it's an unhappy story for shareholders" and that "it sucks". But he argued that he was not told how bad things were when he arrived. He was surprised by the shape the company was in, and at that point decided not to issue any shares. He said the company was under water and so had to do something pretty difficult.

So here's what I think is going on, and this is speculation on my part. Sifton has wanted a sweetheart deal every since he joined the company, but did not get one, so he resigned. But during his short tenure, he did a good job cutting costs and so gained the market's confidence (shares traded between 2 and 2.5 cents before he resigned, and 1.5 and 2 cents after). After he resigned, the board decided to meet his demands as they felt they needed him. But if they were going to give him a sweetheart deal, they wanted to be able to participate as well. So this is why we're seeing big, unnecessary (in my opinion) dilution at a price no ordinary shareholder has access to but that insiders have likely jumped all over.

In my opinion this private placement at such a ridiculous price reduces the value of the equity by over 10%. On top of that, I think a discount on this company is probably warranted because of the poor way in which the company treats shareholders. Nevertheless, I think the shares remain very cheap because of the low multiple and business prospects the company faces. I'm not happy to be in this situation but at the current price I'm not selling either.

In addition, this capital raise does make the debt safer, which is rightfully trading higher on the news.

Disclosure: Author has a long position in shares of DGI, and

1 comment:

Anonymous said...

So what do you see as the intrinsic value per share post the dilution? Any change in FCF this year? What do you estimate FCF per share to be.