For a Change, Merger Adds Firm to L.A. Corporate List
Wall Street West
by Benjamin Mark Cole
It’s nice when a publicly held company actually moves into Los Angeles due to a merger, instead of out which, with the exception of the acquisitiveness of Northrop Grumman Corp. and a couple others, has been the usual scenario in recent years.
Last week, Steve Kriegsman, president of investment banking shop Kriegsman Group, confirmed that his company has acquired Norcross, Ga.-based CytRx Corp. and moved its headquarters to Los Angeles. “We owned Global Genomics Inc., a private company, and merged it into CytRx Corp.,” Kriegsman said. That gave Kriegsman control of the voting shares of CytRx, so he moved the offices here and became the merged company’s new chief executive.
CytRx, either directly or through minority ownership in other medical research outfits, has a number of drugs or treatments Kriegsman considers promising. The one that has received attention in the stock market is a delivery technology, called “TranzFect,” for DNA-based vaccines. TranzFect has been licensed to drug giant Merck & Co., for use in Merck’s efforts to develop a vaccine for HIV/AIDS.
“That is our flagship project, and it will be an extraordinary asset if the (HIV/AIDS) vaccine can be brought to market,” Kriegsman said.
But Wall Street is evidently not giving it much of a chance it put a market cap on CytRx of only $7 million (about 60 cents a share) before Kriegsman’s acquisition, and that’s about what Kriegsman paid to buy the medical research company in a complicated transaction. Back in 1991, CytRx commanded $47 a share.
Santa Monica-based Sanli Pastore & Hill, an independent business valuation firm, rendered an opinion that the price was fair to CytRx’s shareholders.
PIPE Dreams
The market this year has been receptive to PIPEs (private investment in public equity), but with the lengthening bear market, that receptivity is wearing thin, said Byron Roth, chairman of Roth Capital Partners, the local brokerage. “What we are seeing is very big warrant coverage,” Roth said.
Last year, $9 billion in PIPEs were sold, far eclipsing initial public offerings as a source of capital. In the recent past, shares in a PIPE were sold to one or a few institutional investors, at a discount to market. So a large investor might take down a large chunk of $10 stock, but at $9 a share.
Now, investors also want warrants thrown in. The warrants give investors the right to buy an additional 25 percent to 50 percent of the number of shares acquired in the PIPE, usually at a slight premium to market. So if an institutional investor buys 100,000 shares of XYZ stock at $9, and the stock is trading at $10, it may also take warrants for 50,000 shares at $11. “It’s a big bet on the upside,” Roth said.
There appears to be large capital hoards waiting on the sidelines of Wall Street, notes Roth, along with other investment bankers. The leveraged buyout funds are sitting atop billions, but can’t find banks willing to provide the loans that serve as leverage in their deals. Venture capitalists raised billions only a couple of years back, but now are mostly sitting on their hands. Private equity investors are taking a “wait-and-see” position. Mutual funds are contracting while money funds bulge. “As a result, we are getting stuff done, but it is getting hard to get a PIPE across the finish line,” Roth said. “There is not a lot of courage out there among investors.”
Roth recently completed a $5 million PIPE for Denver-based ACT Teleconferencing Inc., a provider of teleconferencing products. The issue was actually convertible preferred stock, with a 6.5 percent dividend. Warrants were issued, allowing investors to increase their position in the company’s common stock, under certain conditions.
Bear Necessities
Why is this bear market different? “We have two related problems that have broken investor trust,” said Tom Weary, president of Diamond Portfolio Advisors LLC in Santa Monica. Problem No. 1, as evidenced by Merrill Lynch & Co.’s recent woes, is that brokerage analyst research has become corrupted. “Trading commissions just don’t cover the cost of research. So the brokerages have turned the research into support staff for the investment banking arms,” Weary said.
The second problem is that auditing firms want consulting business. “The auditing firms are low-balling the auditing fees, to get highball consulting contracts,” Weary said.
These constitute broken business models, Weary said. In the bear market of the 1970s, there were some scandals, but nothing to suggest that the foundations of Wall Street were rotten. “How do you get investor trust back?” he asks. “You can’t trust the brokerages, and you can’t trust the auditors.”
Weary advises money managers to beef up research operations, and investors to pick stocks they way they might pick mates character counts for a lot. “Character is destiny,” he said. “The future is unknowable, but if you know a corporation’s culture, you know how they will react to the future.”
Despite the gloom, Weary likes some drug stocks, including Johnson & Johnson and Pfizer Inc. both for steady track records and large pipelines of promising drugs or devices.
He also likes motorcycle manufacturer Harley-Davidson. “They make good bikes,” he said. “It is what they are devoted to. Companies which have a mission seem to attract better people.”
Puckish View
“We are going for the hat trick,” said Chip Hanlon, money manager and editor of Manhattan Beach-based Unfundamentals, an online financial newsletter service. Hockey fans know that hat trick means scoring three goals in one game but Hanlon is speaking a bit sarcastically, and predicting that 2002 will be the third straight down year for major stock averages. “I think we may see some rallies, but any rally will just get taken down by the bear again,” he said.
The big problem is that stocks still trade at fundamentally high values, or price-earnings ratios above long-term norms, Hanlon said. While stocks are still trading around 20 times earnings, they reached into single-digit price-earnings ratios back in the 1970s, Hanlon warns. And stocks back then paid 5 percent yields in dividends, not 2 percent like now.
The other worry is that markets tend to overshoot on the top and undershoot on the bottom psychology drives investors past fundamentals, at least for a few years. So we could see single-digit price-earnings ratios again, meaning the bear is only about halfway into hibernation. Investors may want to look for specific trading opportunities, or yield-oriented funds, Hanlon advised.
Contributing columnist Benjamin Mark Cole writes about the local investment community. He can be reached at
[email protected]
