|Congratulations, Mr. Katz. Your faith has been rewarded. A great story with a happy ending. I'm sure the Vegas trip had a dreamlike quality.|
Playing Penny-Stock Roulette
January 23, 2005
By GARY RIVLIN
HIS hair is white and stringy, his beard thick and snowy in the fashion of a hermit who decided long ago to park himself high atop a mountain. He's a touch shy, a self-deprecating man who describes himself as never before lucky in life.
John L. Kingery knows that he is not the sort you would expect to find here sipping a cocktail inside a high-roller suite at the Mirage. Nor were most of the 15 or so others who descended on the hotel this month to toast their collective wisdom - and the millions they had collectively made - in buying shares of Audible Inc., an Internet stock so beaten down that for a time it could be found only in the netherworld of penny-stock trading boards.
Their choice of place could not have been more apt. Mr. Kingery and his fellow travelers, who included a lieutenant colonel stationed inside the Pentagon, a semiretired 26-year-old and a part-time science fiction writer, had each placed wagers as large and as bold as most people who usually inhabit these suites.
The last few years have been a banner time for those inclined to play penny stocks, if only because there are so many of them. A record number of companies have been delisted since the market began its collapse in the spring of 2000, perhaps an outgrowth of the record number of companies that went public during the 1990's. The Nasdaq alone banished nearly 1,100 companies from 1999 to 2002, stamping them as damaged goods because they either failed to meet minimum financial standards or violated Securities and Exchange Commission policy - or both.
Like others who study penny stocks, James J. Angel, a professor of finance at the McDonough School of Business at Georgetown University, cast them as treacherous grounds, offering odds barely better than those of a roulette wheel. Yet, as the story of Audible and its faithful show, risky investing by amateurs does not seem to have perished along with the likes of Pets.com and other dot-com flameouts.
Penny stocks come in several forms. They include those, like Audible, that the Nasdaq tossed off its primary exchange when they fell short in a set of financial tests, though they could be traded on Nasdaq's bulletin board because they remained current in their S.E.C. filings. Then there are the ones kicked off the Nasdaq or the New York Stock Exchange whose filings are not current. Those are traded on the over-the-counter market known as the pink sheets.
"Basically 95 out of 100 of these companies end up dead," Professor Angel said. "If you look three years out, you'll see that very few of them rise like a phoenix from the ashes." That figure does not include those penny stocks that were never listed on one of the major exchanges, either because they couldn't make the cut or because they "didn't want to bow down to the authorities" at the S.E.C., Professor Angel said.
Audible, which lets people download audio books and other material via the Internet, had a typical rise and fall, then a not-so-typical rebound. The company, based in Wayne, N.J., is again trading on the Nasdaq. Its stock, which soared to $21 a share on its first day of trading in 1999 from an opening price of $15.25, hit a low of 15 cents in February 2003 - all before a reverse 3-for-1 stock split in June 2004.
But as the company approached a split-adjusted $10 a share late last year, a group of Audible investors decided that a celebration was in order, and they met at the Mirage. Previously, they had communicated exclusively through postings on an Internet site created by one of their own. (The stock now trades at $25.47, or a split-adjusted $8.49.)
PERHAPS the biggest surprise to be found inside that high-rollers suite wasn't that a penny stock had created a small cadre of big winners. Rather, it was the willingness of this group of true believers to behave so recklessly, despite all those billions lost by investors four years ago.
Consider Keith Chadwell, the director of data services at a company in Greenville, S.C.. He told his fellow investors that he believed so enthusiastically in Audible.com - he figures he has downloaded and listened to 350 books in the past five years - that he invested all of his savings in it, then set aside half of his take-home pay each week for a year to buy more.
Another Audible groupie, Peter Graetz, a computer consultant based in Düsseldorf, Germany, said he had liquidated all of his other stock holdings to buy more shares. "I was the crazy guy of the group," said Mr. Graetz, who had logged 33 hours on airplanes and in airports traveling here from Germany for the celebration. "I was 100 percent Audible."
Mr. Kingery might have been even rasher. He said he bought a large portion of his shares on margin - borrowed money.
As any student of the stock market knows, the riskiest investments are those that offer the greatest payout. Mr. Graetz would not share all the details of his investment, but did say that the stock was now worth more than 10 times what he had paid. Mr. Chadwell boasted to the group that he had made 15 times his investment, turning a belief in Audible and $25,000 into a $400,000 stash.
Mr. Kingery revealed that he had bought a split-adjusted 133,000 shares of Audible at an average cost of 40 cents each. He sold half his holdings recently, when the stock was near a split-adjusted high of $10 a share. His sale translates into a larger payout than Mr. Chadwell's, based on only half his holdings.
THE recent popularity of penny stocks reflects in part the sheer number of technology casualties since the stock bubble burst. "In the last several years we've seen a number of legitimate tech companies that have been beaten down badly but then came back from a near-death experience," said Jay R. Ritter, a finance professor at the University of Florida.
A stock price languishing below $1 a share is the most common reason the Nasdaq boots a company off its primary market, according to data provided by Professor Angel of Georgetown. "If a stock is trading for under a buck, then something has gone dreadfully wrong at that company," said Professor Angel, who serves on a Nasdaq advisory board that oversees its bulletin board. "Generally stocks go public at $10, $15 a share. So if they're trading for under $1 a share, then they've lost more than 90 percent of their value."
Just as a high-end retailer doesn't carry cut-rate products because shoppers may start to doubt the quality of all its goods, the major markets don't want to sell the equivalent of what he called "shoddy apparel."
So many Nasdaq stocks were trading for less than $1 just after Sept. 11, 2001 - one in six, according to Professor Angel - that Nasdaq felt obliged to impose a moratorium on delistings. It lasted three months. Yet for many companies, including Audible, that only meant delaying the inevitable. "One of the things the Nasdaq does well," Professor Angel said, "is flush the losers."
Some plainly needed to be flushed, like PlanetRX and Webvan, two dot-coms that had once had high profiles but that declared bankruptcy and are no longer traded on any public exchanges. But hundreds of once-proud members of the Nasdaq are barely hanging on. The Salon Media Group, for instance, was trading on Friday at 13 cents a share - a paltry figure, though not when compared with shares of DrKoop.com, which were at one one-hundredth of a penny.
Then there are the dot-com comeback stories, including Audible and others. Shares in the Varsity Group, which sells textbooks and other education materials online, hit a low of 16 cents in April 2001 but closed at $6.74 on Friday. The Knot, an online wedding site, traded at 22 cents a share in July 2002; it is now at $5.00. The Knot trades on the over-the-counter bulletin board but applied this month for listing on the Nasdaq SmallCap Market.
And it is companies like these that provide the attraction, for amateurs as well as for some professional investors. Jeffrey D. Saut, the chief investment strategist at Raymond James & Associates, the investment firm based in St. Petersburg, Fla., is gung-ho on penny stocks. To him, the ranks of the penny stocks are about the only place to find real bargains, or what he described as "mispriced pieces of paper, which is to say stock certificates that are undervalued."
In just a few months, he said, he has had an 89 percent return on an investment in a Canadian-based energy stock he bought at 48 cents a share. He has had a return of 37 percent over roughly that same period on a battery technology company trading on a Canadian penny stock exchange.
Yet he sounded like a car commercial that cautions people against trying the stunts themselves. "The average person shouldn't be participating in the penny stock arena," Mr. Saut said. "They don't have the skill set to determine if, first of all, it's a real company or a fraud. And they don't have skill set to understand the accounting or to analyze the assets."
Unscrupulous promoters have exploited investors' ignorance in the past, using false or misleading statements to inflate the value of penny stocks, then cashing out before the companies' true value - or lack of value - become apparent and the stocks tumble. The process is so common that the authorities have given it a name: pump-and-dump.
The amateurs who so aggressively invested in Audible, however, seemed an entirely different breed, starting with the tone of their discourse on the stock message boards so popular on the Internet.
"I think it's fair to say the message boards aren't exactly a model of intelligent interactions," said Donald R. Katz, the founder and chief executive of Audible. The typical participant posting messages at a place like Yahoo or Silicon Investor tends to sound like a sports fan, using too many exclamation points and having a propensity to write in all capital letters, as if screaming.
"But here was a group that did their own financial models," Mr. Katz said. "They went deep into our financials and worked up a pretty classic analytic analysis of the company."
AUDIBLE had a scant 3,000 customers when it went public in July 1999. Yet Mr. Katz said it wasn't impatience or greed that prompted him to sell shares in his young company. Instead, it was a concern about the half-dozen or so competitors looking to cash in on this same market.
"The deal then was that if you didn't take the money, if you didn't step up as the I.P.O. of the category, someone else would have," he said. "Believe it or not, going public was a defensive thing."
When Mr. Katz started Audible in 1995, there was no iPod. Nor was there any mass-market digital player that would serve as a natural platform for the books, magazines and newspapers - including The New York Times - that Audible now delivers digitally in digest form.
That meant Audible needed to invent both the hardware and software required for people to download, store and listen to the audio books and other content that the company intended to sell. At the same time, Mr. Katz had to persuade publishers to take a flier on his fledgling enterprise. "That proved to be much more difficult than I or my investors ever anticipated," he said, with an expression somewhere between a frown and a smile.
Mr. Katz's company arranged for the Mirage suite and a full bar and hors d'oeuvres to help his loyal investors celebrate, and he was in an expansive, reflective mood shortly before the party. A well-regarded author and financial writer before "trying to prove whatever I'm trying to prove with Audible," he said that one of his more vivid memories from the company's early history was a chat with Jeffrey P. Bezos, the founder and chief executive of Amazon.com.
"Jeff said he thought about building an entirely new category, like I was doing, rather than a new business system for an existing marketplace, like Amazon, but he said his analysis showed starting a new category would take 10 years," Mr. Katz said. "I thought we'd get there much sooner, but I hate to say, he was right."
Audible was able to start reporting profits last year, nine years after it was created. Digital media players are now ubiquitous, and the company now sells its audio content through the Apple Computer iTunes store. More recently, it signed a deal with Sprint, hoping to find a place on people's mobile phones.
For early investors, though, Mr. Katz's miscalculation proved painful. The company's stock hit an intraday high of $25 on its first day of trading but within a year it was at less than $5 a share, and after 15 months it was below $1. (The numbers are not adjusted for the subsequent reverse split.)
"It felt for a while there like we had gone away," Mr. Katz said, and in a way it did. Wall Street analysts stopped following the company, and the institutional investors who had believed in it sold their shares. Audible continued its practice of having a quarterly conference call to report on its financial picture and to field questions from the analysts and institutional investors, though almost no one bothered to participate.
"I'd be the only one asking questions," said Ray Unger, the president of Unger Capital Management, an investment advisory firm in Madison, Wis., with $26 million under management. "I'd ask, 'Tell me about your churn rate; tell me about your cash flow.' And then they'd ask, 'Any other questions?,' and there'd be silence until they said goodbye."
Mr. Unger, who described his investment in Audible as a "career win," said the routine repeated itself for around 18 months.
Small-time investors communicated with one another through a message board on Yahoo, but that Internet portal, as is its policy, dropped its Audible site after the company was delisted in February 2003. That prompted William T. Katz - no relation to the founder - to create his own Audible site, which served as the catalyst for the group that would eventually rendezvous in Las Vegas this month.
"People really got riled up when the company was delisted," Mr. Katz said. "They felt it was unfair. People wanted to rally around the company."
Mr. Katz, the investor, once described the hard-core Audible advocates who sometimes posted as many as 10 messages a day as a "motley crew." He upgraded his assessment to "very eccentric" after meeting several of them for the first time the night before the party. He might have offered himself as Exhibit A. Mr. Katz, 40, has an M.D. and a Ph.D. in biomedical engineering from the University of Virginia, but nowadays he devotes his time to writing science fiction and developing an authors' Web site called Writertopia. When proposing a meeting here with a reporter, he suggested a "Star Trek"-theme bar at the Hilton.
Mr. Katz bought shares of Audible shortly after it went public, but instead of feeling burned by a stock that fell so precipitously, he saw a prime buying opportunity. He was a true believer in the service, heartened that the company showed revenue growth quarter after quarter, despite its financial woes. (It burned through $49 million from 2001 to 2003.) Convinced that Audible's stock was priced "irrationally low," he said, he kept buying. Ultimately, he stopped after roughly 60,000 shares, most of which cost him less than $1 each, because he began to worry that he was risking too much of his portfolio on a highly speculative stock.
SUCH stories were heard over and over at the Mirage celebration. At one point during the party, the investors, standing in a circle, took turns sharing tales that seemed to differ only in the specifics. Tom Hallam, 60, a retiree from Hilton Head Island, S.C., told the group that he kept buying shares as the stock price fell, until he ran out of discretionary income when the stock was trading at 30 cents.
Though he owned more than 30,000 shares, he held on until the company hit a split-adjusted $10. Only then did he sell roughly half his stake. "I never would have had the courage to hold the stock without the support of you guys," he said.