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Company Focus 3 prime picks from the pink sheets advertisement
The world of pink-sheet stocks mixes honest businesses with rogues and shells. A plan to impose standards could reduce the risks. Meanwhile, here are 3 elite pinks that experts recommend.
By Michael Brush
It may soon be a little easier to tell the good guys from the bad guys in the stock market's Wild West.
By this summer, the world of "pink sheet" stocks -- a bewildering collection of rogue operators, dubious shell companies and honest businesses -- may have an elite tier of companies more suitable for consideration as investments.
This new upper crust will be reserved for companies with real businesses that report formally audited financial statements. They will also have the blessing of hired sponsors from the investing world who vouch that they are legitimate.
None of this, of course, will mean that these super-pink-sheet stocks are without risk. But if the new system takes hold, it should provide a better way to sift through the nearly 5,000 companies and find the hidden gems. And some of these companies, history shows, have the potential to produce huge investment returns. Start investing with $100. Explore our new ETF center.
Later in this column, I'll give the lowdown on three companies that a pink-sheet expert thinks are worth a look.
Avoid the dogs Pink-sheet stocks get their name from the color of the pages of a daily publication once used to distribute prices and the names of market makers in this nether region of the stock market. A group of investors, led by R. Cromwell Coulson, now president and chief executive of Pink Sheets, in 1997 bought the company that published the pink sheets. Coulson's proposal for a premium tier of pink-sheet companies -- to be called OTCQX -- is part of an ongoing effort to bring more respectability to the pinks.
It's not a bad idea. Despite the bad reputation, pink sheets can offer some rewarding investments. “You can find some great value plays, like economically distressed companies that are trying to work things out after they have fallen off the exchanges,” Coulson says.
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He cites HealthSouth (HLSH, news, msgs), a rehabilitation and medical services chain that left the Nasdaq in 2003 when an accounting scandal nearly drove it into bankruptcy. In its early days on the pinks, HealthSouth stock traded for pennies. But the stock rebounded and recently sold for $4.90, a gain of more than 2,000%.
On the other hand, Coulson admits there are lots of bogus companies in the pinks that do little more than “issue press releases and shares.”
The new upper tier is designed to help investors avoid these dogs. Here's what companies will need to do to join the elite: Have a real operating business.
Provide financials that are audited according to standards known as “generally accepted accounting principles.”
File quarterly and annual financial reports with Pink Sheets LLC, which will make them available to investors, and give updates on material events, just as listed companies report these filings to the Securities and Exchange Commission.
Have at least 100 shareholders who each hold at least 100 shares each. Upper-tier companies will also have a sponsor, known as a designated adviser for disclosures, or “DAD,” who verifies that the business qualifies. Coulson hopes these sponsors -- who will be broker-dealers or securities lawyers -- will serve as gatekeepers to keep out the riff raff.
Why not just choose Nasdaq? The elite tier itself will have two levels. One, known as PremierQX, will be for companies big enough to be listed on the Nasdaq. The other, PrimeQX, is for smaller companies. Coulson says he will start taking applications in the middle of April, and the new tier will launch in mid-June.
But will companies go for it? “We think it is a very good idea,” says Douglas Springer, the finance chief of Burnham Holdings (BURCA, news, msgs), a Lancaster, Pa., manufacturer of heating systems and air conditioners listed in the pinks. “A second tier should give investors a certain degree of confidence that they can believe what companies are saying.” Burnham already produces audited financials and quarterly and annual statements.
“I would imagine that better companies will want to differentiate themselves,” says Robert Robotti of Robotti & Co., a value investor whose firm owns a lot of pink-sheet companies. “But time will tell how many companies decide this is a better place.”
One obstacle might be that professional investors like Robotti can already quickly identify pink-sheet companies good enough to make the upper tier.
And companies that can make Coulson’s upper tier would also qualify to list on Nasdaq’s bulletin board listing service -- a cut above the pinks. So, if they had any sense, they would just go for that option instead, believes Gregory Sichenzia, an attorney with Sichenzia, Ross, Friedman and Ferrence, which advises small companies on financing deals.
Coulson’s effort, though, may get a boost if the SEC refuses to exempt smaller companies from the financial-reporting requirements of the Sarbanes-Oxley Act of 2002. If so, many more small companies will likely delist from the stock exchanges and move to the pink sheets to avoid the costs of compliance.
Several large foreign companies already avoid SEC oversight and follow their home countries' financial reporting requirements. That list includes Volkswagen (VLKAY, news, msgs), Nestle (NSRGY, news, msgs), Heineken (HINKY, news, msgs) and Lukoil (LUKOY, news, msgs).
Think pink Here’s a quick look at three companies you would be likely to find in the elite level of the pinks. Robotti owns these names personally, and Robotti & Co. and its affiliates own more than 1% of the shares of each. His firm makes a market in Southern Energy Homes and Burnham Holdings.
Southern Energy Homes (SEHI, news, msgs): Based in Addison, Ala., Southern Energy sells manufactured homes. Its stock took a hit when the company delisted and joined the pink sheets in 2003 to avoid the cost of complying with Sarbanes-Oxley. Since then, the stock has more than doubled, to $6.
The manufactured-housing sector is on the rebound after years of weakness. Problems arose a few years back following a wave of repossessions from buyers who had been granted loans on easy terms. Excess inventory hit the market, but by now the sector has worked through much of it. Rising interest rates also help Southern Energy because many potential home buyers can no longer afford stick-built houses.
Despite the healthy gains in its stock, Southern Energy still looks cheap. It trades for just 0.37 times sales. The company has about $5.5 million in cash, or 45 cents a share, and no debt.
Advanced Marketing Services (MKTS, news, msgs). Shares of Advanced Marketing have crumbled to $4, from above $25, since early 2002. This book wholesaler has been plagued by internal fraud, the need to restate financials and delisting from the New York Stock Exchange.
Despite all these problems, Advanced Marketing Services still boasts blue-chip customers like Costco Wholesale (COST, news, msgs), the Sam’s Club division of Wal-Mart Stores (WMT, news, msgs) and BJ's Wholesale Club (BJ, news, msgs), points out Robotti. The company expects to ring up $760 million in sales this year, which means that its stock trades for a minuscule one-tenth of sales.
That kind of annual revenue suggests the company could earn 50 cents a share or more after it works through its accounting issues, says Robotti. If things play out this way, the stock could gain 50% or more. Before Advanced Marketing Services could list on the pink sheets’ upper tier, it would need to start releasing audited financials again. Robotti thinks that could happen within a year.
Burnham Holdings' stock has suffered since early 2005 because warm winter weather stifled demand for replacement heating systems. The company also fumbled a move to new facilities. Both factors put downward pressure on the stock, which declined to $20.50 from $27 in the past 12 months. Down here, the stock trades for book value. Robotti thinks both issues are only temporary. Meanwhile, Burnham Holdings pays a dividend of 29 cents a quarter, which works out to a 5.5% dividend yield.
At the time of publication, Michael Brush did not own or control shares of companies mentioned in this column.
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