Short AMCN. Why Is Air Media Falling?

 

This article is the opinion of the author. Nothing herein comprises a recommendation to buy or sell any security.  The author is short AMCN. The author may choose to transact in securities of one or more companies mentioned within this article within the next 72 hours. The author has relied upon publicly available information gathered from sources, which are believed to be reliable and has included links to various sources of information within this article. However, while the author believes these sources to be reliable, the author provides no guarantee either expressly or implied.

 

Summary

Last Friday (several days before I wrote about it), shares of Air Media (NASDAQ:AMCN) fell by around 20% on heavy volume in pre-market trading. It happened to be immediately after the release of the company’s annual report. It appears that someone out there actually bothered to read the annual report. But shortly thereafter, retail day traders pushed up Air Media’s stock on continued speculation about a potential “deal” to acquire the company. The stock closed flat on that Friday. But traders were clearly a bit shaken.

On Tuesday, I highlighted at moxreports.com the fact that Air Media “had no deal” with Shenzhen Liantronics. It was solely the belief in that deal that had propelled the share price upwards by as much as 150% in just a few weeks. To the extent that there was no deal, the stock should be expected to fall by at least 50%, back to around $2.00. This is just common sense.

Following release of my article, the stock fell by as much as 14%, but rebounded to close basically flat on the day.

As far as I can tell from Chinese trading sites such as xueqiu.com, the buying came from Chinese retail buyers who expected a strong response from the company.

As expected, Air Media did put out a response to my article on Wednesday. The company’s PR was entitled “AirMedia responds to false allegations“. It did not mince words in saying that:

The Company believes that the allegations and accusations set forth in the article are false and inaccurate and contain numerous errors of facts, misleading speculations and malicious interpretations of events.

As soon as the PR was released, the stock opened lower. It traded steadily downward and closed at the lows of the day, down 12%. The drop looks set to continue.

The reason the stock fell is that some investors actually bothered to read the contents of the press release. Despite the confusing and reassuring verbiage in the PR, we can see that: a) there is no deal; and b) new (and potentially greater) issues of concern have been revealed.

As shown below, the stock continues to be heavily held by retail investors (particularly in China) who have clearly failed to read the actual disclosure. The bet is simply one based on speculation of “deal” or “no deal”.

There are 5 key problems which were raised from the response PR, and which are causing the stock to now decline. Although some retail investors can be slower to catch on as they grasp these problems, Air Media is likely to see a much more rapid decline.

Problem #1: What about the “due diligence”?

In its response to my article, Air Media noted the following:

The claim that Liantronics has not even conducted due diligence in connection with the Transaction is erroneous. In contrary, Liantronics engaged a major PRC accounting firm, a recognized PRC law firm, a qualified PRC assets appraisal company and a recognized PRC financial advisory firm to conduct due diligence of AM Advertising in March 2015.

I have no doubt that Liantronics has engaged an accountant. I have no doubt that Liantronics has engaged a law firm. I have no doubt that Liantronics has engaged an asset appraisal firm. Of course they have. Duh.

So why do I say that Liantronics has not done due diligence?

It is… well… um… because Liantronics told me so.

In fact, to emphasize this point, Liantronics was good enough to contrast Air Media with a different situation where they actually HAD completed due diligence resulting in a real deal. We can see from this deal what it would actually require for Air Media to get a deal out of Liantronics.

On the same day (April 7th) as the original Air Media PR, Liantronics announced that it had completed a transaction for a very different media company, Shenzhen Precise Focus Media 深圳市精准分众传媒有限公司 (no relation to the former U.S.-listed Chinese company called Focus Media).

In that case, Liantronics had completed due diligence (yes, Liantronics told me so) and found that its target was: a) profitable; and b) growing rapidly year-over-year. Liantronics announced that it acquired a 28.4% stake in Precise Focus for around $12 million. We can see the parts about the profits, profit growth and profits targets in the announced key deal terms.

Key Point: If you believe that Air Media’s advertising sub will earn $31 million in 2015, then you should believe that this deal will ultimately go through. If you believe this, then you should buy Air Media stock with both hands, and do not stop until it hits around $6.50.

Precise Focus is very different from Air Media

The point to be made is that Liantronics’ basis for the pricing, even on just a tiny 5% stake in Air Media, was that the Air Media sub earn an audited profitof $31 million in 2015. Otherwise, Liantronics has the full right to simply cancel the transaction.

Unlike Precise Focus, Air Media has been losing money for 5 years. Unlike Precise Focus, Air Media’s business has shown continuous declines in revenues. Unlike Precise Focus, Air Media has already given partial guidance that revenues are set to decline further. Of greatest concern is that nearly 50% of Air Media’s concession rights will expire by the end of 2015, with aggregate concession fees of over $400 million. These are the reasons why Air Media is looking to get out of this business.

These are also the reasons why Liantronics will not end up buying the Air Media sub (once due diligence has actually been done and financial results are in for 2015).

On April 7th, Air Media told us: “AirMedia Sells 5% Equity Interest of its Advertising Business for RMB150 million”.

This statement was wrong. It was factually incorrect. It was erroneous. There had been no binding or completed deal.

The point is that Liantronics has not even done due diligence. In contrast to the April 7th press release from Air Media, there is no deal. It is something that is to be considered by Liantronics once they have actually done the due diligence and come up with acceptable financial numbers.

So the question now becomes: “Will there be an eventual deal?” Read on.

Problem #2: What about the $31 million in profit?

In its original April 7th press release announcing the deal, Air Media failed to mention the fact that the basis for pricing on the supposed deal was a net profit of $31 million. The company gave the impression that this 5% stake was a “done deal”.

Key Point: If Air Media had mentioned this $31 million profit term in its original press release, the stock would have never shot up in the first place.

In its more recent response to my article, the company addressed many points that I made, but quite notably stopped short of saying anything about the $31 million profit as the basis for pricing. The fact that Air Media said nothing in its response PR about the $31 million profit target is a key reason why the stock fell by 12%.

Air Media did state that once the company divested several money-losing business lines, it “believed” the sub would be profitable (to some extent). But that statement should be in doubt even with just cursory analysis of those tiny divestitures. This should be fairly simple.

The two businesses in question are: a) TV-attached digital frames; and b) airport digital TV screens.

Back in April 2014, Air Media disclosed that:

The interactive platform is built on our TV-attached digital frames and will integrate with our digital TV screens in airports in the future. By sending a text message or scanning a QR code through mobile devices, air passengers can attend lucky draws to win attractive prizes. Through the interactive platform, clients can continuously reach and engage air passengers not only at airports but elsewhere in their daily lives through mobile devices. We believe that this interactive platform will not only increase the media value of our products by attracting greater viewer attention, but also enable us to charge clients an effectiveness based performance fee in addition to the regular display fee.

First point: Within just 9 months of that bullish disclosure, Air Media announced that it was divesting the promising TV-attached digital frames business, describing it as unprofitable. At the same time, the company announced that it would be divesting itself of its airport digital TV screen business, again unprofitable.

Second point: These divested businesses were tiny in size. Air Media divested itself of 81% of the TV-attached digital frame business for just $1.1 million. The digital TV screen business accounted for just 5% of revenues in 2014.

The key point here is that these divestitures were so small that they are clearly not going to swing money-losing Air Media to a $31 million profit all the way from a $25 million net loss – even as other revenues are in sequential decline. Anyone can do the math here.

But again, I repeat: Anyone who believes that Air Media’s sub will earn $31 million in 2015 should certainly be buying the stock with both hands. Because that is the basis for pricing on Liantronics taking this supposed 5% stake.

The fact that investors do not believe this is borne out by the 12% drop in the share price following the PR.

Problem #3: What about the “put options”?

Another major reason why the stock fell after the press release was that this was the first time that many retail investors came to understand the “put options” embedded in the supposed “deal”.

In the original April 7th press release, Air Media failed to mention the fact that this “deal” could be cancelled for any reason whatsoever.

The company has described one of these options as a “call option” and the other as a “put option”. But both of these options amount to the same thing: the right to cancel the transaction. Each of Liantronics and Air Media therefore have the full right to simply cancel the deal. As a result, I continue to use the term “put option” for both of these clauses.

In its response PR, Air Media noted that:

… Liantronics requested and has obtained a put option to revoke the Transaction after the expiration of the Waiting Period.

The reason that the stock originally soared by 150% over several weeks was that the initial press release from Air Media indicated that the company had a “done deal” on 5% of the Air Media sub. That “done deal” fueled the speculation that Liantronics would buy the entire company for $500 million.

Yet, even the 5% “deal” can simply be cancelled for any reason (such as the $31 million profit target), or in fact, cancelled for no reason at all.

The 150% run-up in the stock was nothing more than a naïve retail tradebased on incomplete and misleading information that had been put out by Air Media.

Problem #4: Air Media will now exit the advertising business?!?! Huh?

In its initial press release, Air Media announced: “AirMedia Sells 5% Equity Interest of its Advertising Business for RMB150 million”. This was then repeated in the annual report that came out last week.

Shareholder approval for that proposed transaction was apparently not required, because the transaction was very small. But now, in its response to my article, Air Media has revealed that:

We intend to sell the remaining equity interests of our advertising business in the foreseeable future so that we can focus our resources on the exciting Wi-Fi business.

This statement alone clearly hit many investors as a thunderclap. This statement alone would have caused pressure on the stock.

The “advertising business” comprises 80-85% of the business of Air Media. The company is suddenly planning on exiting it entirely. This is the equivalent of Starbucks (NASDAQ:SBUX) saying that it will be exiting the coffee business to focus on selling pastries – but without ever having told its shareholders.

If true, this exit is a monumental shift in the company’s business, yet there was no disclosure of it in the annual report that just came out a few days ago, nor was there any hint of this on the recent conference call.

Again, this was a thunderclap.

For those who actually caught this statement in the press release, it is yet another reason why the stock fell 12% and closed at the lows of the day.

Yet, the fact that Air Media should want to exit the advertising business is entirely understandable. The business loses money every year. Revenues are declining. Guidance is for further declines. The company is dumping off once-promising businesses for almost no consideration. Nearly 50% of its existing concession will expire by the end of 2015, with aggregate concession costs of over $400 million. So again, the desire to get out of this business is completely understandable.

The point is that if it were a profitable business, Liantronics would genuinely be thrilled to buy it. If it is not profitable, then Liantronics will not. It is entirely as simple as that. That is the reason why Liantronics included a $31 million profit condition, as well as the right to simply cancel the transaction for any reason.

Problem #5: What about this new WiFi business?

Air Media now has said that it wants out of advertising, and for very obvious reasons. The business is faltering badly. But the new direction of the company into WiFi appears to be not much better. Air Media would prefer the uncertainty of the new venture over the certainty (which is bad) of the existing business.

To be sure, the WiFi business has some enticing headline numbers. Air Media has already told us that the Shanghai Bureau alone had 275 million passengers on high-speed rail in 2014, while ordinary trains had 175 million passengers.

It was already one year ago that Air Media won its first contract to provide WiFi on trains from Guangzhou Railway Corp . At that time, the company had told investors that:

We believe the huge traveler volumes by airplanes and high-speed trains, which can be easily monetized, have great commercial value.

But now it has been a year later. There have been multiple new WiFi concessions announced for Beijing, Shanghai, Xinjiang and several others.

Yet, we can see that none of these WiFi announcements has ever moved the stock. The question is: “Why?”

One reason is that a full year later, we have yet to see any meaningful revenues from this business. But more important is the business model itself.

In the recent conference call, Air Media stated that it would be giving away the WiFi service for FREE on trains, and then hoping to make up the losses by getting revenues from advertisers or e-commerce companies.

This may come as a shock to those few who have thought that Air Media would actually be charging for providing WiFi. So after a decade of being an advertising company, it will now be switching 100% of its business into giving away free WiFi. Again, this is a radical and unproven strategy for the company, which may take years to show any results, while requiring substantial upfront capital.

This is why such news has never buoyed the stock. And this disclosure is yet another reason for yesterday’s 12% decline.

Some background on the retail hot money

A few weeks ago, I wrote a scathing article about a small company with significant problems. Following my revelations about this company, the stock was down by more than 50% within a few days. As with Air Media, it was a stock held overwhelmingly by retail investors.

As with Air Media, that company quickly responded to my article with a strongly worded press release, and noted that: “The Company believes the statements made in yesterday’s Report are inaccurate and contain numerous errors of facts, speculation and interpretations of events”. Yet the stock fell further.

At this time, I quickly began seeing online commentary from small investors that it was time to “buy the dip and play the rebound”.

Much of this was inspired by the company’s promise to put out a further response and business update on the following Monday. With the stock down 50%, clearly there was more upside than downside, and there was a positive catalyst in the works. Or perhaps not.

When Monday rolled around, the announcement they got was that the chairman had been arrested over the weekend as he was attempting to flee the country, following my article and that the business prospects were actually quite mediocre.

That stock quickly plunged yet another 20%, and was then halted. It remains halted today. Prospects look grim. Sadly, I see retail investors stuck in this type of “fool’s trade” all too commonly.

Prior to the response from Air Media, the stock had been listed as one of the top 10 “hot stocks” on Chinese retail trading site xueqiu.com. Today, it fell off that list, and we can see from the comments that sentiment has turned suddenly negative. Retail sentiment on Twitter has also suddenly turned bearish. Likewise for retail sentiment on Yahoo Finance. The comments on Seeking Alpha are almost unanimously negative on Air Media.

The point is that retail hot money can easily move stocks up or down, particularly when they are relying on inaccurate or misleading information provided by the companies they follow. These investors often follow simple headlines and rumors, and are much slower to read the actual disclosure which will determine where the stock will ultimately trade. Some of these investors will no doubt eventually read the disclosure from Air Media and then add to the selling pressure. Other retail investors may simply tire of a “headline trade” that is now faltering. Either way, with the only hoped-for catalysts (a company response and a hoped-for “deal”) now out of the way, there is little to support the stock from further downside.

Conclusion

The misleading information coming out of Air Media over the past month saw the stock rise from $2.00 to $5.00 – a rise of 150%.

Air Media led investors to believe that it had a “deal” for 5% of its subsidiary, when in fact, there was no deal. Air Media failed to mention the fact that there was a $31 million profit target. The company then failed to mention that the deal could be canceled by either side. It has now led investors to believe that Liantronics has completed due diligence, when it has merely hired advisors to simply begin looking at the company.

And now the company says its “believes” that the sub responsible for 80-85% of its business will suddenly become profitable after 5 years of consistent large losses simply due to the divestiture of two negligible subsidiaries.

Despite this never-before-released positive guidance, Air Media has suddenly disclosed that it wants to exit the advertising business entirely, just to focus on giving away free WiFi. Until yesterday, it had never disclosed this bombshell to anyone.

The reasons for exiting the ad business are clear. The business has lost money for 5 years straight. Revenues continue to decline. Guidance is for further declines in revenue. Nearly 50% of the current concessions expire by year-end, with aggregate renewal costs of over $400 million. Business is very, very rough.

Yet, we are expected to believe that after Liantronics completes due diligence, it will want to buy the Air Media subsidiary for DOUBLE the current value of the entire company.

This simply defies common sense, and it fully explains why Liantronics required a profit target along with the right to cancel the deal.

The response PR made these problems much clearer to investors who previously had no idea.

As soon as the response PR came out, Air Media’s stock began to fall and closed down 12%, at the lows of the day.

The company is overwhelmingly held by retail investors. Some retail investors who have bid up the stock may be slow to figure out the nuances of the PR. But we can see from the stock price action that the new information in the PR has shown that others are clearly starting to “get it”.

We can see this from new sentiment on retail-focused sites such as Yahoo, xueqiu.com and Twitter, as well as on Seeking Alpha.

As that sentiment spreads to other fickle retail traders, Air Media could be set for much steeper declines in the next few days.