Fool.com: Fool on the Hill: Notes From the Fringe

FOOL ON THE HILL
An Investment Opinion

Notes From the Fringe

By Bill Mann (TMF Otter)
September 17, 1999

The Motley Fool has always stood for the capacity of each individual to take control of his or her investments. It is sometimes easy to believe that we (and by "we" I mean all of Fooldom) are succeeding on all fronts, that the massive shift to common stock investing in the U.S. and elsewhere is part of a great revolution. Indeed, there can be no question that the average American is more aware of equities and the stock market than at any point in the last 70 years.

However, a perusal of any investment message board (even, to a lesser degree, the Fool Boards) will dispel the notion that increased activity directly equates to greater sophistication or knowledge. Too many "investors" are taking flyers to find the next Yahoo! (Nasdaq: YHOO), Amazon.com (Nasdaq: AMZN), or eBay (Nasdaq: EBAY) -- the company that will make them rich beyond their wildest dreams, and fast. Sure, they're out there. But for each person who gambles on this month's Red Hat (Nasdaq: RHAT) and wins, there are many more backing the wrong horse and losing -- big.

Some of the places people put their money defy description in terms of risk. And yet, there they are, on the message boards, cheering like they've got their last dollar on the trifecta in the eighth, shouting "Go, baby go!" These stocks don't just smell. They reek. They reek like catfish bait.

(My brother recently introduced me to the glorious world of catfish bait. I knew we were in trouble when he put on surgical gloves before he picked up the canister. It looks like maggot pate and smells like a malicious combination of chicken entrails, toejam, and cheddar cheese. Catfish love it. I fished for bass instead.)

Let me give an example. There's a company based in Florida called Cyberfast Systems (OTC: CYSI). According to the company's press releases, it is a leader in voice over IP services to certain countries. Earlier this year the company's stock suddenly jumped from $3 to nearly $20, valuing it at some $104 million. Since it is an over the counter (OTC) stock, The Motley Fool will not open a board for it. But Raging Bull has no such restriction. On this board you will see a communion of gamblers hoping they guessed right, not investors evaluating the merits of a good company.

Not to belabor the point, but let's take a look at this company and its track record. Set your stink-o-meters for high, Fools. Cyberfast Network Systems Corp. performed a "reverse merger into a shell" with SmartFit in November of last year, allowing it to become publicly traded without filing all of those annoying regulations like fully disclosing its financial situation to potential shareholders. The merged company became Cyberfast Systems.

So OK, let's examine this "state of the art voice over the Internet" service provider. The company began trading last November but waited until January to disclose that, of the four international circuits it had maintained, three had been shut down by a foreign authority, and the other had been sold. This means that the company had zero revenues from operations and had not bothered to report it. Yick.

As an aside, several newspapers in India picked up the news story of the shutdown of Cyberfast circuits from last September; one named the company (then CNSC) as the culprit, the other named Cyberfast's CEO. This means that the company waited four months, two of which as a traded company, before it disclosed that its only sources of revenue were gone.

Then this year Cyberfast proudly announced that they had received an open line of credit with Cisco Systems (Nasdaq: CSCO). Cisco responded that it never provides open credit lines and more importantly had never heard of Cyberfast. Upon further investigation, Cisco found that Cyberfast had received financing for Cisco equipment through a third-party vendor.

Who else has never heard of Cyberfast? The Federal Communications Commission, for one. IDT Corp. (Nasdaq: IDTC), which Cyberfast's president listed as their main competitor, has never heard of them. pulver.com, one of the leading authorities on voice over the Internet, has not heard of them. Cyberfast has no presence on the Internet, not even a home page. Strange for an Internet company, I'd say.

Just as importantly, the company only in the last week disclosed that it had no revenues through June. So even if you ignore the apparent sloppiness of the company operationally, you still have a company valued upon, well, its word, and not much else.

So who has heard of them? Chris Byron of The New York Observer wrote a stinging piece about Cyberfast in June, detailing several instances of complete fabrications by the company in regard to its business model, and pointing out that the company president could not name a single destination or customer for Cyberfast's services. The government of India has heard of them, and you can rest assured that this company won't be welcomed back anytime soon. Finally, Dun and Bradstreet, the leading corporate credit agency, has heard of Cyberfast, but its report on the company shows no credit rating and exactly two employees. No credit rating means that even the local power company has never heard of them.

And here comes the best part, if there was any question at all that this was an investment suitable for the insane and delusional only. This past week Cyberfast filed its 10-SB with the Securities and Exchange Commission (SEC) in order to become eligible for a Nasdaq listing. If there was ever a case study to see why you should avoid non-reporting companies, this is it. Just to highlight:

- No audited financials attached.
- No revenues between November 1998 and June 1999, which had not been disclosed.
- CEO salary of $300,000, contract signed January 1, 1999. CFO (his wife) salary of $250,000, contract signed Jan. 1, 1999.
- CEO & CFO receive a BONUS of 10% of the quarterly net revenues of the company.
- CEO receives additional options of 200,000 shares per year priced at $4 (at current value this yields an additional $1.2 million in income).
- No independent directors appointed. All directors are also company insiders. In other words, no independent entity at all oversees the operational or financial decisions of the company, including the compensation of the executives. The executives decide what to pay themselves.
- No description of the service, customer list, or list of sites.
- The company has $8,000 in cash.

Kinda like rolling snake eyes. Let me sum up: The two top executives own 85% of the outstanding shares, grant themselves exorbitant salaries and a rich options package, and siphon off 10% of the company's net revenues. The next two executives also get rich salaries, a nice options package, and another 6.6% of net revenues. What is left for common investors in Cyberfast Systems? If the executives of this company can't bring themselves to care, I guess I won't either. But the point is, several contracts have been in place since January, and had Cyberfast not made the decision to move to the Nasdaq, they would have NEVER had to disclose them.

Let's just pretend that this is a worst-case scenario for a non-reporting company. How can you be 100% sure that your penny stock isn't doing the same thing?

You can't.

Do you get the feeling your money may be better off actually investing in a catfish bait company? Well, if you can persuade these guys to go public, you may get your chance. To my mind, your money would be safer, and it might smell better.

So what is it that people are investing in? What makes them foolish enough to risk their money on this company? The promise of fast riches, for one. On the Raging Bull message board you see the words "faith," "scam," "tout," "hopefully," "evidence," and other words that should make a Fool run for cover. This company may turn out to be a good investment, but those investing in it are going on very little evidence.

But my issue isn't so much about Cyberfast. The point is this: Nearly 500 million shares are traded daily on the bulletin boards, and the number is rising rapidly. These companies are generally not required to file operating reports with the SEC, so the investor has the choice of believing the company's own press releases, or not.

I look at the rising number of shares traded on OTC companies as the Fool's contrarian index. The more shares traded, the more work we all have to do to communicate the simple philosophy of buying the best companies and holding them for the long term. We cannot save people from themselves, but how many people out there are under the impression that company statements and press releases are somehow "official"? They aren't, and they're often sheltered under the Federal protection for forward-looking statements. In other words, they can claim whatever they want, but are protected from liability if the claims do not happen to come true.

For the people investing in OTC stocks, may I suggest instead a trip to your nearest casino or lottery outlet? That way, you can at least gamble your money away in a regulated environment.

And if you really want a hot tip, how about this nugget -- put everything on 33 black.

Related Links:
The 13 Steps to Investing Foolishly
The Motley Fool's How to Value Stocks
Forbes' Smell-O-Meter