Editor's note: The prior version of this article said that MCI had $6 million in cash. The actual figure is $6 billion. We regret the error.
Boiler-room operators often scour the recesses of penny stocks, looking for thinly traded companies to pump up with fantastic, often false, news, only to dump their shares at the height of the buying frenzy. Hence the term "pump and dump."
That's why Tom Gardner looks for Hidden Gems that meet certain requirements: a market cap of no less than $200 million (and no more than $3 billion); more than $1 million in daily trading volume; and lots of free cash flow. They may be small and hidden, but they're less susceptible to schemers and hacks.
But what's to be made of the recent bid for former telecom giant MCI (NASDAQ:MCIP) by investment firm LeucadiaNational (NYSE:LUK)?
The relatively unheard-of investment firm sought Justice Department and FTC clearance this past July to acquire a majority stake in MCI. The troubled telecom climbed out of bankruptcy earlier this year. As most don't need to be reminded, its former relationship with WorldCom had gotten tangled in that company's $10 billion accounting fraud and led to it paying a $750 million fine.
Even as it emerged from bankruptcy, analysts have been wondering whether it would have to eventually sell itself because of the anemic state of the telecommunications industry. The bid by Leucadia was seen as confirmation of that assessment, and the stock had rallied about 17% on the news. The investment firm had previously acquired WilTel Communications and ATX Communications when they filed for bankruptcy, which seemingly legitimized the bid.
So was it merely a case of cold feet, or did Leucadia engage in a classic "pump and dump" when it announced that it had sold all of its 5% stake for $266 million, a $20 million profit over its purchase price, a little over two months later?
Leucadia said it doesn't mean it's not interested in acquiring MCI, just that "no assurance can be given that the company will acquire control." Well, it doesn't take an investing genius to figure out that you can't buy up the company with no shares. However, even with its 5% stake, it would have been hard to do as there just weren't many shares available to buy up. Apparently a small group of major investors holds a majority of the telecom's shares, and Leucadia would have had to deal with them all individually -- and probably offer them a significant premium for their stake.
Some analysts believe that the high-profile acquisition of MCI's shares was done for little other reason than to boost the stock's price. One widely quoted analyst, Muayyad Al-Chalabi of telecom consulting firm RHK, claimed even before Leucadia sold its shares that it "looks like a classic pump and dump."
While Leucadia has not commented beyond its SEC filing, it's quite possible the company simply changed its mind. Since it has taken over previously distressed telecommunications companies, it may be that it was just late to the party with post-bankruptcy MCI. Or, perhaps it decided the recent downgrade of its credit rating by Standard & Poor's did indeed mean it was too heavily weighted in the telecom sector. For a company that has done business with Warren Buffett's Berkshire Hathaway (NYSE:BRK.A) and formed a joint venture with it, known as Berkadia LLC, boiler-room tactics seem a little remote.
While the telecom's shares fell 3% on the news, MCI still presents itself as an interesting turnaround candidate. When lead analyst Philip Durell picked MCI in the first issue of his new Motley FoolInside Value newsletter, he noted that management had negotiated favorable reductions in its debt load during bankruptcy proceedings; the company boasts assets that comprise the largest Internet backbone; and it's still capable of producing lots of cash (it has about $6 billion in the bank).
There's one school of thought that says turnarounds rarely ever turn around, and another that says they are some of the best candidates for investors to realize great profits. It's still too soon to tell which camp MCI will ultimately fall into, and the Leucadia situation may end up weighing on the stock price for awhile. Patient investors, though, may end up pumping up their own portfolios by hanging around.
Fool contributor Rich Duprey gets pumped up after drinking too much coffee. He does not own any of the stocks mentioned in this article.
