Stating the obvious
I can't believe I actually have to say this, but here it is:

You should not base an investment decision on your affection for actress Julia Roberts. Or actor Morgan Freeman. Or race-car driver Rusty Wallace. And certainly not musician and ponytailed icon Willie Nelson.

What do all these celebrities have in common? They're currently being used to help promote a horribly unprofitable, bulletin board-traded biofuel start-up called Earth Biofuels (OTC BB: EBOF.OB).

While I have no doubt these entertainers have their hearts in the right place, I believe they have no idea what kind of operation they're involved with, and the potential it has to empty the pockets of their naive, if well-intentioned, fans.

Biofuels: hot, but overhyped
Before we get too far into this, let me spare you the opportunity to funnel any righteous indignation my way regarding conservation, "green" energy, or "energy self-sufficiency." While I own a pair of oil stocks, I'm no fan of the oil industry, nor am I a gas guzzler. To wit: For half the year, I do my 25-mile-per-day commute on a bicycle. The rest of the time, I take mass transit. I fill my gas tank less than half a dozen times a year.

Now, to the biofuel space. While the recent Democratic congressional sweep has given biofuel stocks a lift, the market for ethanol and biodiesel isn't as great as naive investors believe. Here's the basic problem: Biofuel isn't really so competitive at current oil prices, nor is it as environmentally friendly as people would like us to believe. (Raising and harvesting crops takes a ton of energy and a lot more water.)

And even if the cost of oil stays at nosebleed levels, that can make biofuels more attractive economically, which means that anyone can get into this business. And I do mean anyone. You and I could do it. Tomorrow. Indeed, across the nation, many of the leaders of the agri-fuel charge have been small co-ops founded by farmers and other small, local players who cobbled together a few million and built their own production plants. Just about every day, the business wires announce yet another ethanol or biodiesel start-up.

The ease with which capacity can be added in this industry is one reason it will be nearly impossible for most of these small players to make decent profits in the future, no matter what demand turns out to be. The companies who do well will be the big players, the Archer Daniels Midlands (NYSE:ADM) and others who have experience in the field and can leverage their size to get better prices on feed stocks, and eke out profits via more efficient production and distribution processes.

That's not to say there won't be some success stories from small players out there in the hinterlands, but I'm 99.9% sure that Earth Biofuels will never be among them.

What on Earth?
Leaving aside its attempts to wow the public through advisory board (and actual board) relationships with Roberts, Freeman, Wallace, and Nelson, Earth Biofuels is, in reality, a tiny company with a bafflingly complex structure, owning partial interests in fuel-production ventures as well as plain old gas stations. Its trailing-12-month revenues come to only $6 million, yet the firm carries a market capitalization and enterprise value of more than $400 million.

Let's pop that bubble right away, shall we? Earth Biofuels, which loses money hand over fist, trades at an enterprise value-to-revenue (EV/R) ratio around 68. The biggest ethanol producer in the country, Archer Daniels Midland, has an EV/R of 0.7. Notoriously profitable ExxonMobil (NYSE:XOM) trades at an EV/R of 1.2. Wonderfully profitable refiner Valero (NYSE:VLO) carries an EV/R of 0.4. Even other over-inflated alt-energy plays don't trade at Earth's nosebleed valuation. Pacific Ethanol (NASDAQ:PEIX) trades at nearly four times revenues.

By this measure alone, it's clear that Earth Biofuels is horribly overpriced. But it gets worse.

Earth Biofuels' latest well-publicized plan is to build out or buy up its own network of service stations in order to move more of its unprofitable product. Too bad that's a pipe dream, given that, according to the company's own filings, it doesn't have the money to do this. Not even close. As of the quarter that ended in June, the firm showed only $390,000. If you're thinking "Hey, you might be able to open one gas station with that," don't bet on it. Earth's free cash flow outflow shows the company burning greenbacks at a rate of $10 million per year over the past 12 months. And that rate is getting worse, not better, as the top line has grown. The numbers for the first half of 2006 show that while it took in $4.8 million in revenues, it posted a net loss of $19.4 million, and burned $23 million between outflows for operations and investing activities.

Here are the gritty details:

1st 6 Months 2006

1st 6 Months 2005




Net Profit (Loss)



Cash Provided by (Used in) Operations



Cash Provided by (Used in) Investing Activities



Cash Burn



So, seven times the revenues but 894 times the cash incineration. Why would investors buy this? My guess: They're not looking at these numbers. But they should.

Funky math
And if you don't believe me, maybe you'll believe the rest of the market. Here's one of the strangest things about this bulletin board penny stock. The market capitalization now stands at about $460 million. Yet Earth Biofuels is majority-owned by another company, Apollo Resources (OTC BB: AOOR.OB). Apollo Resources carries a market cap of only $50 million.

See the problem here? As of the last 10-Q, Apollo owned 64% of Earth Biofuels, but when I consult my calculator, it tells me 64% of $400 million is $256 million.

If Apollo owns 64% of a company the market values at $400 million, why is Apollo itself worth so much less? If there were smart money out there looking to buy shares of Earth, it should be all over Apollo. That's where you'd get your piece of Earth -- for a big discount.

The fact that there's no one doing this strongly suggests to me that maybe, just maybe, the money flowing into Earth ain't so smart.

"Houston, we have a problem."
Let me make this clear: I don't think you should touch Earth's parent company, Apollo, either. Not with your money. Not with your mother-in-law's money. Not even with Donald Trump's money.

While both Earth and Apollo are actually headquartered in Dallas, I'm going to crib the second most famous Apollo program line to make it clear to you that there appears to be something very funny going on in Cowboy land.

Apollo is another penny-stock "oil and natural gas production" company whose true specialty seems to be bizarre structures and cross holdings. In the past couple years, it's done "asset" swaps with such energy-related super businesses as "Meadow Springs Inc.," a company that owned a website for contractors, and Siam Imports Inc. Meadow Springs was a Canadian-based penny stock, which looks like it was nothing but a shell, and the vehicle by which Apollo sprang Earth onto the public markets via merger. Siam looks to me like, well, a fly-by-night e-tailer. You can judge the business for yourself.

The other thing Apollo excels at is losing money. In the trailing 12 months, its revenues totaled $23 million and it tallied a net loss of $56 million. It sports a rancid balance sheet with $900,000 cash and $14.4 million in debt. Oh, and the share count has ballooned by 91% between the end of 2005 and June 2006.

Trouble starts up top
If you're wondering how companies as crummy as Apollo and Earth could possibly attract any investors at all, you need look no further than the top man at both companies, CEO Dennis McLaughlin. You see, McLaughlin is no stranger to money-losing ventures that see share prices spike, then crater.

The 10-KSB gives us some important clues as to McLaughlin's likelihood of success at Earth and Apollo. Of two other publicly traded companies he's headed, it says, "He was CEO of Blue Wireless & Data, Inc. (a publicly traded company) from June 2004 through April 2005, and continues as Chairman from June 2004 to the present. He was CEO and Co-Chairman of Ocean Resources, Inc. (a publicly traded company) from September, 2003 to January 2005."

Penny-stock horror stories
Oh-oh. Here's a current chart for Blue Wireless. Alas, I can't find a decent data provider to help me out, or I would show you the more sickening slide that's taken place from December 2004, when these shares dropped from $2 each to the current $0.06. That's a 97% loss. It's no surprise, of course. These things happen to a company that manages to lose $3 million on a measly half million in revenues. Still want to invest your money with McLaughlin?

Then try this one on for size.

Here's the quote for Ocean Resources, a McLaughlin company that began as a jewelry outfit called "Clip N Pierce Fashions" and then proposed to harvest sunken ships for scrap metal. (No, I'm not joking.) That's right; this McLaughlin special is now worth eight one-hundredths of a penny. A share is worth less than the paper it's printed on. As of its last 10-Q (December 2004), it had $885 in cash on the balance sheet. For that year, it lost more than $11 million on zero revenues.

Again, the stock is so worthless that it's hard to find an online data provider that can graph the loss that investors took while McLaughlin was in charge. Data from Capital IQ shows me that these penny shares spiked from $0.30 to $0.54 in September 2003, then began a slow, inexorable slide to $0.04 each at the end of January 2005. That means investors lost only 87% of their money during McLaughlin's tenure, unless they bought in at the top, in which case they would have been out 94% of their cash.

Although McLaughlin's Earth Biofuels biography says he was uninvolved in Ocean Resources after January 2005, the most current data I can find (again, via Capital IQ) reports that the company is headquartered in the same office as Earth and Apollo -- as is Blue Wireless. Hmmm.

By the way, if Ocean Resources sounds familiar to you, maybe that's because it was one of the many overly promoted, underperforming penny-stock flops that Pegasus Wireless CFO Stephen Durland was involved with. I documented his hair-raising history here. And there are some other spooky similarities to ponder. For instance, those who believe that A-list endorsements are a good guarantee of stock market success should note that Pegasus' attempts to find refuge in celebrity appearances (including first-pitch appearances for the CEO, and a so-ridiculous-it's-not-funny, post-Clapton-concert product preview party) have not stopped the stock from burning investors for some 88% since I first wrote about it back in August.

Foolish bottom line
There are a million reasons to stay away from Earth Biofuels. Actually, there are 23 million reasons: Remember, that's how much cash Earth has burned in only the first half of 2006. This is a company that will be operating (note: I didn't say competing) in a space that will be dominated by large players with scale and experience, if it thrives at all. Earth Biofuels has none of these, very little cash, and worse yet, it's run by someone with a pretty solid history of driving companies, along with their stock prices, directly into the ground.

I doubt that Julia Roberts, Rusty Wallace, Morgan Freeman, and Willie Nelson have taken the time to read the financials or consider McLaughlin's past efforts on behalf of investors. Personally, I hope they sever their relations with this company before they help their innocent fans lose money in what looks like another guaranteed financial flop.

Investors, don't chase this house of cards. It's only a matter of time before it comes crashing down, and when it does, the affection of Hollywood stars will be cold comfort, if any.

Seth Jayson first became acquainted with this company via The Motley Fool's new, free stock-rating service, CAPS. Have a contrary opinion on Earth Biofuels? Think Seth is wrong? Bring it to CAPS and prove your mettle. At the time of publication, Seth had earned a 99.9 percentile player rating in CAPS, mostly by putting virtual shorts on overpriced companies and outright scams.

At the time of publication, Seth Jayson had no positions in any company mentioned here. View his stock holdings and Fool profile here. See what he's Digging these days. Fool rules are here.