When your company has been living under the shadow of fraud for nearly a year, any bit of good news can serve to create a bit of enthusiasm. Such is the case with stamp and coin trading house Escala
Tuesday, Escala reported it had completed its own internal investigation and found that -- surprise! -- no one had done anything wrong. That apparently cheered investors so much that the stock nearly doubled in price on the day, rising to over $8 per share. It's a long way from those heady days when it traded at $35 a share, but better than when it looked like it was going to zero.
Which it still might. There are reasons beside shareholder enthusiasm that could have played into yesterday's run up.
Nearly 20% of Escala's shares are sold short, meaning that people have borrowed the shares in the belief that the stock price will go down. When there is a sharp rise in the price of the stock, short sellers buy back their shares at the higher price to limit their losses, which fuels further share price increases and more shorts buy back their shares. And so on. It's called a short squeeze, and it can really run up a stock's price.
When sales are not sales
Escala said it was going to restate its financial results from 2003 to 2005 as well as the first three quarters of 2006. Certain "archival sales" of stamps to Afinsa were improperly recognized as related party transactions but should have actually been divided between related party sales and additional paid-in capital, which is money a company receives from investors in addition to stock they received. Afinsa is the largest shareholder of Escala, owning nearly three-quarters of the stock, and was also the third largest auction house in the world behind Sotheby's
Escala estimates the value of the restated archival sales is approximately $73 million of the total $417 million received since 2003. However, those sales comprised a much larger portion of the company's profits during that time period. While the sales represent only 17% of the revenues for the period, they accounted for 73% of the $100 million in profits Escala made.
Sales and profits from transactions with Afinsa had always amounted to the bulk of Escala's valuation. Having completely severed ties with its parent, Escala will earn only the slimmest of margins from its other arms, such as A-Mark Precious Metals that it acquired last year. Even then, however, I wonder how long that can last. The president of A-Mark is also the president of Spectrum Numismatics, another Escala affiliate that is at the center of its own fraud scandal over coin deals made with the Ohio Bureau of Worker's Compensation. The central figure in that scheme has already been jailed and the investigation continues.
Value is what I say it is
Escala's supposed independent investigation leaves a lot to be desired. In addition to the archival sales, additional sales to Afinsa were supposedly conducted at arm's length, meaning the terms agreed to were similar to those that could have been arranged with an independent third party. Yet the audit committee said that was not the case and their value was vastly overinflated as well.
The committee found that the prices negotiated for the stamps sold to Afinsa were sometimes referenced to catalogue prices, a discredited means of determining a stamp's true value, since it was Afinsa or Escala themselves who set the catalogue prices. Furthermore, for some of the transactions not set by catalogues, appraisers did not have complete information to make a valid appraisal. The committee could not say that more complete information would have changed the valuation, neither could it determine the fair market value on its own.
Moreover, while the press release issued by Escala touted the fact that everyone cooperated with the investigation, further on in the filing was the note that "certain other persons did decline to be interviewed, and the Audit Committee was unable to compel these individuals to provide information. Further, persons providing information to the Audit Committee did not do so under oath."
Based on "the available" evidence, the audit committee has come to conclusions based on incomplete evidence.
More room for doubt
Let's hope they explain some of the anomalies in their statement. If you remove the $73 million in special sales, the audit committee wants us to believe that Escala sold to $344 million worth of stamps to Afinsa over 13 quarters, or about $106 million a year. Yet that's implausible because that's roughly equal to the entire amount of all collectible stamps sold by U.S. auctions annually, according to industry publication Linn's Stamps.
Escala is delinquent in filing its financial statements with the SEC. It has not filed its annual report for the period ending June 30 or its report for the September 30 quarter. Despite having been advised by the Nasdaq exchange that it faced delisting and had a meeting with the listing committee, it is now more than 30 days past the deadline set by the exchange to have its financials in order. Considering the length of time involved in being delinquent and that they just admitted to grossly overstating revenues and profits over several years, one would expect additional extensions be in short supply.
Despite the claim of having found no fraud, there has been a wholesale departure of top executives in recent weeks. CEO Jose Miguel Herrero, former CEO and founder Greg Manning, and past CFO Larry Crawford have all resigned. Indeed, Greg Manning resigned on Friday, right after the audit committee's report was reviewed by the board of directors. It's certainly an interesting way of responding to a report that supposedly vindicates and exonerates you.
One Fool's final thoughts
Escala was once a thriving, if parochial, stamp and coin trading dealer. Swept into the maw of its parent Afinsa, it seems to have gotten caught up in the pattern of fraud and deception which has brought down the Spanish trading house. While it might not have overtly committed a crime, it certainly benefited from it.
Escala massively overstated its revenues, the recasting of which wipes out huge swaths of previously reported profits. This Fool finds it hard to believe such actions occurred unintentionally, and the mass resignations certainly suggest that others agree.
Thus far it has been kept alive by the good graces of Nasdaq's governors, who have yet to throw the company off the exchange, but should it survive that death knell, it still may have to contend with Spanish authorities who have hinted that any remaining value left in Escala may be seized to make whole the Spanish investors that have been swindled.
Look at the rally of the last two days not as a portent of things to come, but perhaps as a last gasp before the gavel falls.
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