Pink Sheets

Ok, so now I see why both CXTI and ETLT have dragged in this bizarre set of rules for outstanding liabilities. Both of them have these floorless convertibles based on a fraction of the recent stock trading price. CXTI's is fairly easy to see. ETLT's is very small and associated with a legal settlement. I have to admit that I really didn't fully grasp the truly unlimited liability nature of these things.

I'm not worried about ETLT, where the face value of the convertibles is insanely small. But it's worth looking at CXTI more closely. If CXTI's stock price spent a week at some insanely low value before Halloween 2006 (how appropriate), then the dilution would be horrendous. Let's say CXTI drops to 20 cents for a week. Then the convertible holders get 40 million shares of stock in the conversion. Considering that my totally diluted estimated share count is 42 million, that's a nearly 50% dilution in ownership.

So it's conceivable that the convertible holders could manipulate the stock to increase their ownership of the company. Of course this could very easily backfire for them. It means having to sell possibly a gigantic number of shares for an entire week. There's no telling who might be sitting at the other end of the transactions, including people associated with the business, and how much money they'd be willing to sink into the company. Those people could end up buying a large part of the company at very cheap prices subsidized by the would-be stock manipulators. Here's another problem for them: there's a limit to how much of the stock can be sold. If someone gobbles up the shares and sits on them, then if the convertible holders short more than the float, they're screwed. Actually they're screwed well before shorting all of the float.

So shareholders look at this and see potentially unlimited dilution, but the convertible holders also have enormous risk in trying to manipulate the stock by any huge amount. A more realistic worst case would be CXTI selling for 90 cents for 5 days. In that case, the convertibles turn into less than 8.9 million shares.

We need to add that full amount to my share count, and probably bump it up to 10 million for a totally diluted share count of 52 million shares. Earnings for 2005 now look more like 17.9 cents per share and the stock would be currently trading at a trailing P/E of 10.

The convertible holders had a perfect opportunity back in early November 2005. And since the convertibles have such a short shelf life of one year, you'd think they would have done it back then if they were going to push the stock down and do the conversion. Here are the prices at that time:

10-Nov-05	1.71	1.86	1.71	1.85	246,100	1.85
9-Nov-05	1.72	1.75	1.61	1.73	243,200	1.73
8-Nov-05	1.63	1.74	1.58	1.71	515,500	1.71
7-Nov-05	1.28	1.75	1.28	1.62	713,100	1.62
4-Nov-05	0.96	1.27	0.56	1.26	447,800	1.26
3-Nov-05	0.90	1.00	0.90	0.94	464,300	0.94
2-Nov-05	0.90	0.90	0.78	0.86	428,100	0.86
1-Nov-05	0.84	1.01	0.84	0.90	1,496,300	0.90
31-Oct-05	1.28	1.28	0.82	0.84	1,943,700	0.84

Pushing the price down on Nov 4 and Nov 7 would have done the trick. Maybe they tried, I don't know. The volume was a bit heavy on Nov 7. At that time, they would have had no idea what developments might unfold over the coming year and news was at least as likely to be good (causing a higher stock price) as it was to be bad (giving them a lower stock price).

It's appropriate that I mentioned what Buffett wrote about Arcata in the 1988 letters to shareholders. With most of my investments, I view them as having two major parts, the first being very tangible and based on what seems clearly likely in the future. That's the part you'll see on this blog. The second part is the stuff that's difficult to pin down precisely, the possible payoffs that can't be relied upon. I can't say exactly how it might play out, but I want as much of it as I can get. Stathmore has a huge potential upside. So does ETLT, CXTI, and even EPLN.

With Buffett's Arcata, the market pushed the price of the stock even higher than the valuation of the tangible stuff that could be clearly nailed down and Buffett did something odd, but something he would do much more in the future: he continued buying at the higher prices because he started relying on the value of the icing on the cake. Ben Graham would never have bought Coca Cola at the prices Buffett paid, nor most of the private business purchases, I'd guess.

I look at CXTI and ETLT and see early businesses in what is clearly going to be a gigantic market in the future, not to mention the benefit of an overvalued US dollar in buying ownership of the businesses. CXTI could become an EDS and ETLT could become an ADM. Hey, Wal*Mart's own CEO said he thought the first Wal*Mart store was the worst store he had ever seen. But they don't have to be that successful for them to be extremely good investments today.

UPDATE: CXTI wins another big contract!

Amongst 83 cities and counties in Fujian province, only 7 of them have started their e-government construction and we have signed contracts with 6 of them.

UPDATE April 8, 2006: Why did CXTI get such a crappy deal when raising cash?
I don't know why CXTI paid a high price for cash. I look at other Chinese reverse mergers like Sunwin and they got reasonably good terms of around 6% interest. China Digital Media got diluted by a factor of 10, although I don't recall if it was raising cash or not. China Bak Battery raised $17 million on Jan 18, 2005 using shares at $1.98 and the shares soon after sold for around five dollars. That's in the same ballpark as what CXTI got. American Dairy raised $4.7 million (page 19 in the Notes) in 2004 selling 1.8 million shares of stock, 1.8 million warrants. Let's call it 3 million shares, which corresponds to getting about $1.56 per share. The shares were selling for over $2.50 during the entire year. So I don't see CXTI getting that much of a worse deal than other similar Chinese reverse merger companies.