First the facts, which are well established by now: On Thursday, RMG Networks reported an abysmal first quarter in which revenue came in at $12.6 million, off 16% year-to-year, and the company booked a net loss of $8.3 million. The latter number seemed to really
surprise anger The Street, and the shares of RMG took a hit of nearly 71% in a single day, with about three-quarters of the public float changing hands during the day. The company’s market capitalization dropped to less than $13 million. As a measure of the magnitude of that valuation decline, RMG had purchased Symon for about $45 million in cash just 13 months earlier. This is a meltdown of epic proportions.
To be clear, I get no rush of schadenfreude from RMG’s distress. There are some really good people who got hurt by this, especially the Symon alums in Dallas. It does no one in this business any good to have a very public debacle of this nature, and serves as another reference point to make potential investors skittish, be they public or private. Nonetheless, a Ronin-esque loss of shareholder value is worthy of analysis.
Back in December, 2012, I posted about the Special-Purpose Acquisition Company (SPAC) that became RMG Networks months later. It is a complicated bit of financial alchemy, and historically has been better for sponsors than investors. At the time I wondered, “whether this is a strategic combination or an opportunistic one”. With the benefit of a year’s passing, it would seem that it was more likely the latter. While Symon has closed some nice deals (largely overseas) there has not been much evidence of synergy with the existing RMG network businesses, and it would appear that the profitable Symon business was from the outset a good shield for the very real problems within the RMG media business. The exit of many Symon employees in the months following the merger was probably the best signal that RMG was taking a different direction than the previous Symon management team. Many of those exits were involuntary, and culture was changed dramatically overnight. Given the networking activity that went on yesterday, there are likely to be some voluntary departures in the coming weeks.
From that same post:
The SCGQ deal will be good for the industry if it is consummated and begins to trade with credible volume and reasonable transparency in the New Year. Strong market support for a DOOH conglomerate would bode well for future deals in the public and private market for networks and providers alike. The fact that the VCs and PE firm have a positive exit in the space is also a good thing. While SPACs have a checkered history, and there is plenty of market risk and execution risk involved, I hope that this one works out well for everyone.
As it turned out, the stock has been thinly traded, averaging less than 11,000 shares in daily volume. That, combined with the steady decline in the stock price since its IPO last year has created a real challenge for the RMG executive team. Their strategy and stated intention was to make several more acquisitions. Ideally, those acquisitions could be done with shares trading at a healthy price, preserving precious cash for other priorities. But the low volume and weak price were a double whammy. First, targeted companies were not eager to take illiquid stock in exchange for their own equity. By way of example, a company taking $10 million worth of RMG shares trading at $8 a share would need 113 days of average trading to liquidate its position after the lockup period, ignoring the downward pressure their selling would inevitably have. That is less than ideal, and at least one major deal in the past six months died at the eleventh hour for that very reason. Second, RMG itself would have to dilute its own shareholders (the vast majority of its outstanding shares are held by insiders) more than they would want to in order to buy companies with equity, even if they could. And they couldn’t, so they were left with trying to grow Symon and solving RMG’s core problems. So it has been a tough year for Garry McGuire and his Board, and now their problems have multiplied. So what is next?
The Stock Price
Trading under a dollar at the close of business on May 8th, most of the bad news is built into the price. There will likely be what is known in the business as a dead cat bounce as short traders decide to cover and take their gains while bargain hunters and believers snap up shares at a perceived bargain price. That said, it is unlikely that the losses from May 8th will be easily recovered without a quarter or two of better performance, as in profits or some stellar news. Routes to support the stock price might include either a share repurchase by the company (probably not a great use of cash, and silly, since it would reduce public float further), or aggressive buys from insiders, sponsors and believers. Given the nature of how the company came to be, I don’t rate the odds of that as very high. As a result, RMG’s momentum as a public concern will stall until it can justify a higher share price. For those of you who love numbers, the 70.6% price decline will require a 240% rally just to get back to where it was on May 7th, which in turn was still 67% below the 2013 IPO price.
RMG is unlikely to be able to make any new acquisitions until there is some substantial recovery in the stock price. Such is the risk in a strategy that is based on using public equity to cobble together a business. The option to sell Symon or even the media business does not solve any problems, and would only embolden the class action attorneys who are no doubt preparing to feast on the plight of RMG as you read this. Therefore, dramatic growth and improved results will have to be accomplished through great execution and improved sales efforts. That will not be easy: direct entry into the giant Brazilian market was reportedly aborted earlier this year as management cut bait after a brief and costly foray, so the company will count on performance from various partners in South America. Things appear more robust in EMEA and Europe, and second quarter revenues should show seasonal improvement, but all eyes will be on the bottom line. The company’s CEO, in his only tweet of the day posted immediately after the earnings call, called attention to a not-so-coincidentally timed blog post about their beautiful and costly new Experience Center in their new Dallas office. Somehow, that just didn’t feel like the right topic at the right time.
Presumably the Board had the results in hand well in advance of Thursday’s conference call. They knew the news was grim, but they did not know if they could spin it positively. They found emphatically that they could not. Will this mean changes at the top? Unless there is a miracle worker waiting in the wings, it would be largely symbolic, but don’t underestimate the potential reaction of the insiders who hold so much of the equity of RMG. There are 9.6 million warrants outstanding with a strike price of $11.50. Employees and major insiders holding these warrants do not need the Black-Scholes model to determine the value of their holdings: they are effectively worthless. As a result, some who were hanging on hoping for the pot of gold are now working the phones and LinkedIn, which may have a distracting impact on performance, to say the least.
As noted above, it would have been beneficial to the broader industry if RMG had seen early, demonstrable success. Unfortunately it has not, and now its ability to execute its stated strategy, growth by acquisition, is stalled for the foreseeable future. Once again, the suitability of a public vehicle for a digital signage entity is called into question for everyone except those turning it into a liquidity event. A potential consolidator has been neutered and an opportunistic merger has failed to excite investors, evidence yet again that well-conceived business models will ultimately win over financial hocus-pocus. The old double whammy will be felt well beyond Dallas and San Francisco for a time to come.