This is a brief update on new red flags we have identified since our original December 11th piece on Riot (NASDAQ:RIOT), which had detailed a broad array of red flags relating to the company’s sudden name change and business pivot from a medical device company, its 3rd metamorphosis within the span of a year.
Since that original piece, a slew of new information has come out, much of it having been released on Fridays after the market close. Given that these releases have occurred during periods of relative market inactivity, we believe the timing may have mitigated the impact of negative developments.
Per an S-3 filed on Friday after the close, the company is registering 3,292,226 shares of common stock and common stock issuable upon warrant exercise. The implication of this filing is that investors who had purchased shares in the recent private placement offering will be free to trade them once the statement is declared effective. We believe this could create near to mid-term selling pressure, especially if the investors take a cue from the company’s own CEO who recently sold off a significant portion of his shares.
The number of shares being registered is meaningful. Per the filing, as of January 4th, the company had 11,622,112 shares of common stock outstanding. The 1,646,113 common shares being registered represent over 14% of the outstanding common shares. The registration of 1,646,113 warrants issuable into shares of common stock at a $40 strike price also could create additional selling pressure. Note that the company has 1,458,001 preferred shares convertible into common issued and outstanding as well.
According to an 8-K filed Friday after the close, EisnerAmper LLP was dismissed as auditor and MNP LLP (headquartered in Calgary Canada) was engaged on January 5th. Based on the S-3 filed Friday after the close, we see that the company had used a different audit firm, GHP Horwath, P.C., until January 13, 2017. The S-3 notes that the partners and employees of GHP joined another independent registered public accounting firm, likely in relation to its acquisition by Crowe Horwath LLP.
We find the frequent shuffling of auditors to be a red flag that warrants investor caution. Given that Riot has had 3 auditors within the span of a year, we have little faith in their financial controls.
Readers of our earlier piece may recall that we had uncovered oddities in relation to the company’s transaction to acquire cryptomining equipment. For example, rather than purchasing the equipment directly from the manufacturer’s website or from a supplier, Riot chose instead to acquire a 2-week-old corporate entity called Kairos Global Technology (“Kairos”) that held the cryptomining equipment. Our belief was and continues to be that Riot significantly overpaid for these assets, and new information not only corroborates those initial conclusions but also raises additional questions.
An audit of Kairos was filed as an amended 8-K and was also released Friday after the close. It confirmed that Kairos had purchased its equipment for $2,089,679, which was close to our earlier estimate of $1.9 million. The “excess purchase price over acquired assets” of Kairos was recorded as $8,637,545, confirming that net of cash the company paid more than 4x for equipment from the entity that existed for only about 2 weeks.
While the above corroborated much of our initial analysis, one item turned up in the audit that we did not expect. We had mistakenly assumed that Kairos (i) purchased the cryptomining equipment directly from the manufacturer; then (ii) Riot dramatically overpaid for the equipment by purchasing Kairos at a premium. Instead, in the “Related Party Transactions” section of the Kairos audit, we found this:
During the period, the Company [Kairos] purchased equipment of $2,089,679 from a company controlled by the president of the Company.
In other words, Kairos actually purchased the mining equipment from a yet another entity (a related party one) before ultimately being acquired by Riot.
After all, why buy cryptomining equipment directly from the manufacturer’s website or from a supplier when you can dramatically overpay for it by simply purchasing it through a 2-week-old entity that purchased it from a different related party entity that purchased it from (presumably) the manufacturer or a supplier?
We believe Riot is on a collision course with the annals of history. Despite this, given the company’s recent $37 million private placement, we fully expect there to be more forthcoming announcements of purchases of varying amounts of cryptomining equipment or token investments in blockchain-related assets. Investors recently have responded feverishly to such press releases, so we expect the stock will have continued future volatility. We therefore are hedged and are positioned for a bumpy ride along the way. Best of luck to all.
Disclosure: I am/we are short RIOT.
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Well this seems age not so well….