CareView Communications Is Still Flying

This is a follow up on our CareView Communications (CRVW.PK) note written April 25th.

CRVW's price has dropped from $2.34 since our April article to $2.04 (as of August 13). But the market cap remains bloated near April's levels at $258M including 10.6M shares issued at $0.52 per share in the second quarter. This 125.5M share count excludes the effect of 7M in warrants with a strike price of only $0.52, or the effect of potential payment-in-kind shares.

CRVW provides video monitoring of hospital patients, that can then be linked into local area networks or internet feeds with medical staff and patients' families. There is not any real proprietary technology. A service business model plans to charge a monthly service fee of $60 per month to the hospital and $13 per day to the patient plus a transaction fee. But no material revenues have been generated yet.

In fact, CRVW's financial performance continues to be abysmal. First-quarter 2010 revenues were a measly $42k, net loss was $3.1M, but cash from operations was only negative $0.6M due to major non-cash expenses such as using shares as payment. Over the twelve months ended March 2010, revenues were $0.1M with a net loss of $8.2M.

So why has CRVW stock rocketed 94% year-to-date despite the weak financials? The company accelerated its equity raise with $5.5M in additional capital early in the second quarter, which replenished a cash balance that was down to $33k on March 31st. Supposedly, this caps the equity offering. The downside is that it was done at a 75% discount to the current stock price.

A second reason for CRVW's positive market action so far in 2010 was the company had positive news releases this year: a lease financing agreement with Fountain Partners, a US East Coast distribution agreement with Foundation Medical, an irrelevant release on a filing of a bed sore patent (based on moving the patient around using its monitoring system, that does not sound novel or defensible), and a China JV announcement. However, the China JV announcement may be a bit premature. It is only a signed letter of intent to enter into a joint venture, subject to execution of definitive contractual documents, which if executed would give Weigao Holding an exclusive license to manufacture and distribute the CareView System in China. Thus, providing no more than a royalty stream to CareView, if the agreement is ever executed and honored. In sum, these news items were more fluff than substance.

But suppose I am wrong, and there is more to these announcements than meets the eye. What are the chances that revenues will reach the $100M+ revenues and $10M+ profits with the current share count to justify today's $258M market cap? Can management completely reverse its losing streak of nominal revenues of under $200k for each of the last five years, with negative gross margins since 2008, and net losses doubling each year to the current bloodbath of $8.2M? The probability is extremely low that management will be able to penetrate that many hospitals, and then charge and maintain these prices, for a low-tech video surveillance service despite the attached marketing bells and whistles (e.g. Baby View, Movie View, etc.).

The answer to the question of why CRVW has nearly doubled year-to-date to such a bloated market cap does not lie in fundamental analysis. It lies in the nature of the OTC retail market where news and stock prices can move in exaggerated swings, and that for technical reasons, some of these technical upswings can be maintained for longer-than-expected time periods.

Specifically, CRVW has some powerful backers, including Chairman of the Board Tommy Thompson. Mr. Thompson had served as the Secretary of U.S. Department of Health and Human Services under President George W. Bush, and prior to that was the Governor of the State of Wisconsin for 14 years. T2 Consulting owns 13% of CareView. Other Board members include Craig Benson, the former Governor of New Hampshire, and some other well-connected businessmen. These deep-pocketed insiders can provide the cash funding and connections to keep the stock price at elevated levels for some time.

Secondly, April's cash replenishment should also delay bankruptcy risk for a few quarters, providing quasi-fundamental stock price support. Third, the hyping of news flow amongst retail investors of the OTC markets creates short-term price momentum. Finally, the nature of the OTC bulletin board and pink sheet exchanges which disadvantages short sellers also lends stock price support. (For more details, please see my Gravity article dated March 24th.)

Technical support factors in the end will be trumped by the tens of millions of shares owned by insiders at a fraction of the current market price that will be coming out of lock-up in the coming quarters. Even if Board members continue to restrain themselves from realizing tens of millions of dollars in paper profits, the wider base of retail investors and vendors that participated in the more recent large financings should be rushing to exit anywhere near the current price of $2.04 with a cost of 52 cents a share.

Fundamentals should also bring CRVW down to Earth. Unless there is a complete reversal of financial results, CRVW will be facing bankruptcy risk over the medium term, and then will likely have to resort to issuing shares like candy to remain solvent, at the expense of current shareholders.

You would think that investors should make a bundle in shorting extremely overvalued stocks with no fundamentals like CRVW. But if it were that easy, then these ridiculous valuations would not exist in the first place.

Disclosure: Short CRVW