It’s now a $2 stock and it is clear why. As I suggested in my post in April, the working capital requirements of supporting this business are eating the company alive. Even with solid inventory management – sales are nearly double the year earlier period, while inventory increased 20%, and A/R somewhat more – the cash burn is killing the company.

Even with continued scale in operating targets, the firm is likely to have to consider floating additional equity to provide the cash to get it through the next 18 months. It seems unlikely that it can truly generate enough operating CF to avoid dilution, which is what is driving the market’s response.

The problem is, of course, that lower prices mean more dilution, which further discourages purchase of the stock. If the company had a large enough war chest, I would be encouraged to make an investment at $2 per share, but how many more shares have to be floated to get over the growth phase? I guess we will know more after the conference call.

Looks like there was some reason to show skepticism at $3, after all.

I wrote a report myself which you can find here.
http://www.oldschoolvalue.com/2008/05/aerogrow-aero-valuation.html

I took a look at the 10-k and most recent 10-q. The company appears to be improving margins and possibly heading toward an operating profit as early as the 4th Quarter of this year.

Residual sales of seed kits are growing as a source of revenue, suggesting that there are quite a few people who are continuing to use the unit. I want to believe that they are building a “razor and blade” like business, but I suspect that many people will buy these kits to grow an herb not available from the company – ahem.

The red flags though are the following -
1. Lots of “phantom” equity – 1.8 mio options outstanding, 6.5 mio warrants outstanding and the high probability that additional equity will be floated to provide working capital

2. Huge growth in working capital. This is a rapidly growing business, so some growth in inventory and receivables is to be expected, problem is, this business is nowhere near cash-flow positive. Will likely turn a profit within next 12-18 months but have neg operating CF

3. Management are a bunch of serial “startup” guys whose businesses have a pattern of reverse-merger activity. That is, they create alot of “development stage” businesses and take them public, then effect reverse mergers to take other startups public without a big registration effort. So far, none of the CEOs earlier businesses remains a going concern.

This may be the biggest business he has ever run.

My bottom line – its a big risk. Stock has already declined to $3 since the original post. Undercapitalized small growth companies with questionable management, negative operating cashflow have lots of downside in any environment, especially this one. There might be a bounce if the fourth quarter shows a profit, but I would sell that bounce.

http://www.youtube.com/watch?v=x54brLGrQIM

The growth rates are quite astonishing, but I just don’t know how well a stock like this will do with household incomes being stretched to the limits at present. Plus, the unit is rather pricey and must have a massive markup if it’s being sold through TV shopping networks.

Although, if you have bought fresh herbs from a grocery store lately, paying $5 – $10 for a few oregano leaves is crazy. Note – real oregano, not the “other oregano”.