In the netherworld of risky penny stocks, reverse mergers are out and initial public offerings are back in style. Buyer beware.
By Brandon Kochkodin, Forbes Staff
About an hour by rapid train northwest of Shanghai, China in the city of Changzhou (pop: 5.2 million) are the offices of Jin Medical International, a maker of “high-end” wheelchairs. Incorporated in the Cayman Islands in January 2020, Jin’s wheelchairs are known for being ergonomic and lightweight and recently the company began making electric and ski-friendly models.
Last March, with the help of a little known New York-based underwriter named Prime Number Capital LLC, Jin Medical IPO’d on Nasdaq, raising $8 million at 40 cents per share on a split adjusted basis. While the Nasdaq 100 index, which includes market stars like Nvidia, has risen 40% in the last 12 months or so, Jin’s stock has climbed to $14, logging near 3,000% gains and a market capitalization of $1.73 billion. Though the company hasn’t filed any financial statements with the SEC since August 2023, at the time its revenues were running at about $20 million annually, with profits of around $3.5 million, giving it a price-earnings ratio in excess of 500.
The most important news released by Jin Medical came in December 2023, when it announced a potential acquisition of Jiangsu Zhongjin Kanglu Information Technology, a medical equipment company adept at “leveraging its manufacturing expertise and big data analytics technology” to rent or share wheelchairs among 1,600 hospitals in China. Few other details were given, except that serious negotiations would commence in March 2024.
Jin Medical’s story is the type that brokers, schooled in the Jordan Belfort method of stock flogging, dream about. Add China’s rapidly-aging billion-plus population, with the demand for ergonomic, lightweight wheelchairs and then sprinkle in big data and AI powered “wheelchair-sharing,” and you get a stock that climbed from under $1.50 two months ago to a recent high of $16.
Fifteen years ago, Jin Medical would’ve probably picked a reverse merger for its market debut. That’s when a private company merges with an already listed public “shell” company, skirting the formal IPO process which typically involves lawyers and underwriters and considerable costs. Dormant shells of public companies are plentiful, so reverse mergers tend to be cheaper, and they don’t need an underwriter’s nod or brokers’ buy-in. Sounds ideal, but reverse mergers, especially those involving Chinese companies, are now considered tainted merchandise by investors, so the peddlers of microcap stocks have avoided them. In 2013, McKinsey estimated that suspended and delisted reverse mergers involving Chinese companies cost investors as much as $40 billion in 2011 and 2012, alone.
In January, the SEC announced a tightening of its regulations for reverse mergers and SPACs, including more stringent disclosures of conflicts of interest, sponsor compensation and shareholder dilution. With the advantages accessing public markets via a reverse merger diminished, small companies like Jin Medical are increasingly choosing initial public offerings, egged on by a growing group of penny-stock underwriters, brokers and a legion of day traders looking to flip them for a quick profit. Between 2010 and 2023, the U.S. witnessed an average of 104 reverse mergers each year, according to FactSet data, including de-SPAC transactions. In 2023, the number fell to just 40, the lowest since 2012, which recorded 71.
Kyle Asman, managing partner of Backswing Ventures, an Orlando, Florida-based venture fund, thinks reverse mergers have suffered because small caps have been out of favor for some time. These days, even novice retail investors realize that simply investing in large cap dominated index funds, like the S&P 500, has proven to be an easy, winning strategy.
“It’s the top 20 stocks that are driving all the stock market growth,” says Asman. “These younger companies aren’t getting the multiples that they were…if you do a reverse merger and the stock doesn’t rip, it’s a death knell.”
Reverse-mergers may no longer be the product du jour, but tiny initial public offerings are back with a vengeance. According to data collected by Jay Ritter, a finance professor at the University of Florida, there were 47 penny-stock IPOs last year, and a total 120 from 2021 through 2023. From 2000 through 2020, there were just 108 such deals.
“The last two years, there’s been an unusually large number of microcap and penny-stock IPOs,” says Ritter.
IPOs, unlike reverse mergers, come with little stigma attached. And compared to reverse mergers, they’re sexy. Traditionally, if you wanted to buy an IPO, you needed to be both rich and connected. This is where diy investor-friendly brokerages like New York City’s Webull come in. On Webull’s web site it advertises an IPO calendar of stocks their clients have a chance of buying into. The list, which currently has 20 offering available over the next month or so, is brimming with penny stocks. Many of them are operating in Asia, including Mingteng International, a Chinese maker of automotive molds for electric vehicles which had $8 million in revenues in 2022, and Zerospo, which rings up about $13 million in annual sales operating a chain of relaxation salons throughout Japan.
PENNIES BY THE POUND
The number of penny stock IPOs has skyrocketed since since 2021
Founded in 2017 by Wang Anquan, an alum of Alibaba and Xiaomi (the world’s third-largest smartphone maker), Webull is somewhat of a Robinhood clone. It’s zero-commission trading platform boasts more than 17 million users globally, per a May 2023 press release, with, according to a FINRA database, 86 registered brokers scattered across offices in New York, St. Petersburg, Florida, and Changsha, China. And while it might not be a household name like Robinhood, sports fans likely recognize Webull because it pays $30 million a year to have its logo on Brooklyn Nets jerseys.
But it’s Webull’s financial ties to Xiaomi, the company that was an early backer of its parent company, that raises eyebrows in political circles. A 2020 Forbes investigation on how Xiaomi collected and stored its users data set off privacy alarms for cybersecurity researchers. Then, three years later, in the last days of the Trump administration, Xiaomi landed on a U.S. Department of Defense blacklist, flagged for its supposed ties to the People’s Liberation Army (an accusation the company denied). That didn’t last long, however. By May of 2021, the Biden Pentagon rescinded the decision in response to a lawsuit filed by the company. But that hasn’t eased concerns.
Former Republican Congressman Lee Zeldin expressed his doubts about Webull’s data security given its connection to Xiaomi in a 2023 Washington Times op-ed. Zeldin highlighted that Chinese law could force companies like Webull to surrender data to the CCP, potentially compromising American users’ personal information. Zeldin argued that this leaves Webull’s operations and the security of American investors’ data out of U.S. regulatory reach, casting a shadow over the platform’s trustworthiness.
Webull did not respond to requests for comment.
While enticing story stocks like Jin Medical can soar to valuations that defy financial logic, the risks of manipulation and extreme volatility in thinly-traded microcaps is high.
“Follow the money. You basically need at least two groups involved to make one of these things fly: the underwriters and the issuers,” says James Angel, a professor at Georgetown University’s McDonough School of Business. “These penny-stock IPOs are pretty small, but apparently underwriters have found a way to market them.” Webull is an active dealer, but it has plenty of company. Irvine, California’s Boustead Securities is an underwriter, notorious for its “hot” IPOs according to a website called IPO Warriors.
Retail investors’ long history of investing in penny stock IPOs has not been good. In a recent study called “Lawful But Awful” by OTC Markets Group, a company that now runs an electronic version of what used to be known as the “Pink Sheets”, the 91 microcap deals that came public in 2022 were down on average 65% average as of August 2023. That’s no anomaly. In 2022, Bloomberg reported that Robinhood’s IPO listings also had dismal performance. Of the 23 IPOs offered, including Robinhood’s own, every one of them was down by double digits at press time.
“What I suspect is going on is a little bit of the speculator’s greater fool theory,” says Georgetown’s Angel. “Investors say they’ll get in on one of these dodgy things, and the manipulators play their games. When one of these stocks with a limited float takes off, it forces the index providers to buy in at inflated prices. The people that get hurt when the stock inevitably drops are the innocent bystanders in index funds.” Some of these microcap IPOs have found homes in broad-based ETFs like Fidelity’s $6 billion ONEQ which tracks the Nasdaq Composite and iShares $50 billion ITOT which captures Nasdaq and NYSE listings.
Prime Number Capital, the underwriter behind Jin Medical’s sizzling stock offering was founded in 2018 by Xiaoyan Jiang, an ex-BNP Paribas executive who’s firm boasts blue chip Wall Street credentials from places like Goldman Sachs, Morgan Stanley and Merrill Lynch. On its website, Prime Number lists that it has completed 19 initial public offerings, raising a total of $1.6 billion. The company also boasted of a posh Manhattan office at 1345 Avenue of the Americas, with “fabulous views of Central Park.” But a Google search reveals that the second floor, where they claimed their office was located, is actually a coworking space.
Jin Medical, with its recent 3,000% surge, has been a home run for Prime Number. Virtually all of its other offerings have been losers to the tune of negative 65% return on average. Only one of its 19 IPO stocks besides Jin, a Los Angeles-based vaporizer company called Ispire Technology, is currently trading above its day one closing price. Five of Prime Number’s latest six stock offerings have found their way onto Webull’s IPO calendar, though Jin Medical isn’t one of them.
Prime Number Capital did not respond to requests for comment and CEO Xiaoyan Jiang didn’t answer questions sent to her via LinkedIn.
Jin Medical may not be a shining outlier for much longer. In December, Nasdaq served the company a delisting notice. Despite its share run-up and $1.73 billion market cap, the company’s stock is concentrated among so few holders that it fails to meet the exchange’s requirement of a minimum of 300 public shareholders who each own at least 100 shares. Jin will plead its case before a Nasdaq panel in March.
(Note: Jin Medical underwent a 20 for 1 stock split on Feb. 8. Prices in the story were updated to reflect the change.)
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