SF company Handheld Entertainment this week announced that they have finalized their reverse merger into shell company Vika Corp. They also announced that they have raised $7.6M in a private placement, and that they would starting trading publicly as HNDH.OB on March 6. Handheld is the home of the ZVue portable video player, which is a $100 portable video player sold primarily at WalMart (95% of 2005 revenue), and they are attempting to follow iTunes into the video delivery marketplace as well.
With about 14M shares outstanding, the valuation for Handheld should be about $28M when it starts trading, based on the $2 price the private investors just paid. So what do you get for $28M? Well the good news is that you get a hell of a lot more than you do with always-amusing and stupendously overvalued Digital Music Group (DMGI). You have a company riding the YouTube and video iPod wave of Internet video content, and which offers the lowest price, secure media (including Windows DRM) video hardware in the industry. Executive compensation is somewhat reasonable, although the most recent $.37 option grants may seem a little low to the IRS, given the 409A regulations just put into force.
The bad news is that you now have a small public company with $1.2M revenue run rate (25x sales valuation), a negative 10% gross margin (see earlier post on bad gross margin companies), a massive customer concentration, and potentially higher than industry average customer returns, at least according to its own documents. It is also counting a lot on expanding its business model by trying to move deeper into the higher margin video services business - the primary issue is that Apple is the only hardware company which has shown an ability to create compelling software, services and revenue. Sony is a typical example of a total disaster in those areas - has anyone seen Sony Connect or even a good PSP game in the last 12 months? Maybe they can be on next season's Lost story arc.
The second issue is that we have one of the frothiest venture markets in the last few years, with hardware/services company Sling Media raising $46M in financing, but Handheld had only $38,747 in cash at the end of Q3, and apparently thought that the somewhat less than respected "back door" (Wikipedia definition here) IPO was the best way to raise money - another example of avoiding the "smart" VC money by going with the "dumb" public money, as we often see in bubbles.
So why should any non-VC invest in this company? Well, they shouldn't. Small unprofitable companies generally shouldn't be public - the costs of being public (Sarbanes alone) rarely make the move worthwhile, especially since few stock analysts will cover anything of this size. This makes this purely an arbitrage play like Digital Music Group, gambling that the company can raise money at a higher valuation in the public markets than private. Even if correct in the short term for the company, it's rarely a good move for the general public investor since the risk profile is way too high - the company may do fine, but it should be private until it shows greater results.