Vertical Branding: A Predictable Failure

In a post last March ("Applying the Altman Z"-Score Model to a Non-Manufacturing Company"), I mentioned a company called Vertical Branding (at the time it was on the OTC BB; now it's on the Pink Sheets: VBDG.PK). I noted at the time that the Altman Z"-Score model predicted bankruptcy for the firm and that when I had shared this information with the folks on the Investor Hub message board for the stock, I had gotten the Enemy of the People treatment.

A few days after that March post I was indefinitely banned from Investor Hub's VBDG message board, by a moderator who was indicted for securities fraud a few months later. After the close today, Vertical Branding released a "corporate update". Excerpt:

The company's restructuring efforts have failed to achieve expectations or intended results and the company lacks sufficient cash flow to maintain normal operations and meet its current financial obligations. The company's Board is presently reviewing the company's options for reorganization, recapitalization or other methods of deriving value from the company's assets to satisfy the company's liabilities. Because of its working capital shortage, the company has substantially reduced operating expenses by laying off all but three employees and by suspending various operations.

In this case, my getting banned for posting fact-based, bearish comments about Vertical Branding didn't do much good for those who continued to hold the stock. Investors need a site where they can post and read a full range of comments about stocks, including bearish or skeptical comments. Soon they will have one.

Update: The site I alluded to is live now: shortscreen.com. Use of the message boards on that site is free; you just need an e-mail address to sign up here.

Alloy Steel, Altman Z-Scores, China, and Vertical Branding

Connecting the dots between some recent topics:

- Alloy Steel International (Nasdaq: AYSI.OB) is the sort of company that is benefiting from China's New, Self-Propelled Economy.

- The Altman Z-Score model can be used by equity investors to evaluate current long holdings for signs of financial distress, as we did with Alloy Steel most recently back in May. When the model predicted that the company was not at risk of bankruptcy at that point, we added more to our position (at about 23 cents per share), despite the weak quarter the company had just announced.

- The Altman Z-Score model can also be used to look for potential short ideas, as in the previous post re BAGL. We'll see how that one works out.

- Vertical Branding (Pink Sheets: VBDG.PK), retailer of such fine, made-in-China products such as this,



is an example of the sort of company associated with China's pre-self-propelled, more export-dependent economy. When China's exports of these sorts of products started to drop precipitously as the global economy sunk into recession, one of the concerns pundits raised was the plight of the migrant workers from China's rural West who were getting laid off. China decided to address this via its stimulus package by increasing investments in Western China, including job-creating infrastructure projects there. Infrastructure requires steel, and to make steel you need iron ore. Companies that mine for iron ore need wear plates to protect and increase the efficiency of their mining equipment. Alloy Steel International makes best-of-breed wear plates.

Update on VBDG

In a post in March ("Applying the Altman Z-Score Model to a Non-Manufacturing Company"), I mentioned a company called Vertical Branding (at the time it was on the OTC BB; now it's on the Pink Sheets: VBDG.PK). I noted at the time that the Altman Z-Score model predicted bankruptcy for the firm and that when I had shared this information with the folks on the Investor Hub message board for the stock, I had gotten the Enemy of the People treatment. Since then, in addition to getting kicked to the Pink Sheets for not filing its financial statements, the stock has dropped 50%.

A few days after that March post I was indefinitely banned from Investor Hub's VBDG message board. The moderator who banned me was the plaid-shirted fellow holding the fish in the photo below (the photo comes from his moderator profile on Investors Hub).

Update: I didn't note this at the time, but this fellow happens to be Matt Brown, the lead site administrator of Investors Hub, who was recently indicted on criminal securities fraud charges, and remains free on a $50,000 bond posted by his father.



This illustrates one challenge in managing stock message boards. You need some form of moderation to minimize spam and other comments that detract from a board, but when you give the authority to moderate to an individual, such as the fellow pictured above, you are forced to rely on his assessments, and if your moderator's assessments aren't objective¹, you risk losing informative posts. I believe there is a better way to moderate stock message boards, but that will be a subject of a future post.

¹E.g., perhaps he is long the stock and is biased against bearish posts?

Applying the Altman Z"-Score Model to a Non-Manufacturing Company

Tools and ideas for short sellers, including an automated calculator and screener based on the Altman models.

In a previous post ("Using the Altman Z-Score to Calculate the Risk of a Company Going Bankrupt") I used Altman's original model on a publicly-traded manufacturing company. On Tuesday I used the Altman Z-Score model on a publicly-traded (micro cap) non-manufacturing firm, Vertical Branding, Inc. (OTC BB: VBDG.OB), the marketer of such fine products as the "MyPlace Cozy" lap table, pictured above. I had seen this company mentioned as top pick by a few regulars on the Investor Hub website. Initially, I used the original Altman Z-Score model -- which was designed for manufacturers -- on Vertical Branding. Recall from our previous post on the subject, that the original Altman Z-Score model uses these five terms:

T₁ = Working Capital / Total Assets
T₂ = Retained Earnings / Total Assets
T₃ = Earnings Before Interest and Taxes / Total Assets
T₄ = Market Value of Equity / Total Liabilities
T₅ = Sales / Total Assets

And weights them this way:

Z Score Bankruptcy Model:

Z = 1.2T₁ + 1.4T₂ + 3.3T₃ + .6T₄ + 1T₅

Using an online calculator based on the original Altman Z-Score model, I got a score in the "distress" zone, one that indicated that bankruptcy was likely within two years¹. I mentioned this on Vertical Branding's Investor's Hub message board. Unsurprisingly, I got the penny-ante version of the Enemy of the People treatment for my trouble. I did get one legitimate criticism though, that I had used the Altman Z-score formula designed for manufacturers. So I ran the numbers again using Ironwood Advisory's online calculator, which gives the option of selecting for non-manufacturing companies. That option uses the modified Altman Z"-score model, which uses only the first four terms used in the original multivariate formula, and eliminates the fifth variable, sales/total assets, because this variable varies widely among non-manufacturing firms, which tend to be less capital-intensive. The Altman Z"-score model weights the first four variables differently:

Modified Altman Z"-Score Bankruptcy Model:

Z = 6.56T₁ + 3.26T₂ + 6.72T₃ + 1.05₄

Using the calculator set for non-manufacturing companies produced an even worse Z-score than the original model did. This was consistent with Penn State Accounting Professor Gregory Eidleman's observation that the original Altman Z-score model can under-predict bankruptcy of non-manufacturing companies. After correcting an apparent data-entry error on my part, I got an Altman Z"-score of -4.30 for VBDG. For non-manufacturing firms, any score below 1.1 is an indication that the firm is at risk of bankruptcy within two years.

Coincidentally, on Thursday morning Vertical Branding filed an 8-K noting that it was in continuing negotiations to restructure its debt and that the company's board of directors had authorized its management to

[E]valuate and pursue all strategic opportunities available to the Company, including the potential sale of the Company.

On this news, VBDG dropped 31%.

¹This makes intuitive sense, if you look at the company's income statements and balance sheet: the company has negative earnings before interest and taxes (EBIT), negative retained earnings, and negative working capital; essentially, it's a money-losing, debt-laden company.