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Do You Own Any “Dark Stocks?” This New SEC Rule Could Hurt Them

This week, the SEC enacted a rule that will hurt so-called dark stocks. Here’s what they are, and what to do if you own any.

This Tuesday, a new SEC rule change went into effect. On September 28, SEC rule 15c2-11 changed, and with it, “dark companies” (or dark stocks) will have much lower trading liquidity.

First, let’s define what a dark stock is.

There are different versions of dark stocks, but in short, a dark stock is one that doesn’t report its financials to the SEC or to OTCmarkets.com.

Some companies only share their financials with their shareholders, but many “dark companies” post their financials (which sometimes have been audited, sometimes they haven’t) for public consumption on their website.

In the past, brokers could provide price quotes for these types of stocks if the brokers could confirm that the company had made current information available (the financial information didn’t need to be filed with the SEC or with OTCmarkets.com).

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Now, however, brokers will not be able to provide price quotes for dark companies anymore.

As a result, many brokers are no longer allowing their clients to buy or sell dark stocks in the wake of Tuesday’s SEC rule change.

Here’s what Schwab has shared with its clients:

Schwab and others will no longer allow their clients to buy dark stocks.

What Will Happen to Dark Stocks?

It’s too early to tell what exactly will happen with dark stocks.

Will liquidity 100% evaporate? Will another solution develop (capitalism usually finds a way)?

As you would expect, many dark stocks already fell in anticipation of the September 28 rule change.

Check out TreeCon Resources (TCOR).

TCOR may now be considered a dark stock, and shares have fallen accordingly.

It is a tiny company ($6.7MM market cap) that is considered “dark” because it doesn’t report its financials to the SEC or to OTCMarkets.com.

But it does post its financials on its website, and through the first half of its fiscal year, it generated $0.10 or $0.20 in EPS on an annualized basis.

At its current price, it’s trading at a price/annualized earnings multiple of roughly 2x!

The problem is we don’t know if investors will ever be able to buy the stock again.

It’s cheap, but unless it’s sold or liquidity improves, it may stay dirt cheap for a long time.

This brings be to another micro-cap stock that is being impacted by this rule change.

This Micro-Cap Could Benefit from the New Rule

Liberated Syndication (LSYN) is a micro-cap company that is currently late on filing its financials. As a result, its liquidity will be impacted by the 15c2-11 rule change.

You can see this in Libsyn’s stock price:

LSYN may also be considered a dark stock, but there's a gray area.

But the good news with Libsyn is its management team is working to get current with its financials, and when it does investors will likely rush back into the stock.

First, let’s cover why Libsyn’s financials are delayed.

In March of this year, Libsyn filed an 8-K noting that it needed to restate its financials for prior years, disclosing that it didn’t property collect local and regional sales taxes on sales.

In June, it filed another 8-K indicating that the net liability is expected to be $2.1MM in taxes and a $650,000 in penalties.

While less than ideal, this penalty isn’t material given the company had $11MM of net cash on its balance sheet (last disclosed) and is very cash generative.

Eventually, Libsyn will restate its financials, which I believe will reveal a fast-growing business.

Libsyn’s business is comprised of podcast and website hosting. The podcast hosting business is in secular growth and the company itself is experiencing rapid growth.

Also, Libsyn recently announced and closed an acquisition of a podcast monetization software business called AdvertiseCast, which grew by 45% last year.

On a combined basis, Libsyn/AdvertiseCast are growing at 17.5%.

By my estimates, the company is trading at 3.0x 2020 revenue and 2.5x 2021 revenue. Simply put, this is way too cheap for a high-growth software company that is riding the secular growth of the podcast market.

Fast-growing secular winners can trade as high as 10x to 20x revenue. While I don’t know exactly what fair value is for Libsyn, I think it’s significant above where it trades now.

In terms of timing, I expect Libsyn to restate its financials by the end of 2021, which will enable all investors to own it.

*Full disclosure: I own LSYN shares as do many of my Cabot Micro-Cap Insider subscribers.

Do you own any micro-cap stocks? Any potential dark stocks? Tell us about them in the comments below.

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Rich is a trained economist and Chartered Financial Analyst (CFA). He has researched and invested in stocks for more than 20 years and has become a recognized expert in micro-cap stock investing. He started his career at investment advisory firm Eaton Vance where he covered a wide range of sectors including software and internet, financials, and health care.