Lighting Sciences Group (LSCG.OB) is a step above the everyday vermin that inhabit the OTC BB. It has two real businesses, one of which manufactures and distributes LEDs, and the other of which installs LED and other lighting systems. The one problem with Lighting Sciences is that its value as a real company is dwarfed by its market cap. In this way it resembles some other companies I have criticized in the past, including Continental Fuels (CFUL.OB) and Noble Roman’s (NROM.OB).

Market Cap

With a total of 26.524 million shares (fully diluted) outstanding after its recent 1-for-20 reverse split, and a recent price of $9.90, Lighting Sciences has a fully diluted market cap of $263 million. The company has some sales and is a real business, but the thing it is best at selling is its shares: its share count has doubled in the past year alone (see the 10Q on page F-3 for details; this calculation excludes the 1-for-20 reverse split).

Book Value

Book value is something that cannot easily be faked. While different industries have different capital requirements, book value is a very good way to compare the size and intrinsic value of different companies in the same industry. As of September 30, 2007 (also according to the company’s 10Q), the company had a book value of $3.5 million. However, after a recent reverse merger with a private company, LED Holdings, the combined company has much greater book value of $24 million, including $16 million in cash (see the pro-forma financial statements).

Sales

The combined company (which will keep the name Lighting Sciences) had $5.7 million in sales for the first eight months of 2007. This is equal to an $8.5 million annual revenue run rate. This leaves the company with a stratospheric price to sales ratio (P/S) of 31, as compared to a P/S of just about 2 for General Electric (GE) [$33.55 0.00%, market cap: $337.1B], one of the best and most consistent manufacturers, and a P/S of 6.5 for CREE Inc. (CREE) [$32.35 0.00%, market cap: $2.769B], a much larger manufacturer of LEDs.

I should note that LED Holdings has had a poor 2007 in terms of sales. Sales for all of 2006 were $8.9 million, but they fell to $3.7 million (a run rate of $7.4 million) in the first half of 2007.

Losses

While quickly increasing revenues is normally a good thing, it is not good to increase both revenues and losses at the same time. Lighting Sciences’ (not including LED Holdings) loss over the first nine months of 2007 ($8.1 million) was 4.8 times greater than the loss over the same nine months in 2006. The third quarter 2007 loss of $4.8 million was 3.7 times larger than the third quarter 2006 loss. LED Holdings, while being profitable over the last few years (with a profit of just over $1 million in 2006), has seen much slower growth in sales, and its profits in 2007 will be a lot lower than in 2006. The combined company would have had a pro-forma loss of $5 million over the first eight months of 2007.

PIPE Dreams

Longtime readers know of my disdain for PIPEs, or private investments in public equity. With penny stocks, these usually mean that a well-heeled investor gets shares at a deep discount to the market price, and as soon as a six-month or year-long lockup period is over that investor will flip the shares onto the public for a tidy profit, even if the stock price of the company decreases.

Note 11 in the 10Q details a PIPE from a year ago in which the shares were placed for $0.30 ($6 per share, post-split). In addition to 0.667 million post-split shares, the investors also received (for free) 0.5 million post-split Class A Warrants, and 0.667 million post-split Class B Warrants. The Class A Warrants give the holders the right to by the post-split stock at $7 per share. The Class B Warrants give the holder one full share, and the right to buy 3/4 of a share at $6 (post-split) per share. Given a stock price of $9 (below the current $9.90), the the “PIPE-fitters” would have garnered themselves $8.5 million on an investment of $3.6 million ($9 per share times 0.667 million shares plus $2 per share times 0.5 million Class A Warrants plus $3 per share times 0.500 million Class B Warrants).

When PIPE investors do so well (more than doubling their investment in under a year), the company and its public shareholders do poorly. In return for a measly $3.6 million in cash (plus an extra $6.5 million when the warrants are exercised), shareholders were diluted by 1.667 million post-split shares with a market value of $15 million. If Lighting Sciences’ business were truly doing well, it surely could have found more advantageous funding sources.

La Revanche de David Gelbaum

Perhaps a good investment strategy would be to short sell any stock in which David Gelbaum invests. His Quercus Trust showed up as a large holder of Octillion (OCTL.OB) and he is also a large holder of Lighting Sciences.

Comparables

Perhaps the most comparable company to Lighting Sciences is CREE. It manufacturers LEDs and has some good technologies and patents. It trades at a P/S of 6.5, and a price to book ratio (P/B) of 2.7. If CREE is fairly valued, and both it and Lighting Sciences deserve similar multiples, then Lighting Sciences is overvalued by 500% according to the P/S ratio, and by 430% according to P/B ratio. Being generous to Lighting Sciences, I would call it 400% overvalued, and give my fair value estimate as $2.35 per share, which is a quarter of the current price of $9.40. Of course, because Lighting Sciences is not profitable (unlike CREE) and is much less established, it deserves to trade at a significant discount to CREE. A 50% discount would be reasonable, and would result in a fair value of around $1.20 per share (88% below the current market price).

A Bit of Positive Press

Perhaps you caught Jeff Bishop’s positive review of the company on SeekingAlpha. His article is entirely fluff. Furthermore, his company, Beacon Equity Research, has a nasty habit of covering a ton of OTC and Pink Sheets stocks, and rating them “speculative buy” or “outperform.” I looked at over half of their reports, and all of the companies that were rated (one was not rated) were rated either “speculative buy” or “outperform.” Highly rated companies included such utter dreck as Rocket City Automotive and Universal Property Development and Acquisition Corp. Beacon is paid to cover most of the companies it covers, either directly by the companies or indirectly by large shareholders. That explains why Beacon is so overwhelmingly positive about the companies it covers.

Reverse Stock Split

Lighting Sciences recently completed a 20 for 1 reverse stock split, increasing the market price from around $0.48 to around $9.60. Academic research (pdf file) has consistently found that companies that undergo reverse stock splits underperform the stock market drastically.

Conclusion

Lighting Sciences Group Co. is at best a halfway decent company that could eventually become profitable. At worst, it will continue to lose money for the foreseeable future. Either way, it is very overvalued. While LEDs will be a great market, there is little reason to believe that Lighting Sciences will be a leader in that market. It has too many competitors with more resources. If anything, my target price of $1.20 for Lighting Sciences is too high. I would argue that the comparable I used for the valuation, CREE, is overvalued as well. In fact, CREE is one of the most highly shorted companies on the NASDAQ.

Lighting Sciences Group Corp. is overvalued by any means. Smart investors should head for the exits and watch this company’s stock collapse from the sidelines.

For More Information:

3rd Quarter 2007 10Q

Pro-Forma Financial Statements

LED Holdings Financials (and those of its predecessor company, LED Effects)

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