Guest-Tek CEO risks shareholder scorn with stock buy

The life of a small cap tech company shareholder is tough, even at the best of times. There’s the lack of trading liquidity, fleeting interest on the part of large institutional shareholders in the space, and an opportunistic M&A universe (think Certicom, BridgeWater, etc.). Courtesy of Calgary’s Guest-Tek (GTK:TSX), there is something new for shareholders to lie awake at night and worry about: your own CEO appears to be taking over the company, and you don’t know what he’s paying for it.

For those who may not recall, Guest-Tek Interactive Entertainment was one of a handful of tech companies that was launched on the IPO market at a time when investors were excited about new tech stories. This happens about once every 30 months or so, and Guest-Tek found its way into the cue. Priced at $10 (or was it $12?) a share. Soon after the 2004 IPO, expectations were missed and it was quickly put into the Bay Street penalty box by lead underwriter BMO Nesbitt Burns.

Guest-Tek “offers hotels a true triple play solution by providing High-Speed Internet, HDTV and voice service with the highest support service available.” Remember the last time you wanted to log into a hotel Wi-Fi network, firms such as Guest-Tek set these up for the hotels and clip their fees on the way by; at last count, Guest-Tek had lit up over 500,000 rooms at various Hyatt, Mariott and Starwood properties.

At $0.15 a share, few if any institutions own the stock and I haven’t seen an equity research report on the company for years. Unfollowed, unloved, but not unique. That was, until yesterday.

Guest-Tek CEO Arnon Levy is showing the stock some real love with his acquisition of 6.7 million shares of the company. Today he owns about 1.48 million of the company’s shares, or 9.3%. A figure that’s large enough to make shareholders believe he has a meaningful stake in the rock. We all love the notion of “alignment of interests”. But, as the price of the shares has waned over the last half decade, that original stake is now worth about $220,000. Not exactly “stick around” money that $70 million in stock represented 5 years ago.

For whatever reason, Guest-Tek’s largest shareholder, Japan’s M.P. Technologies wants out. Two of their board representatives resigned in February, and the sale of their stake shouldn’t come as a surprise (even if it is weird that they are selling just 6.7 million of their 9.1 million share position). Nor should it be a surprise that the CEO loves his EBITDA breakeven story enough to be first in line to buy the block. There’s a line about CEOs “loving to smoke their own dope”, and this is a perfect example of that.

What will come as a surprise to shareholders is that, once it closes, Mr. Levy will own precisely 52% of the company via this purchase. With a hair’s breath more than 50% post-purchase, he is truly in the drivers’ seat: he controls enough votes to fire the Guest-Tek board at will, and if anyone wants to buy the company down the road, he has the ultimate blocking position.

I dare say Certicom would’t have been sold to Research In Motion (RIM:TSX) for $3 earlier this month if its CEO owned 52% of that company’s shares.

Two things are odd about the specifics of the proposed transaction: 1) that M.P. Technologies didn’t want to sell its entire 9.1 million share stake, and 2) that Mr. Levy was able to negotiate with M.P. to buy just enough stock from them to put him at 52%, versus a non-controlling position of less than 50%. The difference between buying 49% and 52% is merely $71,000 in this situation (at $0.15 cents/share anyway), but in practice that $71k may well decide the future direction of a company with close to $40 million in revenue. Well negotiated by Mr. Levy, I’d say!

Some might think this is what’s known as an illegal “creeping takeover bid”, but it doesn’t look like one to me. Stock exchange rules allow an individual to do what are called large “private market” purchases, without triggering takeover bid rules, provided that one pays less than a 14.9% premium to the quote, and you do it in no more than 5 different trades. This is a bit of a loophole to the rules that are designed to protect shareholders from someone buying enough stock to control a company without paying what’s known as a “takeover premium”.

Those rules are designed to prevent oppression of minority shareholders, and long-suffering Guest-Tek retail shareholders might think they’ve had one put over on them now that they’ve potentially lost any real chance for a strategic acquiror to buy GTK. That may be true, but it all looks legal to me.

But that won’t make anyone feel better. GTK’s retail shareholders only need to look at Xenos (XNS:TSX) to understand how much fun it is for the minority shareholders when your management/board owns ~50% of the stock. XNS has traded between $1.50 and $2.50 for the past five years. It is no secret on Bay Street that every rumoured takeover proposal, recapitalization or shareholder maximization proposal put forward this decade has been rebuffed at XNS.

That’s the luxury of controlling, in practice or reality, 50% of a company’s shares when you’re in management. Guest-Tek shareholders will soon find out what, if anything, it means for them as Mr. Levy goes from being their employee, to his own.

MRM