October 1, 2009

Volume 2, Issue 9

Empirical Finance Newsletter

Turning academic insight into investment performance

Editor’s Note:
The Empirical Finance, LLC team has been synthesizing, cataloguing, and writing empirical fi-
nance research for many years. Our investment programs integrate many of the research insights
highlighted in the Empirical Finance Research Newsletter, but not all of them. This newsletter is
meant to highlight ideas we look for and consider when developing our investment technologies.

Shell Games: On the Stock Price

Performance of Shell Companies
Ioannis V. Floros and Travis R. Sapp
Working paper
Abstract:
In each of the last eight years reverse mergers have outnumbered traditional IPOs as a
mechanism for going public, and shell companies are providing fuel for much of this growth.
We study 287 trading shell companies over the period 2006-2008. The purpose of most of these
shell firms is to find a suitor for a reverse merger agreement. These companies have no
systematic risk, operations, or assets, and their share price tends to decline over time. When a
takeover agreement is consummated, shell company three-month abnormal returns are 48.1%.
We argue that this exceptional return is compensation for shell stock illiquidity and the
uncertainty of finding a reverse merger suitor.

Data Sources: DataStream. Of the 1,083 shell firms they

Shell companies are defined by the SEC as
those with ―no or nominal operations and with
no or nominal assets‖ other than cash. Such
Empirical Finance, LLC
companies are required to identify themselves
16192 Coastal Hwy. pursuant to Rule 240.12b-2 of the SEC Act.
Lewes, DE 19958 The authors use a dataset from DealFlow
T: +1.773.230.4727 Media’s PrivateRaise database that is
constructed from this publically disclosed
F: +1.888.517.5529
information. The dataset includes all reporting
http://empiricalfinancellc.com
shell companies from 2001 to present.
Because the stock of most shell companies
does not trade on major exchanges, the authors
use market data from Thomson One Banker/
identify between 2006 and 2008, 287 of them
are actively traded and meet the authors’ data
requirements.
Discussion:
Reverse mergers are an easier and less
expensive way of going public than an IPO.
Most of them are conducted through the
acquisition of a publicly traded shell company
by an existing operating company, thereby
allowing the operating company to obtain
access to the public listing and established
shareholder base.

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 Shell Games: On the Stock Price Performance
of Shell Companies
In fact, the authors of this paper document that
50% of all reporting shell companies undergo a
reverse merger each year. However, for those
that do not, the effect on the stock price is
substantial. The typical shell companies loses
half of its market value every 172 days.
Conversely, among those shells that do enter
reverse mergers, the mean abnormal return is
48.1% over the subsequent three months. This
means that investors in shells should be
particularly concerned with the timing of a
merger announcement.
This raises interesting risk/return questions.
Clearly investors in shell companies are betting
on the consummation of a reverse merger, but is
such a bet rational in a risk/return sense?
Moreover, most shells are particularly illiquid
and difficult to trade. Are the huge abnormal
returns compensation for severe liquidity risk?
The authors argue that investing in shells is
rational and spend much of the paper
identifying factors associated with the
consummation of the merger. In so doing, they
estimate the conditional likelihood of any given
shell undergoing a reverse merger.
The authors also document the returns and
liquidity around the announcement of the
reverse merger. They find that the shell
companies earn a 27.87% return in the first
thirty days after the announcement. Liquidity
also increases substantially, from an average
daily volume of 15,100 shares before the
announcement to 28,800 shares after the
announcement.
Empirical Finance, LLC Using an advanced regression technique, the
16192 Coastal Hwy. authors determine the variables that contribute
to a successful reverse merger deal. The
Lewes, DE 19958
authors also estimate the amount of time, given
T: +1.773.230.4727
the values of these variables, that it will likely
F: +1.888.517.5529 take for a merger to be announced.
http://empiricalfinancellc.com
The empirical evidence suggests that shells
which are incorporated in Nevada or Delaware
conduct a reverse merger much more quickly
(time to merger is 69% lower) than those
incorporated in other states. Also, shells traded
on Pink Sheets conduct a reverse merger much
more quickly (time to merger is 60% lower)
than OTCBB stocks.
Finally, the authors classify each shell in to one
of three categories: development stage shell,
natural shell, and virgin shell. There is evidence
that development stage shells conduct reverse
mergers the fastest, but it is not statistically
significant.
This process of using shell companies to
conduct reverse mergers has become especially
popular in the last five years, as has the use of
Special Purpose Acquisition Vehicles (SPACs),
a different type of shell company that conducts
an IPO of its own. For purposes of comparison,
the authors also show the returns of SPACs and
find that shell reverse mergers are far superior to
SPACs in terms of market reaction to the
announcement of an acquisition. This is
consistent with the nature of SPACs, which
guarantee some return of investment if no deal
is found. Thus, SPAC investors are not exposed
to the level of downside that shell investors are,
yet they sacrifice a tremendous amount of
upside as well.
Investment Strategy:
1. Obtain a list of shell companies with an
acceptable liquidity profile.
2. Focus on those shells incorporated in Nevada
or Delaware and which trade on the Pink Sheets.
3. Do your own due diligence and tread
carefully.
Conclusions:
Shell investing is a specialty in the microcap
investing space, and has made many an investor
very wealthy. But it is largely off the radar of
most professional investors as well as academic
researchers. This paper provides fascinating
insight in to the nature and profitability of shell
investing. In general, investing in shells is
lucrative and can be done responsibly with
careful risk management.
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 Empirical Finance LLC
Current Stock Screens

Empirical Screen #1
Piotroski F-Score and signaling factors
This table highlights all companies that have the highest score possible on the Piotroski F-Score
fundamental analysis screen (slightly augmented). We screen for small-cap companies that have
book/price ratios in the top 20% of all companies traded on the NYSE/AMEX/NASDAQ. We add
information on CEO ownership to signify ―skin in the game.‖ Finally, we highlight any open
market repurchase activity that has taken place in the last 6 months (signals that shares are cheap).
Ideas generated in this screen are not meant to be short-term trades, but represent long-term
opportunities that, on average, have outperformed the general market by great margins. (Screened
on September 30, 2009).

Company Name, Mkt. Cap. Book/ Recent CEO %

Exchange, Ticker ($mm) Price Buybacks ownership
Comfort Systems USA Inc.
(NYSE:FIX) 444.4 0.63 - 1.03
Apogee Enterprises Inc.
(NasdaqGS:APOG) 419.2 0.80 - 1.45
MYR Group, Inc.
(NasdaqGM:MYRG) 416.5 0.39 - 0.827
M&F Worldwide Corp.
(NYSE:MFW) 391.3 1.19 - 0.026
Advance America, Cash Advance
Centers Inc. (NYSE:AEA) 345.2 0.56 - 0.785
Kensey Nash Corp. 03/18/2009
(NasdaqGS:KNSY) 321.9 0.38 Buyback 1.49
Republic Airways Holdings Inc.
(NasdaqGS:RJET) 321.4 1.55 - 0.574
Matrix Service Co. 02/04/2009
(NasdaqGS:MTRX) 284.8 0.59 Buyback 0.46
International Shipholding Corp.
(NYSE:ISH) 228.2 0.94 - 6.19
Asset Acceptance Capital Corp.
(NasdaqGS:AACC) 221.7 0.62 - 0.375
Preformed Line Products Co.
(NasdaqGS:PLPC) 209.7 0.71 - 15.14
Young Innovations Inc. 07/20/2009
(NasdaqGS:YDNT) 207.9 0.54 Buyback 1.41
Spartan Motors Inc. 07/24/2009
(NasdaqGS:SPAR) 169.0 1.04 Buyback 2.14
Frisch's Restaurants Inc.
(AMEX:FRS) 132.1 0.85 - 21.53
Spectrum Control Inc.
(NasdaqGS:SPEC) 107.4 1.03 - 1.22
Screening Criteria: ►Market Value between $100mm and $500mm ►Book Value /
Empirical Finance, LLC Market Value less than 3 ►LTM Net Income greater than 0 ►LTM Cash from Operations
(CFO) greater than 0►LTM Return on Assets % greater than 5% ►LTM CFO greater than
16192 Coastal Hwy.
LTM Net Income ►LTM LT Debt / Capital greater than LTM-1 LT Debt/Capital ►LTM
Lewes, DE 19958 Current Ratio greater than LTM-1 Current Ratio ►LTM Shares Outstanding less than LTM
T: +1.773.230.4727 –1 Shares Outstanding ►LTM Gross Margin greater than LTM-1 Gross Margin ►LTM
F: +1.888.517.5529
Asset Turnover greater than LTM-1 Asset Turnover.
http://empiricalfinancellc.com

*Please Note: This newsletter is published by Empirical Finance, LLC, which serves as the general partner for various investment vehicles. Empirical
Finance, LLC may purchase or sell securities and financial instruments discussed in this newsletter on behalf of its clients. Empirical Finance, LLC is
not an investment, legal, or tax advisor, and none of the information available through the newsletter is intended to provide tax, legal or investment
advice. Nothing provided through this report constitutes a solicitation by Empirical Finance, LLC for the purchase or sale of securities.

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 Empirical Finance LLC
Current Stock Screens

Empirical Screen #2
Top 10 Long/Short Net Operating Asset companies
These tables highlight the companies with the lowest net operating assets and the highest net
operating assets. Low NOA ideas generated in this screen are not meant to be short-term trades,
but represent long-term opportunities that, on average, have outperformed the general market by
great margins. High NOA companies are good short-sell candidates. (Screened on September 30,
2009).
Long:
Company Name, Mkt. Cap. CEO %
Exchange, Ticker ($mm) NOA Ownership
EpiCept Corporation
(NasdaqCM:EPCT) 113.9 -3.79 0.19
Insmed Incorporated
(NasdaqCM:INSM) 106.1 -2.99 -
Energy Recovery, Inc.
(NasdaqGM:ERII) 292.9 -2.36 1.04
Hemispherx Biopharma, Inc.
(AMEX:HEB) 252.5 -2.33 0.36
BioSpecifics Technologies Corp.
(NasdaqGM:BSTC) 194.7 -1.56 21.80
Agria Corporation
(NYSE:GRO) 134.6 -1.53 -
Maxygen, Inc.
(NasdaqGM:MAXY) 256.1 -1.21 1.51
China Distance Education Holdings
Limited (NYSE:DL) 249.8 -1.10 7.65
China Education Alliance Inc.
(AMEX:CEU) 149.7 -1.09 52.25
StemCells Inc.
(NasdaqGM:STEM) 176.4 -1.06 0.22

Short:
Company Name, Mkt. Cap. CEO %
Exchange, Ticker ($mm) NOA Ownership
JMP Group Inc.
(NYSE:JMP) 200.4 1.83 14.97
NPS Pharmaceuticals, Inc.
(NasdaqGM:NPSP) 194.6 1.61 0.26
Crown Media Holdings Inc.
(NasdaqGM:CRWN) 163.5 1.59 -
KapStone Paper & Packaging Corp.
(NasdaqGM:KPPC) 230.9 1.48 9.30
Valence Technology Inc.
(NasdaqCM:VLNC) 228.4 1.43 0.00
Empirical Finance, LLC Revlon, Inc.
(NYSE:REV) 250.6 1.42 0.05
16192 Coastal Hwy. Raser Technologies, Inc.
Lewes, DE 19958 (NYSE:RZ) 114.5 1.28 0.00
Dynex Capital Inc.
T: +1.773.230.4727 (NYSE:DX) 114.4 1.24 4.68
F: +1.888.517.5529 Empire Resorts Inc.
(NasdaqGM:NYNY) 101.5 1.23 3.93
http://empiricalfinancellc.com Safe Bulkers, Inc.
(NYSE:SB) 442.6 1.21 -

Screening Criteria: ►Market Value between $100mm and $500mm ►NOA=[(Total Assets
-Cash and Equivalents)-(Total Assets—Total Debt)]/Total Assets year prior)
*Please Note: This newsletter is published by Empirical Finance, LLC, which serves as the general partner for various investment vehicles. Empirical
Finance, LLC may purchase or sell securities and financial instruments discussed in this newsletter on behalf of its clients. Empirical Finance, LLC is
not an investment, legal, or tax advisor, and none of the information available through the newsletter is intended to provide tax, legal or investment
advice. Nothing provided through this report constitutes a solicitation by Empirical Finance, LLC for the purchase or sale of securities.

Page 4