On August 7, Sharesleuth.com, the investigative journalism venture launched earlier this year by billionaire bad boy Mark Cuban, claimed its first victim: Xethanol. Apparently, Xethanol was going around telling investors that its alternative fuel solution had the potential to become a game-changing innovation for the energy sector. Jumping on Wall Street's ethanol bandwagon, the company claimed that it was able to turn wood chips, corn stalks and paper sludge into cheap alternative fuel. However, Xethanol's claims turned out to be nothing more than an elaborate innovation hoax, proving that it's best to do your homework before investing in overheated, speculative markets such as the one for ethanol companies.
An extensive Sharesleuth.com investigation found no evidence that Xethanol had produced significant quantities of ethanol from any raw materials. In fact, one of the company's two ethanol-producing plants turned out to be inactive and shuttered for more than a year. Moreover, Xethanol's claim that it would become one of the first companies to commercialize ethanol technology ("a sort of Holy Grail in the renewable-energy world") turned out to be false as well. Xethanol actually spends little or nothing on R&D and has a "glaring absence" of scientists on its staff, introducing tremendous uncertainty about the company's long-term innovation potential.
In fact, a little digging on Google Finance turns up the fact that Xethanol, far from being a revolutionary pure-play ethanol company, was actually formed from a corporate shell company called Zen Pottery Equipment! In the five years prior to its IPO in February 2005, Xethanol underwent a handful of name changes, none of them having anything to do with ethanol (e.g. FreeReal-TimeQuote.com). Not only that, but Sharesleuth.com found that the company's shareholders and management team were cross-linked in a matrix of questionable dealings. Several primary shareholders of the company had been the subjects of disciplinary actions by regulators, and the CEO of the company had a shadowy past.
If the goal of Mark Cuban's Sharesleuth.com was to ferret out the types of innovation hoaxes that generally appear during periods of speculative excess, then he certainly succeeded. Going forward, investors will likely be more careful before they invest in alternative fuel companies making outrageous claims about the future. If the goal was to shake up the management team of Xethanol and spur a change in corporate strategy -- a laudable goal for any shareholder with a significant stake in the business -- then he also succeeded mightily. Just days after the Sharesleuth.com investigation, Xethanol announced a shake-up of its management team, the appointment of a new interim CEO, and a series of aggressive new initiatives related to ethanol production.
However, if the goal of the venture was to enable others to profit from short-term swings in the share prices of overvalued companies, then it is not so clear whether there is still money to be made. Consider the share performance of Xethanol over the past four months. On April 18, shares of the company were selling at a high of $16.18. By mid-May, approximately the time period when Mr. Cuban started accumulating his short position, the share price of the company had sunk to $12.65. Over the first two months of the summer, the share price of Xethanol traded between $8 and $10, finally settling into a range of between $6 and $7 during the first week of August. In the two weeks after the story appeared, shares of the company have stabilized around the $5.20 mark.
For those who believe that big bad hedge funds with their aggressive investing methods are roiling markets, the saga of Sharesleuth.com and Xethanol seems to tell a different story. As can be seen above, the damage had already been done long before the news of potential misdoings broke on the Sharesleuth.com site. Nearly 30 days before Mr. Cuban started to accumulate his position, Xethanol's share price had already dropped by 21% from its April high -- a sure sign that something was amiss.
By the beginning of the summer, the market had already started to question the hype surrounding the ethanol market. After a number of mainstream media outlets started to report potential problems with the projections made by ethanol producers, the dealmakers of Wall Street attempted to sneak a final batch of ethanol companies (i.e. Hawkeye Holdings, Aventine Renewable Energy, VeraSun) through the IPO window. Instead of receiving a warm greeting from investors, these offerings fell flat. Shares of VeraSun, which traded as high as $30.75, are now trading near $21.50. Shares of Aventine, which traded as high as $42.50, are now trading near $25.50. Hawkeye is still waiting to make it out the IPO door. Just as Mr. Cuban suspected back in May, share prices of ethanol companies had been vastly inflated through irrational exuberance.
Viewed from this perspective, hedge funds and short sellers are not the barbarians at the gate as they are usually portrayed. They are not extorting money from shareholders and wrecking companies. As in the case involving Sharesleuth.com and Xethanol, investors with the time and inclination to engage in "nook-and-cranny research" are the front-line troops, digging up the kind of information that makes markets more efficient. By bringing greater transparency to the stock market and forcing fly-by-night ventures to clean up their acts, ventures like ShareSleuth.com hold out the promise that the "little guy" can avoid getting burned by the next big innovation hoax.
The author is a TCS Daily contributing writer and editor of Fortune Business Innovation Insider.