On2 Technologies, Inc. Announces Restatement of Financial Statements

There’s no way to dress up this pig today. Nothing but depressing news for a Whole Hog investor.

• Fraud revealed via Audit “two sales accounts for which revenue had been recognized in the third quarter of 2007, had been falsified”, most of the revenue concerns being flushed rather than moved to a different quarter.
• An embarrassing slap across the face of the CEO “In addition, management has identified a material weakness in the Company’s control environment, specifically relating to Company’s tone at the top, as evidenced by the control tone and control consciousness of the Company’s chief executive officer”
• Revenues were down significantly from last quarter, from over 6 mil last quarter to just 4.5 in Q1.
• The most painful line item for me was the heavy loss for Q1.

The loss for all of 2007 was only $6,837,000. Ouch. Really want more details on that one.

Quite a feast eh!

Bottom line: Am I squealing now? Ready to push that sell button?

Nope. The Whole Hog call was made based on future revenue potential. I still see royalties from embedded chip applications as the real fuel for stock price appreciation. Its clear that we should not expect to see the real impact of those until later this year at the very earliest. The recent JAVA news was huge. That combined with the Silverlight/Move partnership means that ON2 truly has the potential to be Every Video, Everywhere.

Could things be very wrong at ON2? Yes. The accounting snafus really don’t reflect well on leadership.

Is Whole Hog investing a very stupid thing to do? Yes.

Did today’s ugliness materially change the reason for being so stupid? No.

It’s very easy to become deluded when you are in a Whole Hog position, however –

I will remain in the pigsty. Some times there are risks you just have to take.

Whole Hog Investing: Recklessly and foolishly placing all (or almost all) of your investment account in a single equity position.

Very interesting to see the 11% increase in short interest on my Whole Hog play (ON2 Technologies) this last reporting period.

This lends credence to a hopelessly outside the loop Whole Hog investor’s conjecture that the main reason we did not get the reverse split by the deadline was because of the short interest pile on.

What are the shorts to do now? How do they plan to cover that heavy load without causing a squeeze? While I’m sure they thought that the ON2 share price rose far too fast when matched up against current revenues, I do think that they were also attracted by the chance to capitalize on the reverse split. Here’s how ONT shareholders have faired since the Hedge Hogs went Hog Heavy on the short end:

Mighty successful Hedge Hogs. They sure were successful at driving down the price. But volume has dried up significantly and I wonder what negative catalyst they see that will enable them to get the high volume days that they will need to cover. This is the boom time of the year traditionally for ON2, and this year is shaping up as no exception to that rule with the CES show just around the corner. There’s imminent China Mobile news hanging in the air, as well as a possible VP8 deployment. I just don’t see a big chance for any real negatives to hit the stock in the coming weeks. (Of course, I’m just a no nothing Hog outsider). What would happen when some real positive news hits with all these short shares left to cover? Are the shorts just going to sit on this one for months? If revenues increase again this quarter, the current valuation is really not that extravagant.

All of this is pure conjecture however. Dealing with conjecture/speculation, and reigning in flights of fancy is a key factor to successful Whole Hog investing. Its a fine line you walk between solid analysis of the evidence at hand, and fantasy speculation that ignores negatives and overemphasizes any positive. When you go Whole Hog its very easy to fall into that Pollyanna trap.

So let’s add another well worn premise: Regarding the decision not to reverse split, the other conjecture that could lull a foolish Whole Hogger into fantasy land is the possibility of a buyout. (A key element to most Whole Hog plays has to be that its priced at a tempting big boy buyout price) Who are possible bargain shoppers? Adobe of course, plus Cisco because of their recent video emphasis. Nokia, naaa. I’ve always wondered why Microsoft never seemed to show an interest in ON2’s proprietary technology. Once the news came out that their VC-1 codec was only 2% Microsoft proprietary technology, it became even more puzzling. What would have fit their proprietary plans better than the VP codecs? I think the age of Microsoft has really ebbed now. The intensity to dominate that Bill Gates displayed over the years really seems to have dimmed significantly. I’m just not sensing buyout right now however. I think it was the Hedge Hog short threat that stopped the Board from triggering the R/S.

I’ve got my borrowed funds at the ready. I may sit out this week. I think there could be another effort to drive down the price before the CES show. We really seem to have run out of sellers at this price however. This stock took a severe pounding in the second half of the year and it really did not phase the institutional investors at all. Institutional share ownership really hasn’t dimmed.

Looking forward to an even higher percentage of my wealth to be wrapped up in a single company - boom or bust.

So says Overstock CEO Patrick Byrne, as he predicts complete economic disaster on CNBC. Watch it here - if you dare.

We are living at the edge of a 1929 kind of disaster.

Guess Americans shouldn’t be buying anymore Overstock crapola, right? We really better save our pennies now. The Overstocked CEO foresees a dim future for us all.

The American economy is like an old man in an oxygen tent that you flood with oxygen, but when you turn off the oxygen he fades very quickly.

Does Overstock sell oxygen now perhaps? Maybe that’s a new corporate initiative at the Big O.

Got to hand it to the Overstocked Swami. What’s rarer than a Swami CEO going public with gloom and doom predictions for all of mankind? He is one of a kind.

So, let’s review: the CEO of a company that sells junk that no one wanted the first time it went to stores is telling the world that global disaster is imminent. And it will be just like 1929 when Americans could barely afford bread, let alone trinkets from the Big O. So what happened to his company’s stock after the Overstocked Swami gave his forecast of impending global doom?

Gee, glad I didn’t own any Overstock this week.

This one will be pretty easy to follow. We have to see complete disaster begin to hit in 2008. Trouble is, if the Overstocked Swami is correct, I will be too busy begging in the streets for food to be checking back on his prognostication prowess. If I haven’t hocked my computer for groceries by June, I’ll check back in on this noble CEO and his bold predictions.

I am still hoping for the reverse split however, as it has played out extremely well for 2 of my Whole Hog plays. Both companies saw significant revenue increases post split. I think the split enhanced their ability to attract long term holders. Here’s one example:

Here’s a nice interview with Bill Joll, where he describes the low bit rate edge that VP6-S has over H.264, and the fact that ON2 has the chipset solution, no matter which HD codec is used.

 All of terrestrial television has to go to digital by 2009

Swami Syndrome: A proclivity for predicting the future coupled with a blinding disconnect to the fact that a coin toss (or the proverbial monkey) would be more accurate than your lame prognostications.

Way back in June of 2005, The Big Swami wrote a sternly anti-Swami article entitled Apprentice Investor: The Folly of Forecasting. He speaks about the “perils of predictions” and how investors often give far too much weight to analysts, professors and other talking heads who are stalwart in their prognostications, yet hopelessly afflicted with Swami Syndrome.

I wish an SEC-mandated disclosure accompanied all pundit forecasts: “The undersigned states that he has no idea what’s going to happen in the future, and hereby declares that this prediction is merely a wildly unsupported speculation.”

The bottom line is that I’ve yet to find anyone who can accurately and consistently forecast the market behavior with any degree of accuracy, beyond short-term trend following. That inconvenient factoid never seems to dissuade the prophets — or the press — from their fortune-telling ways.

No one truly knows what tomorrow will bring. Nobody.

Those are some pretty strong statements regarding Swami Syndrome.

But - just 2 months later, in August of 2005, The Big Swami wrote an article entitled Real Estate Begins to Cool, wherein he lays out of the perils that face the US due to the Subprime Mortgage mess, and then concludes with a very bold prognostication:

We expect a recession in the 2006-07 time frame.

Yikes!! What part of “Nobody knows what tomorrow will bring” am I not understanding? Did the Big Swami have a sudden flash of insight into the workings of the universe that made him boldly pronounce a recession for 2006-2007, in bold type? Or was he just inflicted with that malady that seems to strike everyone who gets “Expert” tagged next to their name on the TV screen, Swami Syndrome?

Let’s check the Thesaurus, maybe we’re off base here:

Nahhh, we’re on the right track. Diagnosis confirmed?

Now there are a few rare souls out there who do seem to have a genuine knack for big picture prognostications. Is the Big Swami the real Salami?

We expect a recession in the 2006-07 time frame.

Well he made it easy for us on this one. Since its December of 2007 already, all we have to do is count the recessions in 2006 and 2007. Let’s see, growth, growth, growth, growth……….

Uh oh. Actually, we’re not even close to falling into a recession so far. And its basically 2008 already.

The Big Swami has one last chance on this one. He needs Q4 to show negative growth, and we need to follow that up with the same negativity for Q1 2008.

Let’s check back in the Spring. We will check on some other Big Swami pics as well in a later post.

UPDATE: no momentum there for sure, stopped out at $102.25. Do we switch hit on it? thinking, thinking thinking, No.

UPDATE: Getting out early was smart. Not switch hitting was smart. Should I have raised my stop up a bit when it crossed $103? Yeah.

Swami Syndrome: A proclivity for predicting the future coupled with a blinding disconnect to the fact that a coin toss (or the proverbial monkey) would be more accurate than your lame prognostications.

Way back in March of 2007, Bill Cara took a look at the real estate market in the U.S., and the subprime market in particular, and came to an alarming conclusion.

In his article The why and how America is in trouble,

he buffed up his crystal ball till it was glowing red hot and pronounced:

The whole of the world watched TV images of the inhumane treatment of the poor of New Orleans following Hurricane Katrina. With great respect to those couple hundred thousand disadvantaged souls (as my readers know I have), I believe those ugly TV images may even look mild compared to the scenario that would follow angry mobs across America if market interest rates rise beyond the tipping point that would collapse the entire US mortgage market.

Yes, I believe there will be a US economic recession, but the elements are now in place for the first time in 80 years for America to sink into a depression.

Heavy stuff!!! Get your shotguns now everybody, Bill thinks the whole nation is about to get Katrina’d.

The Doomsday Swami backs up his claim with many pie charts and graphs that indicate just how badly the American banking system was mismanaged. Of special note is how he identifies the banks that are the most overexposed to Alt-A/Subprime risk, and he provides a chart to show his Swami prowess on that point. Well done. He also shows some real Swami Swagger by showing us a chart of U.S. builders while claiming he called the top in the real estate market. He backs that one up pretty well.

But he used the “D” word here. Only the bravest of Swami’s would go that far.

Is Bill Cara the Swami of the Decade? or is he just a Chicken Little Psuedo Swami with a very bad case of Swami Syndrome?

I think by June of 2008 the answer to that should be very clear. We have to see at least a really nasty recession, not just a little blippy one that reverses, for the Doomsday Swami to be proven correct.

Since I’ve got most of my net worth locked up in a video codec company, seems appropriate that I attempt to post an internet video.

Here’s a good interview with Bill Joll wherein he outlines the key addition to ON2 that is the final piece of their Any Video, Anywhere plan.

…but the Razr, which sells by far the largest volume for them is a single chip phone and that requires an embedded offering and that’s where the technologies and the capabilites that Hantro brings to the table helps us….

So what exactly would make you change your mind on that? What would make you turn tail and run with what’s left of your hard earned cash?

Yeah, what exactly would make you squeal?

How about if your Whole Hog genius position had a chart that looks like this?

Holy Hot links! Talk about a free fall. Was that a squeal of surrender I heard? No???

You don’t give up yet?

How about some fundamental analysis from the renowned MSN Money Computer Swami:

Damn, ON2 rates a whole 1 (and they don’t use zero). The worst of Hollywood’s movie crap never rates that low.

But you know better, right Einstien? And you’re still still holding onto this pig in desperation?

OK, so let’s throw some scholastics from the Computer Swami at you. How about this?

ON2 is the High School Drop Out of the Amex based on those scores.

High Risk + Low Return = Say what? ONT is a Fundamental Flunky here so far.

You’re ready to click the SELL AT MARKET button now right? No??

OK so what about the short interest? Surely you’ll take the advice of those HedgeHog pros.

Everyone knows that they are the real professionals right?

• ONT short interest in January 1,694,107
• ONT short interest in November 16,192,091

It’s now TEN TIMES HIGHER!!

You have to sell now, the entire universe is telling you that you’re wrong!

Give it up already subliminal sissy, not only am I not selling - I’m smashing my piggy bank for pennies to buy more.

A few issues that would concern me are:

Capitalization - I made a mistake on an undercapitalized Hog that was bought out way too cheap because they were backed into a corner. ON2 is well covered on this issue. They are running cash flow positive already and have quite the piggy bank to tide them through till device royalties kick in.

Debt - A company with a lot of debt is a serious concern for me. ON2 has none.

Competition - This is always a huge concern with a technology company, and this is the issue I spent the most time reading up on. I still believe that ON2 provides the best all around product on the market, and it has several huge advantages over the main competitors, which are standards based. This is a risk, but so far I have only seen ON2’s competitive advantage increase on this issue.

So what would make me squeal?

If my sole reason for buying ONT changed. As long as I see a very high probability of increased revenues for ON2 Technologies, I will stay in the pig pen.

The price drop doesn’t worry me at all, it just gives me an odd craving for bacon.

Click the image to enlarge

Let’s imagine that I was not such a foolish investor who would Whole Hog an AMEX stock that specializes in manipulating zeroes and ones:

and say buy AAPL at $174.81 - to hold through (and reconsider on) the day prior to earnings - or to be ruthless stopped out at the red line of course!

Note: I can’t actually buy AAPL at these prices for a decent swing position, I’m up to my sow’s ears in ONT.

12-7-07 UPDATE: Nice crash through green today, which commences the challenging part for me. I put in a trailing stop at $180. I still see a lot of upside to this one, up until earnings. (yeah, I know - this ones purely a paper trade)

 UPDATE 12-26-07: Moving the trailing stop up to $188 now that Apple has broken through $200.