Magic Empire Global Limited (NASDAQ:MEGL) is a recent Nasdaq IPO that achieved 5 minutes of fame with its meteoric 60x return from IPO price in a matter of days. However, investors who bought on the first few days of trading aresitting on catastrophic losses. This article looks at this particular transaction and highlights multiple red flags. Hopefully, this will help investors identify and avoid these overhyped IPOs in the future.
Company Background
Magic Empire Global Limited is a financial services firm based in Hong Kong. They primarily provide corporate finance advisory and underwriting services such as IPO sponsorship, financial advisory (mergers, acquisitions, and divestitures), underwriting (global coordinator, bookrunner, underwriter, etc.) and compliance advisory.
Since the firm's establishment in 2016, MEGL has been the sole sponsor for 8 IPOs. In the 2020 and 2021, MEGL was engaged in 6 IPO mandates, 31 financial advisory mandates, 24 compliance advisory mandates, and 3 underwriting mandates.
Hong Kong Capital Markets
Historically, Hong Kong has been known as an international financial hub and a gateway to access China. As of December 31, 2021, the Hong Kong equity markets rank 7th in the world and 4th in Asia, by market capitalization (Figure 1).
Figure 1 - Hong Kong capital markets(MEGL F1 filing)
MEGL Corporate Structure & IPO Terms
MEGL was incorporated under the laws of the British Virgin Islands ("BVI") as the ultimate holding company which owns 100% of Giraffe Financial Holdings Limited ("GFHL") which owns 100% of Giraffe Capital Limited ("GCL"). GCL is licensed to advise on corporate finance ("Type 6") and securities dealing ("Type 1"). Figure 2 shows the corporate holding structure.
In April 2022, MEGL announced a US IPO for 5 million ordinary shares of MEGL at a proposed range of US$4 to $5, representing 25% of the company. Fellow Seeking Alpha contributor Donovan Jones wrotea good summary of the IPO transaction. Ultimately, MEGL's IPO was successful, with the company raising US$20 million at $4 per share, valuing the company at $80 million.
Figure 2 - MEGL Corporate Holding Structure(MEGL F1 filing)
MEGL Started Trading With A Bang
MEGL stock began trading in the American markets on August 5. Partly on the back of the meteoric rise of another Hong Kong-based financial services company, AMTD Digital Inc. (AMTD), MEGL began trading with a bang. MEGL shares opened at $49.25, more than 12 times the IPO price of $4. On day 2, the stock reached at high of almost $250. Since then however, the stock has collapsed by more than 95%, trading recently at $11. In the 5 days since the stock began trading, an incredible 30 million shares have changed hands, representing more than 100% of the total shares outstanding. Figure 3 details MEGL's brief trading history.
Figure 3 - MEGL trading history(stockcharts.com)
Multiple Red Flags From The Disclosures
After such an epic rise and fall over then span of a week, are there lessons to be learned for retail investors? Yes. I will detail some red flags that I was able to gather from the available information.
1) Limited Financial History
Looking through the F1 filing for MEGL, we can see that the company has a limited financial history. In 2020 and 2021, MEGL recorded HKD$10.7 and HKD$6.8 million in revenues respectively, or roughly USD$1.4 million and $0.9 million. Net income was only HKD$4.2 million and HKD$1.6 million respectively (Figure 4)
Red Flag 1:How can the company look to raise US$20 to $25 million in the IPO, valuing the company at US$80 to $100 million based on these limited financials? That would translate to 400 to 500x trailing P/E.
Figure 4 - MEGL had limited financial history(MEGL F1 filing)
2) No Skin In The Game
Furthermore, if we look at the capitalization table in the F1, existing shareholders have basically zero 'skin in the game' (Figure 5). The 15 million in existing shares have a zero cost base, and of the HKD$5.5 million in retained earnings as of December 31, 2021, HKD$4 million was paid out as a dividend in February 2022. Therefore, the company only had equity capitalization of HKD$1.5 million (less than US$200k), or $0.013 per share pre-IPO. Existing shareholders are looking to get a 300-400x lift on their invested capital (based on IPO price range).
Red Flag 2:Bewareinvesting in IPOs where principals have no 'skin in the game'.
Figure 5 - MEGL cap table(MEGL F1 filing)
3) Poor Business Record
Of the8 companiesGCL has taken public, 1 has been delisted and the average return of the other 7 is -69%. (Figure 6). While capital markets have been tough the last few years, this is an abysmal record.
Red Flag 3:Poor Business Track Record Speaks Volumes.
Figure 6 - MEGL IPO track record(Author created with price data from HKEx)
4) Poor IPO Track Record
Another area investors should take into consideration is the track record of the lead underwriter. In this case, the underwriter is Network 1 Securities Inc. Figure 7 shows the 2021 and 2022 vintage IPOs led by Network 1. All the stocks below exhibited massive rallies followed by massive declines. GSUN is a recent IPO that started trading on June 21.
Red Flag 4:Check Performance Of Underwriter.
Figure 7 - Network 1 IPO track record(Author created with price data from stockcharts.com)
5) Questionable Use Of Proceeds
An interesting wrinkle in this IPO is the use of proceeds. Reading through the F1, we see that a group ofselling shareholderswill sell 2.4 million shares (Figure 8). (Note, this disclosure was only found in the F1 and was not found in the final prospectus 424B4. It is unclear whether the selling shareholders sold their shares.)
Figure 8 - Selling shareholders(MEGL F1 filing)
Of the IPO proceeds (2.6 million shares) that go to the company, a significant amount (HK$11 million or US$1.4 million) will go directly to two directors, as they had 'advanced' funds to the company (Figure 9).
Figure 9 - MEGL related party transactions(MEGL F1 filing)
Furthermore, the company is offering a generous underwriting discount of $1.4 million to the underwriter (Figure 10). (Note, due to thesizeof the deal, a 7% IPO fee is considered 'standard'.)
Figure 10 - Underwriter concession(MEGL 424B4 Prospectus)
Finally, another $0.7 million is set aside for transaction expenses (Figure 11).
Figure 11 - MEGL IPO transaction expense(MEGL F1 filing)
So all told, of the $20 million raised, only $7 million actually goes to the company!
Red Flag 5:Check Where The Money Is Going.
Best To Avoid
Although I have highlighted many red flags with MEGL, does this mean this is a good short candidate?
The answer is no. As we saw from the meteoric rise of the share price, these are tightly held stocks that could quickly double, triple, or go up 10x against you if you are short, if you are able to find a borrow in the first place. The best bet as an investor is to avoid these stocks like the plague.
Conclusion
From a quick two hour reading of the F1 filing and quick searches on the internet, I was able to identify multiple red flags with the MEGL IPO. My investment radar would have been blaring a loud'red alert'when it began trading on August 5th and I would have avoided the stock.
Hopefully, I have shown some common areas investors can look at, the next time they come across a 'hot IPO'.
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