Take a Pass on Applied Digital

To raise cash to fund its new RFID ventures -- including a more recent acquisition of eXI Wireless that has a product to monitor patient wandering and infant protection and location systems -- Applied Digital recently pulled off a $9 million private placement that brought its net cash number to more than $15 million, based on our calculation. The shares were bought by asset management firm Satellite Strategic Finance Associates, which has been its largest investor over the last year, though it is listed as a net seller of 506,000 shares in a filing at the end of September. We phoned Satellite to ask about its interest in Applied Digital, but the money management firm declined to comment.

Another troubling issue is Applied Digital's management. The group, which constantly promotes its stock with bullish press releases about its future and present business, doesn't seem to have enough confidence in their abilities to own many shares in their own company. The company's CEO, Scott Silverman, has less than a 1% stake in Applied Digital, and he is the largest shareholder on the management team. He is well taken care of by the board of directors, though, which approved his $1.67 million salary in 2003, despite the company's continued weak operating results.

Applied Digital also has to deal with the Big Brother issues that come with invasive technologies that allow others to view personal information electronically. The company's chips contain sensitive and personal information, which carries the potential of identity theft. These issues are generally overcome when a technology could really improve the standard of living, but it is just another bump in the road for this first-to-market company to overcome.

We are also struck by the lack of coverage for the company on Wall Street. Not a single analyst covers this stock. Normally this would serve as a catalyst and would allow us to take a position ahead of new coverage and institutional demand for the stock. But in Applied Digital's case, we believe it signals more a lack of confidence in management and an unwillingness to get behind the story given the company's spotty track record.

Normally, we would hesitate recommending selling a low- dollar stock with a lot of momentum due to the volatility involved with speculative-concept investments like Applied Digital's. Just look at the move Mace Security (MACE Quote) made earlier this year. Mace, a car wash turned homeland security company, in April ran to $14 a share from $2 a share only to have insiders sell boatloads of stock and send its shares back to $5 today. But the fuel for big runs like that, usually a large short interest or daily trading volumes of fewer than 100,000 shares, is not present here with Applied Digital. Only 6% of the float is short, and that can be covered in one day, based on the stock's recent trading surge. The risk/reward is skewed against the longs here.

To Applied Digital's credit, its sales have slowly rebounded this year, though its operating cash flows have deteriorated on a year-over-year basis for the first nine months of 2004. Management has also signed some interesting supplier deals that will help it bring VeriChip to the masses. But this story hinges on the tagging of human beings, and we don't expect that to be a big market anytime soon. When we overlay the uncertainties for its product with its confusing corporate structure and acquisitive nature, we believe the best way to play Applied Digital is to sell now at the stock's high.

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