XpresSpa (NASDAQ:XSPA) CEO Doug Satzman knew XSPA stock was in trouble. The month was March, and not only was Satzman’s company unprofitable – burning $10 million in cash throughout 2019 – it was now facing a global pandemic.
By the end of March, what was left of the company crumbled: air travel sunk by 92%, all 51 of XpresSpa’s locations were closed and XSPA plummeted to 42 cents.
Yet, by July, the company raised $48 million from investors and its stock skyrocketed 1,550% to $7.11. Much of its activity came from Robinhood, an online trading platform, where 100,000 investors jumped in. It would seem as if all’s well that ends well, with XpresSpa recently announcing a massive $200 million capital raise.
If I were less inquisitive, I might not ask how this failing company pulled itself up by the bootstraps. I definitely wouldn’t wonder how its management came to fool investors with its coronavirus pivot and shroud the inevitability of its stock’s almost-certain trajectory to zero.
Only, I don’t need to ask. XpresSpa managed to perform its hat trick in a three-part act in front of our very eyes.
XSPA Stock Part 1: The Setup
If you have ever looked at an XpresSpa and wondered, “how do those stores stay in business,” you would have been right to ask. The company has never turned a profit from its spa business. Even in good times, its average sales per square foot of $850-$1,000 fell far short of other airport retailers.
By 2019, its auditor, CohnReznick, predicted the company would go bankrupt within twelve months. CohnReznick “anticipates that during 2020, [XpresSpa] will not have sufficient capital to repay its current obligations,” the audit firm reported. “Furthermore, the Company’s recurring losses from operations, working capital deficiency and stockholders’ deficit raises substantial doubt about its ability to continue as a going concern.” By then, the company had just $2.1 million in cash to fund $16.2 million in current liabilities.
To add to worry, the auditor also refused to sign off on XpresSpa’s books, citing “material weakness in its internal controls over its financial close and reporting process.”
Then the coronavirus hit.
Part 2: The Idea
On May 24, XpresSpa had a stroke of brilliance: It would announce an agreement with JFK’s Terminal 4. The company would provide Covid-19 testing services for airport and airline staff. Markets cheered, sending the stock up 65%. Investors had biased toward “Covid-19 winners,” and the spa company’s move into coronavirus testing seemed just authentic enough to confirm this bias.
Shares would continue rocketing upward to $7.11 through June 6.
But what did a spa service have to do with Covid-19 testing? The company had no experience in the field. Its employees were masseuses and manicurists, not nurses and insurance professionals. How would they navigate the complex world of diagnosis, insurance billing and safety? Squint hard enough, and you might see some connection. XpresSpa deals with airport retail leasing, after all. And they have a recognizable brand name. But why would XpresSpa be more suited than, say, McDonald’s (NYSE:MCD) or any other duty-free store to perform Covid-19 screening?
It isn’t the first time a company has jumped on an investor fad. During the late-90s tech boom, firms that added “dot-com” to their company name saw their shares rise 74%. No business change needed. And more recently? In 2017, a beverage company, Long Island Iced Tea (OTCMKTS:LBCC), changed its name to “Long Island Blockchain.” Shares rose 289%.
These rebrandings often end in failures. In Long Island Blockchain’s case, shares sank below $1 once investors realized the beverage company had no business in blockchain. The Nasdaq stock exchange swiftly delisted LBCC a month later.
XpresSpa seems no different.
Over two months after announcing its JFK partnership, the company has failed to sign up a single new airport for Covid-19 testing. And even XpresSpa’s sole location at JFK T4 remains underutilized. Availability on the company’s online scheduling tool remains wide-open. The stock price of XSPA is down 50% from its peak.
Part 3: The Getaway
Yet, XpresSpa’s management seems intent on getting the most out of investors. On Friday, the firm made the unusual move of submitting an oversized S-3 shelf registration to the SEC. The filing allows the company to issue another $200 million in stocks, bonds and warrants to supplement working capital.
Not only was the timing highly unusual (the company had just concluded a $48 million secondary offering in late June). The $200 million amount is also massive relative to XpresSpa’s size. (For comparison, the company generated just $48 million in 2019 sales.) Only a high-growth tech company warrants raising that much cash relative to sales.
Investors should stay away from buying stock in XSPA and its shelf registration. Despite CEO Satzman’s best efforts, the firm will continue to burn through cash. Its spa business remains shuttered, and its adventure into Covid-19 testing hasn’t been working.
The only reason a company should raise $200 million is if management thinks they’ll need it. And by all indications, XSPA will.
Tom Yeung, CFA, is a registered investment advisor on a mission to bring simplicity to the world of investing. As of this writing, Thomas Yeung did not hold a position in any of the aforementioned securities.