Mysterious Price Action in Shares of Datasea, Inc.

6 Mar 2022

• Last Closing Price: $2.63
  
• 50-Day Simple Moving Average: $1.60
  
• Volume Weighted Average Price: $2.66
  
• Relative Strength Index: 72.09
  
• 20-Day Average Daily Volume: 572,924
  
• Shares Outstanding: 24,244,130
  
• Available Borrow: 100,000
  
• Borrow Fee Rate: 3.80%
  

Last month around Valentine’s Day, someone fell in love with Datasea, Inc. DTSS. The company’s stock price, which had been declining since Jul. 2021, suddenly sprang to life on Feb. 10, 2022. Over the following 12 days, the price rose 81% to $2.64 per share.

It wasn’t the first time Datasea’s stock price had spiked inexplicably. In Jul. 2021, when Datasea was down to its last $50,000 in cash, the company tapped its 2020 shelf registration to sell 2,436,904 shares at $3.48 per share in a registered direct offering. For each share purchased, an investor in the offering also received an unregistered warrant to buy 0.45 of a share at an exercise price of $4.48 per share.

Issuers aren’t required to publicly disclose private offerings before they occur. Therefore, Datasea didn’t announce its offering in advance. However, during the five business days before the sale, the company’s stock price levitated as if by magic from $2.93 to $4.41 per share on unusually heavy volume. Moreover, short interest in Datasea’s stock reached 945,341 shares, which was 38 times the short interest two weeks earlier.

When Datasea issued a press release announcing that the offering had closed, its stock price slumped to $2.68 per share, preventing the investors who had just bought at $3.48 from selling at a profit. Nevertheless, someone profited. By Jul. 30, short interest in Datasea’s stock had fallen to 41,637 shares, indicating that traders had covered 96% of the short interest that had been open before Datasea disclosed the offering.

Wall Crossing
When an issuer like Datasea is planning a private offering, its selling agents gauge the interest of potential investors in confidential discussions before the offering is announced publicly. The process is commonly called “wall crossing” since the potential investors cross over to become temporary insiders pursuant to Regulation FD. As such, they are prohibited from trading on information they learn during the discussions.

A study published in the May 2017 issue of the Review of Finance found evidence of widespread short-selling before private placements were publicly announced. The researchers showed that pre-announcement short sellers are able to predict announcement day returns. The effects are especially strong when a high number of hedge funds are buyers in an offering.

The investors in Datasea’s Jul. 2021 offering were hedge funds that routinely participate in such deals: Intracoastal Capital, LLC; 3i, LP; L1 Capital Global Opportunities Master Fund; and Hudson Bay Master Fund Ltd. As of Nov. 16, 2021, they still appeared to own all the shares and warrants they acquired in the offering, according to a registration statement.

The securities purchase agreement they signed prohibited them from shorting Datasea’s stock once they received a term sheet containing the offering price. But the agreement acknowledged that the investors may have already shorted the stock before receiving a term sheet and that they were free to short the stock after the offering closed.

Hudson Bay Rules
Regulation M, Rule 105 of the Securities Exchange Act prohibits investors from buying stock in an underwritten public offering if they have shorted the same stock within five days before the pricing of the offering. In fact, one of the investors in Datasea’s offering, Hudson Bay Capital Management LP, consented to a cease-and-desist order from the SEC in 2013 after allegedly engaging in such activity. But the rule does not apply to private offerings.

To be clear, we are not suggesting that Hudson Bay Capital or any other participants in Datasea’s offering violated any securities laws, breached any contracts, or manipulated Datasea’s stock price. Rather, we are using Datasea’s offering to demonstrate how an investor who was privy to such a sale could, in theory, benefit from the type of price action Datasea’s stock exhibited before and after the transaction.

The jump in Datasea’s stock price last month wasn’t tied to an imminent sale of shares. A charitable interpretation is that heavy buying ensued after the company released its 10-Q report for the quarter ended Dec. 31. Indeed, Datasea reported revenue of $8,979,479 for the quarter, which was a 70-fold increase from last year. The growth came mostly from 5G messaging services, which the company recently began selling to Chinese telecom carriers.

However, Datasea sold the services barely above cost. The company earned gross margin of only 3.07% on 5G messaging because it undercut competitors on price to gain market share. Accounts receivable grew faster than revenue and contributed to -$2,424,653 of negative cash flow from operations during the quarter. Net loss increased 73% to -$1,677,293.

Datasea ended the quarter with $2,240,708 of cash, which will last less than six months at its current burn rate. That means the company will likely sell more shares in another dilutive offering this year. Given the market’s reaction to the last offering, we believe the recent rally in the stock will be short lived.