KeyOn: Why an Obscure Net Provider's Stock Soared
By Ben Steverman

November 5, 2009 7:06AM

KeyOn is a prime example of the risks and potential riches in microcaps, typically companies with market capitalizations of less than $350 million. Investors have poured into the stocks of these companies in recent months; the best-performing small-cap companies are like KeyOn, with low market values, low share prices, and no profits.

Although the U.S. stock market has soared since spring, few companies can match the meteoric rise of a small Internet company based in Omaha. Since May 1, the stock of KeyOn Communications Holdings, which provides Internet connections to companies and individuals, has climbed to $2.10 from 4 percent, an increase of more than 5,000 percent. No company in the Standard & Poor's 500-stock index or the Russell 2000 Small Cap Index came close to that over the same period.

Investors have bid up KeyOn's stock on hopes it will get a slice of the billions the federal government is doling out to expand broadband Internet service in the country. The company has applied for about $150 million in grants and loans, which KeyOn says it will use to expand its operations and improve its financial performance. Today, the company provides wireless Net service to 15,000 rural customers in 11 Western and Midwestern states. "We certainly weren't worth [just) 4 percent," says Jonathan Snyder, KeyOn's chief executive. "We have a real business with real customers and real product, and a business that can generate real cash flow."

But KeyOn isn't generating cash now, and it's far from clear the company will ever be able to deliver on investors' high hopes. The stock's run has been fueled by bullish comments from an analyst who has been paid by the company, a questionable practice that has not always been disclosed to investors. KeyOn is losing so much money that Snyder has had to sell stock eight times this year to cover its cash needs. And it's quite possible KeyOn will never see a penny of broadband money from the government, since requests for funds total seven times the amount of money available. One KeyOn competitor says Snyder, in essence, is betting his company's future on "winning the lottery."

Microcaps' Risks and Rewards

KeyOn is a prime example of the risks and potential riches in microcaps, typically companies with market capitalizations of less than $350 million. Investors have poured into the stocks of these companies in recent months, driving the Russell Microcap index up 75 percent since its low in March. Steven DeSanctis, small-cap strategist at Bank of America Merrill Lynch, says the best-performing small-cap companies are like KeyOn, with low market values, low share prices, and no profits.

KeyOn went public in 2007 and saw its stock hit $16 a share before it ran into the buzzsaw of last year's recession. As credit dried up and investors fled risky stocks, KeyOn shares dropped to $2 last May and pennies by end of the year.

The company's fortunes began to change in mid-May when it hired John Liviakis, whose Mill Valley [Calif.) firm takes stock in small companies in exchange for publicizing their prospects to investors. Liviakis and his associates received 2.12 million restricted shares in KeyOn, 19 percent of shares outstanding, on the condition they couldn't be sold for at least a year. Liviakis says his goal has been to create a "national presence" for KeyOn, working the phones to his database of brokers and institutions. By the end of May, KeyOn shares hit 72 percent, an eighteenfold increase.

The stock has kept rising on positive comments from other supporters. Joseph Noel, an analyst with Emerging Growth Research, began writing bullish reports on KeyOn in July and has also done audio interviews available online. In one interview in September, he said: "You're going to see this company awarded a lot of money."

What Noel doesn't tell investors in the interview is that before he began covering the company, KeyOn awarded him 75,000 restricted shares. Noel tells BusinessWeek that "if people ask, I'm very up-front about [my financial stake interest)." He adds that he has also bought more than 200,000 shares with his own money. "I love the company," he says.

His September report on KeyOn says he "has not received, and will not receive compensation for the production of this report," which Noel says is correct because KeyOn only paid for his first report in July. "You don't want to wreck your report by putting a big disclaimer on the front," he says.

Michael W. Mayhew, chairman of Integrity Research Associates, which advises investors on research issues, says such financial transactions are a red flag. "The paid-for-research industry has a stink to it, of being biased, of maybe even being a scam," he says, speaking generally and not specifically about KeyOn. Most sophisticated investors know to be cautious, he says, but the less experienced can be fooled. "Retail investors might think it is an objective piece of research," he says.

KeyOn CEO Snyder says that Noel's analysis of his company has been "pretty even-handed." He adds that, "If [Noel]'s not properly disclosing, I don't think he's doing it maliciously."

The run-up in KeyOn's stock price has solved some of Snyder's problems. By issuing millions of new shares at the more recent, higher prices, KeyOn has been able to pay down almost $1.9 million in debt. Still, the newly issued shares have diluted existing shareholders and the company continues to bleed money. After losing $8 million on revenues of $7.8 million last year, it lost $1.5 million during the first six months of this year on revenues of $3.6 million. It still has $4 million in long-term debt, which it is scheduled to begin paying back next year.

It's almost impossible to know if KeyOn will get broadband money from the government as the cash is handed out in coming months. The company is applying for $95.6 million in loans and $56.3 million in grants, and Snyder argues his chances are good. "We're an experienced applicant," he says. The company says it would use the money to build out its wireless network so that it covers as many as 16 states with 6.5 million potential customers.

Yet experts say the odds of success for any company are long. Companies have requested a total of $28 billion for broadband projects, while only $4 billion is being awarded in the current round of applications. "Because of the demand and the competition, there are going to be a lot of disappointed folks out there," says James Lightfoot, head of the Oklahoma City consulting firm ACRS 2000, which advises companies on the application process. "There is not enough money to go around."