Editor’s note: This article was updated on June 16 to remove a sentence that incorrectly states that the Nasdaq prohibits cumulative reverse splits of 1-for-250.
Mullen Automotive (NASDAQ:MULN) has long surprised me with its ability to stay alive. Every time cash has run short, the firm has managed to issue more convertible debt and spin it to retail investors as a positive event.
“As of Feb. 28, 2023, Mullen has $87,400,009 of cash and cash equivalents, including restricted cash, and Mullen expects to receive an additional $110 million from firm commitments by June 1, 2023” a March press release noted.
Even its overpriced acquisitions have been a masterclass in how to hide intangible assets. I detailed here how Mullen’s financials likely overstate the carrying value of its acquisitions by a wide margin. The EV startup’s balance sheet might seem surprisingly robust to an unsuspecting investor.
Nevertheless, Mullen’s house of cards is beginning to collapse. On May 15, the company’s top backers delayed a $45 million cash injection by a month. And with retail investors finally giving up on the stock, Mullen appears to be entering the final stages of its funding death spiral.
The Mullen Death Spiral
In late 2021, Mullen’s management stumbled upon a financing option that Wall Street has long known. By converting debtholder securities into Series C Preferred stock and warrants, the EV startup made $20 million of its debt “magically” reappear as common equity. The nature of preferred stock means common stockholders escaped immediate dilution.
But such enchanted financing is rarely used by healthy companies for one reason:
Convertible instruments can often trigger a “death spiral” in their underlying security.
Consider a separate deal that Mullen inked in July 2022. According to corporate filings, $275 million of Series D preferred shares and warrants were approved that month. Holders could exchange their preferred stock for the lower of $1.27, or the closing price of the stock, subject to a 10-cent floor. The firm also threw in some warrants as a sweetener.
In the best-case scenario, Mullen’s stock trades above $1.27, and the dilution is minimal. Mullen had 509.3 million shares outstanding, so $275 million Series D would theoretically create only another 216 million new shares. (That’s $275 million divided by the $1.27 conversion price). With shares trading at roughly $1.17 (not adjusted for Mullen’s 2023 reverse split), that capital raise would have involved only a 42% dilution, ignoring warrants.
But in the real world, convertible debt can create a feedback loop. For every cent a stock falls below the exercise price, the amount of dilution rises exponentially. At 50 cents, Mullen would need to issue 550 million new shares ($275 million divided by a 50-cent conversion price). At 25 cents, that comes to 1.1 billion shares, and so on. These new shares then depress prices even further. Investors know that millions of new shares are coming onto the market, so they revalue existing shares accordingly. The incentives are so perverse that even creditors might become tempted to short shares of companies they own to protect from downside risk.
Suddenly, you have a funding “death spiral” on your hands.
5 Signs That Mullen Is Entering a ‘Death Spiral’
Occasionally, this downward spiral can last for years. Shares of retailer Sears lasted the better part of a decade, thanks to continuous restructuring and debt-to-equity conversions. If trust in a company or its CEO is high enough, the market can often absorb the impacts of dilutive issuances.
Eventually, even a 100-year-old company like Sears will run out of cash. Each financing round becomes increasingly dilutive, making fundraising more difficult as time goes on. At some point, either creditors or shareholders give up. And if neither do, U.S. exchanges will eventually step in.
Mullen has impressed me for its ability to resemble Sears. But recent news shows that the end is also coming for this once-promising EV startup. Here’s why.
1. Renegotiated Agreements
On May 15, Mullen’s creditors delayed an agreement that previously “irrevocably committed” them to buying $45 million of Series D Convertible Preferred Stock and Warrants.
This is particularly worrying because all of Mullen’s key creditors were involved, including Esousa Holdings and Acuitas Capital. This is often a sign that creditors are beginning to worry about a company’s liquidity — it’s a red flag no one was willing to extend credit alone. No matter how cheaply these preferred shareholders can convert their stock, they can only cash out if the company still exists. At the time, I suspected this would lead to increasingly onerous financing deals that would increase dilution.
2. Shortage of Preferred Shares
These suspicions were further confirmed on June 5 after Mullen announced a new deal with Acuitas Capital. Instead of issuing 27.6 million of Series D convertible stock in exchange for $20 million in cash, the EV startup agreed to give 78.6 million of stock and pre-funded warrants that could be immediately sold in the open market.
That suggests that Acuitas is no longer interested in holding Series D Preferred to convert later. Instead, it now seems interested only in quick deals for immediate cash. This new round of funding essentially costs common shareholders $55 million in dilution for $20 million of liquidity. (That’s 78.6 million of stock and warrants, multiplied by Mullen’s current market value of 70 cents).
3. Declining Retail Interest
Retail investors aren’t blind to Mullen’s accelerating pace of dilution. According to data from Fintel.io, the estimated share of retail investors has dropped by approximately one-third since last year.
Sentiment on social media sites has also turned decidedly negative since Mullen’s 1-for-25 reverse split last month. Here’s what I noted last week:
“Suddenly, former fanatics began realizing that management seemed more committed to enriching insiders than rewarding external shareholders. For many, the reverse split turned out to be the last straw.”
That’s a significant red flag for Mullen’s funding campaign. If the volume of common stock traded begins to drop off, the company’s creditors will hesitate to buy discounted stock. No loan shark wants to get caught with shares they cannot resell, and Mullen could soon reach that tipping point if more retail investors leave.
4. Cash Flow Issues
Mullen’s cash outflows are also beginning to threaten the company’s solvency. In the three months to March 2023, the firm burned through $34 million in cash from operations, compounding its $33 million outflow from the prior quarter.
On April 4, 2023, Mullen raised another red flag by inking a $20 million promissory note agreement payable two weeks later on April 17, roughly the date when $45 million of fresh capital was expected to arrive. This is generally a sign of a capital shortage and that a company’s supposed cash balance is not as liquid (or available) as investors might believe.
The company’s cash flow issues are worsened by 1,000-vehicle order from Randy Marion. According to previous deals with Randy Marion, the $63 million agreement is likely payable on delivery, meaning that Mullen must foot the total cost of production. Assuming a similar expense structure to Rivian (NASDAQ:RIVN) — which needed $4.78 billion to produce 24,337 vehicles — producing 1,000 vehicles could cost Mullen as much as $196 million. That is three times more than the $60.3 million Mullen has in cash.
5. De-Listing from the Russell Indices
Finally, Mullen is scheduled to fall out of the Russell 3000 (and thus the Russell 2000) indices by June 26, when the index reconstitutes. The FTSE Russell requires a minimum price of $1 on its rank day, and Eddie Pan notes that Mullen missed the mark. The stock also remains on the list of planned index deletions.
Mullen’s creditors should be worried. According to data from Thomson Reuters, three of the top-10 fund owners of the stock are Russell 2000 tracking indices. The company could also fall out of the CRSP US Total Market Index by September, which would affect the other seven funds.
That would make Mullen’s stock far harder to trade and reduce its attractiveness. The most forward-looking of creditors will slow their deal-making as these key dates approach.
Where Will MULN Stock Go?
In the short term, a few key creditors will determine how long Mullen will last. Predicting their moves is next to impossible.
Still, there are some dates to watch.
The first is June 12, the date when creditors are expected to inject another $45 million into the EV company. If creditors further delay this funding, Mullen could theoretically run out of liquidity within months.
The second date is June 26, when Mullen potentially drops out of the Russell indices. The selling pressure by these funds could determine whether creditors finally get too nervous about pumping in more cash.
The final is Sept. 7, when Mullen could lose its Nasdaq listing. The process will take around 30-45 days and leave the company in the OTC market. At this point, too little liquidity might remain for creditors to invest.
None of these scenarios bode well for Mullen’s stock. Shareholders and institutional investors have kept the zero-revenue EV startup alive longer than expected. The U.S. financial system and its regulators won’t let that continue forever
As of this writing, Tom Yeung did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.