American Apparel CEO Bets Stock Deal Will Save Him From Nude Photo Lawsuit

Last Updated Apr 29, 2011 4:34 PM EDT

American Apparel (APP) CEO Dov Charney has lost control of a majority of the company's stock in a equity financing rescue package, as I predicted on April 22, according to disclosures to the SEC. As Charney is also being sued for allegedly posting on the web nude photos of three women who previously accused him of either sexually assaulting them or coercing them into unfair binding arbitration, the moves leave him more vulnerable than he has been in years to being fired by his creditors and investors.

There is no sign of that happening yet -- the lead investor is a Charney fan -- but the rescue package puts a price on a question that never seems to go away: Why do Charney's investors tolerate his presence as CEO when they have so much money at stake?

In the new suit, former employee Alyssa Ferguson alleges she "was often forced to pose for certain suggestive photos." Ferguson and two other models, Tesa Lubans DeHaven and Irene Morales, claim that Charney posted pictures of them on three blogs in which he pretended to be them. The blogs mocked the women's sexual harassment claims with nude photos, emails and text messages that appear to show the women enjoying consensual encounters with Charney. The suit brings to seven the number of women who have accused Charney of harassment through the years. Four suits settled; the others are ongoing or in arbitration.

At any other company, a CEO who attracted this much negative attention would have been given a pink slip years ago. Charney, however, owned 54 percent of the company's stock and thus could not be fired by his board -- until now. The new deal looks like this:
  • Charney bought 777,778 shares for 90 cents each (total $700,000).
  • Canadian financier Michael Serruya and his family, Delavaco Capital, Dynamic Power Hedge Fund and Front Street Investment Management bought 15.8 million shares for 90 cents each plus the right to buy 27.4 million more. The Canadians now own 15 percent of the stock, and could own 22 percent if they exercise their full rights.
  • That now makes Charney a minority holder. However, the investors have also given Charney extra purchase rights that will allow him to regain a majority of the stock if the price of the stock rises above $3.25 (It's currently at $1.46). Those rights could give Charney 38 million more shares.
Retail investors get screwed
There's a problem here that sticks out like a sore thumb: All these deals required the issuance of new stock, diluting the stock that's already on the market. That dilution prevents the price from rising -- and is therefore a deterrent to anyone who might consider buying APP in the hopes that the new management's turnaround plan actually works.

If the stock begins to rise, two things will happen: The Canadians will sell their shares, depressing the price; and Charney will gain more new shares, further depressing the price.

Investors should also be wary of Charney's recent refinancing history -- he has repeatedly either diluted the stock by buying new shares with his own money or he's sold new shares to new investors, also diluting the stock. It would be unfair to call this a Ponzi scheme -- American Apparel does still sell T-shirts, after all -- but given that Charney's survival plan consists entirely of printing new stock certificates that ruin the investments of existing holders, it sure comes close.
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