Investment Company Tries Speculative Route to Riches

Until early this year, Discovery Associates was little more than a couple of guys with plans to make a pile of money.

Now the Encino investment outfit is a public company with $2.25 million in ready cash, and it says that it will complete a deal this week to buy the Leo’s Stereo retail chain for $30 million. On top of that, Discovery’s two founders, who put a total of $56,900 into the business in 1984 and 1985, today own stock worth $2.2 million on paper.

So how did Discovery, whose only employees are founders Harvey Bibicoff and Stephen S. Berglas, come so far so fast?

In part, by being a type of shell company that troubles securities industry regulators. Two-year-old Discovery is a corporate vehicle commonly known as a “blind pool” or “blank check,” which is set up to tap money from investors without making specific promises in return.

800 Invest ‘Blindly’

The company’s prospectus for its initial public securities offering in February, for example, disclosed plans to establish a financial consulting and investment business without indicating what kinds of industries it wanted to enter. Thus, Discovery’s 600 to 800 investors put their money “blindly” into the company’s hands with few strings attached, a situation that securities regulators say is prone to abuse.

As it sometimes does with highly speculative investments, the California Department of Corporations restricted initial trading of the Discovery shares issued in February to investors whose net worth--not including the value of their homes, furnishings and cars--exceeded $100,000. State officials said the restriction was imposed because of Discovery’s failure to disclose how it will use its funds, the relatively low price at which the founders acquired their shares and other factors.

John C. Baldwin, the director of the Utah Securities Division and a regulator who has had considerable experience with blind pools, said putting money into one “is not truly investing. It’s a gamble, and that’s why we’re concerned.”

Bibicoff and Berglas concede that some of these shell companies are abused.

A blind pool “is as good or bad as the people behind it,” said Bibicoff, who attributes Discovery’s rapid advance to his and Berglas’ good luck, financial contacts and reputations.

Discovery, as a blind pool, differs from the norm in at least two ways. First of all, its public offering raised $3 million, a far cry from the $250,000 to $500,000 that blind pool underwritings typically draw from investors.

Buying Known Firm

Secondly, instead of merging with an obscure, fledgling company as many of its counterparts do, Discovery plans to buy a well-known, substantial firm, Leo’s.

Discovery’s initial public offering, however, was par for the course for blind pools in one respect: It used the new shareholders’ investment to inflate the value of the founders’ holdings. For that, Bibicoff and Berglas, native New Yorkers whose wives are sisters, have no apology.

“We’re the guys who are going to make it happen,” Bibicoff said.

Discovery’s shareholders have had more ups than downs. The stock, which traded at as low as $3 in April, climbed to a peak bid price of $6.87 1/2 in September before going on a slide that brought it to Monday’s close of $4.87 1/2.

Bibicoff, Discovery’s chairman and biggest shareholder with 20.5% of its stock, is an experienced investment promoter who holds a law degree from Columbia University. Wiry, hard-nosed and quick to speak his mind, Bibicoff, 47, has extensive connections in the securities industry on both coasts.

Fined in 1973

His career has had rough moments. In 1973, Bibicoff was slapped with a $2,000 fine by the National Association of Securities Dealers, a regulatory organization.

The NASD would not disclose the circumstances. Bibicoff said he was penalized because a defunct securities firm he partly owned suffered losses that dragged its capital reserves below required levels.

He moved to California in the late 1970s and eventually formed a financial public relations firm, Bibicoff, Brown Associates, that is his principal business.

Unlike most of its counterparts, Bibicoff Brown regularly acquires stakes in its clients, which are mainly obscure public companies. That way, Bibicoff Brown can make big profits if it successfully promotes its clients’ stock. Although that would seem to give a public relations firm an unusually strong incentive to tout unworthy stocks, Bibicoff says there is no conflict-of-interest problem.

“As long as we tell the story as it is, we have no conflict,” he said.

‘Credible, Bright’

Bibicoff has his share of admirers and detractors. Neil Rosenstein, president of both Peregrine Entertainment, a Los Angeles producer and distributor of television programing, and Jackpot Enterprises, a Las Vegas-based operator of slot machines, said Bibicoff is “credible, very bright, and he understands the securities business.”

“He’s a very, very strong, determined personality,” added Rosenstein, who has hired both Bibicoff and Berglas on different occasions.

Ronen Amiran, chairman of First Transtate Financial Group of Encino and one of Discovery’s three biggest shareholders with a stake of nearly 5%, said: “If he came here today and asked me for $500,000, I’d write him a check.”

On the other hand, a broker who asked not to be identified said he was unnerved by Bibicoff’s single-minded determination “to get to where he wants to go.”

Martin S. Blinder, president of Van Nuys-based Martin Lawrence Limited Editions, described Bibicoff as “volatile” and said he stopped using Bibicoff Brown after a few months because he thought the firm was ineffective.

Big 8 Experience

Bibicoff’s partner in Discovery, Berglas, is the company’s president and one of the three largest shareholders, with a 4.4% stake. The company’s number cruncher, Berglas, 43, comes across as gregarious but less forceful than Bibicoff. After graduating from Fairleigh Dickinson University in 1963, he went to went to work for the Big 8 accounting firm of Ernst & Whinney for seven years.

Since then, he alternately has been in business for himself as a financial consultant and held a string of corporate finance positions.

Aside from family ties, Bibicoff and Berglas said they were brought together by a desire to run their own show after spending most of their careers raising money for other people. To fulfill their ambition, they chose an increasingly common type of company.

The New Issues investment newsletter of Fort Lauderdale, Fla., reports that 74 blind pools went public during the first nine months of 1986 in offerings registered with the Securities and Exchange Commission. In the three previous years combined, the total was 27.

The number of new blind pools actually is much higher than 74; New Issues’ statistics are based on a narrow definition of blind pools and exclude concerns that go public in regional offerings and thus do not notify the SEC.

Compared to Mutual Funds

Blind pools can serve much the same purpose as mutual funds, allowing small investors to buy stock in an enterprise run by more expert money managers. They also are used to convert private firms into public companies through deals called reverse acquisitions that leave the private firms almost completely intact.

Securities regulators warn, however, that some blind pool operators simply are out to make quick money. Baldwin, the Utah regulator, said he has seen one or two promoters drive up a stock’s price and then sell out to unwitting investors shortly before the shares collapsed.

Sometimes, regulators say, that sort of manipulation is orchestrated with a larger group of early investors.

“Friends and associates are told when to get in and when to get out,” Baldwin said.

Promoters Benefit

Promoters frequently draw fees from their blind pools and find other ways to benefit personally, regulators say. Discovery’s prospectus notes that the company rents its 400 square feet of office space from Bibicoff’s public relations firm.

“Those are the types of conflicts-of-interest that are prevalent in low-priced offerings that I find obnoxious, that you would never see in a sophisticated, high-priced offering,” said Norman Fosback, editor of New Issues.

Bibicoff and Berglas counter that they are committed to making Discovery a success. The size of their $3-million underwriting reflected investor confidence and provided enough money to make a sound acquisition, they say.

Their stated plan for Discovery is to buy good, undervalued companies and then expand them and take them public at a profit. They call Leo’s, a Carson-based chain of 45 consumer electronics stores, a perfect acquisition candidate.

Bibicoff and Berglas say Leo’s has been run almost entirely by one man, company President Leo David, and that the chain has gotten too big for that.

$100-Million in Revenue

By hiring seasoned executives from other consumer electronics concerns, Bibicoff says, Leo’s can boost its profit margins and grow faster. Bibicoff says the company, whose annual revenue is roughly $100 million, already has a pre-tax profit margin close to industry norm of 6%.

Discovery’s founders say Leo’s can thrive by relying largely on its niche in the car-stereo market and by keeping out of more competitive, high-ticket arenas, such as the appliance business.

The Leo’s deal poses risks, however. Many analysts say that Leo’s stores, typically 4,000 to 5,000 square feet, are too small to thrive in the current era of so-called “superstores,” consumer electronics supermarkets that have 25,000 square feet or more of floor space.

Furthermore, the deal resembles a leveraged buy-out, in that the purchase will be financed largely by borrowed money that is to be paid off with earnings from Leo’s operations. Although Bibicoff insists it will not be a problem, experts say such buy-outs are tricky in that the debt payments can become a financial albatross if the acquired company’s earnings slump.

In fact, lenders may be frightened at that prospect. When Discovery announced a definitive acquisition agreement in September, the company said it expected to close the purchase by the end of the month. Bibicoff says the deal was delayed by a lender that eventually backed out without giving a reason and by longer-than-expected reviews by lawyers for the parties in the transaction. David, who controls Leo’s, declined to comment.

Bibicoff says, however, the acquisition now is set, and Discovery is ready to take off.

“I see this becoming a billion-dollar company in five years, and I’m not a crazy person,” he said.