Skip to content

Gran Colombia’s Debenture Redemption looks favorable

On Thursday Gran Colombia announced the warrant terms of a $152 million USD senior secured note offering.  Attached to the notes the company is offering 124 warrants priced at $2.20 per share per $1,000 of note principle.

Dilution amounts to 18.8 million shares.  This compares to 72.2 million shares that would have been issued under the existing 2018, 2020 and 2024 debentures if they were fully converted (the table below is from the third quarter MD&A filing).

I think the deal, if it is approved, is pretty positive.  Consider:

Under the prior share structure, a $2.50 share price translated into a market capitalization and enterprise value of about $230 million (~92 million x 2.50 = $230 million).

Under the new notes, and considering redemption of all of the existing debentures at par, the share count is roughly 39 million and the market capitalization is $97.5 million (39 million x 2.50).  The enterprise value is $202 million (97.5 million + $150 million (x 1.25 CAD/USD exchange) – $45 million (assuming in the money warrant conversion of the 18.8 million warrants) – $9 million).

Debenture Holders can participate

As a debenture holder (I own both the stock and some of the X and V debentures) I’m interested in what my options are with the debentures.

The terms gives existing debenture holders the right to participate in the offering:

Existing holders of the Company’s Outstanding Debentures that are eligible to participate in the Offering may (subject to complying with certain procedures and requirements) be able to do so by directing some or all of the redemption proceeds from their current debentures into Units on a dollar-for-dollar basis.

I’m not entirely sure how to read this.  Does it mean that existing debenture holder gets preference to convert their debentures into new notes or is this just on a best efforts basis where an over-subscription to the notes would mean partial allocation?

I’m hopeful that I can direct my debentures into the new notes, but I’m not counting on it.

Its still cheap on Comps

Gran Colombia continues to compare favorably to other gold producers.

One of the quick scans I like to do compares companies on a simple EV/oz produced basis.  I’ll do the comparison and then weed out why some companies trade at lower multiples than others.  Usually there are good reasons.

At $1,400/produced-oz Gran Colombia trades at one of the lowest multiples of the group.  Only the really poor operators that are cash flow negative at current prices (an Orvana Gold for example) are cheaper.   Most of the companies I compare to are in the $4,000 – $6,000 per produced-oz range.  Even the lower tier companies like Argonaut Gold or the struggling one’s like Klondex trade at over $2,000 per produced-oz.

Its still cheap on Cash flow

Even forgetting that it is a gold stock, Gran Colombia remains reasonably priced as a business.

On the third quarter conference call Gran Colombia reiterated guidance for $16 million USD of free cash flow in 2017.   In the fourth quarter they produced 51,700 ounces versus an average of 40,700 ounces per quarter in the first three quarters.

The indication after the strike at Segovia was that new agreements with artisanal miners should lead to more processed ore at the plant.  Based on this and progress at the Segovia mine, my expectation is that 2018 free cash guidance will exceed 2017.

I suggested in my original post on Gran Colombia that I thought $20 million USD of free cash flow was not an impossible goal.  I still think that’s possible.  Assuming the note and debenture deals go through, the market capitalization of the company will be a little under $100 million CAD at current prices.  Even though the stock has climbed since my original post, this still means the stock is at less than 4x free cash flow.

Conclusion

Eventually the note offering and debenture redemption should be positive for the stock.  But it might take a few months.

What’s tricky is that at $2.40 the stock price is right about where the debentures convert.  It isn’t really in anyone’s interest (other than the current debenture holders, though even that is debatable) to see the stock price rise too much above the convert price until the deal is done.

I’ve been adding to Gran Colombia all the way from $1.40 to $2.20.  I see no reason to take any off the table yet.  The company is doing everything right so far.  Hopefully with the new capitalization and simpler structure the market will continue to recognize this.

Advertisements

Radcom’s Growth is Lumpy (and that’s not a bad thing)

I had an interesting comment about Radcom the other day and given today’s release of fourth quarter earnings, it seemed like a good opportunity to expand on my reply.

First let’s talk about the fourth quarter results.

Revenue in the fourth quarter was $10.6 million.  They turned a nice profit, about 17c per share.  But the big news was announced on the conference call.  A new Tier 1 one win:

We are very excited to share that one of these major NFV trials has come to fruition and resulted in RADCOM being selected by a Tier-1 multi-carrier operator. We expect this to result in a formal contract during the first half of 2018 and we’re making preparations for project execution.

Radcom also gave us some guidance for the first quarter and for 2018.  They said first quarter revenues will be below the fourth quarter.  And they said 2018 revenues will be $43 million to $47 million.

What to make of it?

Let’s go to the comment, which was made by Arf.  Arf correctly pointed out that if Radcom grows by 25% in 2019 and 2020, after hitting the midpoint of guidance in 2018 ($45 million), then the upside is not as much as you’d think.  He estimated the stock had maybe 70% upside if they got a 20x earnings multiple.  This is in 2020 mind you.  Given those assumptions, I think that’s probably fair.

So if that’s the upside, why bother with the stock?

My take is this.  Because Radcom customers are large Tier 1 service providers, the deals are slow and sporadic but also unusually large compared to the existing revenue base.  This combination makes it hard to anticipate the growth rate.  Growth is going to be lumpy and its going to depend on the timing of when these deals are signed and when they begin to on-board.

Let’s look at exactly what 25% growth rate is assuming:

So after growth of about $8 million in revenue in 2018, 25% growth adds another $11 million in 2019, and then $14 million in 2020.

That’s a possible outcome, but I don’t think it is an optimistic one.  After the announcement today of the third Tier 1 win I would say it’s also less likely.

I’ve been looking at it like this. From the fourth quarter results released today, we know that total revenue for the year was $37.2 million and AT&T accounted for 60% of it.  So the deal with AT&T was worth over $22 million in revenue in 2017.

I’ve always assumed that a full win on Tier 1 account should be for at least $15 million.  Based on what we are seeing with AT&T, that assumption seems reasonable.  It might even be low if Radcom can penetrate these other carriers to the same degree they have with AT&T (ie. sell them on the new visibility product that they will be unveiling at Mobile World Congress in a couple of weeks).

The Verizon foot in the door win was for $5 million.  My bet is that eventually Verizon will grow to close the size of AT&T.  Let’s say Verizon can be an $18 million win as the deal matures.   Other large wins (with say a Telefonica or a Vodafone or a Bell Canada) should at least be $15 million.

With those numbers in mind consider this.  A $19 million increase by 2019 ($8 million in 2018 and $11 million in 2019) is really saying that by 2019 Radcom will have successfully integrated Verizon to a similar level as AT&T and not much else.  A $14 million increase in 2020 is saying that Radcom finally gets a single third carrier win by that point.

If it’s into 2020 and RDCM only has AT&T, Verizon and one more win, then something has gone horribly wrong with the thesis. Either NFV isn’t getting adopted or a competitor has caught up or something.

What do I want to see?

The difficulty this past year (and what led me to sell out of my position entirely for a couple of months) has been that the lumpiness of the wins has played against Radcom.  They had no new wins that contributed to 2017 revenue.  They were lucky to have a ramping business from AT&T that allowed for growth in the absence of new deals.

This handicap could become an asset over the next year.  Because of the large, lumpy nature of their deals, even if Radcom gets just two wins per year  for the next couple of years the company’s growth rate should go up substantially.

If I assume that Verizon is an $18 million deal in 2019, that the just announced Tier 1 is a $15 million deal in 2019 and that two more deals are announced in the next year and a half and begin to contribute meaningful revenue in 2020, I get a very different picture:

These numbers assume that by 2020 Radcom has 5 wins worth of revenue, ie. AT&T, Verizon, the announced win today and two others that will be announced in the next year and a half   Its hardly more than one more win a year.  In my opinion, this is not wildly optimistic.

So what’s with Guidance?

Any astute bear on Radcom is going to focus on the guidance.  At first I was surprised it was as low as it was, given the Verizon win and the newly announced Tier 1.  They did $37 million in 2017.   The midpoint of guidance is $8 million higher.

But after thinking about it more, it makes some sense.  We know the first phase of the Verizon deal is $5 million.  We know this new Tier 1 deal is only getting signed in the first half, and even then in all likelihood it will be phased in similarly to the way Verizon was.  So $2-3 million in the second half from the new Tier 1 is probably about right.

In other words, it looks to me like Radcom is guiding to known revenue only.  They aren’t assuming anything incremental from AT&T.  They are assuming no further expansion from Verizon this year.  And they are assuming a slow ramp of the new Tier 1 in the second half.

I think they are setting themselves up for raises later in the year.

But I might be wrong.  The other possibility is that guidance reflects an expected slow ramp of the NFV business for Verizon and other Tier 1.  Given how slow it’s been for deals to materialize, this wouldn’t be that surprising.

It doesn’t matter (in my opinion)

Nevertheless, I don’t think it matters if this is a slow ramp or if it’s sandbagging.  The only thing that matters here is whether I am wrong about these deals ramping to $15 million or more on an annual basis.

In fact with this latest Tier 1 win, deal size is the last leg for bears to stand on.  They need to focus on the $5 million Verizon deal, assume that the deal won’t grow much more, and extrapolate that size to the other service provider trials.

Indeed if I am wrong and Verizon maxes out at $6 million or $8 million or this other Tier 1 maxes out at $5 million, then Radcom is going to struggle.  But if these are $15 million plus deals, and because there is every indication that there will be more to come, then it’s just a matter of waiting until it plays out.

I just don’t buy the former scenario. It doesn’t make sense to me.  These are large service providers.  They are in the ballpark of AT&T and so the size of the deals should be in that ballpark when they are rolled out across the network.

What’s more, the revenue is recurring.  A recent article in Light Reading clarified this for me.  In particular:

Essentially, Radcom’s customers pay a constant, recurring and regular fee to use the vendor’s software, no matter how many instances they deploy and how many customers they are supporting with the software. So whether an operator is deploying Radcom’s probes in one market or ten, and supporting 50,000 customers or 5 million, the fee remains the same — the cost to the operator does not scale as it uses the software more. The traditional model of linking technology payments to boxes or instances or customer metrics doesn’t apply with Radcom.

I know I’ve been talking the Radcom story forever and I’ve been both very right and very wrong about it at various times.  But unless someone can tell me why Verizon or Telefonica or Bell or any other Tier 1 wouldn’t have a deal size roughly comparable to AT&T, then I am going to say that right now things look as strong as I’ve seen them.

Therefore I am pretty excited about where Radcom is going.  It’s my largest position right now.  It’ll probably continue to be painfully slow, but the end goal seems clearer than ever.

Precision Therapeutics – Buying into the Sales Ramp

Precision Therapeutics (AIPT) is roughly a $12 million dollar market cap company.  They have 11 million shares outstanding and no debt.  After a January share and warrant capital raise (which I am including in my share count) they should have about $4 million of cash on hand.  They also have a $1 million note receivable from joint venture partner Cytobioscience.

The recent share and warrant raise diluted shareholders significantly.  The placement was for 2.9 million units, consisting of shares at $0.95 and 0.3 warrants prices at $1 per share.  This was a $1.50 stock as recently as November.

Precision raised the cash because they are burning cash.  I estimate cash burn per quarter is about $1 million per quarter.  This will probably continue.

Those are the facts, most of them not pretty.  So why did I take a position?

The STREAMWAY System

Precision markets a medical fluid waste disposal system called the Streamway System.  The system is a wall mounted device located in the operating room.  During procedures surgical waste fluid is continuously removed via suction, passed through proprietary filters, measured and recorded, and then passed directly into the building’s sanitary sewer.

This is very different than traditional waste handling during procedures.  Competitive solutions use mobile carts and disposable cannisters that have to be replaced, often multiple times during the procedure, and in many cases treated with gels to minimize the chance of contamination.  Even so, accidents occur and they are expensive.  Hospitals spend $4,500 on average for a mishap.

Here is a look at Streamway (Skyline is the former name of Precision) and its competition:

The Streamway system has a number of advantages over incumbent waste disposal options:

  1. Price: Cost of the unit is similar to slightly less than competition (Stryker system plus docking station costs $34,000 though I suspect they have been discounting to try to squeeze Streamway), but the disposable cost is 1/2 to 1/8 of the cost of replacing cannisters
  2. Safety: no chance to spill fluid or to have an accidental catheter removal during a cannister change
  3. Labour: cannisters have to be changed during a procedure anywhere between 2-10 times.  This is entirely eliminated with Streamway
  4. Accuracy: can more accurately estimate volume extraction than the manual estimation using cannisters
  5. Ease of use: removal of clumsy cannisters, latching, and replaces with simple instrument panel with instructions
  6. Time: Procedures do not have to be stopped to replace cannisters which can result into 20-50% faster surgery

The primary negative with Streamway is installation.  It has to be hooked up to the sewage line and therefore the operating room needs to be shut down and the wall cut open to complete the install.  This has been a sticking point, particularly as hospitals are not unhappy with the mobile carts they’ve been using.  Precision has taken to emphasizing the improved safety of using Streamway.

The cost advantage of Streamway is significant.  This is from the last 10-K:

A study by the Lewin Group, prepared for the Health Industry Group Purchasing Association in April 2007, reports that infectious fluid waste accounts for more than 75% of U.S. hospitals biohazard disposal costs. The study also includes findings from a bulletin published by the University of Minnesota’s Technical Assistance Program. “A vacuum system that uses reusable canisters or empties directly into the sanitary sewer can help a facility cut its infectious waste volume, and save money on labor, disposal and canister purchase costs.” The Minnesota’s Technical Assistance Program bulletin also estimated that, in a typical hospital, “. . . $75,000 would be saved annually in suction canister purchase, management and disposal cost if a canister-free vacuum system was installed.”

A second study, by the Tucson Medical Center, found similarly significant savings.  They estimated they would save $22,000 per year in a single operating room.  Bottle costs for the mobile unit they had installed previously were $107 per procedure.  The Streamway disposable cost brings that down to $24 per procedure.

In general, the $24 price tag is a favorable disposable expense compared to the costs of replacing cannisters, waste disposal, gel costs and labor for the competing Stryker and Zimmer systems.  Those systems need to have cannisters replace anywhere between 2-10 times depending on the procedure.  The material and waste disposal costs can be between $25 – $100 (or more) and on top of that there are labor costs and the time cost of having to pause the procedure to empty the cannister.  You add to that the risk of a contamination event (which is going to be a $4,500 hit) and its easy to see how Streamway saves money.

Struggling Sales

So you can make the argument that Streamway is a superior system.  Nevertheless the company has had a horrible time ramping sales.  On the third quarter conference call the CEO Carl Schwartz, came clean about what had been happening:

When I took over as CEO in 2016 like many of you I thought the Streamway System was a slam dunk…Nothing could have been further from the truth.  We had two very entrenched competitors, Stryker and Zimmer, who have their units at most hospital facilities in the country.  In addition they were able to bundle their units in with other operating equipment, offering substantial discounts.  Furthermore, it became increasingly evident that many institutional hospital customers would not allow us to connect to the hospital sewer system because they did not want us to open the operating room wall.  Given these challenges and the fact that their unit and ours effectively removed fluids, what was our competitive advantage?  After several months of effort we discovered that our most competitive advantage was our ability to avoid the spread of infection in the hospital by eliminating any contact between the infectious materials and the patients and staff and we have been hammering that home where ever we present the Streamway system and in newspaper articles all over the country.  As you know it has been a slow going but we are making substantial progress.

In addition to pressure from the competition in the United States, the company has been slow getting regulatory approval in non-US districts.  Up until this year their sales staff and list of distributors was sparse.  It was a situation where you had a solid, superior product, but it was competing against well-funded incumbents, and marketing and sales dollars were not enough to mount an offensive.

In fact it seems like management had begun to give up themselves.  There was a failed merger with Cytobioscience in the summer.  There was a subsequent joint venture with Helomics and a proposed one with Cytobioscience.  Indeed even the strategy for 2018 includes the following statement:

To expand Skyline’s business to take advantage of emerging areas of the dynamic healthcare market. To this end, management is implementing a Merger & Acquisition strategy focused on finding and acquiring high-growth companies that have established operations and the ability to drive both revenue and capital appreciation for the Company, or entering into strategic relationships with these companies.

Even if management was just being strategic with its new diversification approach, investors were frustrated.  Listening to conference calls in 2017 is a painful exercise.  Lots of frustrated investors, many of them long time investors, having been expecting a steep sales ramp, saw unit sales trickle in a 1 or 2 a quarter and the share price lag.

With cash levels dwindling, management had to raise capital with the dilutive raise I mentioned previously.  That, along with the failed Cytobioscience merger, was likely the last straw for many investors.

As a consequence, the share price hasn’t done well.  The one year chart illustrates the disappointment:

Things are turning

I’ve had Precision Therapeutics on my watchlist for the last 6 months.  I can’t remember why I added it, I’m pretty sure it was mentioned by someone on twitter though I don’t remember who.  When I looked at it a number of months ago I thought they had an interesting product but there was no indication that they were gaining any sales traction.  So I passed.

However that appears to be changing.  In early January the company announced that they had sold 5 Streamway systems in the fourth quarter. They sold another 6 systems in January alone.  I wish I had been paying a bit closer attention to the company when this news release came out, as I would have probably started buying it back then.

I did pay attention to the second news release that came out last week.  Precision projected 100 systems sold in 2018 from the United States alone.  I caught the stock soon after it jumped on the news.

Precision sold 10 systems in 2017.  This includes at least 1 system sold in Canada.  So the projection for 2018 is for at least 10x 2017 sales.

While up until now sales have drifted aimlessly, the company has been doing a lot of work behind the scenes that has set themselves up for this type of increase.  They have:

  1. Hired 4 regional sales managers and a VP sales in early 2017. Up until the end of 2017 they had a single regional sales manager and no VP Sales.
  2. Signed a contract with Vizient, which is a healthcare improvement company with a $100 billion in purchasing volume, in the summer
  3. Partnered with Intalere, a health care supply chain manager
  4. Signed a 3 year agreement with Alliant Health, a Service-Disabled Veteran-Owned Small Business that sells medical device products to the federal government, to sell STREAMWAY to into Federal Hospitals

And while early sales have been sporadic, they do mark first steps toward greater penetration, opening up the opportunity for more significant deployment once the systems benefits are experienced.  Take for example, the two units sold in the third quarter.  Both sales were to single operating rooms across much larger hospital networks, in one case a 6 facility network and in the other a 11 facility network.  On the third quarter call Schwartz said they were in discussions to standardize waste management across each network.

Foreshadowing the increase in sales, Precision did 92 demos in the first three quarters and equaled that amount in the fourth quarter alone.  They did 145 quotes in the first 3 quarters, and more than 75 in the fourth quarter.

International sales have been even slower to come then domestic, but in the last 6 months Precision has made some strides there as well.  In June they got the CE mark for the system, which allows them to start selling the devices into Europe.  Later in the year they partnered with Device Technologies, which will be selling Streamway in Australia, New Zealand, Fiji and the Pacific Islands (they seemed quite excited about the Australia opportunity on their third quarter conference call).  They added a distributor in Canada as well as have been selling systems directly.  They added another distributor selling into Switzerland in November and opened a European office a few days ago.  Its worth pointing out that the 100 unit sales projection is not including any sales outside of North America.

One time and Recurring Revenue

Streamway systems retail for about $24,000 per unit.   100 units should equate to around $2.4 million in revenue.

That will be a big uptick from 2017 revenue.  The company has been printing quarterly sales in the $100,000-$150,000 range for the last few years, so the 5 Streamway units sold in the fourth quarter and the 6 and January should provide a nice revenue ramp.

However maybe the more important consideration is that as more Streamways are installed into operating rooms, recurring revenue will scale as well.

Precision generates recurring revenue from the sales of disposable filters and cleaning fluid. According to the 10-K, the filter and fluid retail for $24.  The company recommends changing the filter and cleaning the unit (with the fluid) after every procedure.

I think hospitals are doing this more like every 2-3 days. Nevertheless, Precision has been generating about $100,000 of revenue per quarter from the sales of the disposables.  Given that there is about 100 units currently in operation, it works out to $1,000 of revenue /unit/quarter.  While the company doesn’t provide margins from disposables, its pretty easy to estimate them.  In the second quarter no Streamway units were sold, and the company generated $106,000 at 80% gross margins.

It looks like the average operating room performs 2-3 surgeries per day.  If hospitals actually used the disposables after every surgery, I estimate revenue would be more like $4,300 to $6,500 per quarter per unit sold, or over 4-6x what I estimate it is now.  That’s a lot of reason to promote proper usage.

Even at the current disposable usage rate, 100 extra units means $400,000 more high margin recurring revenue annually.  Add that to existing consumable revenue, and add on the $2.4 million from unit sales, and I get annual revenue of about  $3.2 million for 2018.

CRO Joint Ventures

Probably because Streamway sales have been slow, management has looked to alternative lines of business to boost interest in the stock.  The initiatives kicked off in the summer with an announced merger with Cytobioscience, a contract research organization (CRO) that specializes in testing the cardiac safety of drug compounds.  The merger was subsequently postponed in favor of a joint venture in November, and at the same time a second joint venture was announced with Helomics, another CRO company.

As it stands now, Precision has a 25% ownership stake in Helomics and a $1 million loan to Cytobioscience.  The joint venture with Cytobioscience was supposed to close by year end but I haven’t seen anything to that effect.  Listening to the last conference, it seems like even the merger with Cytobioscience may take place once audits and accounting work are completed (it was suggested that the merger didn’t transpire because of auditing required on Cytobioscience before it could be merged with a public company).  On the other hand this article, which I can’t read in its entirety, says that Cytobioscience walked away from the merger, so who really knows.

I don’t know what to make of these two joint ventures and the move into CRO.  It seems like the CRO business is growing.  Whether these companies are at the forefront is anyone’s guess.  Cytobioscience said on the second quarter call that they expected $700,000 of revenue a month by the first quarter of 2018.  Helomics, which specializes in customizing cancer treatment based on finding patterns with their patient database, is in a growing field.

I’m also not entirely sure why these companies want to merge with Precision.  The Streamway doesn’t really have a strong connection to the CRO businesses that they operate from what I can tell.   Precision does have net operating losses of $11 million that could be utilized against future profits.  So maybe that’s it?

Just last week the Economist dedicated an article (and a cover) to the emerging field of using data to provide better diagnosis and treatment.  The article talks about using AI to better customize treatment to patients.  That is essentially what Precision will be trying to do in their partnership with Helomics.

Summary

Cash on hand should be enough to get Precision through 2018, and maybe further depending on how these sales develop and how much they end up spending on partnerships.  If I ignore cash, the price to sales (P/S) multiple that the company trades at is 3.5x.  Including cash its more like 2.5x.

Given the growth (10x the revenue in 2017), the margins (gross margins of 80%), and momentum in engagements across the United States and internationally, this doesn’t seem out of line to me.

The stock is hated by investors because it has disappointed for so long.  There is a long list of bashers I’ve seen on twitter and a few on SeekingAlpha.  None of these bashers have brought up a point that has concerned me though.  They are mostly just rehashing past price declines.

I think the stock moves higher.  At the very least it should get back to its November levels, which were above $1.50.  If there is evidence that the strengthening of sales of Streamway is sustainable over multiple years though, that should just be the beginning.  The recurring nature of the disposable sales adds a lot of value as more systems are installed.  Finally, if the Cytobioscience merger becomes a “go” again, that would be another catalyst to the stock.

So you have a beaten down stock, pretty clear indications of sales momentum, and the outside chance that something bigger is announced.  All around it seems like a decent bet.

Note: I have been told there is a SeekingAlpha article by Jonathon Verenger on Precision that is quite good.  I haven’t read it yet because I wanted to write up my own ideas first without influence.

Vanadium battery demand and ways to invest in its potential

In past portfolio updates I briefly mentioned my position in Largo Resources and how I have a positive outlook on the vanadium market.  I wanted to expand on those thoughts in this post.

Vanadium Supply and Demand

The Vanadium market has been in deficit for over five years.  I don’t think that is going to change this year and in fact there are factors that could exacerbate the deficit in 2018.

Vanadium deficits have been precipitated by low prices which have led to mine closures and a lack of new mine development.  The low prices were a consequence of cheaper “slag” production in China.  A significant portion of vanadium supply comes via a by-product of producing steel (called slag) from some types of iron ore.

 

As China steel production has boomed, slag production has increased.  This resulting supply has pushed expensive mine supply out of the market.  As well integrated steel production operations outside of China, which also produce vanadium, have shutdown, like Evraz Highveld in South Africa, which closed in 2015:

The consequence is that inventories have been falling for some time.  Recently, this has been exacerbated as long-time stagnant vanadium demand has started to increase.

The traditional usage of vanadium is as an additive to steel that improves its strength.  Demand as a steel strengthener has remained fairly flat (though that may change this year as I will discuss).  But a new source of demand has emerged – vanadium redox flow batteries.

Vanadium redox flow batteries

I started looking at vanadium back in September when I began looking into ways of playing the electric vehicle (EV) revolution.    Vanadium is not directly related to EVs.  Vanadium redox flow batteries are not a realistic alternative for vehicles.  They are, however, an excellent way to store electrical energy at a large scale.  So they are complimentary to the story.

 

A few months ago I read an excellent book called The Grid.  One of its main points is that our grid is about to undergo a massive shift due to renewable generation.  But there is a major problem with renewable generation: it is not aligned with consumption patterns.  An energy storage solution is necessary.

Because vanadium redox batteries are well-suited for large energy storage applications, they are well suited to helping solve the storage problem.

But vanadium redox flow batteries do use a lot of vanadium.  A few numbers will go a long way to illustrating the opportunity:

First consider that the vanadium market is small; its only about 80,000tpy.

From this article, it takes 15 tonnes of vanadium to build 1.6MWh of vanadium redox flow battery capacity.  What this is saying is that if these batteries are implemented at scale, they are going to require A LOT of vanadium.

China is building a 800MWh vanadium redox battery project in Dalian.  This project alone will use 7,500 tonnes of Vanadium.   That in itself would give a big boost to global demand.

If Vanadium redox flow batteries catch on in scale, demand for vanadium is going to increase substantially.

Other factors weighing on supply and demand

In addition to battery demand, other positive developments are occurring.  China is curbing the import of many of the sources of iron ore that produce vanadium as a by-product as part of their efforts to lower pollution.  Producing vanadium from slag is dirty, particularly when its from low quality slag.  So China is banning the import of such material.

I talked about China’s anti-pollution initiatives in my post about rare earth elements.  Much of the same dynamic that I described for neodymium applies to Vanadium.  There has been specific actions in the vanadium market that will squeeze supply further, as the Metal Bulletin reported:

a scrap import ban by Chinese authorities at the end of the year will cut approximately 4,500-5,500 tonnes

At the same time, a second move by China will increase demand.  As another Metals Bulletin article describes,  changes to China’s rebar standards could cause “vanadium consumption to surge 30%”.

These two quotes, which I took from Prophecy Development Corps recent presentation, summarize the current situation.

Largo Resources and Prophecy Development Corp

My preferred way of playing vanadium is Largo Resources.  I also have a smaller position in Prophecy Development Corp.  I prefer Largo because they are more liquid and they are currently producing.  In fact I believe that  Largo is the only public producing vanadium company on the market.  They own one of the few primary vanadium mines still producing after the Chinese slag onslaught.

Largo isn’t perfect.  They have a habit of issuing shares at a cheap price (like this recent 80c placement back in November).  There has been insider selling.  They are a single mine operator, so they have the risk of a bad quarter if the mine has a hiccup.  And they aren’t particularly cheap based on historic vanadium prices.

Of course the bet here is that history is not a good guide for the future.

I estimate that at current levels Largo is trading at about 7x EBITDA based on the third quarter realized vanadium price of $8.75/lb.  As slide 6 of the Prophecy Development Corp presentation I linked to above references, current vanadium prices are $12.80/lb.  As is the nature of mining operations, apart from taxes, all price increases in the commodity fall directly to the bottom line.   I estimate that Largo trades at a little less than 4x EBITDA at current vanadium prices.

Of course, at some point price increases destroy demand.  If this was purely a steel story, like previous prices spikes have been, I would be cautious.  But given the emergence of vanadium redox flow batteries and the significant demand they could represent if adopted at even a modest scale, I remain optimistic that prices can hold these levels and maybe even go higher.  I don’t think that Largo (and Prophecy) are reflecting this yet.

Week 340: Back Writing but Staying Cautious

Portfolio Performance

See the end of the post for my full portfolio breakdown and the last four weeks of trades

Thoughts and Review

I’m back!

Its been a month and a half since I have written.  I was on vacation for the last 3 weeks and before that I was so focused on learning about blockchains (and Overstock) that I didn’t have much time to put my thoughts down.  I should get back to more regular posting going forward.

Overall, my portfolio is doing okay.  I’m keeping up with the S&P, primarily thanks to Overstock.  I have a high cash level, which hurts when the market is going up like it is, but I just can’t bring myself to larger exposure when the market seems so lofty.  If the S&P keeps going up like it has been, and barring another Overstock type move in one of my small-caps, I will likely continue to struggle to keep up with the index.  I’m okay with that.

Overstock

Since the last time I wrote the only big thing that has happened is that Overstock worked. After a big run up I reduced my position down to a more reasonable level before Christmas.  It was simply too big.  Its not very often that an investment causes me to lose sleep, but when Overstock was a 30% position, a level that is unheard of for me, it was doing that.  I reduced too early of course, in the low-$70’s.  I remain holding a more modest 5% position in the stock, which means it remains large, but not to the ridiculous degree it was before.

Apart from position size, I had a few other reasons for reducing Overstock.

First, after reading the offering memorandum for the tZero ICO, it looks like Overstock hasn’t started developing the ICO trading platform.  So this is still early days.

Second, in that same documentation there was no mention of the stock lending platform, which I had been hoping for an update on.

Third, and I might be wrong about this because I’ve heard to the contrary, but it appears to me that the tokens are locked up for a year before they can be traded, which if true removes the upside of “price discovery”, or maybe bubble-discovery if you prefer, that I had been hoping for when the tokens became free trading.

Fourth, Byrne has been on the circuit giving interviews and his comments aren’t always consistent.  I’m still not exactly sure what his plans are with e-commerce, yet I feel like at $75 the stock is pricing in some expectation of sale and a premium price.  Take for example these comments.  They were actually made after I reduced my position, but illustrate how uncertain the direction here is.

“Maybe it’s about time we stop seeing Overstock as two separate businesses,” he said. “Our retail platform had 40 million unique people come to it last month. So as we’re developing these blockchain applications, these blockchain companies, the retail business is an extremely valuable retail business to have in terms of bringing awareness and traffic to the blockchain properties that we anticipate developing.”

It doesn’t seem like the thing you would say if you were in the mid-stages of selling the business.  So I’m not sure what to expect next.

Blockchains

More broadly, while I am very excited about blockchains and what they can do, I also think this is a long game and we are in the very early innings.  I dedicated a significant amount of time over the last two months to blockchain research.  I read books and a whole pile of white papers on individual companies.  I think the opportunity is real, but it is mostly still in a very speculative stage where picking winners is hard.

I started to make some investments in the token space over the past couple of months. They have gone well, but mainly because the whole sector went crazy in December and not because of any particular insight I had.  The token space is insane of course.  It makes no sense to me that they have valuations in the $100’s of millions or billions of dollars when in many cases there isn’t even a platform yet.  Moreover when you read many token white papers, the structure is often premised on a reasonable transaction fee that would seem to me to be negated by the current token valuations.

Nevertheless, the momentum could continue for some time yet.  This is because A. there is a real value that will eventually be realized in blockchain applications, much like there was real value the internet in the 90s, so there is a basis for the enthusiasm, and B. the moves thus far have been mostly retail dollars and if even a sliver of fund gets involved in the next year the bubble should inflate further.

Apart from the tokens, I’ve been in and out of a few different blockchain related stocks over the last couple of months but I’m reluctant to mention them because they are generally pretty sketchy and you buy them for the single reason that you think someone else will buy them higher in short order.

Its all pretty insane.  On the token side, let me just take Factom for example, which I pick because it actually seems like a solid platform and could eventually have all kinds of uses, it has backing and is established and it has an Overstock connection.  It also has a $525 million capitalization for the token.  If you assume that all of the economic benefits of the platform confer to the token holder, that means the platform is worth $500 million already?  This isn’t a hit on Factom, they are really interesting and maybe someday when services use their platform to tie in mortgages and deed titles and stock ownership into their platform then that valuation will be reasonable, but man, $500 million?  All these tokens are trading at multiples that suggest the platforms are mature and with robust usage.  And we just aren’t that far into the game yet.

The irony is that the valuations perpetuate themselves.  You end up trading on relative values and picking up “cheap” tokens that are in reality extremely expensive in their own right.  I bought another token called Tierion because it seemed like a reasonable alternative to Factom at ¼ of the price.  But its still a $100 million market cap for a platform with still limited utility.

It’s all pretty crazy, but I bet it has further to go before it ends.

On the stock side of blockchain the only one (other than Overstock) that I find somewhat interesting is Global Blockchain Technologies.  The stock is expensive (around $175 million market cap at current prices), they provide only a fuzzy idea of what their assets are (crypto mining and a token fund) and they have a ton of cheap warrants outstanding that are likely keeping a lid on the price.  So those are the reasons not to own it, or maybe to short it.

But I think there could be an interesting short-term play with the stock.  The chairman of Global Blockchain is Steve Nerayoff.  He seems to get a lot of flack on twitter, many think he’s nothing more than a promoter.  They may be right.  But he also happens to be a strategic advisor to tZero.  In these two positions it would seem to me that Nerayoff basically has two responsibilities.  A. to find tokens for Global Blockchain to invest in, and B. to help make the tZero ICO successful.  So it seems like a reasonable speculation that Global Blockchain picks up a piece of the tZero ICO.   News of the Kodak ICO investment (which is only about $2 million), briefly sent the stock up 45%.  I have to think that similar news with tZero would be regarded with equal or even more exuberance.

Commodities

As I alluded to earlier I have been reducing exposure to stocks.  Apart from a speculative blow-off its hard for me to add to positions with the market having run so far and with it being so long since the last correction.

However I have been willing to add to my commodity stocks. I continue to hold a number of base metal names, mostly those with ties to electric vehicles and batteries.  I note that Largo Resources has had a nice run up, even after the company diluted shareholders once again at bargain basement prices.  I also continue to own Lynas, Ascendent Resources, Leading Edge Materials, Bearing Lithium, Mkango Resources (very small position), Sherritt International and Norilsk Nickel.  Ascendent Resources announced fourth quarter production numbers on Friday and while mixed, they are still making progress on the mine ramp. The stock is trading at roughly 4x free cash flow if they can reach their 2018 guidance.

Gold stocks have not done much of anything and interest in the miners must be at record lows.  I’ve heard a few people articulate the theme that bitcoin interest is eclipsing gold and that the metal will continue to suffer as a consequence.  I’m not so sure about that.  Gold dynamics are so complicated, with factors from jewelry demand, Indian economics, Central bank proclivities and of course investment interest from individuals and institutions.  I have found that trying to predict the direction of gold from any single thesis usually turns out to be wrong.

What seems to be the best predictor of gold and gold stock movements is sentiment.  When everybody hates gold stocks, that is when they will go up.  And vice versa. This is primarily what my thesis is here.  Nobody wants to own gold stocks, so I think they will do well.

My largest gold stock position for some time has been Gran Colombia, and I really like the way the chart is setting up here.  I think the agreements they signed back in the summer with the artisanal miners give a legitimacy to their business that they haven’t had in the past.   If the market agrees with me the stock will go higher.

I have smaller positions in Jaguar Mining, Wesdome, Alamos Gold, New Gold and Orvana Minerals.

I also have a bunch of oil positions, though I’m a little more reserved about these.  Oil just seems to have such a dismal longer term outlook to me.  I know that the dominance of electric vehicles and renewable power is still a ways off, but I think its inevitable, and I wonder if it accelerates faster then anyone expects as the momentum snowballs.

But in the short term I doubt the market will look far enough ahead to care about that eventuality.  Right now oil inventories are dropping and with oil prices at current levels, the stocks look pretty attractive.  I still like the Canadian services names the best.  The three I own are Cathedral Energy Services, Aveda Energy Transportation Services and Essential Energy Services.  All of these companies trade well below book and have seen improving results over the past few quarters as oil prices have firmed.  I would expect that to continue in the coming year.

On the producer side I still own Spartan, Gear Energy and InPlay on the Canadian side and Silver Bow and Blue Ridge Mountain on the US side.  Blue Ridge Mountain is one of the few gas names that hasn’t moved at all over the past month.  This is because it doesn’t trade at all.  The company sold their Eureka Midstream interest in September for almost double of what the assets were held at on the balance sheet.  In the process they reduced their operating costs, gave them more flexibility for drilling and freed up prospective land that had previously been tied up due to proximity to the pipeline.  The company is now a pure play on the Utica/Marcellus.  It’s got to be worth at least $12 or $13 if not much higher, given the run up in other gas names.

Other Stocks

Just some brief mentions of a few other names in my portfolio.

Aehr Test Systems had a good quarter and announced a new customer for their FoxXP test system.  There is still a lot of selling pressure on the stock, pretty much every pop is sold. If you read through the third quarter conference call its hard not to come away enthused about their prospects.  They have unique technology that provides a tangible efficiency benefit for testing many of the new components that are being developed.  Its just a matter of bringing in more customers and building momentum.  I’ve added to the stock on weakness in the last couple of months.

I’m still holding Mission Ready Services even though the company hasn’t announced its first PO yet.  I came away from their December 7th conference call with many of my fears allayed, in that they seem to be building a legitimate business.  The research I have done on the people they’ve brought on-board and what I’ve already described about the products (and technology) itself make me inclined to wait it out until the first order and hopefully some other good news.  However, the stock is under pressure and probably will continue to be as long as there is no announcement and more existing investors get frustrated and leave.

Portfolio Composition

Click here for the last eight weeks of trades.  Note that the prices below are as of Thursday, January 11th.

HIVE and Proof of Stake

I sold my position in HIVE.  I hate doing an about face on a position so quickly, but I came across an issue that gave me some concern.

My post the other day raised the question from someone of what the expected change in Ethereum to proof of stake consensus would mean for HIVE.  I did a bunch of reading on the matter and it makes me uncertain enough to sell.

Proof of stake is a change to the consensus method used.  If Ethereum switches to proof of stake, I’m not sure what role miners will have.

I wasn’t able to get a good feeling for when or even if Ethereum will implement proof of stake.  It sounds like it could be some time in 2018, but it also sounds like its a change that has been promised for some time and there remain to be issues to be sorted out before it can be implemented.  It may never happen.

Nevertheless based on what I’ve read, it seems likely that if it does get implemented, the need for miners for will be greatly diminished.  While miners will move to other tokens, I can’t quite see how these other tokens, with much smaller market capitalizations then Ethereum, will be able to absorb the supply.

Until I can understand this better I thought I better sell.

HIVE Blockchain as a crypto-mining bet

When I started looking at the crypto-miners a month or so ago, I was pretty skeptical.  I thought there was a good chance that the business was a promotion to make it sound like you were a blockchain company when really you weren’t.  The company’s were all shells that had flipped the switch to blockchain overnight.  It was hard to take it too seriously.

But since then I have come around.

What made me change my mind was profitability.  This post, which is from an excellent crypto-blog, does a great job of describing the opportunity.  If you want raw data, check out this calculator and these GPU hardware stats.  A single RX 480 card has a hash rate of 28 MH/s and takes 160W of power.  Using the calculator, 28 MH/s and 160 W of power at $0.10 per kWh gives you a profit of $31.26 per month from mining 0.143 Ethereum. On Ebay you can buy a 7 GPU mining rig for $3,214.  7 GPUs should pull in $2,600 worth of Ethereum per year at $450 Ethereum.  It’s a pretty solid return and I haven’t even shopped around, tried to buy wholesale like a scaled player or moved my operation to a low cost power district.

You can run through a similar exercise with bitcoin.  You can buy the equipment at retail and still come away with a pretty solid return on investment. If you start shopping wholesale, or assembling the rigs at scale, I imagine the payback is over 100%.

With that said I’m not getting into the crypto mining business.  I have a feeling the devil is in the details, and there is a lot more to it than just buying the equipment and plugging it in.

But you get the point.  The above analysis gave me a reason to look more closely at the miners and what they are trading at.

Stepping my toes into the water, at the beginning of last week I bought a little Riot Blockchain.  I had lucky timing as the stock almost immediately started running.  I bought Riot because on an equipment basis, when I compared it to HIVE Blockchain, it seemed quite a bit cheaper.  But I was never really sold on the story, mainly because Riot hasn’t really given many details about their operation and we don’t even know if they are mining yet.  As such I sold out way too early. I began selling at $11 while the stock got as high as $22 on Friday.

Thus my Riot Blockchain experience is likely finished.  But it led me back to HIVE, which looks more interesting as I have dug deeper.  I took a position in HIVE on Friday at about $2.80 (Canadian), for the reasons I will explain below:

HIVE Blockchain

HIVE started out as a reverse merger of a gold company called Leeto Gold (yes a reverse merger; you can pull out the red flags, I’m not going to deny they aren’t there).  They got into the crypto-mining business when they acquired two data centers in Iceland from a very large private mining firm called Genesis Mining, the first in September and the second in October.  I first looked at the stock after the purchase of the second data center.  I struggled to wrap my head around the business, and the disclosure was (and still is) lacking.  So I passed.

I watched the stock shoot all the way up to $6 (Canadian).  But then it came crashing back down.  With Ethereum prices 40% higher and with HIVE securing a third much larger data center to be built in Sweden (in two phases) I decided to look again.

The short report

Ironically it was a short report that cemented my interest in the stock.  I don’t know who wrote this or where it came from.  Someone posted a link to it on Stockhouse last week.  Reading it made me reconsider my thoughts on HIVE.

The report does a really good job of weaving together the sparse disclosures from HIVE and gauging the size of their mining operation.  It was very helpful to see how you can build a model (a rough one but a model nevertheless) from the somewhat detailed disclosures HIVE gave on the first Iceland data center and the subsequent minimal disclosures of how much each additional data center would increase hash capacity.

Of course the report, being a short report, concludes that HIVE is way overvalued.  But I’m pretty sure this is because of one little mistake.

If you read the report, you will note that it references 2,301 GPU cards in the first data center.  Because of the lack of disclosure from HIVE, all of the other data center calculations are factors of the known size of the first one.  As the report explains, if there is only 2,301 GPUs in the first data center then HIVE isn’t going to make much money, either on the first data center or any of the subsequent one’s.

But here’s the thing.  When I read the report I had done enough research to know that 2,301 GPUs is not very many for a data center.  Moreover, it seemed like there was no way anyone would pay $9 million USD and 67 million shares for that many GPUs.  You’d have to be crazy.

Luckily I have a subscription to Sentieo, including their Canadian data, and that makes it really easy to search for something like “2,301” and find out the context.  As it turns out, the document is hidden in the obscurity of the annual report of the reverse merger parent Leeta Gold Corp.  And it doesn’t actually say GPUs. Here is the relevant paragraph (my underline):

The HIVE Facility consists of 2,301 graphic processing unit (‘GPU”) mining rigs. Maintenance costs, including electrical power, to be paid to Genesis, for operation of the HIVE Facility are expected to be around US$144,650 per month. The maintenance costs will be part of the Master Services Agreement

Its 2,301 rigs.  This makes much more sense and changes the calculations significantly.  Its pretty easy to google “gpus per rig”.  If you do you find that most rigs have at least 5 GPUs.  Many rigs have more than 10 GPUs.

Thus, when I looked at the short report conclusion and saw that they projected $750,000 per month in revenue, I was like, wow, its actually more like 10x that much.  And that’s at $300 Ethereum!

Time to buy.

Conflicting Disclosures

If the short report is off by a factor of 10x then HIVE is a no brainer.  To get a levered play on the direction of cryptocurrencies at a cheap price is a steal.  Unfortunately as I have done more work to make sure the details align, things have become a bit muddled again.

To reiterate what I said earlier, the tricky thing about evaluating HIVE is that:

  1. There isn’t a lot of information about each of the data centers. In fact every subsequent data center has to be based off of the known information about the first data center
  2. The company has provided two fairly different estimates of the profitability of the first data center

So what do we know about the first data center?  Well, we know there is 2,301 rigs.  But we don’t really know how many GPU’s each rig has (though I’m pretty sure its more than one).

The other information we sort of know is the profitability of the first data center.  Unfortunately, I say sort of because HIVE has given us two numbers for this and they aren’t that close to one another.

On June 14th, in this press release, HIVE said the following (my underline):

Based on the computational capacity of the first Data Centre, the historical prices, and required hash rates, and using a mine and immediately sell strategy, the trailing 12 month EBITDA would have been approximately US$7 million.

Later, in their October presentation, HIVE provided this chart on slide 18 (light blue represents the first data center only and dark blue represents two data centers in Iceland).

There is a big difference between $4 million of “gross mining margin” and $7 million of EBITDA.  Because the $4 million number is more recent, I’m going to assume it’s the correct one.

I wanted to try to get to the number independently.  With the disclosure of 2,301 rigs and a reasonable assumption of GPUs per rig its pretty straightforward to use a cryptomining calculator to come up with gross profit, which is likely the equivalent to what HIVE describes as their “gross mining margin”.

But how many GPUs per rig?  I would have expected at least 10.  From what I’ve read, a big miner like Genesis should have at least 10 GPUs per rig.  You’d think Genesis would be using the most efficient GPUs in their stack.

The problem is that the numbers don’t work out with 10 GPUs.  I’ve tabled two scenarios, one with 10 GPUs per rig and the other with only 5.  I actually also had a third scenario with 15 GPUs per rig (the “high” scenario), but given the results that one seems unlikely so I didn’t include it in the table.

Surprisingly, it’s the 5 GPUs per rig scenario that matches a data center generating $4 million of margin at a $300 Ethereum price.

One other possibility is that there are indeed 10 GPUs, but they are lower end processors.  My assumption above was based on the RX 470 card, which has processing speed of 27 MH/s.  I’m told this is one of the most efficient cards.  But maybe the Iceland data centers use R9 280s, which would have a little more than half the processing power as the RX 470s (see the table below).  That would get us closer to 10 GPUs per rig while still staying within the $4 million gross mining margin range.

Of course the other wildcard is that if the earlier $7 million EBITDA number is correct, then my mid case is likely closer to the truth.  But like I said, given the dearth of information I am forced to believe the later number is more accurate.

Once you get the first data center pegged, its easy to figure out the contribution of subsequent data centers from the increases in hash power that HIVE has disclosed for each.

The second data center is said to “increase hashpower by 70%”.  From this information, and assuming a similar power consumption agreement as the first data center, its easy to calculate its contribution.  Keep in mind that it’s the “low” number in the table below that is the one I’m assuming is most accurate.

The third data center (in Sweden) was said to increase hash power by 175%.  Note that I also added a 20% cost escalation for power and maintenance costs on top of what HIVE is paying for the Iceland assets.

For the fourth data center, the company said the following about its Swedish operations on November 14th:

The Sweden Data Centre will consist of newly constructed GPU mining rigs using the latest hardware, custom-designed by Genesis. Each phase is expected to represent approximately 6.8 MW of electricity consumption for a total of 13.6 MW in Sweden. HIVE and Genesis are evaluating expansion potential in Sweden as well as Iceland. In Iceland, HIVE’s current operating facilities represent 3.8 MW in electricity consumption. Completion of the Sweden Data Centre is subject to a number of conditions, including but not limited to, Exchange approval.

To calculate the hash power of the second phase of the Swedish data center I used the same method as the short report, which noted from the above disclosure that Iceland would be 22% of power consumption and Sweden was 78% of power consumption.  Since we already know the hash power from Iceland as well as from the first data center in Sweden It just takes a little bit of math and isolate the second phase in Sweden:

Conclusion

So where does this all leave us?  Well HIVE may not be super cheap, but neither does it appear to be outrageously expensive.  I actually think it’s a pretty interesting way of playing the rise in the Ethereum price (this is something I never would have expected to say a month ago!).  Below is the summation of the profitability of all of the 4 data centers at 3 different Ethereum prices.  Again, remember it’s the low case column that is the likely one, at least given the information that is available.

Of course the numbers above don’t include G&A and taxes so some adjustment has to be made for that.  With 280 million shares outstanding HIVE has had a market capitalization on Friday of $650 million USD.  That capitalization doesn’t seem all that out of line with the low case profitability at $450 Ethereum even adjusting for some G&A and tax.  Especially given the upside blue-sky potential for crypto-currencies and the probability that their relationship with Genesis will lead to more data center deals in the future.

With that said there are plenty of questions remaining.  How long before the profitability drops?  How quickly does the equipment need replacing?  How old are the Iceland data centers?  Is the business actually sustainable over a longer period of time, in particular if the proof of stake changes are implemented?

I don’t have firm answers to those questions yet.  I bought the stock Friday and there is still a lot of digging to be done.  But in the short term, I’m not even sure how relevant those answers are to the primary question, which is where the stock price goes from here.  Its already moved big time today (Monday) and I added a little more at the open this morning.  I suspect we are relatively early on in the speculative excesses of blockchain technologies.  If HIVE can show the above level of profitability and more investors begin to clue into that, I think there is a better chance the stock price moves higher than lower.  And that’s ultimately what we’re all in this for.