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Week 401: Treading Along

Portfolio Performance

Thoughts and Review

Treading water might be the best way to describe my portfolio performance.  I haven’t participated much in the rally we’ve had over the past 7 weeks. My stocks got the initial bump in early January but since then its been only a little bit up.

In fact the tracking portfolio looks better than my actual portfolio because I don’t hedge the Canadian dollar here.  That has helped the numbers by about 2-3% since my last update.

But what are you going to do?  I said last update that I didn’t feel comfortable buying heavily into the rally and therefore I wouldn’t be chasing it.  And I haven’t.  The lack of performance is a consequence.

Nevertheless I am happy with the stocks I own.  I think there are some that could turn out to be decent winners.  Digital Turbine looks good.  No one cares about Mynd Analytics but there is every indication that the merger with Emmaus is going to happen.    Smith-Micro, Mission Ready and Evolus,  all of which I will discuss below, give me plenty to be excited about.

Smith Micro

Smith-Micro had a great quarter.  I added to the stock at $2.30 last week and added again Monday (which won’t show up in the portfolio totals below) as I think it could really turn out well if things continue in this direction.  BTW, a thanks to Mark Gomes for his video on Smith-Micro, which helped give me some insight on the quarter.

I am told that the subscriber count, which is expected to see a doubling of between the third quarter and the end of the first quarter, was not a surprise, but to me it was, and I saw this as very positive news.  Those subs should ramp to over $2 million in quarterly revenue over the next few quarters. That’s a pretty big jump from the $1.2 million of SafePath revenue that we had in the fourth quarter (which itself was up from $1 million sequentially).

Speaking in maximum double negatives, there seemed like there was not much not to like here.  The fourth quarter revenue was really good ($7.4 million which was up from $6.5 million the previous quarter).  They had positive earnings (3c EPS) and positive cash flow.  Smith-Micro forecast another tier-1 win for SafePath in the first half and suggested they could have more than one new tier-1 by year end.

And the valuation is still not expensive at all.

The average estimate here pegs growth in 2019 at 30%.  While that number could be higher or lower depending on how the Sprint ramp continues and the other Tier-1’s materialize, let’s take it at face value for now.  I believe there is about 34 million shares outstanding including the warrants that are in the money again.  So the market capitalization is $85 million.  I realize there is cash with the warrants and on the balance sheet but I’m going to ignore that.  At an $85 million market capitalization Smith-Micro trades at 2.5x forward revenue.  If I didn’t tell you this was Smith-Micro and I just said I had a 30% grower with 80%+ gross margins and recurring revenue at 2.5x sales… I think you’d have to say that sounds like a deal.

Now I realize its never quite that simple and you can go down the road of why Sprint still hasn’t sunset the legacy software, why they didn’t Smith get a Tier-1 by year end like they had suggested they might, why are reviews still mixed on GooglePlay.  There are always questions.  But after these results and with the color they gave on the call I felt comfortable adding.

Mission Ready Solutions

One of the more interesting positions in my portfolio right now is Mission Ready Solutions.  It is a stock I’ve held for a year and a half.  For most of that time I have been flat to underwater on it.  The original thesis I invested on is busted – there was an LOI with a distributor for purchases of their BCS armor vest (called Flex9Armor) from a foreign military.  It never amounted to anything and the LOI was eventually dissolved at year end.

When orders from the LOI didn’t materialize many investors lost interest and were rightfully ticked off.

I stuck with the stock because… well, I don’t know exactly why.  Probably some hope mixed in there. Also their lead product, the Flex9Armor vest, always appeared to be a legitimate product to me, maybe the best ballistic combat shirt out there.  Same for the team at their subsidiary, Protect the Force, which on all indications is a premier R&D firm for tactical gear and body armor.  I kinda took the opinion (and this is purely my opinion) that Mission Ready was likely given the run around by the distributor on the foreign military LOI.  Also, the price of the shares remained surprisingly resilient through the first half of last year, a period of basically zero news and few positives to speak of, which made me wonder why that might be the case.

It turned out that Mission Ready was about to sign a merger deal with Unifire.

Unifire is a manufacturer and distributor of fire, military, emergency, and law enforcement equipment.  The following are their own manufactured products, but in addition they distribute over 1.5 million products from a whole pile of different vendors.

In the first half of 2018 Unifire had $18 million USD of revenue (that number comes from Mission Ready’s original press release on the acquisition).   We don’t have a lot of information yet on revenues prior to that.  Government data shows that Unifire had $31 million of revenue via Federal Government contracts in 2017.

The interesting part, and I wrote about this before in this blog post back in September but will give an update here, is that Unifire is one of six participating vendors in Defense Logistics Agency contracts (DLA).

The most recent awards for two DLA contracts came out in February. Unifire is still one of six vendors for the “$4,000,000,000 bridge contract under solicitation SPM8EJ-13-R-0001 for special operations equipment” and one of six vendors for “$90,000,000 bridge contract under solicitation SPM8EH-12-R-0009 for fire and emergency services equipment”.

These are big numbers but before we get carried away there are lots of unknowns here.  The biggest one is what piece of the pie Unifire will get.  Historically it’s been small.  Like I said, in 2017 Unifire received $31 million of government revenue.  In 2018 that appears to be down to more like $6 million (which may or may not be because they have been tied up with this merger with Mission Ready over that period).

The story behind the merger is that Unifire has been capital constrained and that has prevented them from bidding on higher volumes.  A $20 million available credit line was announced by Mission Ready a few weeks ago and with it in hand Unifire/Mission Ready should be able to bid on (and presumably win) more product.  It makes sense, but we’ll just have to see how it plays out.

At any rate I don’t think it is any coincidence that Mission Ready announced a private placement after these DLA awards were announced.   Literally the next day a $2 million private placement was announced.  Likely a lot of investors had been hesitant to participate in anything until they knew for sure that Unifire was still on the DLA go-to list.

Today they announced that the PP was over-subscribed and would be increased to $3 million.  A good sign as it means they at least have the original $2 million.  It’s certainly better than the alternative.

A successful private placement is good news because it will mean we can finally get closure on the merger.  After being halted for 7 months (maybe it was more? I lost track…), in February Mission Ready announced they had an escrowed close on the merger that still required approval by the TSX Venture to close (this is the first time I’ve ever heard of an exchange escrowed merger close?).  So the merger has so far been a kind-of-mostly-done-deal.  Once the money from the private placement is in hand I suspect it will become a fully done deal.

I added to my position in Mission Ready.  While there is still a lot I don’t know, I do like the direction the story is going.  Finally.

Overstock

Overstock announced fourth quarter results on Monday morning.

While the results missed estimates, disappointed many, and so on, I have to say I actually thought the retail business was in better shape than I had expected.  I mean the fourth quarter wasn’t ideal but that wasn’t really a surprise.

Apart from the fact that I firmly believe that I cannot take anything Patrick Byrne says at face value, the thing that has most kept me from getting behind Overstock again over the last 9 months or so has been this retail traffic problem.

Overstock has had a problem for about two years.  Their search engine optimization (SEO) traffic had been collapsing.  I’m no online retail guru but even I can figure out that if your free traffic is declining precipitously you are probably in big trouble.

I’m pretty sure Byrne knew they were in big trouble too.  In fact I would hazard to guess that the crazy marketing spending spree that Overstock did in Q1/Q2 of last year was a smoke screen to cover for the disaster that was SEO.

Byrne saw that the numbers were going to continue to get worse so he ramped marketing spend to cover for it.  This created a false bump in revenue and allowed him to play the market with his growth schtick. You can even get hints of what they were really up to on the third quarter conference call, where they admit that they spent a lot of that money on testing and R&D. I have my doubts that the spend had much to do with competing against Wayfair.  I think it was about ploughing money into a collapsing retail business in a last ditch attempt to right the ship.

Like many of the things Byrne does, while you can’t take it at face value you can have some confidence there is some legitimate plan behind it.  Just probably not the one stated.  And this time it appears to have worked.

The fact they are off that train and on the conference call said they would bring ad spend back down implies to me that they have some confidence that they will right the ship.   I would be willing to bet that if Byrne didn’t think they could do it he’d come up with some new sleight of hand to get the market to look elsewhere.

There are two pieces of good news here.

The first good news is they did turn around their contribution dollars.  And they are saying they can keep that going.  The first quarter number they gave is quite good.  The fourth quarter number wasn’t terrible either.

The better news is that there is a definitive turn in SEO.  It’s not exactly a hockey stick but at least the collapse appears to be in the past.

I have struggled to see why an acquirer would be willing to buy retail for anything other than a very low-ball offer while SEO was in free fall.   Any acquirer would see the pre-Q4 numbers as part of their due diligence and realize the business is likely doomed.  Even if they were interested in Overstock’s logistics and back-end platform, I doubt they’d be willing to pay much given the negotiating position Overstock would be in.  But the numbers above suggest this is changing.

The final bit of news is that while the first quarter revenue comp looks ugly it is bogus IMO because the marketing spend deluge that was done Q1/Q2 of last year.

Putting this all together, my wild guess would be that they might actually be able to sell retail once they show a couple quarters of solid contribution number and get above that break-even EBITDA number.

Meanwhile on the blockchain front in August tZero opens up to retail investors.  This seems like a big deal to me and I like the idea of holding the stock heading into that.  Its a tiny position but will be interesting to watch.

Evolus

Not much to say here as the stock treads water in the mid-$20’s, I hold my position and wait. Evolus released their fourth quarter results Monday night.  Everything is going fine with the upcoming launch.

The most positive news was that they alluded that they already have the head-to-head data with botox and that the results are thumbs up. That should be a big positive as they will release those results in conjunction with the launch.

The second most positive news was that they received $100 million of debt financing.  This reduces the worry of dilution.

Nevertheless I’m not increasing the size of my position.

Its still going to be a few quarters before we really understand the uptake.  They said that the second and third quarters will be full of trials and free samples as they try to gain traction and take share.

I also need to understand the competition better.  There was a discussion on the call last night about a longer acting toxin that will hit the market in a few years:

Irina Rivkind Koffler, Mizuho Securities: how do you contemplate the market entry of a long-acting toxin sometime maybe towards the end of next year or middle of next year? Does that change the #2 positioning? And can you stay at #2 beyond 24 months?

This toxin, called RT002, is owned by Revance Therapeutics.  They had a Phase 3 study completed and plan to submit a Biologics License Application in the first half of 2019.  A longer acting toxin, if the results are comparable, will likely be tough competition.  Just how tough?  I don’t know.

So I’m not sure yet how I should expect this all to play out.  I’ll keep my position small.

A few comments on stocks I sold

Gran Colombia – it remains cheap and after I sold they changed the offering from shares and warrants to debentures.  Had it been debentures in the first place I’m not sure I would have sold.  I might have though.  The small, worrisome piece of the story that always had me a little on edge is that if you read through the technical report on Segovia the grades are expected to start to decline after 2019.  Now the veins they are chasing have been around forever and have always been high grade so there is every possibility that they find more high grade gold and this is not a problem.  Still, it was the other contributing factor to me selling.

Golden Star – I’d like to see some sign that Prestea is straightening out. It feels like its been a year and the results at Prestea are getting worse if anything.  The stock price has held up really well since I sold and so I am left to wonder if maybe this is the quarter where that happens and I will be kicking myself in a couple of months.

HyreCar – I mentioned in my last post that I had bought and sold HyreCar.  The buying was a great idea, the selling not so much.  I don’t see any news to account for the rise.  I’m guessing that this $2 move since I sold (ugh) is because of the Lyft IPO?  You know I always underestimate things like that.   I mentioned the Lyft and Uber IPO’s as potential catalysts in my notes on HyreCar, but I didn’t really give that much weight to them.  Turns out its the overriding factor.

Superior Drilling – I sold a bit of this.  Nothing is really wrong with the stock but nothing is particularly exciting either.  If I had to give a single reason for reducing my position it would be that their OPEX spend in 2019 is going to be higher than I had thought, so the company will grow, but they won’t be delivering as much free cash as I had hope for.

Liqtech – I have continued to reduce my position in Liqtech, which may turn out to be a mistake.  Why sell the stock?  Well it was a pretty big position and it is also a binary one.  There still are a lot of assumptions in any of the calcs I run.  So its really just a matter of risk management.

Portfolio Composition

Click here for the last seven weeks of trades.  Note that I found a problem with my spreadsheet in the last update.  From December 12th 2018 until my January 2019 update I had double counted my Smith-Micro shares (6,000 instead of 3,000).  Therefore the totals for my portfolio during that time were roughly $7,000 (~1%) too high.  I corrected all my tables and charts in this update.

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A Bit of an Update and Kindred Biosciences

In the month since I last wrote I have mostly stayed the course that I laid out in my last portfolio update.  I took a couple of small positions which I have subsequently sold (HyreCar, which worked out, Graftech International, which didn’t).  I sold out of Gran Colombia, Atlantic Gold and Golden Star Resources, all of which had risen quite a bit over the last 2 months.  I sold out of C21 Investments just this week.  And I also reduced my position in Liqtech as it has appreciated.

Add it all up and I have an even larger cash position now than I had in the fall.  I have only a couple of positions that are more than 1% in size.  I’m close to net short in my account after including index shorts.

My plan is to mostly wait patiently in cash.  I’ve said it before a few times: if the market keeps going up for reasons that I don’t really understand, I’m okay with it doing it without me.

But I’m still on the look out for stocks that aren’t too economically sensitive and offer some upside.

I thought I had found a decent one with Kindred Biosciences.  But my timing was horrible.

I got the idea from @FBuschek who pointed me to this podcast where former hedge fund manager Steve Kuhn says he has 10% of his portfolio in the stock.

I took a 1% position in the stock early this week.  Then the company released earnings last night and the stock tanked today, down 15% at one point.  I’ll get into why, but first a brief overview of the company.

Kindred has a market capitalization of $370 million (39 million shares) and $125 million of cash.  They are mostly a clinical stage biotech – they are only starting to generate revenue from one approved product (Mirataz) and are burning cash at about a rate of $45 million a year.

The twist is that Kindred Biosciences focuses on animal pharmaceuticals.  They develop drugs for companion animals, which means house pets like cats and dogs but also horses.

The high level idea here is that Kindred says they can be much more efficient with capital than your run of the mill biotech.  The line they use at conference calls is that the addressable market for an animal drug is typically one-tenth that of a human drug, but the costs of development are one one-hundredth.

It’s a compelling catch line and I think there is some truth to it, though it remains to be seen whether the incremental value of an animal drug is to the extent Kindred suggests.  After all, Kindred is spending enough on their operating expenses ($53 million in 2018 including $26 million on R&D) that it’s clearly not free.

The other twist on the business is that veterinarians that prescribe the drugs are generally also effectively the pharmacists.  They sell the drugs they prescribe.  So they  have an economic interest in prescribing new drugs that they can sell to their patients.

Kindred’s first drug, Mirataz, was approved last spring and started selling in the third quarter.  Sales in Q3 were $600,000 and that rose to $1.4 million in the fourth quarter.

Mirataz is for managing weight loss in cats.  Preventing weight loss in cats, particularly old one’s, is necessary. Cats that lose 10% of their weight are at significant risk of liver failure and death.  “If you’ve owned a cat, often at the end of their life, what happens is they get sick for some reason, they stop eating and they get sicker and sicker and sicker.”  The trick is to find a way to get them to eat again.

Mirataz is based on a human generic drug called mirtazapine.  The problem with using mirtazapine directly in cats is that its sold in pill form.  The cat owner has to break up the little pill into 8 and then manage to get the cat to swallow it.  Compliance is low.

Mirataz puts mirtazapine into a transdermal delivery system, which means its an ointment, this case applied inside the cats ear, that seeps in through the skin.  Compliance is expected to be much higher. Mirataz was approved by the FDA in May 2018.

It’s a legitimate use case and the transdermal delivery system makes a lot of sense.

Where will sales go?  Well here is where we get into today’s collapse.

There are 9 million cats in the United States with this problem.  3 million of them are being treated right now.  About half of those are considered chronic and will need treatment for months or years.  A tube of Mirataz goes for $15. That is a 2 week supply.  The veterinarians are expected to mark it up to $30.

The big opportunity with Mirataz is on the chronic side – if the 1.5 million chronic cases require 6 months of supply every year that’s an addressable market of $585 million.  That’s a pretty big TAM.   If the other 1.5 million cats being currently treated require a 2 week treatment that is $22.5 million. So the 2-week treatment is much smaller.  The 6 million cats that aren’t being treated are additional upside if the owners bring them in now that there is an option with better compliance.

Putting this all together, the TAM looks quite large.  But how accurate that TAM is and how it translates into revenue remains to be seen.  It’s early. What we are seeing today in the share price is a consequence of that uncertainty.

The stock is selling off today because Lake Street reduced their target significantly (from $30 to $12), on concerns that Mirataz revenue will be lower than modeled.

Kindred Biosciences price target lowered to $12 from $30 at Lake Street Lake Street analyst Brooks O’Neil lowered his price target for Kindred Biosciences to $12 following the company’s Q4 results while affirming a Buy rating on the shares. The analyst says that while Mirataz, Kindred’s first approved drug, is off to a solid start, he now believes revenue from the drug will be lower than modeled previously. However, the company has a “deep pipeline of attractive drug candidates for the large and growing companion animal medicines space,” O’Neil tells investors in a research note.

I don’t have access to Lake Streets research so I don’t know how much they reduced their sales estimate by.

Reading over the conference call it looks like this was probably the key exchange that led to their reduced expectations (my italics):

Brooks Gregory O’Neil, Lake Street Capital Markets, LLC, Research Division – Senior Research Analyst [43]

Sure. It makes sense. In the past, you guys have talked about 9 million cats having inappetence and big percentage, perhaps as many as 50%, being chronic. What have you seen in the U.S. market so far in that regard? And can you say if you see any big differences between the international opportunity for Mirataz and what you’re seeing domestically?

Denise M. Bevers, Kindred Biosciences, Inc. – Co-Founder, President, COO & Director [44]

Sure, Brooks. So again, I’ll just reiterate that our product is labeled for 2 weeks, and that’s what we’re marketing toward. The challenge we have, of course, as I’m sure you understand, is getting down to patient-level data. The way to do this is through market research. We have ongoing market research initiative. What we do know is that unintended weight loss impacts many chronic conditions, cancer, chronic kidney disease, hypothyroidism, diabetes. How the veterinarian chooses to use the product is obviously up to his or her clinical discretion. So we will continue to collect market research and report on that accordingly. As far as opportunity, as I said, it’s about 2/3 typically is about the opportunity in Europe versus the U.S. And we suspect that veterinarians will be treating the same host of cats with these conditions, chronic and acute.

I’m thinking that Lake Street took the response to mean that Kindred was backing off of their expectations for the chronic market.  Is it also noteworthy that Lake Street was not part of the last financing?

So I don’t know.  I was thinking Mirataz could do $50 million of revenue once sales matured.  Is that too high?  Reading through a couple of the analysts I have managed to get research from, I was seeing peak numbers around the $75 million range.  This was prior to today’s call though.   What’s realistic?  Tough to say.  There’s really not a lot of information to go on here, which I guess is the problem.

But I’m still pretty interested in the idea, which is why I didn’t just cut and run this morning (I did do a whole lot of waffling however).  The pipeline is big.  In addition to Mirataz, Kindred Biosciences expects 2 drug approvals and 3 more pivotal studies in 2019.

The nearest term opportunity is with a drug called Zimeta.  It controls fever in horses.  Kindred showed positive results in a pivotal study of 139 horses.  The FDA has done most of its due diligence and all that seems to be left is a last manufacturing inspection before it is approved.  The market for fever in horses isn’t huge, but it looks like the drug should be able to get $10-$20 million of revenue once it ramps up.

Kindred announced positive data on its pilot field effectiveness study for the drug epoCat in January.  epoCat is intended to control anemia in cats.  The results from the study looked to be very good (albeit to my untrained eye).  The next step is a more extensive pivotal study that will take place in 2019 with a read out either in late 2019 or early 2020.  If successful the drug could launch late in 2020.  Based on the analyst estimates I’ve seen the revenue from epoCat could be in the $75-$100 million range.

Stepping even further out Kindred has a couple of drug candidates for atopic dermatitis in dogs.  This is a big problem in dogs and there are already a few other drugs on the market.  There are two drugs sold (Apoquel and Cytopoint) by the very large animal health company Zoetis.  The market size of atopic dermatitis is $500 million plus and growing so there is a lot of opportunity.  It’s possible these candidates, if successful and if they prove more effective than the atopic dermatitis options available right now, the estimates I’ve seen suggest the revenue opportunity is over $100 million.

So there appears to be lots of ways for Kindred to win.  Nevertheless, getting smacked on my purchase only a couple days after I bought makes me wonder if there is too much I don’t know here.  One of the things Kindred has said themselves is that animal health is not very well followed or understood – the research on market potential and on chances of success are not as well defined as in human biosciences.  So we are all kind of flying in the dark.

Looking at the competitive landscape, these animal health companies get big multiples.  Zoetis trades at 8.1x EV/Sales.  Idexx Laboratories trades at 8x EV/Sales.  Elanco, which is not really growing, still trades at 4.3x EV/Sales.

So if I spit-ball it and say that Kindred should trade at 7x EV/sales, then the current stock level is pricing in about $50 million of sales (I’m ignoring the cash which I assume they’ll burn through to get there).  Sales at that level are probably 3-4 years out so maybe I am too optmistic.   But even so it doesn’t seem like a high bar to pass given the pipeline of opportunities they have.

But this is a case where I can truly say – but what do I know?  I’ll keep my position small and wait out more information.  We’ll see how the data comes out with Mirataz and I’ll maybe look at adding if it appears Lake Street is wrong and the chronic market for Mirataz is there.

 

Some thoughts on the CNX Midstream guide down

So this isn’t a stock that I own right now.  I have owned it though.  I’ve been following it and some other midstream plays fairly closely since early December.

Up until recently these midstream stocks weren’t performing all that well.  They were getting beaten up with oil even though some of these companies have absolutely nothing to do with crude.

CNX Midstream for example.  100% natural gas and liquids.  They are the child of the old Consol – basically a situation where the E&P assets went into one company (now called CNX Resources) and the midstream assets, so pipelines, compressors, and facilities, went into another.

CNX Resources is a fairly large Marcellus/Utica producer, wet/dry natural gas, 1.4 bcf/d.

CNX Midstream operates all the pipelines for them.  They basically handle gas for CNX Resources and one other customer (HG Energy, which is private) so they are very concentrated.

Most importantly, CNX Resources owns 33% of CNX Midstream.  They are also the general partner, which means they manage and operate CNX Midstream.

On their fourth quarter call CNX Midstream surprised the market.  EBITDA guidance was $200 million to $220 million.  Distributable cash flow guidance was from $150 million to $170 million.

Up until that point analysts had been expecting an EBITDA guide of around $245 million and the floor on DCF was thought to be $170 million.  So this was a significant guide down.  Below is from their analyst day forecast back in March of last year:

So what happened?

Well part of it was that their E&P partner CNX Resources reduced their activity in 2019.  They phrased it as “minimum activity levels” and stressed that they would be “flexible” and add capital depending on prices and returns, but bottom line is that they are budgeting less than was anticipated.

So there’s that.  What can you do – your customer is worried about prices or returns or whatever else and they decide to reduce activity.   That means reduced through-put for CNX Midstream, or at least less growth than the analyst community was expecting.

But that’s only part of the story.  One analyst, I believe his name was Matt Niblack (?) pointed out that there was still something that didn’t quite compute:

…the minimum [DCF] has been adjusted down from $170 million to kind of $150 million to $170 million due to timing and other factors. But there’s still upside to that, and we just have to see how that goes. I guess my only other question here then is, in the minimum guidance range, if that seems — and also, I think implied in CNX’s production growth range, you’re looking at kind of roughly flat economics relative to Q4, right? And I’m just taking your EBITDA in Q4 and multiplying it by 4. I realize there will be some seasonality associated with that, so that will vary quarter to quarter. But for the full year, that’s what you’re looking at. And yet, there’s significant growth CapEx…

So the question is, why are you spending the same amount of growth capital if you aren’t growing as much?

I read the transcripts a couple times and while the company is a bit vague about it I think the hint they give is when they start talking about de-bottlenecking:

“So a significant portion of the capital that we’re spending in 2019 is associated with de-bottlenecking projects”

So CNX Midstream spends money de-bottlenecking.  That’s either compression, looping, twinning… it’s something that is going to lower pressure in an existing line.  Lower pressure of course means more gas.

But it’s more gas on the back of Midstream’s capital.

This brings up the point about the competing interests of the E&P and midstream.  Particularly when the midstream is controlled by the E&P.  Whose best interests is the de-bottlenecking in?

I would argue that the E&P, so CNX Resources, benefits more from de-bottlenecking.   If it was all one company the capital decision would be based on whether we get more bang (ie production/NAV/cash flow per dollar spent) from drilling a new well or from adding compression/looping an existing line and getting uplift from existing wells.

In this case it’s not all one company.  CNX Midstream pays for the de-bottlenecking.  So its a bit of a free-bee for CNX Resources.

Yes, CNX Midstream gets the volumes as well.  But they just get a toll, and they could have gotten those volumes anyway if the E&P had used its own capital and drilled some more wells.  Now I realize that drilling more wells in an area that could use some de-bottlenecking is likely going to back out other production.  Sure. So drill them somewhere else, where there is capacity.  Volumes are volumes for the midstream.  My point here is that the uplift is paid for by the midstream but they aren’t getting the full benefit.

Of course CNX Midstream says that its a good rate of return. From the call: “I mean, we could follow up with those specifics. I mean, those are good rate of return projects. Otherwise, we wouldn’t do those on a standalone basis. It’s sort of like core, like baseload, sort of like easy low-hanging fruit stuff to do.”  And it does give CNX Resources the ability to ramp production more at some point, now that pressures are lower.  So there’s that.

One thing de-bottlenecking definitely does is it helps an asset look better, at least for a while.  Not saying that’s the case here, I really don’t know.  But type curves never talk about pressure.  It’s rate vs. time.  Nevertheless, you lower the pressure and rates go up.  There is a reason engineers do a bunch of crazy math on their wells and introduce concepts like material balance time and pseudo-time.  Its because its pretty easy to get the wrong impression from a rate vs. time graph.

It all just makes you wonder if CNX Midstream might be taking one for the team here?  CNX Midstream spends some money on de-bottlenecking.  It’s not really a big deal in the grand scheme of things, the stock takes a bit of a hit but it bounces because it doesn’t affect the dividend or anything.  CNX Resources gets some free uplift from it.  That helps their guidance.  Everything looks a bit better. No one gets hurt.

Who knows!  Maybe it’s all just efficient capital allocation.  Nevertheless I think the thought exercise is worthy of contemplation: that there is at least the potential of misalignment with these E&P-midstream separations in the United States.

New Position in Digital Turbine

So far I’ve been pretty cautious about buying any stock that is economically sensitive.  I bought some gold stocks, a couple healthcare/biotech names, but nothing that really is at risk of an economic downturn.

Digital Turbine is a departure from that.  They are directly dependent on smart phone sales, particularly in the United States.

So with all the headwinds around smartphones and my own skepticism about the economy, why Digital Turbine?

I think it has potential, even in the return of a bad market, and there is more here than just following the smart phone sales trend.  The stock performed extremely well while the market fell apart in December.

Digital Turbine provides a mobile device app management solution called Ignite.  This isn’t an app-store app.  Digital Turbine partners with carriers (they have 30 carrier customers including AT&T and Verizon) and OEMs (recently signed up Samsung, have another 7 smaller OEMs signed and have hinted at others to come) who install the apps on the phones before sale.

When a customer buys a phone from the carrier Ignite installs sponsored and partnered apps.  These apps have been curated by the carrier and Digital Turbine based on the users preferences and from a list of app developers who have paid for the right to be included on the install list at the time of activation.  A list of other sponsored apps that might interest the customer is also displayed during the set-up process.

In the past virtually all of Digital Turbines revenue came from these installations and recommendations at the time of activation. App developers paid Digital Turbine for those placements and installations.

Recently the company has leveraged their platform by adding a number of products that add value through the device life-cycle: Single Tap, Smart Folders, and Post-Install Notifications.

The Smart Folder app organizes apps into folders.   Embedded in each folder are recommendations of other apps to download, which based on past preferences the user might find interesting.  For example a gaming folder might be created for the users gaming apps.  When accessing this folder they would see “similar” apps, which are sponsored content of other games that can be downloaded.

Another product is Single-Tap.  This allows the user to download an app directly from a notification, advertisement or Smart Folder list without accessing the app store.  Because the app is not installed via an app store, Google or Facebook don’t take their 25-30% cut.  The app developer benefits with more revenue per download.

These downloads and placements also benefit the carrier.   An important aspect of Digital Turbine’s business model is that the carrier is not Digital Turbine’s customer.  In fact, when Digital Turbine receives revenue from app developers they pass on a chunk of it to the carrier.  Rather than being dumb pipes, the carrier participates in revenue from each placement, install or notification that is generated (note: there is an exception to this if the carrier owns media or apps they want placed on the platform in which case they remit revenue to Digital Turbine for the placement).

It seems like an easy win for carriers.  They put in none of the R&D, none of the marketing, but they get maybe 50% of the margins (its not broken out so that’s my ballpark guess) for simply putting the Digital Turbine platform on their phones.  My understanding is that the carriers are also final decision makers on what and how much content is delivered via Ignite, so they remain in control.

You can see the model is working.  Digital Turbine is installed on 230 million phones right now.  These are all Android phone (the Apple ecosystem doesn’t allow for this type of product).  That is up from 155 million phone in March of 2018.  They peg their annualized install rate at 100 million.

They don’t have a recent snapshot of their quarterly device growth but the snip below is from their Inventor Day presentation in June. You can tack on three more quarters (their year end was March) to get them to the 230 devices that are out there now:

Its a strong base (>10% of android phones) to layer on additional products.  Carriers seem happy to comply since they are getting a nice cut.  To wit, Single Tap was introduced about a year ago and its already on 120 million phones as per the conference call last week.  While the post-install products have all been introduced in the last year, they already account for 15% of revenue.

Revenue is generated as app developers pay for adding their app to the pre-install process, adding it to Smart Folder recommendations, and for notifications or advertisements that are displayed.  The agreements vary between app developers and between carriers but they either take the form of a cost-per-install (CPI) fee, a cost-per-placement (CPP) fee, or a recurring revenue fraction after the app is placed.

The recurring revenue is new, within the last year.  They’ve already signed up Amazon, Netflix, the Weather Channel, Yahoo among others.  If a user installs a Netflix, an Amazon or whatever app via the Ignite platform (be it a pre-install from a Smart Folder recommendation or an ad) then Digital Turbine gets a piece of monthly revenue from that app.

A year ago recurring revenue was nada.  Now it amounts to 5% of revenue.  It was 3% the previous quarter.  Annualized that amounts to maybe $5 million but clearly growing quickly.

The latest big win for the company was Samsung.  They made a deal with Samsung in the fall that added Ignite to Samsung’s factory install.  Once it’s fully rolled out this could mean that Ignite is on every Samsung phone.

The OEM partners are important for international carriers where bring-your-own-device (BYOD) is much more common than in the United States.  Until now an international carrier couldn’t do much to customize the experience of a BYOD customer.  With Ignite pre-installed on the phone, they can turn it on and run through their own customized set-up.

While Samsung accounts for some 500 million devices on their own, Digital Turbine has hinted at more OEM relationships in the works (maybe LG, Sony or Huawei, which were all mentioned in passing on the last call?).

Right now revenue primarily comes from the United States carriers (AT&T, Verizon, T-mobile make up 85% of total revenue).  International is growing.  It was up 100% year over year last quarter with revenue from their large Latin American partner (which must be American Movil) tripling.

This is a business where both revenue and margins are a bit deceiving.  Revenue is more recurring then you think.  The company has an annualized install rate of 100 million devices, so the turnover from that base recurs every few years on a replacement cycle.  The ads, notifications and placements are on an on-going basis.

Margins look weak at a glance, coming in at 35% last quarter.  But those margins take into account the carrier revenue share.  While I don’t know what the revenue share is, it wouldn’t surprise me if its around 50%.  That would make true margins for the business closer to 80%.

Revenue would be less of course.  But if you looked at Digital Turbine and saw an 80% gross margin business with what is essentially recurring revenue, relationships with 30 major carriers, most of the major app developers, and that is on over 200 million smart phones growing at 30% per year, what would you pay?

The company might be a play on 5G as well.  They’ve targeted their platform at phones, but there is nothing stopping them from expanding to other connected devices.  TV’s for instance.  In fact the business model here has some similarities to Roku.

I found the stock on a screen after it popped on its earnings beat earlier this week.  It’s moved some since then and has a market capitalization of $200 million.  Revenues last quarter were $30 million.  With analysts expecting 20% growth next year that’s a P/S multiple of under 1.5x.  They generated $4 million of EBITDA and $2 million of free cash last quarter.  It doesn’t seem that expensive for what you get.

Some of the risks would be:

A. Could Google do the same thing? Maybe, but they haven’t.  They would be cannibalizing their own app store and sharing revenue with carriers when they don’t now, so I don’t know if it would make sense for them.  It’s a pretty small business in the overall scheme of things.  Nevertheless its a risk.

B. Could Google block the platform on Android?  It’s hard to believe that this wouldn’t violate competition laws but maybe it’s a risk?

C. Would carriers develop their own product?  Again, maybe, and in fact based on the filings I’ve read I believe this has been the primary competition for Ignite (though there may be others I haven’t found any other than those mentioned in the 10-K: IronSource, Wild Tangent, and Sweet Labs).  But carriers are getting a pretty good deal here.  They basically do nothing, share in ad revenues, install revenues, app developer relationships that Digital Turbine cultivated.  No R&D, marketing spend on their part.

D. Smart phone replacement cycle slows.  This is why international expansion is important and the OEM deals are key.  Digital Turbine can’t rely on growth in the North American phone market.

E. International expansion doesn’t work. Right now 85% of revenue is the the United States.  They have been working on a ramp with American Movil for over a year now and its still fits and starts.

F. Carriers squeeze margins more.  They just signed deals with Verizon and AT&T so this shouldn’t be an issue in the short-term. It will probably be important to show they can drive revenue growth for the carriers, which of course is good for Digital Turbine as well.

G. The fourth quarter (year end March) guidance did not indicate acceleration – 27% year over year growth at the mid-point and a sequential, seasonal decline greater than last year.  With all the levers: ramping Single Tap, Smart Folders growth, Samsung relationship, I might have thought this would be higher. I’m not sure if I should read into it much though.

H. I feel like their R&D spend is low, which makes me wonder about how robust their business is against competition

I. Oath, which is Verizon’s media group (ie. advertising), represents almost 25% of sales so it is a very large piece of the revenue and represents concentration risk. Overall AT&T and Verizon represent around 80% of revenue.

As always, I’m starting my position small, will add if it appears to be working and will sell quickly if I look like I am wrong.

 

New Position in Evolus

Two biotechs in a row.  I’m out of my comfort zone.

But in a way ,picking biotechs right now is in its own sort of comfort zone.  I remain suspicious about the economy (though the market keeps going up, so what do I know!) and companies with newly commercialized drugs are less economically sensitive then your run-of-the-mill S&P stock.

Of course in this case I picked a plastic surgery toxin, which probably isn’t the best place to be if there is a recession.  So there’s that.

Anyway.

Evolus just received approval for a new neurotoxin called Jeuveau on Friday.  I didn’t hear about it until Monday night.  I took a position Tuesday morning, first at $20 and then at $25.

Its been a big move over the last two days but I am hoping we are just getting stated.

Jeuveau will compete with Botox in the cosmetic neurotoxin market.  Botox has an 70% market share right now.

The cosmetics neurotoxin market is about a $2 billion market worldwide.  Half of that is in the United States.

The market is growing at almost 10% a year.

Apart from Botox, the other competitors to Jeuveau are Dysport (with around 20% market share) and Xeomin (with about 9% market share).

Dysport and Xeomin were the first wave of competition for Botox.  They largely failed in their attempt.  Why?

A few reasons: The drugs didn’t show a real benefit to Botox.  They had different dosing language (called conversion ratios) than botox.  Physicians trained to administer Botox didn’t find it simple to switch over.  In the case of Dysport the conversion ratio changed after the drug was used.  Finally, they didn’t come out of the gate with a marketing push that differentiated them to patients and physicians. They never developed the momentum to unseat the champ.

Evolus is addressing these issues, both with its trials and launch.

Evolus did head-to-head trials with Botox in Canada and Europe.  Patients in those trials preferred Jeuveau to Botox.  No one has done a head-to-head with Botox before.

Evolus plans to use that head-to-head data in their marketing of Jeuveau.

In the marketing push Evolus will focus on brand and on new patients.  They are targeting millennials.  There appears to be more acceptance among millennials for enhancement products like neurotoxins (they say its a consequence of the selfie culture).

Evolus decided to make Jeuveau a cosmetic indication only.  If you look at Botox, more than half the revenue comes from therapeutic indications.  Jeuveau won’t be competing in that market, at least for now.  Limiting the drug to cosmetic means that Evolus has more leeway around pricing and that they don’t have the same constraints on their marketing.

Botox is by far the market share leader but it’s not loved by physicians.  Allergen has jacked up prices on a number of occasions.  The price per unit has increased 50% in the last 15 years.  There is an expectation that physicians will switch if given a better option.

Evolus is owned in part by a group of physicians and plastic surgeons.  The parent company, Alphaeon, which still owns over 75% of the stock, has over 200 dermatologists and plastic surgeons as investors.  I read one place that these investors make up more than 2% of procedures on their own. The top management of Evolus mostly have come from Allergen: CEO, CFO, CMO, Chief Medical Officer.

Evolus said in the conference call Monday that their goal is to be #2 in the cosmetic neurotoxin market.  That implies that they are anticipating at least 20% of the US market.  So $200 million.  That’s only the United States.

Even after this run the stock is trading at $750 million market cap.  My bet is that it can roughly double that if they look like this goal is within reach and get approval for Jeuveau in Europe.

Here’s the risks I see:

  •  Allergan, who owns Botox is “seeking to block U.S. imports of a new rival to the wrinkle-treatment Botox” because they allege that Daewoong Pharmaceuticals stole trade secrets around Botox which led to the development of Jeuveau.  These accusations have been going on for a while but are back in the headlines now that Jeuveau is approved.
  • Botox is a pretty entrenched leader.  Evolus has talked about how their focus are the millennials, which is not in small part because they realize second-generation clients that have had a Botox treatment are less likely to switch over
  • Botox and the other two brands will push back, they will reduce the price of their drugs and step up marketing efforts
  • The stock is basically controlled by the executive team and other owners of Alphaeon.  Hopefully all interests are aligned but you never know for sure.

 

 

 

 

 

 

 

New Position in MYnd Analytics

Well we are less than a month into the new year and I am already breaking a rule.  Rule #2, stay away from illiquid stocks.  So what do I do?  Two days later I buy a stock that trades 20,000 shares most days.

That said the stock has had a lot of volume the last few days.  So it’s not illiquid at the moment.  And I am keeping my promise to write more. So there’s that.

Here’s the scoop.

Mynd Analytics (MYND) has a not-so-interesting legacy business of providing psychiatric help via video conference to patients in remote areas.  They have a second not-so-interesting business of offering a platform (called PEER) that helps doctors prescribe for psychiatric conditions.

Two not-so-interesting businesses are not a good reason to buy a stock.  What is interesting here is a merger that was announced a few weeks ago.  Mynd Analytics is merging with a private biotech firm called Emmaus.

Emmaus has a much more interesting business than anything Mynd has, so this is more of a reverse takeover kind of merger where the new company is going to be Emmaus, not Mynd.  In fact, exiting Mynd shareholders are going to get about 5.9% of Emmaus.  They are also going to get a spin-out of the two not-so-interesting businesseses into a separate company.

So while those businesses are not very interesting to me, the market was still saying they were worth up to $1.50 a few months ago.  So basically as a shareholder I get what I already had, plus now I get a piece of Emmaus.

Getting a piece of Emmaus is interesting.  Emmaus is in the early stages of marketing a drug called Endari.  Endari is approved to treat sickle cell disease.

Sickle cell disease (SCD) is an awful sounding inherited disease where your blood hardens, which can cause stroke.  There are 100,000 patients in the U.S, another 80,000 in Europe, and over 400,000 in Africa and the Mideast.

There is only one treatment on the market for SCD.  It’s called hydroxyurea and its been on the market for over 20 years.  It helps in most cases but it’s not a cure and it produces a lot of adverse side effects in patients.

Endari has went through FDA approval trials and its efficacy has been demonstrated.  It provides improvement in adverse events over the placebo, both on its own and when used with hydroxurea.   Importantly it is well tolerated by patients.

That last clause in the sentence is important, because physicians can prescribe hydroxurea and Endari together.

While it’s expensive to prescribe, insurance companies have been very willing to add Endari to their list.   Why?  Because adverse events for sickle cell patients are severe.  They require ambulances, hospital stays and are extremely expensive.  Endari comes at an ASP of $30,000 ($20,000 net to Emmaus after rebates and coupons).  All it takes is a couple less hospital visits and Endari pays for itself.

Okay, so the drug is effective.  What’s the stock worth?

Well Emmaus just started their ramp with Endari in January.  The CEO, Dr. Niihara, who is also the founder and inventor of the drug, gave us an indication of the sales ramp in a PiperJaffrey presentation they gave in November.  This is gross revenue.

They also said there was about 1,200 patients on Endari at the time (so November).  That roughly lines up with the gross ASP of $30,000/year.

Niihara also forecasted 10,000 patients on Endari by the end of 2019.

So the math on that is 10,000 patients at $20,000 net ASP is $200 million of annual revenue.

The math on the post merger valuation is that there will be about 160 million shares of Mynd Analytics outstanding.  I bought the stock at $1.40 so that gave it a market cap of about $225 million.  Now the market cap is around $280 million.  I actually added a little at the open this morning after I wrote this up because it made more sense to me once I put it down on paper.  Sometimes writing clarifies the mind.

Somehow under 2x revenue for a biotech with a new drug ramping and an orphan drug designation seems too low to me.

Endari is on patent in the US for another 6 years.  There is a 10+2 patent in Europe that doesn’t begin until its approved.  There is another patent in Japan.

The  $200 million should be just a start.  It’s basically a 10% market share in the US, but market share isn’t really the right term here because it can be used at the same time as its competition.  Europe has a TAM of another $1.2 billion (the ASP is Europe is expected to be a bit lower).  ROW TAM is another $3.4 billion.

So the TAM is reasonably big.  It’s not like Endari is going to top out in a few months and stop growing its market.

Given that I think the stock isn’t pricing this in.

On the risk side, I have lot’s of questions.  First, why is Emmaus doing this?  They said they don’t need capital and its cheaper to merge than an IPO, which is fair.  They also get the $60 million or so of net operating losses, so that’s a reason.  But I have to think that after the lock-up (120 days) some of these early investors will want out.

Second is the risk that Endari falls flat.  I have no reason to think that from what I’ve read, but the drug is an improvement, not a cure.  I am also no biotech expert.  There are also a bunch of drugs in the pipeline that are a few years from approval and will be competition.

Third, I’m not sure how far off that competition is.  Both Global Blood Therapeutics and Novartis have recently received fast track designation for their drugs.  It’s not completely clear to me what that means for approval.

Fourth, the spin-off of the psychiatric business is likely to get sold hard when it happens.  Everyone now is buying for the interesting business and the not-so-interesting business is an afterthought.

Fifth, I don’t know much about Emmaus beyond what is on their website and what is in the disclosure documents.

Sixth, if the government shuts down again god knows when this will close.  I’ve been waiting on Eclipse and Blue Ridge to close for like 8 months now.

Seventh, prior to the merger it seems like there was quite a bit of management deals on shares and related party transactions from the not-so-interesting businesses they operated.

There are others, but that’s a few to ponder.

Nevertheless it seem like a decent speculation at this price.  And it let’s me write something up quickly and keep new years resolution #4.

Week 394: New Years Resolutions

Portfolio Performance

Thoughts and Review

Here are a few investment resolutions for the new year:

  1. After a stock has a good run, I will sell a decent amount of it, no matter how much I like it.
  2. I’ll stay away from illiquid stocks that will be hard to get out of in a bad market
  3. I will stay away from stocks with high levels of debt
  4. I will be very thoughtful before purchasing any stock not generating free cash flow
  5. Be selective
  6. Post more!

These resolutions could also be described as Lane Sigurd’s investment strategy for a bear market.

Some of them are at odds to how I have invested over the long bull market we’ve been in.  Over that time I held my winners and watched them turn into two, three or five baggers.  I didn’t worry about debt.  In fact I coveted levered stocks that would really run if the tide turned.  I didn’t give a second thought to liquidity because I was always able to get out.

I think we are still in a bear market.  Maybe we’ll top out soon, maybe we’ll run back up near the highs, I don’t know.  But I am positioning myself based on the expectation that in the next few months there will be another leg down.

Having said that, there is a bit of good news.  The Weekly Leading Index looks like it might be putting in a bottom.

Is it possible this is just another 2016-like blip?  Possibly but I’m still going with the bear market view.  Maybe I’ll have to change my mind on it.  But not yet.

Looking back, December was a tough month, but I had a lot of cash and that helped cushion the blow.  And while I was not lucky enough to go all in at the bottom I did pick at a few positions in December, and the positions I held onto had big runs in January.  So I sit here now at (somewhat shockingly) new portfolio highs.

I’m a bit surprised by that.  My portfolio still has some 70% cash after all.  The market still isn’t great.  It’s really just a bit of luck and timing really.  A number of my remaining positions had big runs.  Liqtech took off.  Gran Colombia took off. Vicor, Golden Star and Wesdome all had nice moves.  UQM Technologies got taken over.  I bottom fed on a few small positions (Identiv, UQM and a few oil names) that all had really nice bounces off the bottom.  Meanwhile I went a few weeks where none of my positions went down.

Having had good performance while not owning very many stocks makes me think that in this market I would be better off being selective than to go with my more usual shot-gun like approach.   In the past I’ve taken small positions in a bunch of stocks, even if I wasn’t completely sold on them all, and watched whether they would develop.  A few would become big winners and I’d add to those as they went up.

I’m not going to do that in this market.  Instead I’ll hold cash and wait for stocks that I have a lot of conviction with.  We’ll see how it works.

So it was a pretty good month.  But I am not overstaying my welcome.

True to my first resolution, I have been selling my winners.  I sold out of three of my trades entirely already (Identiv, Tetra Technologies and Lone Star).  I reduced my Liqtech position by half.  I reduced Gran Colombia and Vicor as well.

I sold some losers too.  I got rid of Roxgold, Gear Energy and reduced my position in Empire Industries.

One stock I’m not selling is Wesdome.  As much as I love my other gold names, the more I dig into what Wesdome is onto at Kiena, the more I love it the best.  It’s not cheap I know, but its got so much going for it.  It’s in Canada and not in an area with questionable politics.  There are two mines with great potential for expansion.  But what I really love about the story is just how cheap the growth from Kiena will come for.  Something I had overlooked in the past were comments by Wesdome management that the mill at Kiena is worth $100 million.  That is basically a $100 million asset that was useless that is now an integral piece of their development plans.  That they can bring Kiena on-stream (and I’m seeing estimates from anywhere between 90,000 oz to 130,000 oz from brokerage for the project) for $50 million is about the most efficient gold development project I’ve seen.

As for my last resolution, I have been lax about posting.  It’s harder to post in a bear market.  Even when I get up the courage to buy a stock, I have weak conviction because of the market.  I find that it takes a lot of conviction to write about something because mentally it kind of ties you to the idea.  That makes me reluctant to lay out a thesis when I might get scared and sell a week or two later.  Or worse, I might hold it because I wrote about when I really should be selling.

UQM Technologies is a good example.  I bought it in November, sold it, then bought it again in December.  I didn’t write about it either time, even though it was a great story.  I was just worried the market might keep falling and I would be doing another round of selling if it did. UQM would be a stock I would cut.  Fortunately the market turned around and I didn’t.

I’ll try to put aside those fears in the new year and write about my positions more.  Even if I look at all of them right now as having the time frame of a pin-pulled hand grenade.

Portfolio Composition

Click here for the last seven weeks of trades.