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Wading into another Biotech: Eiger Biopharmaceuticals

As I have talked about on occasion, I am a newbie to biotechs.  To help with my learning curve I rely on a number of biotech investing gurus .  One of them is, Daniel Ward, and over the last few months I have gotten a couple of ideas from him.  One of these is Eiger Biopharmaceuticals (EIGR).

What I like about Eiger is that they have five trials in mid-stage development and plenty of data readouts in the short term.  So (in theory at least) they shouldn’t have been killed by any particular read out.

But that thesis hasn’t played out as I had hoped yet.  The stock tanked a few weeks ago from $11 down to below $9.  The collapse coincided with data presented at European Association for the Study of Liver (EASL) conference in April.   The results were for phase 2 studies that were investigating how their drugs Lonafarnib and (to a lesser degree) PEG IFN Lambda were successful in targeting the Hepatitis Delta virus (HDV).

These aren’t the only programs that Eiger has in progress.  In total there are 5 programs, targeting 5 indications with 4 different drugs.  In addition to the two drugs targeting HDV, Eiger has a Post-Bariatric Hypoglycemia program, a pulmonary arterial hypertension program and a Lymphedema program.  All of the programs are in Phase 2.

I’m not going to go into all the programs in this post (its long enough already).   I’m going to focus on the Phase 2 results for Lonafarnib that were presented at EASL.   For more detail on the other programs, there is a good presentations archived on their website from the BIO CEO conference that describes all the programs and gives some background into the HDV indication that I won’t get into here.

Eiger and HDV

So to recap, Eiger has two drugs targeting HDV: Lonafarnib, which they obtained from Merck, and PEG-IFN Lambda (Lambda), which came from Bristol Myers.  Both of these drugs are in Phase 2 of development.

Three phase 2 studies were presented at EASL.  LOWR HDV-2, 3, and 4 as listed below.  The LOWR HDV-1 program had been completed and presented in 2015.  LOWR-2 had already had early results presented in 2016.  LOWR-3 and LOWR-4 were brand new data:

The LOWR-3 and LOWR-4 programs looked at different dosing options of Lonafarnib boosted by another drug called Ritonavir (Ritonavir is a drug used for HIV and you add it to the mix to improve efficacy).  LOWR-2, which also looked at dosing, had an additional wing of the study where a number of patients trialed a 3 drug cohort that included PEG-IFN-Lambda in addition to Lonafarnib and Ritonavir.  This was the only part of any of the studies tha looked at Lambda, which will have its own results presented later this year.

So what happened to make the stock tank on the results?  First, they weren’t perceived to be as good as earlier data.  The most apples to apples comparison that can be made is between the 100mg leg of the LOWR-3 program and the LOWR-1 program.   Here are the results from the earlier LOWR-1 program after four weeks:

The LOWR-3 program gave 100mg of Lonafarnib and 100mg Ritonavir once daily for 12 weeks to 3 patients. So that should be comparable to the red bar above. The abstract from LOWR-3 is below. The relevant sentences are about 3-4 lines down in the results section (ignore the highlights, they are just artifacts of a word search I was doing).

The mean log decline for LOWR-3 at the 100mg dosage was 0.83 log IU/ml.   This is quite a bit less than the red bar from the earlier program.

The LOWR-3 study was more comprehensive than just the 3 patients taking 100mg Lonafarnib for 12 weeks.  There were also 3 patients at a 75mg dose and 3 others at 50mg that took the drug for 12 weeks (I’ll talk more about these in a second). In addition to this there were 12 more patients given the drug for 24 weeks (at the same dose increments of 50mg, 75mg, and 100mg).  In the abstract it said that six of these 24 week patients saw greater than 2 log IU/ml decline in HDV RNA, so that’s good.  But there was no mention of an average HDV RNA decline for all 12 patients, which seems an odd omission.  It would be nice to see the entire paper to get all the data.

A second study, LOWR-4, looked at an increasing dosage.  In this study 15 patients were given gradually increasing dosages of Lonafarnib.  They started 50mg Lonafarnib, escalated to 75mg if tolerated and then to 100mg.  They were also give 100mg of Ritonavir throughout, just like the other study.  Below is the abstract.

The mean decline in HDV RNA for this study was 1.58 log IU/ml which, while below the 2.4 log IU/ml from the LOWR-1 study (remember again the red bars from above), is not too bad considering the dose was lower for some of the study.

Maybe the more interesting take-away from the LOWR-4 study was that the standard deviation of patients was +/- 1.38.  I Maybe misunderstanding what that means but it seems like a lot of dispersion to me.  I suspect it suggests that the drug performance has a large degree of variability in different patients.

So far what I’ve described is how Lonafarnib didn’t work as well as previous studies, but that it still worked pretty well.  There was a definitive decline in HDV RNA levels, and it was well tolerated in all 3 studies, so there is no reason a patient couldn’t stay on the drug longer to presumably greater affect.

I think the final piece of the puzzle of why the stock went into a tail spin is evident when we look back at the 12 week dose comparison from the LOWR-3 study (the one I said I’d come back to).  I briefly mentioned how in addition to the 100mg Lonafarnib arm there were other patients taking 75mg Lonafarnib and 50mg Lonafarnib along with Ritonavir.  A comparison of the results of these different wings is surprising:

After 12 weeks of therapy, the median log HDV RNA decline from baseline was 1.60 log IU/mL (LNF 50 mg), 1.33 (LNF 75 mg) and 0.83 (LNF 100 mg) (p = 0.001)

According to the above, the lower dosed patients had a better response(?!?).  This is odd to say the least.  I don’t think the market liked that.

The LOWR-2 results also showed increasing the dosage had a murky impact on efficacy.  I’ve pasted that abstract below.  As I mentioned earlier, this is the second presentation of LOWR-2, as it was completed earlier than LOWR-3 and LOWR-4.  There is a video of the earlier results that were presented here.

As the abstract describes, one arm of the study had 25mg Lonafarnib twice daily along with 100mg Ritonavir.  Those patients saw a mean log decline of 1.74 log IU/ml (albeit for 24 weeks), quite a bit better than the higher dosed 12 week patients from the LOWR-3.  I realize this comparison is not quite apples to apples, but again, it adds to the cloudy picture around efficacy and increased dosing.  Indeed the study concluded that “low dose regimens had comparable antiviral efficacy with less GI side effects than the high dose regimens.”

By far the best piece of news from the LOWR-2 study (and I think what the market is really overlooking) was the outsized effect of the arm that used Lonafarnib, Ritonavir and Lambda together.  Repeating the relevant excerpt from the abstract (my underline):

[Lonafarnib] 25 mg BID + RTV + PEG-IFN alpha, however, resulted in a mean log decline of -5.57 ( ± 1.99 log10 U/ml), with 3 of 5 (60%) subjects becoming HDV-RNA PCR-negative and 5 of 5 (100%) of subjects achieving HDV-RNA BLOQ

In the conclusion the authors speculated at a cure:

NF 25 mg BID + RTV + PEG-IFN alpha leads to the highest rate of HDV-RNA PCR-negativity on 24-week treatment, and suggests that LNF and PEG-IFN lambda have synergistic activity. These regimens are generally well-tolerated, supporting longer duration studies of greater than 24 weeks, which may lead to HDV cure.

Note: In my original write-up I mistakenly equated PEG-IFN alpha with PEG-IFN Lambda.  I didn’t pay enough attention to the Greek symbol being used.  These are different drugs.  Alpha was used in the 3-drug tests with Lonafarnib that I talk about here.  But in future tests Lambda will be used.  Lambda is the drug that Eiger owns.  Eiger says that Lambda has similar downstream signaling pathways as Alpha and that because it targets a different receptor it is expected to have less side effects.  But obviously this means there is a little more uncertainty than if Lambda had been used in the 3-drug trial.  So my conclusions below are a little less pronounced.

To get a better sense of just how well the 3-drug cohort worked, I snipped this screenshot from the earlier presentation of the results.  The 5 patient group taking Lambda in addition to Lonafarnib and Ritonavir is in green.

This seems quite promising.

What do I think of all of it?

Well for one I think it’s a great learning experience for me.  I’m digging into data and trying to make sense of it, and at the end of this investment I’ll be able to look back and see what I got right and what I got wrong and hopefully learn a lot for the next time.

With respect to the HDV phase 2 results, I suspect that the stock has overreacted.  I understand that the results are messy, but there is clearly efficacy here.  Maybe the most important point to consider is that Lonafarnib is producing a large standard deviation and these are a small sample of results.  So the noise is producing some inconsistent data.

Moreover, it seems very significant to me that the 3 drug combination that includes Lambda had such impressive results.   With two drugs in development for HDV there are a number of ways Eiger can win here.

The other consideration that I haven’t focused on in this post is that this is only one of Eiger’s programs.  As I mentioned earlier they also have a Lambda program, a Post-Bariatric Hypoglycemia program, a pulmonary arterial hypertension program and a Lymphedema program.  Each of these are in Phase 2 and will have read-outs this year.

There are a lot of shots on goal here.  And this is a $70 million market capitalization stock with $60 million of cash, so its not pricing in a lot of success.  Again, I would recommend going back to their presentations to learn more about the other programs.  I’ll probably talk more about each of them as new data comes out.

Silicom Design Wins

I took a starter position in Silicom a couple months ago.  I did so because I thought their products were aligned with the software/hardware decoupling that is occurring.  But I kept my position small until I saw more results.

Those results came a couple of weeks ago when the company announced a huge design win for a 100G switch fabric network interface card (NIC):

Silicom has received initial purchase orders (POs) in the aggregate amount of $17 million to cover a small-volume Alpha phase, an intensive Beta program and the product’s first commercial deployment. Having completed deliveries for the Alpha phase, Silicom is now in the process of delivering the Beta-program products while completing two additional activities: 1) finalizing the product configuration and validating the solution’s performance within the servers in which the Silicom products will be deployed, in cooperation with a Tier-1 server manufacturer; and 2) ramping up product manufacturing to a full mass-production level. Based on the customer’s guidance, Silicom forecasts that revenues related to the design win will build to more than $30 million per year.

I added to my position after the news release.

I was surprised that the stock didn’t move more on the news.  I bought into the stock early in the day on the 21st at around $46-$47 but saw it tail back down to $45 as the day went on.  It seems to be just a slow response; on Friday the stock had butted up against the $50 mark (editors note: maybe not! It’s Wednesday now and $50 is no more!).

If Silicom achieves the $30 million run rate they expect, I think this contract has a pretty big impact on the valuation, enough that it maybe isn’t even all priced in, even after the $10 move.

Below I’ve added the $30 million onto a 15% growth estimate (my own estimate, Silicom has said double digit growth for 2017) and assumed that expenses (R&D, G&A) grow by half as much as revenue (the company has said that their business model is levered to growth and that the “majority” of new gross margins will fall to the bottom line, so I think this is reasonable).

I might be too optimistic about the growth rate, maybe some of that $30 million should be part of the 15%.  Everyone can judge that for themselves.  I’ve chosen the assumption because I like the prospects.

If I’m not, at $50 the company is trading at 10x forward EBITDA.  Given 30%+ growth in 2017, it’s not an aggressive multiple for that kind of growth.

Let’s look at the products

I am hopeful that this high growth rate is sustainable.  Silicom has products aligned to a number of growing segments.  To understand my enthusiasm, let’s take a closer look at the product line.

I’m still a little foggy on terminology here so I apologize if I am classifying something wrong.  Most of what Silicom sells falls under the broad category called network interface cards (NICs).  Under that category are server adaptor cards, which is where the majority of their NICs, switches, and FPGA cards.

So what do these cards do?  They provide network connectivity and offload tasks from the CPU (buffer storage, processing packets, that sort of thing) so that the appliance they are working with can run more efficiently and focus on the dedicated tasks they are intended to do.

The cards come in a variety of flavors. There are different network speeds (1G to 100G) and different tasks they are designed to offload.  These are things like data encryption, acceleration (where a chipset on the card performs some CPU tasks at times of peak usage) , data compression, time stamping, and bypass, which recognizes failure of an appliance and reroutes data when it occurs.  There are also FPGA cards, which are programmable, and can made to handle a custom task.

You can see the full list of flavours here.  Below I’ve taken a screen shot of the highest level breakdown of the product line, just to get a feel for what the options are and what the cards look like:

There are also higher end programmable cards using FPGA chips (field programmable gate arrays).  The FPGA cards are an “efficient way for the advanced user to achieve even lower latency and to implement any filters or acceleration that are necessary for a specific application.”  These cards are used in “networking, financial and big data solutions” applications.  The FPGA based solutions are a product line that was came with the acquisition of Fiberblaze in December 2014.

Recently Silicom has had design wins for time stamping with a Tier 1 monitoring company (which I read somewhere was likely Gigamon), for encryption cards with a former customer that they had lost 3 years ago, the aforementioned very large win for a 100Gb switch fabric NIC, and most recently for by-pass cards to be used with a cyber security appliance.

Silicom also has a number of stand-alone products.  There are switching solutions, network appliances and a product that converts off the shelf servers into appliances (SETAC).

Silicom describes their growth opportunities as being in cloud and in cyber-security.  The cyber-security opportunity is pretty straightforward; their cards piggyback off of cyber-security appliances providing a network interface and offloading CPU tasks.  The cloud is a catch-all for many different opportunities, including integration of their cards into monitoring, packet processing, and switching – pretty much anywhere where workloads can be offloaded from a CPU, thus creating efficiency.

SD-WAN Market

Also part of cloud is Silicom’s entry into the SD-WAN market.  I’m going to talk about this one in more detail because I think its potentially a big opportunity, and has the visibility to get the company noticed by analysts.  Their product is an off-the-shelf virtual CPE solution.

SD-WAN is one of the first applications to embrace network function virtualization, or NFV, something I ramble on about when talking about Radcom or Radisys.  SD-WAN entails the decoupling of software from hardware for routing traffic at edges of the network.  As such, traditional proprietary appliances are replaced with “software application running on inexpensive appliances to implement a flexible traffic routing solution between branch offices and the Cloud” (from this article).

Demand for SD-WAN from service providers is surging.  Silicom already has two design wins for SD-WAN appliances.  The first is with Versa Networks, where Silicom is one of three companies (along with Advantech and Lanner) providing hardware.  They announced the win in September.  A second win was for an SD-WAN customized vCPE appliance, which is expected to scale to $5 million annually, and was announced in November.  In this case the customer wasn’t announced, but my guess is its Velocloud, which seems like a likely bet to be an existing encryption card customer.

This SeekingAlpha article suggests that SD-WAN deals could be in the $10 million range, which is a lot bigger than the typical win Silicom has.

As part of the second win, Silicom said this in the press release:

“In fact, the customer’s forecast is another clear demonstration of the momentum of the SD-WAN market, as both enterprises and service providers begin adopting the new technology to enable their transition to the Cloud, NFV and the virtualized environment. We believe that our favorable positioning in this market, due both to our basis in the WAN Optimization market and the unique new technologies that we have developed, will enable us to benefit strongly from the momentum of this ‘hot’ new market space, making SD-WAN a significant new revenue driver for Silicom.”

Silicom also announced that the same customer that they had a by-pass card design win from was “considering the potential use of Silicom’s vCPE appliances as part of its Cloud offering”.

So I like the idea and hope to see more wins

Silicom’s gross margins are generally around 40%, which implies that the “moat” for their products is not very high for a technology company.  While this may be a bit concerning, what I find interesting is that they seem to be the largest non-integrated competitor in the business.   As this SeekingAlpha article points out, Silicom has nearly 200 different SKU’s whereas their nearest competitor (interface masters) has 35.  The large integrated players (Intel for example), are way bigger of course, but they also don’t offer the range of solutions that Silicom has (being constrained to their own chipsets).

I really like this idea.  I think Silicom has the right product set at the right time, ready to take advantage of the shift towards using commercial off the shelf hardware to accomplish more tasks.  I think the recent $30 million design win is not fully being priced into the stock at current levels, and yet it may only be a harbinger of what is to come.  I bought the stock in the mid-$30’s and added in the mid $40’s.  I would probably add one more time on another big win.

Week 298: Keep on Truckin

Portfolio Performance


Top 10 Holdings

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

Thoughts and Review

No great insights this month.  My portfolio continues its upward climb even as the market stalls.  I continue to be buoyed by my large position in Identiv and more recently my large position in Radcom.  Combimatrix is consolidating in the $4’s but it looks healthy and I am hopeful it will break out on another leg up soon.  Silicom has helped a lot and I will talk more about that shortly, as has Supernus.  I still have a bunch of stories that I think are on the cusp and waiting for that final catalyst, Radisys, Vicor, and maybe even CUI Global, which I wrote about a little earlier this week.  Overall, no complaints.

New Position: Daseke Inc.

I added a new position in Daseke after reading this write-up by Dane Capital.  The story seems pretty straightforward.  Daseke is born of a special purpose acquisition company (SPAC) that acquired the previously private company, its trading cheaply relative to its peer group (see chart below from their presentation) and is in an industry that should see a tailwind as economic activity, infrastructure spending and oil and gas capex pick up.  There is not point repeating what Dane Capital already wrote so I recommend going to the article for the details.

I added both warrants and shares.  I’m not really sure whether the warrants are fundamentally overvalued or undervalued compared to the shares, I just thought they represented a good upside given that the stock is probably around two times EBITDA lower than it should be and that if it traded up to an appropriate level it would get to the high teens, which would be a triple for the warrants.

What I added to

I added to four companies over the past month.  In each case I was persuaded by an upbeat outlook about the future that was given by management on the calls.  I’ve already written my thoughts on Vicor.  Likewise I wrote up CUI Global just the other day.

I also added to Accretive Health, which has changed its name to R1 RCM.  I last talked about R1 RCM here.  Not much has changed, they are making progress on-boarding Ascension and finally moved their stock over to the NASDAQ.  I figured the NASDAQ listing would be a bit of a catalyst, so I added the day prior to that.

Finally I added to Silicom on this news.  This is just a huge contract for the company with an $17 million initial purchase order and $30 million expected annual run rate.  I read somewhere that the customer is likely with Gigamon.

I do intend to write-up Silicom, I just keep getting tied up with other stories, and I wanted to spend time understanding their whole product suite before putting any post up.  The good news is that as I have dug more, I have become even more comfortable with the company.

What I sold

On the sell side of the ledger, I already wrote about my sales of Nuvectra and Rubicon Project, and my reduced position in Bovie Medical.

In addition to these names I also sold the last of Willdan Group.  Willdan has been a great name for me.  I added the stock in the single digits, around $8, and am selling the last of my shares in the low-$30’s.  The business is still humming, and the company seems to have shifted to an acquisition strategy that so far is fueling further growth.  Yet at this price I just feel like the upside is priced in, with the stock trading at 25x the upper end of their 2017 guidance (which is $1.20 diluted EPS).

A couple late Biotech Buys

I also bought starter positions in a couple of mid-stage biotechs at the end of last week: Eiger Pharmaceuticals and Inotek Pharmaceuticals.  I got both of these names from Daniel Ward, who comes up with a lot of good ideas.  I’ll try to write up some details on both companies in the near future, but you can get a pretty good overview of the investment thesis if you listen to their recent conference presentation (Eiger at the BIO CEO and Investor conference and Inotek at the Cowen Healthcare conference).

The Catalyst Biosciences Catastrophe

Finally there is Catalyst Biosciences.  This is so painful.  So on Friday I put in a market order for Catalyst in the practice portfolio.  I always use market orders with the practice portfolio because it doesn’t always work to put in limit orders.  With limit orders sometimes you get filled, sometimes you don’t, even if the stock moves below your limit.  But because I didn’t like the bid/ask spread on Catalyst (it was something like 5.20/5.45 at the time, so really big), and because the stock bounces around a lot, in my actual account I put in a limit order at 5.10.  I liked the stock because it was at a big discount to cash, but it didn’t seem like there was any reason to chase it.

It was with great pain that I watched the open this morning.  Catalyst opened in the $9’s and proceeded to move to as high as $18.  I made a killing in my practice portfolio (its not reflected in the update because this update is for the four weeks ended last friday) but I made nada in my actual account.

I hate, hate, hate limit orders.  I rarely use them and this is a big reason why.  If you want to buy a stock, buy it.  If you want to sell it, sell it.  All the pennies I may save putting in limit orders over the next year will not amount to what I should have made on Catalyst today.  It makes me a little ill to think about it.

Portfolio Composition

Click here for the last four weeks of trades.

CUI Global Fourth Quarter: Slowly inflecting

I’ve had a small position in CUI Global since last summer.  I first wrote about it here.  The thesis has been that their gas measurement technology (called GasPTi) is quite a bit better solution than traditional measurement techniques, that slower than anticipated adoption from utilities has punished the stock but that adoption of the technology is on the verge of inflection.  But even at the time I wrote rather presciently:

Given this trajectory, it’s most likely that even if the story works out it will A. be delayed longer than anyone would have expected and B. have a number of false-starts and hiccups before finally showing consistent growth.

Since that time the corner of that inflection continues to be turned, just not very quickly.  Not surprisingly the stock hasn’t done much.

Until the recent quarter the company gave me little reason to add.  In fact, prior to the quarterly release I reduced my position a little on anticipation that the market would react negatively to what seemed like a near certainty to me: that their major customer for the GasPT product, Snam Rete, would continue to be delayed in installing gasPT units because of a regulatory hang-up, making the  fourth quarter and likely first quarter guidance sub-optimal.  Even though this should have been widely anticipated, small caps are forever inefficient and so I thought it probably wouldn’t be.

That is exactly what happened.   The company reported a crummy fourth quarter revenue number ($19 million versus $23 million in the third quarter), and much reduced sales from their energy segment ($5.6 million versus $7.1 million in the third quarter).  The first quarter guidance was no better.  The stock has sold off since.

Yet I feel tentatively optimistic about the company’s prospects.  I added to my position, but just a little.  Here is my reasoning.

First, though Snam Rete continues to be held up by a regulatory hurdle, I am inclined to believe management when they say that this will be resolved.  They commented that Sanm Rete has a team working with the regulator, that they have worked through similar issues before, and that Sanm Rete is close enough to resolution to have originally thought it would be resolved by year end.

As long as you believe the management story, it doesn’t seem like this is anything insurmountable.  And a single news release noting that the hurdle has been cleared will likely lead to a resumption of Snam Rete’s run rate of 100 GasPT unit installations a month and a significant pop in the stock.

(100 units at $15,000 per unit is $4.5 million per quarter, which would boost their energy segment to almost double the fourth quarter level)

While the poor results and stand still on Snam Rete have taken the focus, the news that has been ignored is that CUI Global did get another big player on-board.  I was way off in my original write-up, thinking such an event would be a huge catalyst for the stock.  I wrote:

I don’t think you can sit on the sidelines and wait and see how it plays out.  Because the next contract, if it happens, will likely be the big move when it happens, and the stock will gap before you can react.

Well they announced that next big player, ENGIE, a large French grid operator, but obviously the stock did not respond as I had anticipated back then.  To be fair they don’t have a signed PO in hand, only an agreement for collaboration and a lot of positive color around the deal on the conference call.  The market probably wants more.

In addition to France, ENGIE also has ties to PetroChina and owns pipelines and LNG in China, a market where there have been discussions about taking the GasPT product into.  So this are potentially two markets that the company can penetrate.  The CEO, Bill Clough, didn’t put a lot of numbers to ENGIE on the call, but in the past has said that the opportunity in France is around 2,500 GasPT units (these would be higher pressure units requiring the VE probe for analysis and that therefore would have a higher ASP then the units they sell to Snam Rete in Italy), and he did on the call refer to negotiations of a 1,000 unit project that are ongoing.

One other development mentioned both in the release and on the call was a change in regulation by the UK gas regulator, OFGEM, which will make GasPT units acceptable for smaller installations.  Clough said that “once approved our European and UK customers will be able to replace gas chromatographs with our GasPT simply because the economics favor our solution”.  I’m not sure how big this opportunity will be, but it is expected to materialize into POs shortly.  They also have the previously announced $40 million engagement with National Grid, a UK utility.

Finally, in the electro-mechanical business they continue to talk enthusiastically about their ICE block solution, which is a software/hardware solution for data centers that is intended to reduce power consumption.  They said that this year they have ICE block units being tested by “several industry-leading data center operators”, mentioning on the conference call  a Fortune 100 DC operator, Fortune 500 DC operator, top tier data center hardware provider (this was all previously announced in this February press release).  They also added fourth company in one of largest ecommerce platforms in the world

I’m not as sure about the ICE block opportunity as the GasPT one.  They are a partnership with a company called VPS, where they are essentially the hardware provider for the VPS software.  VPS describes the ICE Block here, and it doesn’t sound like the hardware is a very important part of it, so what exactly the upside is isn’t clear to me.

Nevertheless even without ICE block, the opportunities with GasPT are enough to keep me interested for now.

While none of this has translated into a positive revenue number or a guidance breakout yet, it all feels very directionally positive to me, and seems more and more like the hockey stick of the inflection is just a matter of time.

Talking about the losers: RUBI, NVTR and BVX

I have a lot of losers.

My investment methodology leads me to take small positions in stocks that I’m not entirely sold on.  These are cases where I haven’t had the time to investigate all the details, or maybe I’ve looked at the company closely and while I see a big enough pay off to justify some risk, I’m still not sure about the odds.

Rather than stay away from these stocks, I take small positions and see how they play out.  I don’t know why this works for me, but it does.

There are two potential consequences of this strategy.

  1. The stock goes up. I maybe am not completely sold on the story yet, but I tend to add anyways. With a bigger position I do more work, get some helpful hints from others, gain confidence in the story and have a winner
  2. The stock goes down. In this case having some skin in the game motivates me to look harder.  When I do I generally either find something I really like and break my rule by adding to my position on the drop, or find something I don’t like, take the loss and move on.

I think the classic example of the second scenario playing out positively is my old position in MGIC in 2012.   I bought the stock at maybe $2 or $2.50, at the time didn’t really understand the details of their mortgage insurance business (I would argue few did!), especially not how the capital requirements worked.  I added a bit on the way down, but more importantly figured out how they allocated reserves and how the dynamics of their statutory balance sheet worked.  Thus I knew exactly how important it was when management said on (I think) the second quarter 2012 conference call that they were getting calls from investors interested in raising capital (the company’s issue all along was liquidity), and I was adding stock while the call was still going on.

I never would have learned enough to pick up on this detail had I not already had a position in the stock.

So that is the positive side.  The more common result of course is that I find something I don’t like and I sell.  Take my lump (usually 10-20%) and move on to another idea.  The important thing is to cut them quick if they aren’t panning out.

Somebody once messaged me (derogatorily I might add) that I should just throw darts.  I like to think I’m a little more discerning then that, but I get the point.  My reply is that this works for me and if you think you can beat the returns I seem to pull of for the time I have to put into the research (I work full time and have two kids), then more power to you.

Here are some thoughts on three losers I’ve had recently.

Rubicon Project

Why spend hours writing a free blog? Well one reason is because as you are writing something up it becomes quite clear if your idea is full of shit.

I started writing up Rubicon Project 2-3 weeks ago.  I couldn’t finish it.  I put it down, came back to it, did some more research.  I just couldn’t figure out what the header bidding disruption meant to their business.

Management said it was manageable.  That it would be a headwind to their desktop advertising but that they would get past it.  But I read that header bidding was going to compress margins for everyone.  That there was more disruption ahead with the adoption of server side heading bidding.  It didn’t add up.

The fourth quarter results are out, and while the company actually performed admirably in the quarter, the first quarter guidance was just awful.  They guided revenue in Q1 in the $40’s (millions) when analysts had expected it in the $60’s (which was still a notch down from the year before).  Thankfully I kept my position small, and reduced a little ahead of earnings because I couldn’t make sense of it.  I sold the rest in after hours.


I have to give a hat tip to @Rubicon59 (no relation to Rubicon Project) for helping me suss this one out.  I bought Nuvectra because I thought they had a very good technology (spinal cord stimulation with their Algovita system) and a fairly large total addressable market and so with the right sales push they could generate some impressive growth.  They had a lot of cash, almost their entire market capitalization.  And it was even a legitimate spin-off idea, even had an SA write-up on them.

They still might generate that growth.  Probably will.  But the cost side of the curve is just so out of whack, it’s hard to see how they do it before running out of cash.  Particularly after announcing a fourth quarter, where G&A and R&D costs were (respectively) up from $8 million to $10 million and $3 million to $4 million sequentially.

Just to back of the napkin it, the company generated about $12 million of revenue in 2016. We can say that at least roughly, the Algovita system is going to give them 50% gross margins.  R&D and G&A costs added up to $42 million.  These costs increased as the year went on.

The company said at the Piper Jaffrey conference last November that they figured a good target for a sales region was $1-$1.5 million in 12-24 months.  Right now they have about 50 sales regions.  So you assume they hit the high end of that, they can generate $75 million of revenue, and at 50%, $38.5 million of gross margins.  Problem is that’s still less than current expenses.

I realize they also generate some component sales, but even so the numbers don’t come close enough. and It seems like anything other than the steepest of ramps and they are going to be looking to raise capital in a couple of quarters.  So I’m out.

Bovie Medical

I wrote about Bovie in my last portfolio update.  I provided a pretty detailed explanation as to why I thought the concerns over Hologic were likely unfounded and therefore why I took advantage of the drop in the share price.

It was a well researched, well reasoned piece of tunnel vision.

I spent a bunch of time looking at Hologic and trying to confirm or discredit the idea that Hologic was a concern.  What I didn’t spend any time is whether the third quarter numbers were goosed by Hologic even though they hadn’t actually sold any devices.

How is that possible?  I provided most the information that you needed in my post when I said:

The average selling price (ASP) for a generator is much higher than a hand piece so Bovie generates a significant slice of their revenue from it.  From the 2015 fourth quarter conference call :

I guess when you think about it, the generator ASP is north of $20,000, the hand piece ASP is $375

The other relevant piece of information comes from the third quarter call, where Bovie noted that their partners had been purchasing machines for their sales ramp.

So in the [revenue] number our demo product that we armed both Hologic and Arteriocyte sales forces with that is in the number

What never occurred to me (and what I am kicking myself over) was that obviously the third quarter J-Plasma sales were juiced by demo generators.  Keep in mind J-Plasma revenue was a little over $1 million in the third quarter.  It’s not a big number, it only takes a couple of extra generators to skew it significantly.

Unlike Rubicon and Nuvectra, I reduced my position a bit but did not exit it entirely.  Bovie has a lot of positive catalysts on deck in 2017; two new iterations of J-Plasma that will be marketed in the second half, results from a clinical study using J-Plasma that should raise awareness among surgeons, a new partner to replace Hologic (it sounds like they have a number of interested candidates) and a sales ramp from their CONMED partnership for the PlazXact Ablator.

So there is enough reason to continue to hold the stock, especially down here below $3.  But I sure wish I would have saw what was in front of my face a little bit sooner.

RMG Networks Fourth Quarter Earnings: Still waiting for a step in the top line

I had hoped that RMG Networks would have a blowout fourth quarter.  That didn’t turn out to be the case, but I’m still optimistic about the company and am holding onto my position.

The drag continues to come from the Middle East.  Overall, sales in the fourth quarter were $10.7 million, down from $11.8 million in 2015.  North American sales were up substantially, increasing 25% year over year.  But Middle East sales were down $2.4 million for the quarter year over year, which is just a huge number when you consider that sales for the Middle East were  only $3.4 million for the entire year in 2015.

Below you can see the dynamic.  North American sales have taken off while overall sales have been held back by tough year over year comps in the Middle East.

Now maybe, just maybe this headwind is starting to abate.  First, comps for 2017 are going to be easier because the Middle East generated so little revenue in 2016.   Second, because oil prices are stabilizing they are starting to see things pick up in that region.  On the conference call they said:

I can tell you that obviously we have a plan for every quarter, for each of our geographies and our plan for Q1 for the Middle East we have already completed contractually all the sales required to hit our number for Q1 in the Middle East and that is a dramatic change from 2016

They went on to say they are negotiating another large deal, I believe for the new RMG Max product, with a new customer in the Middle East.  If it closes, the deal would be the “single largest” in the quarter.

The company also provided an update on their partnerships.  It sounds like the Airbus DS Communications partnership (announced in August) has gained the most traction.  The partnership is expected to launch in the first quarter when Airbus releases their next gen 911 system called Vesta which RMG is integrating a display solution with.  They said they had already received $100,000 of orders in advance of the launch.

The Regan partnership, of which I believe the primary motivation is to introduce RMG Networks to new customers, has allowed them to “reach more than 200 companies and have 20 active leads”.

Finally Manhattan, where the update was the least specific of the three, the comments were limited to how the two companies are holding joint webinars and sales training.  Michelsen (the CEO) had said on the third quarter call that they expected to see results with Manhattan in early 2017 but there wasn’t any indication of that on the fourth quarter call.  So we’ll have to watch that one closely to see how it develops.

Overall RMG Networks remains pretty positive about the impact of partnerships.  In response to a question, Michelsen said that achieving 10% of 2017 sales from partnerships was “in the ballpark”.  So we will have to see how 2017 unfolds and whether this forecast holds up.

Finally, the company said the pipeline of sales deals is progressing positively.  The overall size is up about 20% year over year, the larger deal count is up about 1/3 and the average deal size is up 17%.

Overall it was directionally positive quarter, but we need to see this translate into sales.  In my opinion, the first quarter is big.  With the Middle East no longer a headwind, with Europe “improving” and with an expectation of strength in North America, there is no reason that the first quarter won’t be good.  It needs to be or I’m going to start questioning why all the positive “color” is not translating into numbers.  I’m hopeful I won’t have to go there.

Vicor Fourth Quarter Results: Modeling the Ramp

I’ve owned Vicor for over a year.  During that time I’ve been twiddling my thumbs waiting for the promised revenue ramp.  It looks like it’s almost upon us.

The company had a bad fourth quarter: revenues down sequentially from $53 million to $48 million, gross margins down sequentially 17%, negative EBITDA.   But as the stock price attests, none of this matters because guidance and color around the VR13 ramp was excellent.

I first wrote about Vicor back in March of 2016.  The thesis remains the same:

The story going forward is simple.  The company says that with recent design wins and product launches, in particular wins for new data centers that will utilize the VR13 standard (more on that in a second), as well as high performance computing, automotive and defense, they can grow revenue 3-5x in the next couple of years.

Here’s what’s happened between now and then:

  1. 3 quarters of delays in the Skylake Intel chip necessary for the VR13 standard to take off and with that for Vicor to capitalize on its design wins (I’d recommend going back to read my previous post to get the details on the VR13 chip and Vicor’s integration with it), and
  2. the Skylake chip is finally available (at least in pre-production) and fourth quarter suggests a turn is upon us as Vicor has started to ship power converters for VR13 design wins.

The company said on the fourth quarter call that they had “began to ship the VR13 version of [their] 48V point-of-load solution” and that shipments of the VR13 solutions would “ramp more steeply” in the second quarter. Shipments for the 48V point of load solution increased 15% sequentially in the fourth quarter and the 1 year backlog would had risen 14.8% sequentially.  They expected at least 10% sequential revenue improvement in the first quarter.

With the story on the verge of happening, the questions become A. what’s the end game and B. is there enough upside in the stock left.  Keep in mind that even though we are only starting to see the story blossom, the stock is 50+% higher than when I first bought it.

I’m not much into detailed modelling.  I do some models, but they are pretty half-ass compared to what you will see from professional research.  I don’t have a lot of time, and I find that I am better hedging my uncertainty with position sizes and stops then pretending that I can put together an accurate model that I can rely on.

I make a model to get one or two basic answers.  At what growth rate does this company get profitable or at what growth rate does the current stock price start to look cheap?

It was the second question that I needed to answer with Vicor.

I would call Vicor a modeling play.  It seems reasonably clear that revenue is going to ramp.  Its just a question of how quickly and by how much.  The end game is that they reach their objective of 3x revenue in the next 3 years.

Here’s the model.  It’s the same model I put out a year ago, tweaked for current run rate expenses and guidance.  I’m not trying to model 2017.  I’m looking ahead at what the company is saying they can do with revenues as the VR13 data center opportunity ramps to its full capacity.

I’m accepting management’s comments that operating expenses are dominated by headcount, that they don’t expect this to scale with the top line increases, and that most of top line growth will drop to the bottom line. I’m also assuming that management’s assertion that gross margins can transition to the low 50%’s by the end of 2017 is correct.  And my long-term target is a little over 2x revenue, not 3x revenue.

The stock price doesn’t look too bad after considering that there is this kind of upside.  I almost never buy options, but I decided to buy a few October calls on Vicor.  It seems like a reasonable situation for it.  The ramp is going to happen in the next 6 months.  The potential numbers that are materializing should be pretty clear by the fall.  If this is going to play out like Vicor says it will, its going to be clear shortly.  I hope they’re right.