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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.

Nuvectra

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.

Week 294: It doesn’t matter how you get there

Portfolio Performance

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Top 10 Holdings

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

Thoughts and Review

It’s a seminal moment for the blog!  For the first time in what seems like forever my largest position is something other than Radcom.  Thanks to more than doubling in price in the last four months (and even after pulling back from $6 to $5), Identiv now holds that honor.

At the beginning of November I wrote the following about Identiv:

I tweeted a couple of times this morning that I don’t think this stock makes sense at a $20 million market cap… The company has a $55 million trailing twelve month revenue run rate, they are showing growth, they are EBITDA positive now and it’s not an insignificant amount of EBITDA.  That feels like it should warrant at least 1x sales.

We are already at a $55 million market capitalization but with momentum at the company’s back I haven’t sold a share.

A second position, RMG Networks, has also ran up the ladder, and now sits as my fourth largest position at a little less than 5%.

I wrote this about RMG Networks when I first took the position in late June:

With the focus on the new verticals and improve productivity of the sale force new opportunities in pipeline are up over 40%.  And here is where we start to see an inkling that the strategic shift is bearing fruit.  In the sales pipeline, Michelsen said that the number of deals $100,000 or greater has increased by 50% in the last year while the number of $1 million deals have tripled…My hope is that these early signs of sales improvements lead to an uptick in revenues in short order.

We are starting to see that pipeline bear fruit.  The entire move has come in the last two weeks.  The stock has moved from 70 cents to a dollar on news that they had secured contracts in the healthcare vertical and converted one of their previously announced trials into revenue in the supply chain vertical.

Finally, a third company, Combimatrix, which I wrote about earlier this week, is beginning to run and take a more significant position in my portfolio after releasing solid fourth quarter results.

So that’s all great, but the reason I mention these three examples is because they illustrate how bad I am at predicting how things will play out.   In the second half of last year had you asked me what my portfolio would move on I would have replied it will rise and fall on the fortunes of Radcom and Radisys.

Flash forward a few months and my portfolio has moved significantly higher and Radcom and Radisys have done nothing.  Radisys has actually went backwards to the tune of 20%.  Whodathunkit.

This is why I carry so many positions.   A. I’m a terrible timer.  The events that I think are imminent take months or years to play out, while the events that I think are distant have a habit of manifesting much faster.

Second, my favorite ideas are often not my best one’s.  I have no idea why this is.  If I did I would change my favorite ideas.  But it’s uncanny.  I’ll sit on a thesis like Radisys, work it into the ground to understand it in depth, and then along will come a Health Insurance Innovations, which I will buy on a bare thesis (in this case that the Affordable Health Act will be repealed and this is going to be good for HIIQ) and when the dust settles I’ll have more gains from the latter than the former.  Its kinda crazy.

I guess as long as you are moving in the right direction it doesn’t really matter how you get there.

Portfolio Changes – Adding Silicom

I added a couple of new positions this month.  The Rubicon Project and Silicom.

Silicom got hit after releasing what I thought was a pretty good fourth quarter.  The company traded down to $35 from $39 pre-earnings.  I’ll try to get a more detailed write up out on Silicom at some point, but the basic points are:

  • This is a $250 million market capitalization company with $36 million of cash and no debt
  • It’s trading at a little over 2x revenue and just guided 15% growth in the first quarter and double digit growth for the year
  • Their past seven year compounded annual growth rate is 26% and growth was 21% in 2016.

Silicom designs a wide range (over 300 SKUs) of networking, cybersecurity, telecom and storage products. These are generally board level and appliance level hardware solutions.

They expect their security vertical will grow double digits, their cloud vertical will “grow significantly” and that a contribution from SDWAN will kick-in in 2017 and is expected to become a “major growth area”.  They said that over the intermediate term they see a larger opportunity in their pipeline than they have have in the past.

Already the stock has rebounded on news of a significant contract for encryption cards that will ramp in 2017 and reach $8 million in sales in 2018.

I’ll talk more about Rubicon Project in an upcoming post.

Apart from these new positions I did a bit of tweaking of my positions, adding a little to Nuvectra and Combimatrix, reducing my position in Bsquare and selling out of DSP Group.  I also have added to my Vicor position in the last couple of days (subsequent to the update end so not reflected in this update).

Taking advantage of Bovie Medical Weakness

I also added significantly to my position in Bovie Medical.  The stock sold off on news that their pilot project with Hologics for selling the J-Plasma device would not be extended.    As I tweeted at the time, I didn’t think this was as big of news as the market did.

To expand on my reasoning, Hologics has a particular business model they follow for their instrumentation and disposable business, of which J-Plasma would have been a part (from 10-Q):

we provide our instrumentation (for example, the ThinPrep Processor, ThinPrep Imaging System, Panther and Tigris) and certain other hardware to customers without requiring them to purchase the equipment or enter into a lease. Instead, we recover the cost of providing the instrumentation and equipment in the amount we charge for our diagnostic tests and assays and other disposables.

So they go “full razor blade”.  Bovie on the other hand, generates significant sales from generators.   The average selling price (ASP) for a generator is much higher than 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

So the models aren’t aligned.

Second, Hologic’s Gyn Surgical business segment (consisting of the NovaSure Endometrial Ablation System and our MyoSure Hysteroscopic Tissue Removal System) is a $400 million business so J-Plasma is microscopic for them.  They may not have been inclined to bend their model for Bovie.

Also worth noting is that Hologics wasn’t even mentioned in the Bovie 10-Q whereas the agreement with Arteriocyte that was mentioned favorably.

Finally the language used on the third quarter conference call around Hologics wasn’t exactly definitive:

Well, as you know, the sales channel partnership with Hologic,right now,is in a pilot phase.  So we wouldn’t be in a position, if we were to disclose the economic relationship, until that’s a permanent agreement.  So the pilot portion of our partnership will go until the end of February.  So you could look at some period after that before we can announce a permanent relationship and we’ll decide at that point in time if we’re going to elaborate on the economics of the relationship.

The agreement with Hologics hadn’t generated material revenue so there is no hit to the bottom line.  And in a separate press release (which oddly was released on the same day as the Hologics information but didn’t get on their website for a couple days after), Bovie reiterated guidance for 2017, including “accelerated growth for J-Plasma”.

I think the stock sold off in the following couple of days because its small, illiquid and under followed, not because this agreement was meaningful to the company.  So I bought.

Portfolio Composition

Click here for the last four weeks of trades.

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