Archive for

Jul 20

Week 366: The Wishy Washy Portfolio

Portfolio Performance

Thoughts and Review

I’ve done a lot of flip-flopping over the last 6 weeks. I couldn’t get comfortable with certain oil producers, I couldn’t get comfortable with oil servicers and I couldn’t get comfortable with the copper stocks. I also owned and then sold Cameco and Energy Fuels before settling on buying the debentures for Energy Fuels.

These transactions weren’t trades. I don’t really trade in my portfolio. But I often buy into ideas that I am not completely committed to. Having a position clarifies my conviction. If I don’t have it, I’ll sell a few days later.

As it turns out it probably wasn’t a bad idea to step away from these ideas. The oil servicers, which I will talk about below, have done little. Copper stocks, which I talked about here, have done even worse. Cameco has floundered.

What I have added and stuck with over the last 6 weeks is RumbleOn and Smith Micro, both of which I have already talked about, GeoPark, which I’ll talk about another time, and Overstock, which I’ll talk about right now.

Overstock

When I first wrote about blockchain I said I found it interesting because: “it’s a way of dis-embodying trust into technology. The middle man disappears. The skim shrinks. Everyone (other then the middle man) benefits.”

Since that time crypto has gone to the moon and crashed again. While its easiest to base an opinion on the latest bitcoin price, I don’t think that is necessarily correct. I still think the premise of what blockchain promises has value. It just has to find ways of being integrated into applications that have broad usage. If I were to bet, I would say that the current lull in sentiment will pass and that blockchain will come back into vogue in some new form relatively soon.

So let’s talk about Overstock.

I bought the stock two weeks ago after tZero announced that they had received a $100 million letter of intent (LOI) from GSR Capital.

Like most things with Overstock, its a fuzzy data point. First, its an LOI, which doesn’t really mean anything is certain. Juniors on the Canadian venture exchange love to use LOI’s to put out big numbers and generate big hype (coincidentally I will talk about a situation like that shortly!). The deals often don’t amount to anything.

Second, GSR Capital looks a bit sketchy. This post from CoBH kind of makes that point. Of course you can dig in the other direction and find less bearish takes on what GSR is doing.

I’ve always thought of Overstock as a stock that has an asset value with a huge standard deviation. You can create a legitimate case that the stock is worth $30 or $80. There is that much uncertainty about outcomes.

It’s all about buying it at the right place within that band.

Being able to buy the stock in the low $30’s (I got a little at $31, more at $32 and the rest at $33), especially after there was incrementally positive news, seemed like a reasonable proposition to me.

The GSR investment, if it is followed through, represents the first time in a while that something Byrnes has hinted at actually happened. So I’m getting it at the bottom of the band and with a positive data point to boot.

When I sold Overstock in January and February it was because the projections Byrne had made a quarter before were not coming to fruition.

He had said the stock lending platform had billions of inventory and would start making money shortly. But in the tZero disclosures in December there was no mention of the stock platform at all!
He had talked about partners knocking at the door. But all that materialized was Siebert and a couple of other tiny acquisitions.
He talked about the mysterious man in the room and one other big opportunity he had. This turned out to be De Soto, a very interesting idea but something that he himself has said that he only “thinks” can make money.

Byrne also talked at length about the Asian money that was interested in tZero. That was another strike out. Until the GSR investment. Now its not. So something actually panned out.

Its clear that the advanced state of tZero that was described at the end of last year was exaggerated. It also seems likely to me that Byrne was not entirely aware of the state of the software. Witness that the CEO of tZERO was replaced by Saum Noursalehi, who was moved over there to add a “Silicon Valley” mindset to tZero:

But I think this is going to become an innovation game. I think that by putting Saum there, I mean he’s extraordinarily able as an executive anyway, but in terms of managing innovation, Saum and I have a decade’s history of working together on [O lab] And other things that have changed our company and I don’t think anyone I’ve met in New York was going to be able to compete with what I know Saum has in mind.

tZero was supposed to offer a stock lending platform and would be on-loading inventory they had accumulated. That didn’t happen and they are now in the business of licensing it out. The software also probably wasn’t all that functional; on the first quarter call Noursalehi said they were (only now) building out the functionality to allow you to carry the digital locate receipts for intra-day periods. That this wasn’t available in the original software is odd.

They are also only in the process of building out the token lending platform, which is to say there is nothing operational yet (one of the first major red flag I mentioned from the tZERO memorandum last December was that the security token trading system was described as something that still needed to be built!).

Of course the sale of the e-commerce platform, which was supposed to be done by February-March, is ongoing and now more of a “souffle”.

So there are lots of negative spins you can make here. On the other hand they are forging ahead with the tZero platforms, they have over $250 million of cash on the balance sheet and another $320 million from the tZero token offering (if you count GSR and all the executed SAFEs), and the sale of e-comm is still ongoing, so there is the potential for a positive resolution there.

There is also the initiatives to transform e-comm into something that is growing. While these are still in the early stages it seems to be working. So that’s just another probability to add to the list.

Most importantly, at a little over $30 buck a lot less of the positive potential is priced into the stock then at $80.

Look, Overstock is what it is: a stock with a lot of optionality, a lot of uncertainty, operating in an brand new industry that I don’t think any of us know how it will play out in the next 5 years.

So speculators pretend that the price of bitcoin is somehow a proxy for the state of blockchain. It’s probably not. I didn’t buy Overstock as a quick trade to capture a short pop on speculation of GSR. I actually think at $33 it represented a fair value for all the risks and rewards. So I’ll see wait for the next data point how and evaluate from there.

Wanting to Buy Oil Services but can’t

I’m not a trader. When I get into a stock its with the intent of sticking with it for 6, 12 or 18 months or however long I need to in order for the idea to play out.

So when you see me in and out of a stock in a short time frame it usually has nothing to do with trading. Its just indecision.

Such has been the case with the oil services stocks where I’ve been in, out, back in and back out again.

What’s going on? I’m being torn between two sides.

The bull side is simply this: oil is up, growth in production needs to come from the US, and oil servicers should benefit. The stocks are extremely cheap if their businesses are on a growth path.

The bear side is that all of the on-shore servicers are exposed to the Permian, Permian capacity constraints are going to kick in this summer, and volume and pricing of drilling and completion services are going to get squeezed.

I should probably just walk away from the idea. The stocks don’t act well. Considering that this should be a bull market, the action is even worse.

What keeps me interested is just the absolute valuations. Below are 5 companies with average EBITDA multiples for 2018 and 2019 (these prices are from a week or so ago but I don’t think anything has moved much since then so I haven’t updated them).

Seems cheap? That’s what I thought.

But when I buy any of these stocks, all I do is fret about them.

The problem is the Permian. RBN put out a really good piece describing how the infrastructure bottleneck in the Permian is likely to play out, and what the alternatives now. Unfortunately it’s behind a pay wall.

The issue is that there isn’t enough pipeline capacity to get the oil out and new pipeline capacity won’t be finished until the second half of next year. So you have about a year of constrained takeaway.

Source: PLG Consulting

As RBN pointed out the alternatives to pipelines have their own constraints. Rail can only carry as much as the available tankers and loading capacity. This is less than 100 thousand barrels a day.

Trucking is theoretically unlimited but the logistics of bringing in trucks and truckers caps it in reality. A single truck can carry about 180 barrels a day. So for every 10,000 barrels a day of production you need to add 100 to 150 trucks and drivers.

The Permian accounts for about 50% of activity in the United States onshore. As an oil servicing business its hard to avoid the Permian. Exposure of the companies I’ve looked at varies from 30-60%. Solaris has about 60% of their fleet in the Permian.

But just how much of a hit will these companies take? That is the other big question.

According to the company’s themselves, they are insulated. They talk up their long-term contracts, how they are dealing with the stronger operators in the region, and how these operators have secured takeaway capacity and hedged their exposure and thus will be able to keep drilling.

But are they really? I don’t trust them. We won’t really know until the second quarter calls start hitting and they have to fess up about the state of their operation.

So what do you do?

For now I’m back out. I think.

The only exceptions are a couple of non-Permian related servicers that I own. Cathedral Energy, which I don’t believe has as much exposure to the Permian (though they do have some), and Energy Services of America, which is a pipeline builder in the Marcellus/Utica that has a host of their own problems but the Permian is not one of them.

RumbleOn

I was worried that my lead touch was failing me. I am resigned to the fact that I take positions in stocks where I will have to endure months of it doing nothing or going down before it actually begins to move as I suspect it should.

RumbleOn moved as soon as I bought it and before I was even able to get a write-up out.

<sarcasm>Fortunately</sarcasm>, that situation was rectified as the company offered a little over 2 million shares at $6.05.

In retrospect, the entire move to the mid-$7’s and back to $6 was probably bogus. I don’t understand all the in’s and out’s of these share offerings enough to be able to tell you why, but I’ve been held hostage to enough of them to know that this sort of activity seems to be part of the process.

So what do I think of the move to raise cash? I don’t see it as a big deal either way. I had thought they might use their recently created credit facility to bridge the gap to profitability. I figured given the management holdings they’d be reluctant to dilute. But whatever. If the business works the 2 million shares is not going to matter much to where the price goes.

I used the opportunity to add more.

Mission Ready

I have been patiently waiting for 9 months for something to happen with Mission Ready. I haven’t said much (anything?) about the company since I wrote about them last September. That is because essentially nothing has happened.

Nine months with no news (after announcing a massive LOI) is pretty ridiculous. There is a valid argument that I should have walked away. But something about the company made me think its more than just a hyped up press release with nothing behind it. For sure, the stock price has held up incredibly well since September considering that nothing has happened. So I have stuck it out.

Now maybe we get some news? The stock is halted.

Is this the big one? And is the big one a rocket or a bomb? No idea. But I am excited to find out.

Gold Stocks

Back in May when I last talked about the gold stocks I own I wrote:

…these stocks are more of a play on sentiment. I think all I really need on the commodity side is for gold not to crash.

I should have knocked on wood.

That said, the gold stocks I own have held up pretty well. Wesdome is up a lot. Gran Colombia is up a little (albeit it was up a lot and has given back most of those gains). Roxgold is roughly flat, as is Golden Star. Jaguar Mining is down a bit. Overall I’m up even as the price of gold is down over $100.

I still like all of these names. But whereas my original thesis on each name was based on the micro – I simply thought each stock was cheap given its cash flow and exploration prospects, I am actually getting more bullish on the macro. Even as gold has fallen.

This tariff thing is becoming the shit show I thought it would be. I expect further escalation before any agreement.

There are a lot of US based commentators that think other countries will be rational and give in to their demands. I really don’t buy that. I think its got to get worse before that happens.

I’m Canadian. So I am on the other side of the tariffs being introduced. My visceral reaction when I hear of a new tariff being introduced against Canada or I hear Trump make some inaccurate or at least unbalanced comment about Canadian subsidies, is “screw them – I would rather go into a recession than give in to that BS”.

Now you might say that is an irrational response, that it is not reasonable, and point out all the reasons it is wrong. Sure is. Doesn’t matter.

If that’s my response, I bet that is also the response of a lot of other Canadians, and of a lot of other citizens of other countries. We would rather see our government’s stand up for us then be pushed around.

You don’t think that all the other foreign leaders don’t realize that? Look at what Harper just said: that Trudeau is manipulating the NAFTA negotiations because he can gain political points. Maybe, maybe not. It wouldn’t be that surprising. Does Trudeau get more votes next year if he can say he stood up for Canadians or if he says he buckled under because it was the right thing to do? You think the European leaders look stronger if they give into US demands? Same thing for China.

My point is we are all going to stand up for ourselves. It won’t be until we all see (including the US) what it feels like to be sinking in the boat that we reconsider. Right now this is a matter of principle and what is rational is irrelevant.

I expect the trade war to escalate. And gold to eventually start going up.

DropCar, Sonoma

I sold out of both DropCar and Sonoma Pharmaceuticals.

DropCar has been a disaster. When I wrote the stock up I said it was highly speculative, even for me. But I have to admit I didn’t expect it to crash and burn so quickly.

I don’t like selling a stock just because its just dropping. If there is a negative data point that comes out, then sure I’ll dump it in a heart beat. But random drops are frustrating and I often will hold through them.

But the DropCar collapse was too much and I reduced my position in April. That turned out to be a good idea. I sold the rest of the stock after the first quarter conference call. It was just such a bad call.

During the Q&A they were asked about gross margins. They could have provided a long-term speculative answer, talking about how margins are being pressured because of their growth and the drivers they are hiring, and how long term they expect margins to settle in the mid-teens or low twenties.

They didn’t have to be specific, they just had to spin it positively. Instead they basically deferred the question. We aren’t going to talk about that. You can maybe get away with that answer when things are going well, but when you just announced a negative gross margin quarter you just can’t.

Anyways, I sold.

The other stock I sold was Sonoma Pharmaceuticals. Sonoma had what was just a really bad quarter. Sonoma had been growing consistently for a number of quarters and much of my thesis here was simply a continuation of that trend. That didn’t happen.

The problem is if they don’t grow they are going to have to raise cash again. They have a limited run way. The company kind of implied on the call that this was a blip, but it wasn’t enough to convince me with certainty. So I figured I better sell and wait to see what the next quarter brings. If they are back on track, I will add it back. There is still a lot I like about the story.

Portfolio Composition

Click here for the last six weeks of trades. Note that I added Energy Fuel stock to the practice portfolio because I couldn’t add the debentures (a limitation of using the RBC practice portfolio). Also note that Atlantic Coast Financial was taken over and my shares converted but this didn’t happen in the practice portfolio (they just stay halted in the RBC practice portfolio). That’s another change I will have to manually make before the next update.

Jul 12

10 Comments

New Position in RumbleOn: Selling Used Motorcycles Online

I wish I had finished this write-up a day early. I do not like writing up a stock that just went up 15%. But that’s where we are with RumbleOn. I’ve been working on the research and writing all week and then the stock goes parabolic today. I see no news to speak of. Anyways it is what it is, and like all my ideas I’m in this for the long term (insofar as the thesis holds up). Having said that, buying a stock up 15% the previous day is generally not a great idea.

I got the idea a month or so ago from a search of stocks at their 3-month high. When I’m bored and looking for ideas I will go to the 52-week highs or 3-month highs or some other simple price movement screen that gives a signal of strength and I’ll dig into some of the names.

I’ll look for a name that I haven’t heard of, usually keying on one that is small, and I’ll do a bit of work to see if its worth a closer look.

Anyways that’s how I found RumbleOn.

What was fortunate about the timing was that I had just been looking at Carvana. Carvana operates an online used car business that is similar to what RumbleOn does for motorbikes. When I looked at Carvana I couldn’t believe how expensive it was. When I looked at RumbleOn, I couldn’t believe how cheap it appeared in comparison.

Having dug into it further I’m still of that mind. In fact it seems to me that RumbleOn has a better business model than Carvana. I’ll give that comparison in a bit, but first let me describe what RumbleOn does.

An Online Motorcycle Marketplace

RumbleOn operates an online marketplace for buying and selling used motorcycles. They have a website (rumbleon.com) as well as an iOS and GooglePlay app.

The company makes cash offers for bikes to individuals looking to sell. If accepted, the bike is shipped to one of their regional partners (dealers), inspected and reconditioned and then put up for sale on the site.

Anyone can sell their bike to RumbleOn. Upload the vehicle info, fill out a form, add a few pictures and RumbleOn will make you a no-haggle offer. Its good for 3 days and you either take it or leave it.

It’s meant to be the opposite of going to a dealer or selling the bike yourself. There is no haggle, no pressure tactics, and you won’t deal with tire-kickers or nitpickers.

For a while RumbleOn also bought bikes through auction and had dealer inventory on their site. However they’ve stopped both as their retail acquisition channel has become self sufficient. They do buy bikes via some auto-dealers that take them on trade but don’t have a marketplace and just want to get rid of them.

Early on the goal was to insure that the site had adequate inventory. So the company reached for it from other channels. They are now focused entirely on generating inventory through consumers.

Buying a bike on RumbleOn is geared to be just as simple. Pick a bike from the available selection and put down a $250 deposit. The full price of the bike is paid in cash or financed through an unaffiliated bank or credit union partner shortly after.

Unlike most of the online used car dealers (like Carvana), RumbleOn is agnostic to who they sell the bikes to. Most of the car selling sites are focused on the consumer channel.

RumbleOn does that, but they also sell to dealer and auction channels. At the moment dealers are most of the business (via online and through auction). They made up 91% of sales in the first quarter while consumers made up just 9%.

The company expects to build out the consumer channel as awareness of the brand grows. This is a new business, a little over a year old. Marketing of the app and website should grow the percentage of sales coming from consumers. I expect all the channels will grow but that consumer sales will grow the fastest.

Margins on consumer sales are higher so they are the preferred customer. With a dealer sale RumbleOn has to share the margin.

In the first quarter dealer sales had an average selling price of $8,874 at a 7.8% margin while consumer sales had a $12,207 selling price and 13.7% margin.

Gaining Traction with Consumers

The website and app are only about a year old. Consumer momentum takes time. AppAnnie and Alexa show that both the website and the app are growing in popularity.

AppAnnie Ranking

Alexa Traffic Rank

Bringing retail owners and buyers to the site is all about experience. RumbleOn needs to make the experience, both for buying and selling a bike, as painless as possible.

Buying or selling a bike is not a lot of fun. The alternatives to RumbleOn are selling your bike yourself or selling to a dealer. If you sell yourself then you will inevitably “suffer the tirekickers and hagglers and deal with shaky payments”, in the words of one Harley rider commenting on a forum about the service. Selling to dealer likely means haggling, waiting onconsignment or a lower price than what RumbleOn can offer. Buying a bike offers the same problems in reverse.

What RumbleOn has to do is make the experience so effortless that its worth your while to give up a little margin.

It’s a trade-off to bike enthusiasts. Reading the reviews of RumbleOn and reading through forums where bike riders talk about buying and selling their bikes, its something that potential bike sellers are very aware off.

The most common complaint you hear about RumbleOn is that their offers are too low. But most bike owners also understand what they are getting in return for the margin they lose (which amounts to maybe $1,000). They get guaranteed cash and no hassle. They do not have to live for weeks or months with strangers coming over to their garage, trying to push a lower on price, and dissing their bike on minor issues. They also recognize that the offer price is usually better than what they’d get from a dealer.

Sales Growth

So far the model is working. Bike sales went from 355 in the fourth quarter of last year to 878 in the first quarter. The company said they expected that to double again in the second quarter.

I was a bit worried about how they could double sales when the website/app bike inventory seemed to be stagnating. At the end of the first quarter inventory was a little above 1,000 units, whereas now it is slightly below that number.

But it turns out this isn’t the case. Inventory has been rising. The appearance of stagnant inventory is because of the removal of dealer listings.

Adding Bikes

If you go back to the first quarter call management was asked about the disappearance of the dealer listings:

And then just as a follow up, it looks like you’ve taken the dealer listings off the site, is that a temporary thing or is that a permanent change?

Marshall Chesrown

Yes, I wondered if someone is going to say that. We have a plan – we’re getting ready to launch as we said some really, really interesting enhancements, I will be interested to get everybody’s feedback on them with regards to the website and we do see a huge opportunity to be a significant listener of vehicle both for consumers and dealers but we want to do it in a different format and I won’t get into all the details of it but I would tell you that before the quarter you will see what that plan is as it’s rolled out.

Excluding dealer listings, inventory has grown from ~125 in November of last year, to ~300 in March and now to a little over 1,000 today.

My take is that inventory procurement is the gating factor. The company has said that themselves. On the fourth quarter call CFO Steve Berrard had this to say:

This is really a buying product challenge. It’s not selling it. We proved we can sell it by the fact you know, when is the last time you heard a vehicle retailer have days-turns in the 20s, because the market is there to sell it. It’s buying of it, that’s the bigger challenge for us.

A key metric to watch will be how well they continue to acquire inventory. The ramp over the last 3 months as well as the confidence they showed by removing dealer listings are positive data points.

Acquiring inventory is all about making lots of offers and getting the owners to accept them. To expand inventories RumbleOn needs to:

ramp offers
improve acceptance rate

The ramp of offers is all about using technology to streamline the process:

We already which is very early in the cycle earlier than we anticipated we already do not have data people but data is being produced by our system and the data that we have we simply have a supervised whether it is released in those vouchers if you will, those cash offers. We have gone from being able to do about 20 an hour with the new technology enhancements, a single supervisor can do about an 100 an hour

Cash offers were 3,900 in the fourth quarter. That improved over 200% in the first quarter to 12,000. On the last call they said they were on pace to double cash offers in the second quarter.

Acceptance rates on those offers have been trending in the right direction as well. Acceptance rates were 12% in the fourth quarter rising to 14.9% in the fourth quarter. Chesrown thinks they can get this as high as 20% over time.

So all good signs. Even so I feel like obtaining the right inventory at the right price is going to remain the big challenge for the business.

Reviews

Case and point: if you look for negative reviews of the company, what you find will almost inevitably be a bike owner complaining that the offer RumbleOn made for their bike is too low.

The business is based on the premise that you are saving enough in terms of time, hassle and getting a guaranteed cash payment to make you willing to give up the $1,000 that you might get if you sold the bike yourself. And this is an equal or better price, all with less hassle, then you’d get if you went to your local dealer to sell.

You can find reviews of RumbleOn on BBB, Facebook, GooglePlay and on the Harley Davidson forums.

Other than the complaints about the offer prices the reviews are almost all positive. Customers get paid for their bikes on time, they receive their bikes quickly and they are consistent with what was ordered. The app is easy to use, it’s a simple process to get an offer on your bike and likewise it is easy to purchase a bike.

Guidance for the year

The company reiterated their full year guidance. They expect $100 million of revenue in 2018 and “in excess” of 10,000 units for the full year.

They changed the way they are getting to the $100 million from what they said on the previous call. Management had previously guided to $100 million but on 8,100 units sold. Their mix has changed. Rather than expecting sales would be dominated by Harley’s they now expect a better balance between Harley’s and non-Harleys. Harley’s are higher price, lower margin units.

This is a really new business and I don’t feel like management (led by CEO Marshall Chesrown and CFO Steve Berrard) know exactly how all the levers will play out. They’ve been surprised by the number of non-Harley’s, surprised by the number of dealers buying, and surprised by the strength and margins they are getting from the auction channel.

Nevertheless I’m pretty confident that Chesrown will navigate his way through this. The guy has a impressive background.

Management

Chesrown started off selling cars first in San Diego and then in Colorado, where he was managing 17 dealerships by the time he was 25. He started his own dealership chain soon after which was eventually bought out by AutoNation for $50 million. He has been called the “best used car salesman in the country”. There is a great biography of his early life in this article in the Inlander.

After making a fortune in the auto business Chesrown tried his hand in real estate development and lost it all in the crash of 2008. But not to be deterred he went back to his roots and founded Vroom in 2013.

Chesrown was COO and a director of Vroom until 2016, when he left to start RumbleOn. Though Vroom has hit on harder times this year, it was valued at over $600 million last year.

There are some similarities between the model used by Vroom and RumbleOn but there are also differences. I get the feeling Chesrown learned there and the learnings are now being applied. There have also been a number of executives that have left Vroom for RumbleOn.

Steven Berrard, the CFO, also has a pretty crazy history. He was the CEO of Blockbuster in the 90s, left there to work with (his friend?) Wayne Huizenga as COO of AutoNation, and from there took over Jamba Juice and eventually became CEO. He also led Swisher, which eventually ran into accounting problems but that was all after he left.

It’s a little nuts to me that these guys are leading an $80 million market cap company.

The management team and directors own a lot of shares. Together its about 75% of the Class A and Class B shares. Chesrown and Berrard own 36.5% between the two of them, and together the two own all the (1 million) Class A shares, which have 10:1 voting rights and effectively give them full control over the direction of the company.

Profitability

Buying and selling motorbikes online is new but buying and selling vehicles is not so much. In addition to publicly traded Carvana and Vroom, there have been Beepi, Shift, Fair, Auto1, Carspring and Hellocar and a bunch of others.

These companies haven’t all been successful. From what I can see Beepi, Carspring, and Hellocar all ran out of money. Shift and Fair seems to be doing ok, though Shift has had some bumps in the road by the looks of it. Auto1 is a German company that seems to be doing well.

I think the basic problem with theses businesses is what you see in Carvana’s financials. It takes a long time to get cash flow positive. Carvana has already been around for 5-6 years and yet when I look at the estimates it doesn’t look like they are expected to generate positive EBITDA until 2020.

So these companies need a source of funds to keep themselves going. When those funds dry up, like they did for Beepi, the business goes away.

RumbleOn has similarities and differences here. This is low margin and always going to be. In the first quarter RumbleOn had gross sales profit, which is defined as the difference between the price RumbleOn bought the bike and the price they sold it at, was $1,132 per bike, or 12.3%. Gross profit, which includes costs associated with appraisal, inspection and reconditioning, was $788 per bike, or 8.6%.

The average margin on a Harley was 7.5% while for non-Harley Davidson’s it was 13.1%. Non-Harley’s seem to have a higher gross margin than Harleys, which has to do with their lower price point.

So it’s a low margin business and always will be. So RumbleOn needs to be tight on expenses and focused on volume.

That’s why I think the thing I like best about what I hear from Chesrown and the RumbleOn management team is their focus on getting to profitability and inventory turns.

They want to get RumbleOn to cash flow positive quickly.

Breakeven

Berrard laid out where they would be in terms of costs by the fourth quarter. They also said the goal is to be cash flow positive by the fourth quarter. Guidance for the year is $100 million of revenue, 10,000 bikes sold.

To get to the unit sales guidance they need to sell 4,500 bikes by the fourth quarter, up from 878 in the first quarter. I’m assuming they hit their second quarter guidance of doubling bikes sold in the second quarter.

I took all the guidance information and made a few assumptions around consumer sales (expecting it to rise from 9% in Q1 to 25% in Q4) and their warranty financing (expecting uptake/dollar value to rise from 35% in Q1 to 53% in Q4), and I came up with a break-even model (thanks to @teamonfeugo for helping me work the kinks out of the model).

So I don’t know if this model with be accurate. The business is new, there’s some guessing on my part and I’m just going on what we know from the calls. But what is clear is that the growth is significant and if they can get there by Q4, then 2019 should be the year of cash generation.

It’s also worth noting that margins so far are primarily driver by the vehicle margin. Companies like Carvana are generating about half their margin from financing and warranty sales.

Comps

RumbleOn has 12.9 million shares outstanding. So at $6.25, which is roughly the average price I bought the stock at (I know its ran up the last couple days but I don’t want to redo all of this again), the market cap is about $80 million.

Compare that to Carvana, which has a market capitalization of over $6 billion. Carvana is of course much bigger. But on a per unit basis, RumbleOn looks very reasonable.

Carvana has higher gross margins per unit than RumbleOn but that is because of financing, service contracts and GAP waivers. As sales to consumers grow RumbleOn can expand these other offerings.

On just a pure selling price minus purchase price basis, once scaled RumbleOn has pretty comparable margins to Carvana. It also took them a lot less time to get there (Carvana vehicle unit margins were only about $600 as recently as last year).

It’s hard to look for comparisons from the other online car companies. Vroom, Shift and Fair.com are all private and I can’t find much information on valuation or how many cars they sell. The only somewhat interesting observation I can make is that in terms of unit inventory (this of course being cars for these three companies versus bikes for RumbleOn), they do not appear to be significantly larger. Vroom has about 2,500 cars on their site, Fair has a little over 7,000 and Shift only has about 800. RumbleOn was a little over 1,000 at last glance.

Multiples

Here’s a table of what RumbleOn’s market capitalization looks like at different revenue multiples and $100 million of sales. The 3.4 multiple is based on Carvana’s forward 2018 revenue multiple.

I realize the numbers are high, but it is what it is. I’m using the company’s guidance and Carvana’s multiple. Consider that RumbleOn is growing faster than Carvana at this point.

What sort of multiple does RumbleOn deserve? I’m sure you can make an argument that because the margins are low, the multiple should be low. That’s one perspective. But they are also growing like a weed. And then there is Carvana. If Carvana gets almost a 4x multiple, I don’t see why RumbleOn shouldn’t get at least something above 1, probably more. That multiple should grow as they become more established.

I realize that the used car market is way bigger and so maybe there is a premium for that. But used bike sales aren’t exactly small themselves, especially compared to RumbleOn’s size. According to their S-1 there were 800,000 motorbikes sold in 2016 and 50% of those are done on a peer to peer basis. Then there is the eventual expansion into other sports vehicles. RumbleOn also doesn’t have the 5-10 online and gazillion bricks and mortar competitors fighting with them for share.

What to look for

First, I want to see the website inventory continue to expand. Offers should continue to grow and acceptance will hopefully increase. At the same time their days sales are equally important. That number was 42 in the first quarter versus 38 in the fourth quarter. Carvana days to sale were 70 in the first quarter, down from 93 year over year. RumbleOn has focused on turns and needs to continue to do so.

Second, I want to see consumers comprise a greater percentage of sales, and (ideally) I want dealer sales to take place more and more through the website. But most of all I just want to see sales grow.

Third, I don’t want to see their costs blow up. Costs are going to increase as the business scales but they should also come down to their targets in terms of percentage of revenue.

Fourth, at some point I expect they will expand into other sport vehicles. They’ve mentioned expansion into ATV’s, UTVs, snow machines and watercrafts as other targeted areas.

Conclusion

Online used vehicle selling is a tough space to be in. Carvana has a great chart this year but there was a lot of skepticism (and a high short interest) when it went public.

A lot of other players have ran out of cash. Beepi, Carspring, Hellocar and now Vroom have all struggled.

But all these guys are all selling cars. I think RumbleOn has some advantages selling bikes.

They are much easier to transport.
They are a niche market compared to used car sales and thus more difficult to sell yourself via Craigslist or Kijiji.
They don’t have the same level of competition online. And their traditional dealer competition is arguably less savvy than the used car dealer incumbents (remember that a lot of used car dealers take bikes on trade but don’t want to sell them, so they are actually a source of inventory to RumbleOn).

They are also offering a quick cash, no haggle, simple model for buying and selling bikes in a business that has traditionally relied on squeezing extra margin by making the process as difficult and opaque as possible.

The other advantage here is that RumbleOn is 100% online. On the last call they talked about how they can scale without adding to headcount outside of marketing and technology. They basically operate out of a single building. They aren’t even touching the inventory themselves.

The other advantage RumbleOn has over most (not all) of the online car players is that they’ve involved the dealers. Like I said earlier they are agnostic on the distribution channel. They will sell to consumer, dealer and auction.

This allows them to ramp sales (albeit it at a lower margin) much faster than if they had to rely exclusively on consumer marketing of the app and website.

Finally, I think these guys have the right idea by focusing on inventory turns. They don’t care who they are selling to, and they aren’t trying to squeeze every last bit of margin out of the sale. They just want to get that inventory in and ship it out as quickly as possible.

When they get into power boats, snow machines and ATV’s I think most of these advantages are amplified.

If I’m thinking about this right, growth is gated by how quickly they can acquire inventory. Given the rate at which cash offers and acceptance are increasing, I think that is well under control.

So it looks pretty interesting. Nevertheless its a tough business because gross margins are guaranteed to be low. Its all about driving volume, keeping costs down and where possible upselling through warranties and financing.

So far they doing all of this quite well.

As you know I usually take a small position (usually 2% or a little higher) in a stock and then if it works I start adding as it rises. With RumbleOn, I’m excited enough about the idea to make that higher right from the start. I think if this works it will have some legs. So we’ll see.

Jul 7

25 Comments

Smith Micro: Stealing a Good Stock Pick

So I can’t take credit for this idea. I also don’t have much to say that hasn’t been said already. But I added the stock to my portfolio a couple weeks ago so I need to talk about why.

Smith-Micro is a Mark Gomes stock pick. In fact if you go to his blog you will find so many posts on Smith-Micro that reading them all would keep you busy for a few days.

I’m not going to repeat all the information he provides. I’m just going to stick to the story as I see it, the reasons that I took a position and what makes me both optimistic and cautious about how it plays out (this is just a typical 2% position for me so I’m not betting the farm).

Yesterdays Smith Micro

Smith-Micro has been a bad stock for a number of years. But it used to be worth a lot. This was a $400 million market cap company stock back in 2010. Revenue in 2010 was $130 million.

At the time revenue relied on a suite of connection management products called Quicklink. This suite of products maintained and managed your wireless connection as you moved around with your USB or embedded wireless modem (remember those!). They also had a visual voicemail product that transferred voicemail to text and provided other voicemail management features (in fact they still do have this product).

From what I can tell it was Quicklink that was driving revenue. They had 6 of the 10 big North American carriers onboard and 10%+ revenue contributions from AT&T, Verizon and Sprint. It was a cash cow.

Now I haven’t figured out all the details of what happened next, but the short story seems to be that the smart phone happened. Smart phones had embedded hot spots or mobile hotspot pucks for accessing mobile broadband services. No more dongles, no more laptops looking to keep their connectivity. And the connection management product was no more.

That was pretty much it for Smith Micro. The company never recovered. 2011 revenue was $57 million. 2012 was $43 million. By 2014 it was down to $37 million.

Today’s Smith Micro

The struggles have continued up until today. Over the past few years the company has had a difficult time creating positive EBITDA and revenue growth has been in reverse. Revenues bottomed out at $22 million last year. It’s gotten bad enough that the company included going concern language in the 10-K.

The company currently has a suite of 4 applications.

CommSuite is their visual voicemail product. It is still used after all these years and generates about 60% of revenue. QuickLink IoT seems to be a grandchild of the original Quicklink products but with the focus on managing IoT devices. Netwise seems like another Quicklink spin-off, managing traffic movement for carriers by transitioning devices from expensive spectrum to cheaper wifi where they can while insuring that an acceptable connection is maintained.

So those are the other products. But there is only one that is really worth talking too much about and that’s SafePath.

SafePath is a device locator and parental control app. With the app installed on all devices in a household a parent can keep track of their kids or the elderly (or spouse for that matter) as well as control and limit what apps and access each device has.

Smith Micro gave a rundown of the SafePath functionality in their latest presentation, comparing it these app store based competitors.

Essentially what these apps let you do is a combination of:

Keeping tabs where all the other devices in your network are including geofencing alerts if the location is unexpected (ie. children not in school)
Panic button if a family member is in trouble
Content constraints on what apps can be downloaded onto each device, what websites can be visited
Time constraints and time limits on when apps and web content can be accessed
A history of device usage, location

I think it’s a pretty useful product. I actually didn’t know that so much functionality was available for parents to control what their kids have access to (my kids aren’t at that age yet but I could see a product like this being a purchase for me one day).

SafePath isn’t a unique offering. There are several apps on the market that offer a combination of the features. Each carrier seems to offer some sort of flavor. And there are freeium products available at the app stores, such as Life360 and Qustodio which are the comps used in the table above.

Both the Life360 and Qustudio apps are not associated with any carriers. You get them via the app store and you get some reduced version of the product for free (can only track a couple member of the family, don’t have all the controls, etc). You upgrade to the premium pay version if you want all the features.

For the premium version the pricing on the Qustudio app is between $4.50 to $11 per month depending on the family size. I believe the Life360 app costs $5 per month but I can’t really find recent information on that, and I would need to sign up to get pricing via the app itself which I can’t do here in Canada.

Before I talk about the SafePath pricing, I want to mention that maybe the most important differentiator for SafePath is the white label. Rather than providing a product into the app stores, Smith Micro licenses the app to carriers. They put their own labeling on it and offer it to their clients.

That’s where Sprint comes in.

Why SafePath?

Last fall Smith Micro added Sprint as a SafePath customer. Sprint obviously is a huge win, with 55 million wireless customers.

Sprint has named their version of the app Safe & Found. The product was launched near the end of 2017 but didn’t really accelerate until the last couple of months.

Prior to Safe & Found Sprint offered a product called Family Locator that provided location detection for families. They had a separate app for parental controls called Family Wall. These products didn’t work at all on iOS.

Combining the functionality into a single app that’s available on all operating systems is likely part of a bigger strategy. At the LD Micro conference William Smith, the CEO of Smith Micro said this:

[Safe Path is] an enabling platform for a carrier that is looking for a strategy to grow their consumer IoT devices… [such as] wearables, pet trackers, a module that goes in your car and lets you track your teens driving, a panic button that you give to your parents…

Putting together a single product geared at families is about attracting families to the carrier. Families are low churn and high dollar value customers.

Sprint is selling the Safe & Found app for $6.99 per month, so in-line with the other apps that are available. Smith Micro has a revenue sharing agreement, taking a cut on each customer. Apparently, Smith gets about $3/customer/month from Sprint (though I haven’t been able to verify that number).

The Sprint Bump

Ok so now let’s throw out some numbers.

Smith Micro has about 24.5 million shares outstanding. At $2.50 that gives it a market capitalization of $61 million. There is about $10 million of cash on the balance sheet (maybe a bit more but they are still burning cash so call it $10mm) and $1.5 million of debt.

TTM revenues were about $23 million and gross margins are 75-80%.

Now let’s look at what Sprint does to those numbers.

On the fourth quarter conference call Smith said:

While the conversion of Sprint’s existing customer base is still underway, it will equal approximately $3.5 million in additional quarterly revenue for the company once it’s completed.

That’s including breakage. So this is a $6 million revenue per quarter company that is guiding that it can add $3.5 million a quarter on a Sprint ramp? Obviously, that’s the opportunity here.

The company said that margins on SafePath will be around 80% and that almost all that margin should fall to EBITDA.

Not surprisingly, if you model this out the company becomes much more attractive.

The above assumes 6% operating cost inflation (gets you to $6.2 million per quarter).

An analyst on the fourth quarter call said Sprint’s installed base was about 300,000 customers, so the above would assume a ramp of those customers (with breakage) to Safe & Found (I would really like to have this number verified though, I can’t find evidence of how many Sprint’s Family Locator subscribers there are anywhere else). Its worth noting that if the 300,000 subs is accurate it is is less than 1% of Sprints installed base. So there’s clearly lots of blue sky if all goes well. On the fourth quarter call Smith said that:

I think it is the goal of not only Smith Micro but also of Sprint to see millions of subs using the SafePath product and that’s a goal that, I think, would be echoing in the executive aisles of the Sprint campus as well.

So we’ll see. The numbers can get quite big when you are dealing with 80% margins and a large installed base.

Can Reality match the Model?

That’s the big question. Are these numbers achievable?

Look, I take small positions in a lot of little companies that give a good story. I tend to take management at face value.

This is a bit unconventional. I get called out for it by more skeptical investors. When these investors are right, which is more often then not, then they get to gloat and I get to look like a naïve fool for trusting management.

But bragging rights aren’t everything. There is a method to my madness and that method is that when I am right, I sometimes get a multi-bagger out of it. The big wins drive the performance of the portfolio and while on a “naïve-fool-basis” I come out looking poorly, I also come out profitably.

Nevertheless, I always try to keep it at the forefront of my mind that there is a pretty good chance that this isn’t going to end well.

With Smith Micro I’m taking management at face value. If they say they can do $3.5 million a quarter from Sprint, then okay, I’m buying the stock on the basis that they do $3.5 million a quarter from Sprint. They say the goal is for millions of subs then I say, okay, lets see that happen.

But I also recognize that might not happen.

My Concerns

Honestly my biggest hang-up with the stock right now is the reviews. The reviews on Google Play could be better.

I recognize you have to take these reviews with a grain of salt. First, they make up a very tiny percentage of the total downloads so far. Gomes put together a very helpful table of his estimated downloads and the reviews that have been added. Reviews are much less than 1% of downloads.

Second, its not clear that the reviews are all legitimate. I haven’t done this, but some others have dug into the reviews and questioned that they are often coming from locations that aren’t even in the United States.

Third, apart from a few legitimate concerns like battery drain (which other reviewers actually contradict), most of the reviews seem to be more about complaining that the Family Locator app they were used to is gone. Fourth, the trajectory of the reviews has been getting better.

Nevertheless the reviews are a datapoint and right now a somewhat negative one.

My second hang-up with the stock is that, at least from what I can tell, Sprint hasn’t completely shelved their legacy Family Locator app. On the first quarter call Smith said this:

The legacy product was originally due to sunset in the first quarter of 2018, but has subsequently been delayed for several months. This change was based solely on Sprint operations and was not a result of the SafePath application or change of our contract status.

Why has Sprint delayed the sunset? I have no idea. It could be (probably is) a completely benign reason. But again, it’s a bump in the road to weigh against the $3.5 million a quarter that I am taking at face value.

My third concern is that management hasn’t been on target with their projections. Originally they said the ramp on the Sprint installed base would be complete by the first quarter of 2018. That turned out to be way off. They were also positive on a Latin America carrier win that doesn’t appear to have panned out.

Finally, concern number 4 is that we are dealing with a service provider. These guys are A. Slow to adopt, and B. not at all loyal. We’ve already seen point A prove itself out as the ramp has lagged. Point B is something I’ve already experienced with Radisys, which was dumped unceremoniously by Verizon. Smith Micro has had this experience multiple times in its history, most recently by Sprint themselves when they dumped their NetWise product after what Smith Micro called a promising launch.

These are all reasons this is a 2% position for me.

On the other hand, Sprint does seem to be moving ahead. There was a big promotion in May including a joint deal for AAA members (talked about here), reps have been visiting stores and getting the sales staff up to speed, and stores are promoting the app to varying degrees.

One other potential positive is that Sprint might not be the only Tier 1 win. The CFO, Tim Huffmyer, presented at the Microcap conference in April. He mentioned a second win with a Tier 1 European carrier.

Huffmyer said that they had already been selected as the family safety application for this carrier but that the contract process was still ongoing. If they get the contract finalized it would be rolled out to Europe, Asia and the Middle East where this carrier operates. He didn’t give any more details on size but presumably it would not be a small rollout.

I know from painful experience how slow Tier 1 wins can be. But quite often they get around to it. It’s a good sign that they are moving down that road with others.

A Typical Stock for me

This is a Mark Gomes pick and I am stealing it. But I am stealing it because it fits right in my wheel house.

There is no question the stock could be a dud. The Sprint ramp might stagnate, Sprint might walk away and go back to the incumbent or to some other option, and then there is the merger with T-Mobile that throws yet another wrinkle into the equation. Who knows what’s in store?

The one thing I do know is that if the launch is successful and Smith hits their targets, the numbers are big enough to justify a higher stock price. Viable growing businesses with 80% gross margins and a recurring revenue model don’t trade at 1-2 times revenue. Simple as that.

So this is a classic stock for my investing style. An uncertain opportunity that has some positives, some negatives, no sure thing, but an upside that is more than large enough to make it worth throwing your hat in the ring.

How often do these sorts of opportunities pan out? Definitely somewhere south of half the time. If it doesn’t then I get to look like a naïve fool for trusting management. But if it does I get a big winner. It’s these sorts of moonshots where the 5-baggers come from. And that’s what drives the out-performance. Crossing my fingers that Smith-Micro will be next.