Comments on RumbleOn and Liqtech, also Smith-Micro and Vicor
I wrote a couple of lengthy responses in the comment section that I have reproduced here. One was on RumbleOn (here). The other was about Liqtech (here). I also comment on Smith-Micro and Vicor briefly.
1. Isn’t the installation of scrubbers self-defeating if too many ships continue to use HSFO?
A couple points. First, assuming that there is a point where its self defeating to install scrubbers (which I am going to raise a question about in a second) I believe that its far enough away that if it happens Liqtech will have benefited well beyond what is justified by the current share price. Consider that right now we are talking a couple thousand ships getting scrubbers out of a 70k fleet. And my numbers are assuming Liqtech only gets a fraction of those ships (ie. I don’t have the latest framework agreement modeled in there, I don’t have direct to shipowner sales, no sales from the other 4 scrubber manufacturers they are working with). Second, are we sure it would be self-defeating? Consider this – What are current HSFO to LSFO equivalent spreads (you have to use a gasoil equivalent for LSFO because there isn’t a true LSFO right now) and what would be the payback on scrubbers at those spreads? I was looking at this a month ago and thinking that at current spreads (so right now, with all ships still using HSFO) scrubber payback would still be pretty good. Isn’t this the worst case scenario for spreads after 2020? To put it another way, the reason ships aren’t installing scrubbers right isn’t because spreads aren’t favorable, its because they don’t have to.
2. What is a fair multiple for Liqtech given that their growth is concentrated on the next seven years and will massively flatten or even be negative thereafter?
While it’s hard to predict that far out in the future, there are opportunities that could result in significant earnings even after the retrofit opportunity has passed. First there is the new build opportunity – 60% of new builds are being installed with scrubbers. 1,000-1,500 ships a year get built I believe (I’ve never been able to pin that number down exactly, its always given on a DMT basis, not ship basis) and Liqtech is dealing with 7 of the 10 largest scrubber manufacturers. So the opportunity is quite large.
Second, I think the upside from the ramp could far exceed the current share price on its own. While its tough to project because we don’t know yet whether Liqtech will hold its market share through the build, how many scrubbers will be closed-loop or hybrid, etc, if an optimistic scenario holds then the cash they taken in should exceed the existing share price by quite a bit.
Further off there are other verticals where the exposure from being used in a large number of ships will help give them credibility to expand into – such as scrubbers for power industry, oil and gas flowback filtering, and maybe further inroads into DPFs.
But the main answer i that I think the new build opp is going to be large. The bigger question is what does the regulatory regime look like in 7 years and have even stricter environmental regs come in and how do scrubbers fit into that. And the other obvious big question is whether there are more hiccups in the implementation of the regulations between now and 2020.
3. Will we see lower revenue because the latest framework agreement is for lower ASP systems?
No, I don’t think that’s right. Consider that the new framework agreement is entirely incremental to my model. You can basically add 80-100 units at $230K and 70% margin (they said higher margin and we know existing units at scale are 65% with the Mark 6 design so 70% is my guess). So I think my numbers actually change pretty dramatically for the better with the new agreement. Also consider that the number in my model (80) is actually less than the other two framework agreements. I conservatively said 80 but if you read the transcripts Liqtech said they expect 120 from these two framework agreements.
4. How likely is another capital raise?
Liqtech came out last week and said they don’t need to raise capital this week. They said they had more cash then they had at the end of the second quarter. And soon they are going to be getting a tonne of cash from orders. I agree $4 million doesn’t seem like a lot but given their comments it would definitely be a surprise to me if they raised at this point.
What I think of the IMO 2020 meetings
This wasn’t a question but I had commented last weekend about IMO 2020 here. This is obviously the big weight on the share price. I think the upside based on what can happen is a pretty clear picture. It’s what will happen that was thrown a curveball when the US threw its hat in the ring leading up to the MEPC meetings. But since that time the IMO approved the fuel carriage ban and basically told the flag states that if you want us to consider a proposal for a more gradual approach we want to see more details. So the result was constructive for Liqtech.
The risk remains, but in my opinion the risk specific to Liqtech falls as time passes. The implementation of the fuel carriage ban was the last step for enforcement and that was passed. The rebuke of the flag state proposal says to me that the IMO wants any proposal to clearly state that they are asking only for waivers when compliant fuel is not available and not looking to delay enforcement generally. While the clarification comment that the flag states made leading up to the meetings (which I mentioned in my previous comment) said as much, the actual proposal being voted on last week (which was what the flag states wrote at the end of August and had been interpreted by some as “an attempted coup”) sounded like it was more vague. I don’t think the IMO wants to implement a vague proposal that might open other doors. So they closed the door on that.
At this point the IMO meets next May. That meeting might have a clearer proposal for waivers on the table but I think it’s less likely that some sweeping change comes out of the blue and derails the whole thing. Barring an unforeseen event in the interim, shipowners are going to have to move forward with what they know. I think this means scrubber purchases move ahead.
I was also asked what I thought of the Wholesale acquisition by RumbleOn.
I was initially skeptical about the deal. RumbleOn’s third quarter numbers, on the surface, weren’t very good. The reulsts matched what I had suspected when I was watching inventory on a daily basis – in September the numbers flattened out/turned down. As a consequence they missed the unit number. I was surprised that ASP was down too. So when I saw the acquisition my first reaction was: hmmm, are they just trying to paper over a bad quarter and slipping growth?
But since then I’ve listened to the conference call a few times, read through all the documentation and I’m coming around to the deal. The quarter was still not very good though.
Let’s talk about the quarter first.
While the third quarter results and guide are disappointing I’m not sure that they are as bad as they appear at first glance. If you take management at their word, they changed their acceptance criteria for making cash offers, basically limiting offers to cases where they thought they could make at least $1,000/bike. Their “terminated” offers (meaning offers that they didn’t decide to make after the seller went through the trouble) went up from 2% to 15%, which is a big increase. They said this resulted in a 700 bike slip in inventory. That slowed unit sales, which is what I saw on the site myself.
Now you can believe them or not here. Maybe this is an excuse and the business just slowed. But what I have seen on the site is consistent with higher margin bikes being available. They said that their ASP has been much higher in Q4 (anecdotally I saw that too at the end of quarter – that ASP of inventory has definitely gone up).
Maybe the bigger negative about the quarter is that the SG&A as a percentage of revenue did not come down. It was up a little from the second quarter. I had been hoping it would come down soon as the company moved towards profitability. But this didn’t happen, which is a negative.
When I look at the Wholesale acquisition, I understand why the market was lukewarm to it. Wholesale gross margins are tiny, like 4.3%, so even with the volumes (they are expected to sell 2,000 cars a month next year) and even growing 15-20% that’s tough. Carvana has double the margins and the story there is margin expansion as they layer on services. But Wholesale can’t really layer on services because they are selling wholesale, not to consumers.
Therefore on the surface the acquisition kind of looks not that great. What you can say is that it wasn’t expensive (as one analyst on the call pointed out they are getting the business at 12x income and asked why the owners would sell so low).
So that was my first take. But I’m more constructive as I’ve thought about it some more. Here’s how I’m thinking about it now:
How much would it take RumbleOn to create a platform and distribution network to populate their new car and truck online portal with 2,000 vehicles available to consumers from the go, ramp their sales to dealer/auction up to 20,000 per quarter (which is the current Wholesale run rate), building out that network in the process, and build a distribution network to manage the supply chain? I don’t know that number but I think its higher than $23 million.
For $23 million they get immediate inventory that can go to the soon-to-be launched consumer facing site, they get a built and operating distribution network for deliveries and dealer network, and they get to layer on their consumer cash offer business. And yes they also get the dealer purchasing vertical that Wholesale excels at as well as a couple of retail locations.
Yes margins at Wholesale are really low, but it’s because they buy from dealers, refurbish and sell to auction/dealer. Wholesale seems to me to be essentially an arbiter. But I don’t think RumbleOn bought Wholesale because they were enamored with this dealer to dealer business.
To put it another way, Wholesale also has an existing network and inventory that can be leveraged to more quickly build the higher margin consumer purchases and higher margin consumer sales that RumbleOn has always planned. RumbleOn has the automated cash offer system to drive consumer purchases which will be better margins. They have their site/app/brand to drive consumer sales.
I think that looking at Wholesale’s business as-is or trying to think about how RumbleOn will improve Wholesale’s existing business is probably not paramount to how Chesrown and Berrard are thinking about it – yes, RumbleOn should be able to make incremental improvements on what Wholesale does through data analysis that improve decisions but that’s not the primary motive for the acqusition – the point is layering on the consumer online buy side with the cash offer model and consumer sales through the website, and leveraging Wholesale’s existing dealer network to maximize turns right from the start. Improvements to Wholesale’s existing business are peripheral to what they are really going for here in my opinion.
They said it multiple times on the call – RumbleOn is creating a supply side solution – they are demand side agnostic – consumer/dealer/auction – whatever. They need to be able to access each vertical and the more they can sell to consumer the better but unlike Carvana, Vroom, et al the focus is not sales to consumers. Its closer to the other way around – the focus is buying from consumers. They will sell whereever they can sell fastest to maximize turns. It’s the buy side that matter, procuring as much inventory from as possible from consumers while insuring it’s the right vehicle at the right price. If they get the buy side right the sell side sorts itself out. Wholesale fits nicely into this IMO.
So I like the acquisition. But I also think the logic behind it is complicated and I’m not totally sure the market will agree with me right away. I also think the quarter was not so good and you have to buy into management’s explanation to be okay with the results. So we may get more pain. Nevertheless, I did buy back a position on Friday.
A couple other things
I bought back Smith-Micro after the earnings report. I had said in my update that I was worried they would miss estimates. They did, kind of. I could have sworn the Roth estimate (the only analyst) was $6.7 million of revenue for the quarter. The company came in at $6.5 million. But when I looked after earnings it appears the estimate was actually $6.1 million. So I don’t know if I imagined that $6.7 million number or whether Roth changed it at the last minute.
For what its worth it means they beat, but the stock fell anyway. I didn’t think it was a bad quarter at all though. Safe & Found adoption at Sprint continues at a steady pace, there are overtures of a second carrier in the next 6-9 months, and it appears that the sunset of the legacy product used by Sprint customers is coming. These are all positives and really the only negative had to do with the peripheral Graphics business, which saw a steep revenue decline but is now at the point where it can’t hurt the company going forward. So I bought.
Vicor stock action remains a gong-show. I’m holding on (pretty much HODL at this point) and I did think their quarter was fine. There is weakness in the legacy business but the new products bookings were up 20% sequentially, which is a great number. Apparently there is a negative report or article on Vicor that has been out for a while that could be the basis for some short selling of the stock. John Dillon mentioned it on SeekingAlpha. If anyone has the report I’d really appreciate seeing it.