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Posts from the ‘Photon Control (PHO)’ Category

Week 262: Simplify

 Portfolio Performance



Top 10 Holdings


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

Thoughts and Review

I made a grand total of two transactions this month.  I think that might be a record low for me.

The dearth of transactions is that it is not by design.  It’s the result of a shift I made back in February when the market was crumbling.  I decided I would get away from anything that looked like a swing trade.

In the past I’ve taken positions in stocks not because I see strong fundamentals or a particularly good event horizon or an industry development.  Instead I’ll take it as a trade because the stock has sunk down to what looks like the lower level of a range and I think I can catch a bounce as it traces back.

Its a strategy that I think, overall, has been profitable.  Over the years I’ve done it with success with companies like New Residential, Northstar Realty, Brookdale Senior, various oil stocks, and with the tanker stocks.

But its a strategy that expends a lot of brain power and it drains a lot of emotional capital without the opportunity for a big upside.  It also tends to put me into positions that I don’t have a lot of conviction in, and when a market event like what happened in January and February occurs, I end up selling stock at the wrong time.

So I’m not doing it any more.

For example, even though the tankers have traded down to what is really very cheap levels, I’m not playing a bounce.  I didn’t buy into any of the REITs that have recovered since earlier this year.

For what its worth, its probably saved a few grey hairs as I watch Teekay Tankers and DHT Holdings flounder with no appreciable momentum even as the market as a whole rises.  While some REITs have done well, others continue to flounder at lower levels.

It makes for a more boring and arguably slightly less profitable portfolio, but also for one that is easier to stand by through the market gyrations.  As Brexit hit and the market tanked for a couple days it didn’t even occur to me to sell any of my positions even as I lost a few percent.  The stocks I own I do so because I like them and I want to see them through to the events that I believe will result in their upside.

Without many trades this month I will talk about a stock I bought the previous month but haven’t discussed yet (BSquare), one event worth mentioning (Empire Industries spin-off) my investigation into cybersecurity stocks, and an update on what has been happening in the world of NFV/SDN.


I’ve owned Bsquare once before but under a different auspice.  The first time around it was because of a good earnings report that made it look cheap.  But I didn’t have a lot of conviction in the business so I sold it soon after for a small gain.

This time I’m buying BSquare for the potential that they may be on the cusp of some growth.  This is another one of those stories like Radisys, like DSP Group, where you have a so-so legacy business and company that has traditionally floundered but there is a new product coming along that might be able to change that.

In BSquare’s case that product is DataV.  DataV is a software application that collects device data, performs monitoring and analytics on the data, and applies rules for predicting future conditions and failures and automating corrective processes within the device.

The product is an example of an Internet of Things application, where a companies assets are connected to the network, information obtained from the asset is used to quickly identify problems, and solutions and operational changes are pushed back to the asset through automated routines.

DataV operates both on the asset and in the cloud at the data center level.  The figure below illustrates the functionality at each.  The green boxes represents a feature set provided by DataV.  At the asset level monitoring and automation of simple rules are performed for time critical conditions.  At the data center level further monitoring and more complicated and less time sensitive automation rules are performed, as more complicated analytics like predictive rules and optimization routines are performed.


Unlike some of the IoT solutions I researched, I feel like DataV is going down more of a solution specific path.  Rather than providing a platform to be implemented across an company’s asset base like some of the bigger IoT names, DataV is being targeted to customers to deliver specific solutions where there is an existing issue that it can solve. It seems like the right strategy, especially since their target market for DataV is the smaller end of the Fortune 500, who are less likely to invest large amounts of capital up front for a platform solution.

BSquare announced their first DataV contract with a major industrial company back in June.  The company described the use cases to be addressed as follows:

Predictive failure. The use of data analytics and real-time device information to accurately predict problems that could impair asset uptime, as well as prescribing remediation steps.

Data-driven diagnostics. Further use of data analytics and historical repair information in order to speed diagnostic and repair time, getting vital assets back in operation more quickly while reducing service and warranty costs.

I also found the following quote from the press release useful for understanding the product:

“This project is emblematic of what is truly possible with IoT: real-time data analytics applied to very large data sets in order to predict future conditions, prescribe corrective steps, and accelerate repair times. Collectively, these DataV capabilities can dramatically improve uptime while reducing cost. We look forward to a long-term relationship with this customer, working closely with them as they leverage IoT to achieve business objectives throughout their organization.

The contract is for $4 million over 3 years.

My hope here is that this is the first win of many.  While the company has only one win, they did make the following comment in one of their job postings, which gives me some optimism that there will be further wins:

Bsquare is investing significantly in marketing demand generation tied to its industry leading DataV IoT platform.  Market response has overwhelmed our current sales capacity, and we are looking for proven inside sales dynamos to join our team. 

I would say my conviction that this works out is medium at this point, so like many of my positions I will start small and build as positive data develops.  Given the size of BSquare, a $66 million maket capitalization with $27 million of cash on the balance sheet, there is plenty of room for upward appreciation if the product takes off.

I have also looked closely at the legacy business and while I don’t want to spend too much time on it here, I will say that it gives me pause.  The company is almost wholly dependent on Microsoft as a reseller and the contract terms with Microsoft have recently tightened.  It doesn’t feel like a very comfortable position to be in. Please contact me if you want more of my thoughts on the legacy business or if you have any insights into it yourself.

Empire Industries and their Hydrovac spin-off

In February Empire Industries announced that they were spinning off their Hydrovac business into a separate company. The transaction makes Empire more of a pure play on their amusement park ride business and creates a new hydrovac focused entity.

Both sides of the spin-out look pretty interesting.

Dynamic Attractions, which is the existing Empire business, is still very cheap, trading at around 3x EV/EBITDA with a market capitalization of about $25 million.  There is a healthy backlog of $107 million though that is down from year end of $130 million.

There is some talk that the next step will be the divestiture of the steel fab business, which would be another step towards making Empire a pure media attraction product company.  The company still has the telescope business and the 30m telescope contract, though recent setbacks make it unclear whether a new site will have to be found for the project before it can proceed.

Equally interesting is the hydrovac spin-off called Tornado.  As part of the spin Empire partnered with a Chinese company, Excellence Raise Overseas Limited, who injected a little under $10 million into Tornado.  $6.9 million of that is equity, $2.5 million is debt (it was supposed to be $7.5 million but the injection was done in USD and Reminbi and the Canadian dollar has gone up since the original agreement).  The equity portion gives the Chinese firm 45.5% of the new hydrovac entity.  If you do the math on that the Chinese entity paid about 25c per share.  The stock is trading below 15 cents.

Tornado is going to use the cash to set up an operating subsidiary in China and offer Hydrovac services there.  In Canada they just sell the trucks.  The business in China will be more akin to Badger Daylighting; contracting out the usage of the trucks and personnel.

Here is what the Tornado management said about their new business endeavor in their first ever MD&A:


What I find interesting about Tornado is that at the current price the market capitalization is $9.5 million you are only paying a little more than what the Chinese partner invested in the company.  Yet you are getting both the existing hydrovac manufacturing business in Canada, and the new Chinese expansion.  While the truck manufacturing business has been poor of late, basically delivering flat EBITDA for the last year, before the collapse in oil prices this business generated $2.5-$3 million of EBITDA.

So there is plenty of upside from the existing business that is arguably not priced in.  In addition you have a stake in what happens in the China segment, which is admittedly uncertain.

In addition to what I received with the spin-off, I bought a little bit of the stock because it seems cheap.  I would like to buy more but its hard to get a real sense of how substantial the opportunity in China is.

I have no idea if this is a huge market that they will win big with, or whether this is going to be an uphill battle.  It seems somewhat positive that the Chinese company wants to take a big slice, presumably they are doing so because they see the market opp, and the Empire management has been pretty astute, but who knows for sure.

So we’ll see.  Management is making some interesting moves, they may have some more up their sleeve.

I’m not smart enough to invest in security companies

I spent quite a bit of time over the last month trying to familiarize myself with the cyber security universe.   I went through transcripts, listened to conference calls, read presentations and 10-Ks.  I looked at Palo Alto, FireEye, Proofpoint, Rapid7, MobileIron and Qualys in some detail and more briefly at Tanium, Imperva and Splunk.  I come out of the whole thing still feeling like I only have a foggy understanding of the space.

Of all the firms I think I understand the biggest, Palo Alto and FireEye, the best.  Palo Alto is a firewall company and FireEye is an intruder detection and mitigation company.  I think on the most simplistic level, Palo Alto is trying to stop an intruder whereas FireEye is trying to detect and stop one once one gets in.

Both companies and for that matter most cyber security companies, provide an appliance (which is essentially a server blade that goes into the stack) supplemented by one or more subscriptions (along with maintenance and support which may or may not be bundled into the subscription price, depending on the company).  The appliances sit on premise and perform the basic protection services.  Some of the subscriptions are attached to the appliance, and some are not.

For example Palo Alto, to the best of my understanding, offers an appliance and 8 subscriptions.  These are shown in the diagram below.  The red boxes are subscriptions not attached to the appliance while the blue one’s are stand alone


Just to give some color on what these do, Wildfire updates the firewall appliance with new emerging threats, Aperture provides the ability to monitor SAAS applications, Traps, is installed at the endpoint that prevents untrusted apps from operating. GlobalProtect extends firewall capabilities to mobile and offsite devices, Autofocus allows you to access a database of threat tags that help you identify the source and nature of a threat you’ve discovered, and Threat Prevention and URL Filtering provide some of the basic data required for performing the firewall functions.

So that’s Palo Alto.  If you go through the universe of companies you will find something similar in terms of an appliance with subscription services and/or stand-alone subscription services.

Where things begin to get fuzzy for me is once we get into the smaller players.  So Proofpoint software is primarily geared towards email protection.  Rapid7 and Qualys provide data hunting and analytics that try to aggregate and streamline the vast amount of data coming down to what is relevant.  Mobileiron’s platform manages security for mobile devices.  Imperva provides security to data centers and to a lessor degree to cloud applications and websites.

What I can’t figure out is how it all plays out between these niche companies and the larger one’s like Palo Alto and FireEye.  Is there room in IT budgets for all of these products?  Do the niche players get bought out by a consolidator?  Or does revenue growth start to slow for some of them?

 Another question that isn’t clear to me is how the move to the cloud impacts these businesses.  Some of these companies still generate a significant amount of revenue by selling the appliances.  As those appliances become virtualized and sales are software only, I wonder how margins and revenues will be affected?

In this regard, one of the most interesting things I listened to was this discussion at the Bank of America Global Technology Conference with former FireEye CEO, now Chairman David Dewalt.  Dewalt makes a number of very strong comments; that security is going to move to the cloud, that this will be disruptive, that this will change the landscape of what products and services are required, and that it will move dollars from a product or appliance bucket to a subscription bucket.

The final piece is whether spending has been artificially heightened by a few outsized threats.  There were some significant breaches in 2014 and even some of the company executives I listened to described the following period as being one where companies were throwing money at the problem without discretion.  That appears to be changing now.  We just saw Imperva issue pretty dismal guidance.  Qualys recently characterized the environment as “much more rational” and that we were seeing more caution on the part of customers, that they were looking to consolidate vendors, etc.

Finally, I don’t really understand the growth expectations behind all the names I looked at.  For example, the Stifel universe has 22 cybersecurity companies and the average revenue growth of those companies is 19% for 2016 and 2017.   Yet the cybersecurity market as a whole is expected to grow at 6.9%.   So who are all these low growth or market share losing companies?

It all sounds like one big bucket of uncertainty.  Which is hard to stomach when you are paying the multiples you are for these companies.  So the research has been interesting, but I’m not sure I will be adding any of these names soon.

Whats Happening in the NFV/SDN World

There are a whole lot of datapoints hitting the presses in the world of NFV/SDN.   Here’s a brief run down of what I have come across.

In the last week AT&T announced that they will offer the code to their SDN platform into open source, that they will be introducing virtual security functions for their virtualized network, and that they will be launching network functions on demand starting with 4 virtualized functions.  Of this news, the second may have relevance to Radcom, where there have been hints that their contract with AT&T could be expanded to some sort of security application.  The third piece (more details here) refers to a 3rd party server vendor for the white box back end, which certainly could be something Radisys provides.

Along the lines of the third news item, Radisys and AT&T held a joint presentation demonstrating their Mobile-CORD initiative and how you can monetize SDN and NFV.  Some more circumstantial evidence of the relationship developing between Radisys and AT&T.

This article (here) compares the move to NFV as being the equivalent to the datacenter move to cloud over past decade.  The key difference is that enterprises moved apps like Oracle, Exchange and SAP, CSPs are moving network functions that deliver wireless and wireline calls, text messages, and streaming media, along with services such as VPNs and firewalls.  This article specifically highlights service assurance as one of the two most important attributes of software defined infrastructure:

The second important characteristic of a software-defined infrastructure is service assurance. Customers expect seamless voice, video, and media quality and data protection. A truly carrier-grade infrastructure will deliver on these expectations by quickly analyzing the root causes of component failures, remediating those failures before they impact subscriber services, and ultimately, predicting and avoiding outages and performance issues before they occur. All of this can only be accomplished through automated software.

Another article I found interesting was this one, which exposes 10 myths about NFV.    Two important points made are that encumbents will have to rebuild from the ground up to make their app virtualized:

The best way to build a carrier-grade virtual network function (VNF) is to take a ground-up approach, starting with a purposefully designed modular architecture that addresses performance, scalability and other important requirements, Luxoft recommends.

And that Verizon is looking to share risk with vendors, also move might be to subscription type of relationship with vendors:

Verizon, for example, proposes a new business model in which its vendors share the risk in the introduction of new services.  If a service succeeds everyone will make money.  If it fails everyone shares the risk…Furthermore, virtualization lends itself to usage billing models, not only for consumer services but for business to business services.

I also found this article that talks about the need for both SDN and NFV being brought on by the amount of data that will be travelling the network as the Internet of Things grows:

As the Internet of Things (IoT) becomes more of a reality, and as these companies look to deploy 5G and reap all its promised benefits, most realize that they need to revamp their networks in order to deliver value and to compete (with you-know-who). These trends will result in significantly more data of widely different types traveling across their networks, and to retain service agility on a more-or-less static infrastructure, these operators need NFV and SDN, along with “cloudification” and advances in distributed computing.

This article gives the rather impressive 116% CAGR for NFV and SDN from now until 2021:

Spend on NFV and SDN ramped up in 2015, with analyst firm TBR forecasting the market reach nearly $158 billion by 2021, representing a 116% CAGR.

And finally Mark Gomes gave some interesting scuttle about Radcom in a conversation with an industry contact that he posted over the weekend.

Reluctantly exiting Photon Control

There is nothing more fun than getting this kind of press release about one of your companies while being on vacation with limited internet access.


I have absolutely no insights into how this plays out.  Maybe the loan gets repaid and the company puts itself up for sale at a premium.  Maybe the company rights itself and gets on with the business of delivering sensors.  No idea.

What I do know is that when I don’t know what is going to happen, I am more often than not better off selling first and asking questions later.  So I sold my shares.

I note two things since that time.  First, the shares have held up reasonably well, so there is clearly someone willing to buy into the panic.   Second, there hasn’t been any news that the money has been paid back.

I continue to watch the story because the company valuation is compelling.  The market capitalization is $73 million and the company holds $27 million in cash.  After subtracting cash, the stock trades at only about 3x free cash flow.

This is too cheap if the business is viable and there isn’t any overhang from executive malfeasance.

The sensor business hasn’t grown like I had hoped, but that still may come and even in its current state it remains nicely profitable.  I’d love to get back into the stock, but I need to remove the uncertainty before I do.

Portfolio Composition

Click here for the last four weeks of trades.  Note that the two transaction labeled Adj are me manually readding the Empire Industries and Tornado shares.  When Empire did the stock consolidation and spin-off my shares were lost in the practice account.

Also note that I bought RMG Networks stock, which I talked about already owning last month.  This was another unfortunate example of me forgetting to take a position in the practice account, and as a result having to buy the stock later at a higher price.  Oh well, if I am right about RMG Networks the upside will make 20 cents more I paid irrelevant.



Week 2015: Maybe its just a bear market

Portfolio Performance



See the end of the post for the current make up of my portfolio and the last four weeks of trades

Monthly Review and Thoughts

I don’t flash sensational headlines about bear markets for the sake of getting attention.  I get about 100-150 page views a day and given the frequency and technicality of my writing I don’t expect that to increase materially regardless of the headline I post.

When I raise the question of whether we are in a bear market, its simply because even though the US averages hover a couple of percent below recent highs, the movement of individual stocks seems to more closely resemble what I remember from the early stages of 2008 and the summer of 2011.

A breakdown of the performance of the Russell 2000, which is where a lot of the stocks I invest in reside, was tweeted out this week by 17thStrCap and I think illustrates the pain quite well:

us market

The Canadian stock averages have been made respectable by Valeant and not much else. In a Globe & Mail article appropriately capsulizing my comment here called “The market is in much worse shape than the TSX index suggests” the following comparison was made between the TSX Composite and an equal weighted version of it that dampens out the Valeant effect.


When the Federal Reserve ended its quantitative easing program last year I was concerned that the market might revert back to the nature it had demonstrated after first two QE endeavors.  But for a number of months that didn’t happen.  Stocks kept moving; maybe not upwards at the speed they had previously but they also did not wilt into the night.

I am starting to think that was nothing more than the unwinding of the momentum created by such a long QE program.  Slowly momentum is being drained from the market as the bear takes hold.

A week late

I am a week late getting to this update.  We were on vacation last week, which made it tough to write.  As well I was in no mood to ruin my vacation and write with my portfolio going through significant perturbations to the downside.

It is frustrating to see my portfolio doing poorly.  My investment account is being saved by two things:

  1. Shorts
  2. US stocks in Canadian dollars

As I mentioned last month I have had a number of technology shorts, some shorts on Canadian banks and mortgage providers, and hedges on energy and small caps via the XOP and IWM.  I actually took a bunch of the tech shorts off in the last few days for the simple reason that they are up so much.  I had some decent gains from INTC, SNDK, MU, ANET AVGO, RAX, HIMX and TSM.  I also ended my multi-year short on YELP.

I am covering my shorts because with earnings season over I think there could be a counter rally resulting from the news vacuum.   The China collapse angle has been beaten up and priced in; I could see the perception shifting towards the positive outcomes of the stimulus. And I’ve read that Apple is increasing orders for the iPhone 6s and 6s+ which may or may not be warranted (I suspect not) but could lift tech results in the short term.

I would put these shorts back on if the stocks recovered.  But I don’t feel like I know enough about tech to be pressing my luck on the names.  And as I reduce my long portfolio and raise cash, I feel less need to have what feel like stretched shorts to hedge those positions.

Without the benefit of short hedging this blog’s online tracking portfolio has done worse.  I’m down about 5.6% from a brief peak I hit in mid-July (when the tankers were at their highs) and I am essentially running flat for the last 4 months.

At the center of my frustration are tankers, airlines, small caps and the REITs.  So pretty much everything.  Let’s talk about each.

The Tankers

With oil oversupplied and refiners working at record capacity producing gasoline, jet fuel and heating oil, one would expect that the market would turn to crude and product tankers as a natural beneficiary.

No such luck.

The recent moves by my favorite tanker plays: DHT Holdings, Ardmore Shipping and Capital Product Partners, have been to the downside.  There was a brief move up towards the end of July that coincided with earnings (which were outstanding) but it was quickly unwound and now we are back to levels seen a few months ago.  While I sold some along the way up, it wasn’t (and isn’t) ever enough.

Ardmore Shipping

Particularly with the product tankers (specifically Ardmore Shipping), I just don’t get why the behavior is so poor.  I found it difficult to come away from their second quarter conference call with anything but an extremely bullish take on the company’s prospects.

The product market is benefiting from extremely strong refinery utilization and strong demand for products.  It is also benefiting from the move by Middle East nations to add refining capacity with the view of exporting finished products.

Ardmore had earnings per share of 30c.  They achieved those earnings with 18.4 ships. By the end of the year, once all of their newbuild fleet is delivered, the company expects to have 24 ships.  If newbuilds had been operating in the second quarter, earnings would have been 43c for the quarter.

In the second quarter Ardmore saw spot rates of $22,400 TCE.  So far in the third quarter spot rates are up again to $23,500.  At current $23,500 spot rates and with 12 MR’s in the spot market, EPS would be $1.85.  The stock has been trading at around $13.

Yet the stock sells off.

DHT Holdings

Likewise, I couldn’t believe it when DHT Holdings traded down to below $7 on Wednesday.  At least the crude tanker market makes some sense in terms of rates.  Voyage rates have come off to $40,000 TCE for VLCC ships.  This is seasonal and if anything rates have held up extraordinarily well during the slow third quarter.

DHT stated on its conference call that they had more than 50% of their third quarter booked at $80,000 per day.  The company has a net asset value of around $8.50 per share.

While I already had a pretty full position heading into the last move down I held my nose and added more at $7.15 (i never catch the lows it seems).  I’m not holding these extra shares for long though.  In this market having an over-sized position in anything seems akin to holding an unpinned grenade.

The Airlines

While Hawaiian Airlines has been an outperforming outlier, responding well to strong earnings, Air Canada has languished.  The stock got clobbered after the company announced record earnings and great guidance.

Air Canada reported 85c EPS and $591 million EBITDAR.  In comparison, BMO had been expecting 90c EPS and $618mm EBITDAR and RBC had been expecting 77c EPS and $558mm EBITDAR.

The story here really boils down to the Canadian economy.

Both WestJet and Air Canada are increasing capacity.  The market is worried that they are going to flood a weak market and pressure yields.  On the conference call Air Canada addressed the concern by pointing out that A. the capacity they are adding is going into international routes and B. they have yet to see anything but robust demand for traffic.

What’s crazy is that while investors have responded negatively, analysts have been bullish to the results.  I read positive reports from RBC, TD and BMO.   Only Scotia, which I don’t have access to, downgraded the stock on concerns about no further upside catalysts.

Its rare to see multiple upgrades accompanied by a 7% down move in a stock.  I would love to see one of the darling sectors, tech or biotech, respond in such a manner.

So the analysts are bullish and the company is bullish but right now the market doesn’t care.  As is the case in general, the market cares about what might happen if some negative confluence of events comes to fruition.  And it continues to price in those worries.

Its just a really tough market.

Trying to find something that works

Another contributor to my poor performance has been that what has worked over the last five years is working less well now.

In particular, over the last give years I have followed a strategy of buying starter positions in companies where I see some probability of significant upside.   In some cases I will buy into companies that do not have the best track record or are not operating in the most attractive sectors.  But because the upside potential is there I will take a small position and then wait to see what happens. If the thesis begins to play out and the stock rises, I add.  If it doesn’t I either exit my position or, in the worst case, get stopped out.

This has worked well, with my usual result being something like this.  I have a number of non-performers that I end up exiting for very little gain or loss, a few big winners, and a couple of losers where I sell after hitting my stops.

I’ve had a lot of winners this way over the last few years: Mercer International, Tembec, MGIC, Radian, Nationstar, Impac Mortgage (the first time around in 2012), YRC Worldwide, Pacific Ethanol, Phillips 66, Nextstar Broadcasting, Alliance Healthcare Yellow Media and IDT Corp are some I can think of off-hand.  In each case, I wasn’t sold on the company or the thesis, but I could see the potential, and scaling into the risk was a successful strategy of realizing it.

Right now the strategy isn’t working that well.  The problem is that the muddling middle of non-performers is being skewed to the downside.  Instead of having stocks that don’t pan out and get sold out at par, I’m seeing those stocks decline from the get-go.   I am left sitting on either a 5-10% loss or getting stopped out at 20% before anything of note happens.  Recent examples are Espial Group, Hammond Manufaturing, Versapay, Higher One Education, Willdan Group, Acacia Research, Health Insurance Innovations and my recent third go round with Impac Mortgage.

All of these stocks have hair.  But none has had anything materially crippling happen since I bought them.  In the old days of 2012-2014, these positions would have done very little, while others, like Patriot National, Intermap, Photon Control, Red Lion Hotels and most recently Orchid Island would run up for big gains and overall I’d be up by 20% or so.  Instead this year the winners still win, albeit with less gusto, but its the losers that are losing with far more frequency and depth.

So the question is, if what has worked is no longer working, what do you do?

You stop doing it.

I cleaned out my portfolio of many of the above names and reduced a couple of others by half.

So let’s talk about some of what I have kept, and why.

Health Insurance Innovations

HIIQ announced results that weren’t great but the guidance was pretty good.  Revenue came in at $23 million which is similar to Q1.  In the first quarter the company had been squeezed by the ACA enrollment period, but in the second quarter this should have only impacted April.  So I had been hoping revenue would be a touch better.

The guidance was encouraging though.  The company guided to $97-$103 million revenue for the year which suggests a big uptick in the second half to around $28 million per quarter.  In my model, I estimate at the midpoint they would earn 40c EPS from this level of revenue if annualized.

Also noted was that ACA open enrollment would be 90 days shorter next year, which should mitigate the revenue drag in the first half of the year.  And they appear to be doing a major overhaul of management – bringing on people from Express Scripts (new president), someone new to evaluate the web channel and a number of new sales people.

Its been a crappy position for me but I don’t feel like there is a reason to turf it at these levels, so I will hold.

Impac Mortgage

As usual Impac’s GAAP numbers are a confluence of confusion.  The headline number was better than the actual results because of changes to accretion of contingent expense that they incurred with the acquisition of CashCall.

The CashCall acquisition had contingent revenue payout and that payout expectation has decreased leading to lower accretion via GAAP.  Ignoring accretion the operating income was around $8 million which was less than the first quarter.

The decline was mostly due to lower gain on sale margins, which had declined to 186 bps from 230 bps.

While origination volumes were up 8% sequentially (see below) I had been expecting better.  The expansion of CashCall into more states was slower than I expected.  In the second quarter CashCall was registered in 19 states.  I actually had thought that number was 29.

q2volumesBy the third quarter CashCall is expected to be compliant in 40 states.  And really that is the story here.  Volume growth through expansion.

CashCall is a retail broker dealing primarily with money-purchase mortgages (mortgages to new home owners).  Therefore Impac is not as dependent on refinancing volumes as some other originators.

While it was not a great quarter the company still earned 70c EPS.  Its lower than my expectations but in absolute terms not a bad number.  On the conference call they said that Q3 margins looked better than Q2, and while July production was only about $700mm, they expected better in August-September as the pipeline was large.

I made a mistake buying the stock at $20 on the expectation of a strong second quarter.  But I think at $16 its reasonable given earnings power that should exceed $3+ EPS once CashCall is operating nationwide.


The response to the PDI quarter is indicative of the market.  The company released above consensus earnings on Thursday along with news that their molecular diagnostic products were being picked up by more insurers.  In pre-market the stock was up 20% and it looked like we were off to the races.

It closed down.

Recall that PDI operates two businesses.  They have a commercial services business where they provide outsourced sales services to pharmaceutical companies looking to market their product.  And they have the interpace diagnostics business, which consists of three diagnostic tests: one for pancreatic cysts and two for thyroid cancer.

I suspect that the market decided to focus on the one negative in the report: reduced guidance for interpace revenues from $13-$14 million to $11-$12 million.  The guidance reduction was caused by a delay in receivables from some customers.  The metric by which to judge the growth of the actual operations, molecular diagnostic tests, increased from 1,650 in the first quarter to 2,000 in the second quarter.

But in this market you gotta focus on the negative.  At least on Friday.

Patriot National

When I bought Patriot they were a new IPO whose business was a platform that allowed them to procure and aggregate workers compensation policies for insurance carriers.  They sign a contract with a carrier for a bucket of policies with particular characteristics and then distributed that to their pool of agents, collecting a fee in return.

But over the last couple of months Patriot seems to be expanding that role to something more holistic.  Among their nine acquisitions in the past six months is an insurance risk management firm, an auditing and underwriting survey agency, an insurance billing solution platform and a beneits administration company for self-funded health and welfare plans nationwide.

Patriot describes themselves in their latest presentation as follows:

whattheyarePatriot has shown solid growth since their IPO, both through their roll-up strategy of small insurance businesses and organically.  They have increased their carrier relationships from 17 to 82.  They are expanding their relationship with a few big carriers like AIG and Zurich.  They have grown their agent pool from 1,000 to 1,750.

I’m not really sure what it was about the second quarter that caused the stock to sell-off like it has.  It was down 16% at one point on Wednesday, which is about the same time I tweeted that this is crazy and pulled the trigger.  I suspect its simply another case of a bad market, a run-up pre-earnings and a release that didn’t have anything clearly “blow-outish” about it.

Nevertheless the company provided guidance along with its results and for 2016 predicts 37% revenue growth and 55% earnings growth.  These numbers make no allowances for further accretive acquisitions, which undoubtedly will occur.

The stock trades at 6.5x its 2016 EBITDA multiple.  From what I can tell its closest peers trade at around 10x, and they aren’t growing at a pace anywhere near Patriot.  As I said I added under $16 and would do so again.

Orchid Island

I have followed Orchid Island for a long time having been an investor in its asset manager, Bimini Capital, in 2013.  I never bought into Orchid though; it seemed small, it always trade around or above book value and being an mREIT it seemed that you had to have more of an opinion on the direction of rates than I have had for a while.

But when the stock got below $8, or a 30%+ discount to book value, it just seemed to me like the opportunity was too ripe to pass up.

There have been a number of good SeekingAlpha articles by ColoradoWelathManagementFund on Orchid where he describes the MBS investments and also the Eurodollar hedges.  These hedges, which require a different GAAP accounting then other more commonly used hedges, seem to be at least partially responsible for confusing the market and leading to the massive discount to book.

However I don’t plan to wait this out until book value is realized.  When the stock hits double digits again I expect to be pulling the trigger.

Higher One Education

I bought back into Higher One after it got clubbed down to $2.20, where it seemed to be basing.  Upon buying the stock was promptly clubbed down again to below $2.

Like many other names I am not sure if the clubbing is warranted.  The company’s second quarter results were better than my expectations.

Adjusted EBITDA in the second quarter came in at $8 million versus $7.2 million in Q2 2014.  While the disbursement business EBITDA was down, both payments and analytics were up (46% and 38% respectively).  EPS was 8c which again was better than last year.

They lost 6 clients representing 86,000 signed school enrollment (SSEs), signed 4 new clients with 16,000 SSEs and renewed 59 clients with 675,000 SSE’s.  Their total SSEs were 5mm at the end of Q2.  Given the headwinds in the industry, Higher One is holding their own.

The overhang in the stock is because the DOE proposed new rules that ONE and others are pushing back on, with the biggest issue being that you can’t charge fees for 30 days after deposits.  From their conference call:

The way the rule is proposed every time there is a disbursement made into the students accounts, we’d have to freeze all fees for 30 days.

This of course would severely impair Higher One’s ability to be profitable with these accounts.

On Friday after writing this summary I decided to sell Higher One.  I’m waffling here.  I like the value but don’t like the uncertainty and if the market can knock it down to $1.90 then why not $1.50?  Uncertainty reigns king.  I might buy it back but its difficult to know just how low a stock like this can go.

My Oil Stocks

I’ve done a so-so job of avoiding the oil stock carnage of the last few months.  After the first run down in the stocks I added a number of positions in March and ran them back up as oil recovered to the $60’s.  Then oil started dropping again and in May I began to sell those stocks.

oiltweetBy mid-June I was out of all my positions other than RMP Energy.  By July I had reduced RMP Energy down to about a percentage weighting in my portfolio.

So far so good.

Unfortunately I started buying back into the oil names in mid-July, which was too early.  I bought Jones Energy in the mid to high-$7s but sold as it collapsed into the $6’s.  I tried to buy RMP again at $2.20 but got pushed out as it fell to $2.  I bought Baytex and Bellatrix which was just stupid (I sold both at a loss).  I’ve probably given back half of the profits I made on the first oil ramp.

In this last week I made another attempt but I am already questioning its efficacy.  I took small positions in RMP Energy and Jones Energy and a larger position in Granite Oil.  The former two have done poorly, while the latter had an excellent day on Friday that provides some vindication to my recent endeavors.

One thing I will not do with any of these names is dig in if the trend does not turn.  I’ve learned that commodity markets can act wildly when they are not balanced, and the oil market is not balanced yet.  So its really hard to say where the dust settles.

Even as I write this I wonder if I should not have just waited for a clear turn to buy.

These positions are partially hedged in two ways.  First, I shorted XOP against about a quarter of the total value of the positions.  And second by having so much US dollar exposure (still around half my account) as a Canadian investor they act as a bit of a counter-weight to the wild moves I can see from currency changes.

Jones Energy

One of the interesting things happening right now is that natural gas production is flattening, in many basins it’s declining, and yet no one cares.  When natural gas first went to new lows in 2012 many pointed to the declining natural gas rig count, believing prices would quickly bounce back.  They didn’t, in part because of the associated gas coming from all the liquids rich plays.

With the oil collapse much of the drilling in those liquids rich plays is no longer as attractive.  You have to remember that even as oil has fallen, natural gas liquids like propane and butane have fallen even further (ethane, which is the lightest of the liquids, is now worth no more than natural gas).  Many producers that were labeled as oil producers, because they produced liquids, really produced these lighter liquids that are now trading at extremely depressed levels.  Drilling in light-liquids rich basins (the Marcellus but also the Permian and parts of the Eagleford) has declined precipitously, and with it all of the associated gas being produced.

Meanwhile much needed propane export capacity is on the horizon and expected to arrive en-masse in 2016.

Jones Energy has too much debt (around $770 million net) but they also have oil and natural gas that take them out into 2018.  I think they are a survivor.  They have reduced their drilling and completion costs in the Cleveland from $3.8 million to $2.6 million.  They actually increased their rigs in the Cleveland in June, though I have to admit that might be dialed back again with the prices declining.  I bought back into the stock for the third time this year when it was clobbered on what seemed to be pretty good earning results (a beat and guidance raise).  Its a play on oil, but also on falling natural gas production, as natural gas makes up 43% of production and much of the associated liquids are light.

RMP Energy

I think that the miserable performance of this stock is overdone, but I have thought that for some time and down it continues to go.  RMP gets punished over and over again for essentially the same concern – Ante Creek declines.  This latest pummeling seems to have been precipitated by the disclosure that August volumes at Ante Creek were around 8,500 boe/d.   This is a decline from April volumes of 12,200boe/d but similar to end of June volumes.  Below is a chart from Scotia that details Ante Creek production:


The April increase coincided with the new gas plant.  The subsequent fall was because the company drilled no new wells in the second quarter.  That production has stabilized from June to August without any new wells being drilled is encouraging.

But the market sees it differently.

Lost in the shuffle (with nary a mention in any of the reports I read) is that RMP has reduced its drilling and completion costs by 30% and that operating expenses were down from $5.26/boe to $3.89/boe.  Also forgotten is that the company is experiencing positive results at Waskahigan with it new frac design.

RMP trades at about 2x Price/cashflow and has debt of about 1.35x expected 2015 cash flows.  Its not levered like many peers and its not expensive.  These constant concerns about Ante Creek need to be priced in at some point.

Granite Oil

Of the three names I own, this is the one I am going to stick with the longest.  Granite has a $150 million market capitalization and $50 million of debt.  Their asset is a large position in the Alberta Bakken (350,000 net acres).  They can drill 240MBBL wells that are 98% oil for $2.8 million per well.

And they are beginning a gas injection EOR scheme that is showing promising results.  Below is company production as gas injection has increased.

alberta-bakken-eorThe results are well above expectation and show minimal decline even as the number of wells drilled has only increased marginally.

The result is some pretty strong economics even at lower oil prices.


Granite management had been loading up on shares in the $4’s.  I did too.  The company announced earnings on Friday and is probably the only oil company to announce a dividend increase.  Like I said, this will be the last oil position to go for me.

Portfolio Composition

As I’ve said a number of times in the past, I sometimes forget to mimic my actual trades with the online RBC portfolio I track here.  After a while these differences get too out of whack and I have to re-balance.  I did some of that on Friday, and so the transactions on that day are simply me trying to square up position sizes.  I don’t have things quite right though; the cash level of my online portfolio is negative while my actual investment account is about 15% cash.  I looked at why this is and its the contribution of a number of positions that are all slightly larger in the online portfolio than they should be.  I didn’t have time to adjust everything exactly so I’ll just try to reduce this discrepancy naturally over time.

Click here for the last five weeks of trades.



Week 177: Perspective

Five weeks ago I wrote that I was walking away for a while.  And so I did that.  It didn’t last as long as I had anticipated.

At the time I had taken my portfolio to about 60% cash and I had a number of shorts that helped hedge out the exposure from my remaining longs.  In early October I had basically stepped away because I had made some mistakes and lost confidence in my decisions.  It had started with the mistake of not looking closely at the oil supply/demand dynamic, which was compounded by the mistake of selling the wrong stuff when the bet began to go wrong.  As I lost money on a few oil and gas holdings, rather than reducing those positions I reduced other positions, presumably with the intent of reducing my overall risk.  Unfortunately this isn’t really what I was doing.  What I was actually doing was selling what was working while holding onto what wasn’t.  A cardinal mistake.

The consequence was that I saw my portfolio dip 12% from its peak by the second week in October.  More frustrating was that as stocks recovered in late October, I watched as some of the names I had sold near their bottom, in particular Air Canada, Aercap, and Overstock, recover their losses and were on their way back up.

I wrote my last post on a Friday afternoon after the market had closed.  Over that weekend I was virtually unencumbered by the markets.  My portfolio was cash, my blog was on hiatus, I had nothing to prevent me from thinking clearly. I don’t remember exactly when the moment came, but at some point that weekend I had a realization.

For those who have followed this blog over the past few years, you will remember that in December of last year I made a very large bet on New Residential.  The stock had gotten hit down to below $6 at the time.  I thought this was rather ridiculous and so I bought the stock.  I bought a lot of the stock.  I made it a 25% position in my portfolio.

In a narrow sense, the trade worked out.  By the end of December the stock had jumped close to $7 and I sold the position for a tidy profit.  But in the broader sense, it was an abject failure. Read more