After publishing Part 1 of this analysis, I received a few more emails than I usually do, most of them negative. Most of them said something like “you are an idiot”, and while I can’t necessarily dissuade anyone of their opinion, I can say this: those readers probably misunderstood my intent. My intent was not to say that “Reliq is a bad company”, rather it was to communicate the idea that “mispricing and overvaluation happen more often than not, and here’s how to avoid getting sucked in”. Simply put, through my own experience, I’m hoping to show some folks what to look for so that they can avoid the next such debacle. For others, who have more experience and wisdom than myself, I will admit that I probably won’t be able to enlighten you. In that case, you need read no further.
In Part 1, I detailed the signs and signals that I used to exit my position, which although it was well into the money, could have been much more into the money had I waited longer . For those of you that might have bought in when I was selling, or even later, you might be asking a similar question. Specifically, while I might be wondering “why didn’t I sell later ?” , you might be asking “why did I buy when it was so expensive ?”, or “why did I wait so long to sell ?”. Ultimately, I can’t answer all of these, but I can provide some insight into how one might have read the signals a little better.
When I exited my position in Reliq, the three year chart looked like this:
Obviously, with my crystal ball being out of order, I left a lot of money on the table. However, many investors started piling in after this point, which brings us to the why – or more specifically, why did other investors buy in ?
The typical financing process of a small cap company: To answer why others are buying when some are selling, it’s probably useful to explore the typical financing process of a small cap company. Unlike large companies, small caps are for the most part “undiscovered”. They are undiscovered and ignored for a number of reasons, primarily:
- Recently, indexing has become popular, which ignores very small companies.
- In Canada in particular, small cap is synonymous with mining & energy, which many investors avoid.
- Small companies have no name (or brand) recognition.
- Institutional money tends to come in late, when the market cap has expanded.
All of these factors are barriers to large amounts of money flowing into small caps, but the last point is perhaps the most important, and in the case of Reliq, the biggest reason why you (or someone you know) bought Reliq.
When a small company starts out, they obviously have to raise money, some of which comes from founders. However, they may go out to the public market to do a small initial raise. As I mentioned in my first post, this is how I got involved with Reliq. The investors that participate in this raise are typically very risk tolerant, and understand that they may lose their entire investment. In turn, these initial shares are usually relatively inexpensive (usually under $0.50), which gives these early investors leverage – if things work out.
As the company starts operating, it will end up following one of two potential paths:
- Things muddle along, or don’t go well: The company may still be trying to find out what it wants to do when it grows up, or it may have figured that out, but is just burning cash too quickly (this is likely where Reliq is). The company, recognizing the need for further capital, has an interest in raising that capital at the best possible prices. Good press means the price stays strong, and attracts investors. The “formula” is basically: New idea (or good idea) + good press = increasing investor interest = the ability to raise capital at higher prices.
- Things go well. The company starts becoming profitable relatively quickly, so much so that it becomes self financing. When this happens, it may or may not draw attention to itself through press releases, and the share price may (or may not) move significantly. If the share price does not move significantly, it may provide an attractive entry point, assuming there is a disconnect between price and perceived value. Mostly importantly, because the company does not require extra capital, it does not engage the investment banking community. It then typically disappears from investors radar, as only the most savvy retail investors find it, and institutions likely ignore it. Institutions ignore it because the market cap is likely too small, and trading is too illiquid. The next time it makes a significant splash in the press is usually when it is acquired at a significant premium to the normal trading price.
For many of you, I am willing to bet more than a $1.00 that you found Reliq via the first path, not the 2nd. From the emails that I have received, most investors have suggested that they are “down significantly”, which means they acquired Reliq at prices north of the current (October 22nd) price of ~ $0.60.
So the First Red Flag I’m trying to highlight here is excessive press. You may recall that in my first post, I started to think about unloading Reliq in the latter part of 2017. Not surprisingly, Reliq had lots of coverage from the investment community at that time (and later), as one can see from this snapshot of the BNN website.
At the same time that institutions are starting to sing the Reliq song, retail stock message boards start going bananas. The screenshot below shows a flurry of activity on the Reliq message board in late 2017, which likely only became more intense as time wore on.
This kind of coverage & discussion is great for momentum, as retail investors pile on while the broader investment community provides the impetus that the retail investor needs. A retail investor at this time would have been looking at the chart, and would likely have been gripped with the thought that “I’m going to miss this one”, which is only driven home by the voice of brokerages and institutional investors. Those institutional investors may or may not have interest in the long term story, but they can finally participate in the action as the market cap is getting bigger (which is what they need) and increased liquidity allows them to move in or out more easily. Lastly, the increased number of eyeballs on Reliq also provides for an opportunity to raise capital, which is exactly what happened:
So, for many of you, the coverage from analysts and/or retail investors was likely the “push” that got you to buy into the Reliq story, and the takeaway from all of this is a lesson your parents might have imparted upon you as a child: be wary of that kid that’s always telling you how awesome they are. That being said, many of you are frowning right now, wondering if maybe I’m throwing out the baby with the bathwater. Which is why we’ll move on to our Second Red Flag, which will require that we look behind the scenes.
So let’s assume that you, like many, thought that Reliq offered compelling value, and you bought in at $1.00 in late 2017, approximately the same time that analysts were covering it. At this point you wouldn’t have known it, but you could have done quite well. In fact, you would have had no less than nine months during which you could have unloaded Reliq for prices well over the (assumed) $1.00 purchase price. During this time an investor would have had no less than four distinct sets of financial statements to guide their decision – and in those financials, he or she could have seen the writing on the wall.
Below I have taken data from the four sets of financials issued, starting with year end financials for 2017 (released on October 30th 2017), to the most recent 9 months released on May 30th 2018. Rather than show each of the financials in detail, I am simply showing key data that I believe communicates the story. Additionally, one should be aware that all income statement and cash flow information for quarterly financials has been annualized. So, when you see revenue of $2,274,622 for the period ending December 31 2017, this is actually the total for the 6 months of $1,137,311 x 2, which provides us with a rough forecast for what we might expect over the full year. While this is imperfect, it provides us with something directional.
Investors who were doing their homework noticed the following:
Revenue is growing: Absolutely. Revenue continued to trend up each quarter, which every investor loves. Nothing to complain about here.
Cost of goods & gross margins are staying healthy: COGS, after strangely disappearing in Q1, resurfaced, but managed to stay fairly constant at ~ 20% – 25%.
Expenses are out of control: This is where the train starts to come off the tracks. Some investors apparently didn’t notice that while revenues were growing each quarter, expenses were growing even faster – and every passing quarter was looking worse.
Net income is getting worse with each passing quarter: This is probably redundant, given our statement about expenses, but if some investors didn’t look at the expenses in detail, they should have noticed that net income wasn’t improving.
So with the income statement firmly in the penalty box, one might have turned to the balance sheet, which actually stayed quite clean. On the balance sheet, all the action happens on the asset side of the ledger.
Cash is growing – for the wrong reasons: Without a doubt, Reliq managed to grow its cash balances, but only because of capital raises. Each new round of capital diluted previous shareholders, but did provide some de-risking to the balance sheet. Investors that bought in to Reliq were getting the signal that “you are being diluted, and the company has to perform that much better in the future”.
Accounts receivable start ballooning: As we all know, this is what popped the bubble recently. While growing receivables by themselves are not necessarily an issue, they have to be viewed in the context of total sales. In the case of Reliq, this issue first shows up on the statements issued February 2018. At that time, Reliq had billed a total of $1.1 MM in the six months of operations ending December 31 2017, or approximately $2.2 MM if one were to forecast for the full year. Of the total $1.1 MM billed, approximately 75% was waiting to be collected. By the time the next quarterly statements were issued, this percentage had increased to 87%, as receivables totalled $1.99 MM on total sales of $2.27 MM. Not good.
With the balance sheet offering up little comfort, other than a large cash balance, an investor could have turned to the cash flow statement in hopes that something positive might turn up. Unfortunately, that was not the case.
Operating cash flows, including and excluding working capital, are negative: The only saving grace is that on the final statements released May 2018, total cash burn suggests that Reliq could operate for somewhere between 2 and 6 years, if it continues to burn cash at the same rate, which is why this section is amber instead of red.
Valuation continues to climb: Lastly, under the cash flow information, I inserted a table to show how the increasing share count of Reliq and the increasing price continued to signal a risky proposition. For example, by the time Q2 financials had been issued, investors had the opportunity to sell Reliq (in March of 2018) at prices between $1.63 and $2.62. Even at the much lower average price of $1.44 during the preceding months, the valuation of Reliq suggested that it had to hit approximately $4.4 MM of EBITDA for the year to be valued at a very rich EV/EBITDA multiple of 30x EBITDA. Given the actual state of the six month financials, this would require an astronomical jump in revenues.
So, while I started this section saying we would investigate what I considered to be the Second Red Flag, I guess in actuality it was one big flag made up of lots of little ones. That being said, there are some among you that might be thinking that the financial statement information is a lot – an awful lot – to go through. So, with that in mind, I’d suggest that there was a Third Red Flag that was probably easier to read.
Back to the chart: I have stated before that I am not really a technical kind of guy. However, I still do pay attention to technical factors, as I believe there’s information to be found both in the technical and fundamental information.
The problem with charts is that most of us only have the chart today, when we really need the chart from yesterday. What I mean is that if we look at a chart of Reliq today, hindsight tells us that we should have sold. The trick is interpreting the signals when they are happening, not after. With this in mind, I have re-created what the chart of Reliq would look like at four different intervals. Please note that since I am not a “hard-core” technician, the charts I show provide only high and low price, volume, and the 10 and 30 week moving averages.
December of 2017: Congratulations! You are now a Reliq shareholder, at the bargain price of $1.00. Like many of us, you are a busy guy (or gal), so you don’t have the time to poke through financial statements. With this in mind, you decide to take a look at the 1 year chart of Reliq, which looks like this:
All the action is off to the right side of the chart, and there are three key things that I would takeaway from this chart:
- Both high and low prices (darker blue line and green line) are leading both of the moving averages, and have been since approximately August of 2017.
- Both of the moving averages are nice smooth lines, which are starting to crest upwards, after having been basically flat for a year.
- The 10 week moving average is leading the 30 week moving average, which simply confirms that recent prices have been strengthening.
This chart says good things, and if I see a chart that looks like this and the company has reasonable fundamentals, I typically try and buy as much as I can. So at this time (December of 2017), this chart is what I would call all green.
March of 2018: Wow – this thing keeps on going. You may want to think of taking some money off the table, as you have now doubled your original investment. The chart is basically a stronger version of the previous one – all systems are go.
Key points that are worth mentioning here (as of March of 2018) are as follows:
- High and low prices have continued to lead both moving averages, and there is only one instance where price threatens to break through the 10 week moving average.
- As the price continues to climb, price volatility has increased a bit.
- However, overall, the comments from the previous chart are still valid here. Things are still pretty green.
June of 2018: Storm clouds are on the horizon, as price has slipped, and things are not looking quite as rosy. If you haven’t taken any profits, you may want to consider doing so, as this chart is flashing red.
Unlike the previous two charts, you are now seeing a different story play out:
- Other investors have gone through the most recent statements, and are worried. Selling is starting to happen, and high and low prices have broken through both moving averages, which is usually bearish.
- The 10 week moving average is pointing firmly downward, while the 30 week moving average still has bit of upward momentum.
- This chart is telling you to either sell or pay close attention in the coming months, if you aren’t already. That being said, one could still sell out at prices well over $1.00.
October of 2018: You will notice that this chart only goes up to October 1st 2018, not the 16th, where the real action happens. However, this chart, like the previous one, is telling you to move on.
While there is a short recovery in late June / early July, the bulk of this chart communicates the following:
- Price has been trending down, and has been firmly below both moving averages since August 2018.
- The 10 week moving average is clearly pointing down, and the 30 week moving average, having come off its peak, is starting to do the same.
This chart, which preceded the October 16th announcement, is telling you to “sell” in no uncertain terms.
So even if all the other signals escaped ones attention, the story told by the charts, the Third Red Flag, was there to see without looking at press releases or financial statements. The key, as always, was to be paying attention and to not let hope guide ones investment decisions.
When I started this series, I indicated that Part 1 would be about how I determined to sell Reliq (unfortunately, too early), and that Part 2 would be about how others might have read market signals to avoid the significant decline in share price. After posting Part 1, not only did I receive emails telling me how abhorrently stupid I was (that’s ok, I have thick skin), but some emails asking should I sell ?
If you are still holding Reliq shares, and are wondering what to do with them, I would say this. Bear in mind that I’m compelled to issue the usual caveat that I am not an investment advisor, simply an independent investor. That being said, what would I do ?
Very simply, based on my investment style, all the information that is available to me today, and my experience, I would not be a buyer of Reliq today. In it’s current state, it does not fit my investment philosophy. That being said, I will continue to watch it. For you, your decision to hold, buy, or sell should be based on:
- How risk tolerant you are. If this meltdown has cost you a lot of sleep, then it may make sense to unload the shares.
- Your time horizon. Are you trying to make a profit in a week, a month, a year, or 10 years ? It is always harder to be right in the very short term.
- Are you working with a lot of capital ? If you have a lot, then this loss shouldn’t impact you severely and you could continue to hold – and hope.
The bottom line is that Reliq is now firmly in the penalty box, and will find it more difficult to raise capital, so it very much needs to remedy its problems. If it does make a dramatic turnaround, meaning that it significantly increases revenues and actually collects on those revenues, then we will see a dramatic run up in share price. However, if Reliq simply “muddles along”, and there is no significant uptick in revenues and cash flow, then the share price is likely to stay flat or drift lower.
As always, these are only my thoughts and opinions. Let me know if you found this post informative, or if you just have questions or comments. I can be reached at: email@example.com