Year end note – December 2020

For those of you that are looking for last minute investment ideas, this post will be of little use, so you may want to cut bait quickly. While most of the content on this site is rife with numbers and estimates of various probable (or improbable) events, this one is a distinct departure. But, if you have time on your hands, and are comfortable with a bit of philosophical musing, read on….

I think it would be a fair statement to say that 2020 has been a less than stellar year, regardless of the context. Some more eloquent colleagues of mine have suggested that 2020 has “sucked ass”, and while that language may offend some, I would tend to agree with that assessment. The onset of COVID-19, ongoing lockdowns, widespread unemployment, rioting in major cities, and divisive political rhetoric have all contributed to a distinctly negative tone, and most of us will be glad to see 2020 come to an end. While no one can unequivocally state that 2021 will be better, I’m guessing most of us are hoping for that.

However, there are a few days left in 2020, and in those last few days (and nights), there is one “Grey Swan” left that is free, beautiful, and may offer a moment of peace in an otherwise painfully hectic (and noisy) world.

Today (December 29th, 2020) is the day of the “Cold full Moon“, the last (and highest) full moon of the year. If you happen to live in a snowy climate, this means you may be witness to a confluence of events that constitutes what I would suggest is a Grey Swan of sorts.

When I was much younger, I grew up in a small Canadian town where there were few (if any) streetlights, and once it was dark, it was really dark. However, I do have distinct recollections of those few nights in the winter when it wasn’t snowing, the sky was crystal clear, it was cold (but not too cold), and there was a full moon. On those evenings, you didn’t need any light, as that giant flashlight in the sky bathed the world in blue luminescence that was amplified by the snow cover. As I got older, I made it a point to get outside on evenings like that, as that combination of events is worth taking in. While I can’t profess to say what the actual probability of such an event is, some very rough math tells me that “small” is the right word. If one assumes a 50% probability of a clear night, a 50% probability of full snow cover on the ground, a 50% probability of “goldilocks” temperatures which won’t freeze fingers and toes, and the ~10% (3 days our of 31) that the moon is effectively full, the conditional probability is 1.25%. The point here is not to prove out the math, but that this happens less often than one would think. For those of you that are mathematically inclined, my apologies for any incorrect use of nomenclature.

So what does that mean for you (or me)? Well, given that 2020 has proven to be so ugly, it would seem to me that it makes sense to partake in a moment where one can enjoy something rare and beautiful, that also offers up a chance to get away from the “Sturm und Drang” that is daily life. If you have the chance, bundle up and take a walk outside in the moonlight. If you can find a place that is away from the glare of city lights, all the better, and if you live in a rural setting, you will have a front row seat. Small moments of tranquility like this are guaranteed not to last, and if nothing else, you will have a few moments of time to yourself. Trust me – once you get back to the office (or the home), life will assume the same frenetic pace, and will continue to throw curveballs at you.

This is likely the last post of this year, so with that in mind, we wish you all the best for the remaining Holiday Season, and best wishes for the New Year. See you in 2021.

The “Grey Swan” of COVID-19

One of the few upsides of getting older is experience. When something happens, it’s no longer necessarily something “new and novel”, and from that well of past experience, one can better formulate actions as life presents new challenges.

When COVID-19 arrived, some might have argued that it was a “Black Swan”, and while I agree that it has been impactful, I would suggest it fits more into “Grey Swan” territory. Human history is peppered with stories of germs and viruses that have decimated populations, and while there hasn’t been an event of “Black Plague” proportions in modern history, we needn’t look too far back to find numerous smaller pandemics, such as SARS (2002-2004), Avian flu (H5N1 2008), and MERS (2012), all of which have happened in the very recent past. With these having occurred so recently, it suggests that COVID-19 was a swan much more grey than black.

Most of us (myself included) could never have predicted how exactly an event like COVID would play out, or exactly what impacts it might have. However, from an investing perspective, if there is one thing I have learned it’s that events such as this will continue to happen – with almost painful regularity. Investors who are successful over the long term learn from these events, and come back more prepared the next time. The pain of each of these events are valuable lessons, and the learnings which they impart are ignored only by the foolhardy.

I started managing my own capital in the late 90’s, and in doing so, I have seen my fair share of bumps along the way. Wikipedia lists no less than a dozen or more crashes and mini-crashes since 1997, but the most significant of these that I distinctly recall were the Tech bust (2000), the impact from the world trade center attacks (2001), and the Financial crisis (2008), to name just three. Since all of these are so different, some might ask how learning from one helps predict (and avoid) the next event, but that isn’t the intent. Forget about “predicting and avoiding”, because it’s usually a fruitless task. Sure, I can predict that there will be a major health scare (or financial crisis) in the future, but when, and where? Predicting when crashes will occur is a mugs game. The learning is utilized not in avoiding, but in having a plan, preparing, and reacting – appropriately – when such an event does occur.

Each of these market downturns (and all the others that I didn’t mention) were different with respect to the root cause, but each were the same when one views the outcome: initially there is shock, followed by denial, despair, acceptance, and finally, recovery. When that shock initially hits, it signals to the prepared investor that they need to implement their plan, as opportunities will undoubtably present themselves.

I once heard a money manager compare the investing process to fire fighting. For firefighters, there are long stretches of boredom, when there are no fires or emergencies to attend to, and finally, a fire breaks out somewhere. Firefighters often experience long stretches of “nothing”. Those with experience know that this time is precious – it allows the firefighter to train for the actual event and check and re-check the life saving equipment they will need when things do get ugly. When that call finally comes the last thing you want to think about is whether or not the fire engine tires are pumped up, or whether those holes in the hoses have been repaired. What you want to be able to do is put on your gear, turn the ignition key, and go – without any thought other than getting the job done. Preparation is the groundwork on which useful actions takes off from.

For the investor, this means doing “something” when nothing is really happening. Too many novice investors are action junkies, and feel compelled to hit the buy or sell button in order to feel like they are really investing. The brokerage loves this, but this isn’t what I mean when I say that one should be “doing something”. This may mean different things to different investors, but at the very least, there are some common themes. On a proactive basis, here are just a few examples of what an investor should be doing – before the market starts to nosedive.

  • Determine how an extended downturn might impact you. Is some of the money that is currently invested earmarked for something important in the near term?
  • If you derive income from your portfolio, how much will dividend cuts impact you? During this last downturn, more than a few companies reduced or eliminated their dividend.
  • If you are employing margin, ensure you understand to what degree a margin call might impact you. During the 2008 credit crisis, I personally knew of more than a few investors who did not understand how the margin on their account was calculated.
  • Identify those sectors (or companies) where you truly have insight. If you work in a particular sector (tech, real estate, energy, etc.) then your experience gives you an edge.
  • Maintain a shopping list of companies you would like to own, especially within those sectors where you have experience or insight.
  • For those companies you wish to acquire, develop a 5 or 10 year history of where the shares have traded in relation to various valuation metrics. Data such as this is invaluable in identifying when companies are under or overvalued.
  • Develop an understanding of what factors will help (or hinder) a particular company’s prospects. Read whatever you can get your hands on to expand your investing knowledge.
  • Lastly, because this blog tends to deal with small and obscure companies, research the different ways to ferret out good small cap opportunities – aside from paid newsletters.

During the first few downturns that I experienced (in the early 2000’s), my portfolio was small, and I didn’t have significant amounts of capital. Not only was I unprepared, but many of the companies that I owned were small and illiquid anyways, so the impact on me wasn’t the same as what I saw in major indexes (and large companies). However, I knew that I was missing something. I knew that opportunities were appearing, but I didn’t know how to assess them, or to determine if they truly were opportunities.

This changed during the financial crisis of 2008. During the credit crisis, I was both lucky and unlucky – lucky because I dealt with a sector that was heavily impacted (banking) and unlucky because I couldn’t allocate as much capital as I might have liked. In 2008, much of the work that I did peripherally involved the world of banking, and I had come to understand how Canadian banks differed from their American counterparts. From both my work and my travels in the U.S., it had become abundantly clear how many more banks were competing for business in the U.S. when compared to Canada, even after adjusting for population size. Nowhere in Canada could I go to a “First Farmers bank of Easter Manitoba”, whereas in the U.S., First Farmers bank is a real thing. What was clear to me was that while Canadian consumers complained bitterly how the “Big Six” gouged them on fees, the fact that they dominated the industry in Canada, and the fact they were an oligopoly made them more stable than their American counterparts (a comparison of the two can be found at Visual Capitalist). When the financial crisis hit, I was lucky in that I already had an understanding of the banking sector. At that time, everything in the banking space was painted with the same brush, and when I saw the dividend yields on Canadian banks hit unprecedented levels, I knew that the opportunity wouldn’t last. I took what little money I had and invested in a basket of the “Big Six”. At the time of writing this, these same investments spit out dividends whose average today is 15% and growing – such are the fruits of preparedness.

When COVID hit, I didn’t quite have the same advantage, but since that time (in 2008) I have always maintained a “shopping list”, I have 10 year histories of many companies on hand, and I update my personal financial snapshot on a monthly basis. As the markets weakened in Q1 and Q2 of 2020, it was clear to me that many companies were “on sale”. Readers who have visited here before are already familiar with the kinds of small (overlooked) companies that I tend to write about and hold in my “high risk” bucket, but I also kept an eye on larger companies, and many of these were fire-sale priced during the depths of COVID. While it was difficult to do, during some of the dark days of the market downturn, I tried to ignore that unsettled feeling in my gut and purchased various companies such as Deveron, Pioneering Technologies, Scotiabank, Suncor, and Vitreous Glass, to name a few.

Ultimately, we can’t reverse COVID and turn back the clock, and by no means am I trying to downplay the human cost of the pandemic. It is my sincere hope that something like this never happens again, and it’s also my hope that the various nations can learn from the missteps of this pandemic, and be better prepared next time. In the meantime, on a much smaller scale, if investors learn from the pain of this event, it also means that they will be better prepared for the next financial downturn, and will be better able to react appropriately once the next Grey (or Black) swan arrives. If there is one prediction I am confident making, it is that another such event will occur in my lifetime – and probably a lot sooner than I might like.

As always, If you have questions or comments, I can always be reached at mark@grey-swan.com. 

Deveron – update at Q3 2020

On November 18th 2020, Deveron released Q3 results. The numbers were a mixed bag – not bad & not great. Generally speaking, because market expectations weren’t overly inflated, it would appear that results have been viewed in a positive light. However, there is always the risk that enthusiasm (for shorter term investors) might be waning, which brings us to our usual first stop – the Deveron chart.

The Deveron chart is still looking “up”. For those who read my last Deveron post, you will recall that I originally had trouble sourcing the Deveron chart on Yahoo. It would seem that the recent move from the CSE to the TSX Venture caused issues for Yahoo, as the chart below shows three years of Deveron price and volume, but one can see that the current price that is displayed ($0.23 as of August 27th), the symbol (DVR), and the exchange (CN) are incorrect. Despite these errors, the chart displays correct historical and current pricing, and one can see that from a chartist’s perspective, things still look positive as of November 23rd. While there was some selling pressure on the 18th, other investors with a longer view have picked up the shares.

The balance sheet is still OK. Since the end of Q2 (June 30th 2020), Deveron has burned some cash ($618,000), and overall current assets are down by $489,000 to just over $2.0 MM. When compared with the prior quarter, longer term assets are essentially the same, with no significant changes. So, in the “big picture” context, total assets have fallen entirely as a result of cash burn, and now come in at $4.33 MM vs $4.79 MM at Q2. If one goes further back (to December of 2019) it’s clear that total assets have increased by $480,000 (+12%) since December of 2019 – but in this case, this is all growth in Goodwill, which is the result of acquisitions.

On the liability side of things, total liabilities at $779,000 are up as compared to both the prior quarter ($777,000) and December 2019 ($736,000). The bulk of that change is found in the current liabilities section, in overall growth in Accounts Payable. However, while total liabilities are up, they are not up so much as to be a major concern. So, the balance sheet, while it’s a bit worse off, still falls into “ok” territory. Of all the balance sheet items that are worth discussing, it’s the very first one – cash burn – that leads right into the income statement.

Revenues are up – but so are costs. Revenues are up by $647,000 (+44%) over this period last year, at $2.117 MM vs $1.470 last year. When compared to the prior quarter, the change is not quite so dramatic, with only a 10% increase, but it’s still up. Additionally, gross margins for the full 9 months are healthy, at $1.628 MM vs $1.033 MM last year, an increase of +58%. All things being equal, this section should look a lot “greener” – but it’s not.

When looking at “why” earnings are good (or bad), I prefer to look at cash expenses in isolation. The truth is that non-cash expenses are sometimes subject to more discretionary measures, which can obscure what actually happened. So, in this case, for the nine months ended September 2020, we have taken all the non-cash expenses that appear on the cash flow statement ($307,000) and subtracted them from the total expenses ($2.963 MM) on the income statement. This process tells us that the actual cash expense for this period was $2.656 MM, or about $295,000/month. If we complete this same exercise for the 9 month period in 2019, we come up with non-cash expense of $625,000, which is backed out of total expenses of $2.429 MM, to come up with actual cash expenses of $1.804 MM, almost exactly $200,000/month. All in all, cash expenses were up 47% YoY, which unfortunately outstrips any gains in revenues.

So with costs growing faster than revenues, why is this section not red ? Well, the silver lining in this cloud can be found in the press release following the earnings announcement, from which we have taken the following excerpt:

Data collection revenue lagged in Q3 due to late harvesting across North America with most bookings rescheduled for Q4. Gross margin decreased 13% largely due to the company expanding its collection capabilities in the United States. Deveron relies on third party contractors to drive new network node expansion and expects margin improvement as the Company fills these positions with employees.

So, the short and sweet summary is that revenues normally would have been larger, and future costs should fall as the company transitions from more expensive 3rd party contractors to (hopefully) less expensive employees. Additionally, if most bookings are going to happen in Q4, then we should see a particularly good Q4. So, this tidbit keeps the income statement story amber for now, as we wait to see what Q4 brings.

Along with increased costs, increased cash burn. Yes, that heading is correct – it is showing two colors – amber for the fact that cash burn is essentially the same, red because it hasn’t improved. Not surprisingly, increased costs also means that cash burn hasn’t slowed down. While it isn’t out of control, cash flow (before changes in working capital) for the current 9 month period came in at -$757,000 vs -$771,000 during the 9 months of 2019, virtually unchanged. After changes in working capital, the story is the same, as operating cash flow came in at -$1.294 MM, slightly higher than the 9 months of 2019 at -$1.190 MM. So operating cash flow hasn’t come off the rails, but it hasn’t improved either, regardless of how one looks at it. Again, given that a significant amount of revenue has been pushed into Q4, we will have to wait to see if this situation turns around. In the meantime, if operating cash flow doesn’t improve, Deveron has a little more (or a little less) than a year’s worth of cash left before it will have to raise capital or seek other financing.

Insiders continue to hold. Not surprisingly, not much has changed since the prior Deveron post in mid-October. There is no indication of insider selling, and the three largest shareholders (Greencastle, William Linton and Roger Dent) still hold 13.8 MM shares, or about 27% of the total shares outstanding.

Deveron remains relatively unknown. Deveron remains unknown in the general market, and has not engaged in “excessive” PR. So, while expectations are higher (for those that are familiar with Deveron), there remains a much larger segment of investors that have never heard of the company. If one searches for something like “Deveron analyst coverage”, the end result is usually something like this:

Suffice to say that the company hasn’t engaged the typical “press cycle” yet, which in turn means that upside from such engagement is yet to come.

The share count may increase again. Usually, a heading such as this is red, as it was in the prior post. However, as mentioned above, Deveron has virtually no following – yet. If Deveron decides to leverage the improving share price and raise incremental capital, it may happen with coverage from whatever investment bank or wealth management firm that leads the charge. So, the question becomes: is the potential dilutive effect less (or more) impactful than the increased number of investors chasing the story? Ultimately, the answer is unknown, but with Deveron executing reasonably well, and demonstrating top line growth, it would not be a huge leap to see a capital raise that would attract a larger investment following, which in turn drives the share price. With this in mind, we recognize that this issue has both good and bad impacts, hence the amber heading.

So, while Q3 wasn’t great, Deveron isn’t a write off. We continue to hold our Deveron position, as we believe that over the longer term, it has promise. In the meantime, most of the key points from the October 16th post still hold true, plus a few new ones:

  • The move to the TSX should keep drawing new investors: Given that Deveron is still relatively unknown, this should still be the case. Additionally, any capital raise will likely draw new eyeballs.
  • There is expectation around Q4 results: Deveron clearly indicated that Q4 results will include business that usually would have fallen into Q3, thereby “kicking” expectations down the road.
  • There is still strength from a technical perspective: As of the date of writing this (November 23rd 2020), the Deveron share price is still trading around $0.35-$0.37. We believe the share price would have suffered more (around the 18th – 19th of November) if current investors were “giving up” on Deveron.
  • Investors should maintain a clear exit strategy: Depending on one’s stomach for volatility, have a plan before going long, which is even more important for those that consider themselves short term traders. If one thinks of investment horizons in years, then you probably will sleep well despite volatility. If your investment time frame is shorter, be aware that the share price has the ability to move quickly – either way.
  • Bankruptcy remains a non-issue, but dilution still might be: Insolvency is unlikely, but any future capital raises will obviously create dilution. If a capital raise does occur, hopefully Deveron can do so above the current $0.35 – 0.37 range to minimize dilution.
  • Liquidity is still good, so pricing is less choppy: Trading volume & liquidity are still solid, so the bid/ask spread is better than it was when Deveron traded on the CSE. With this in mind, one is better able to potentially fill bids at the lower end of the spread rather than having to hit the ask right away.

I continue to be long on Deveron, with an average purchase price of ~ $0.25 CAD. As always, these are only my thoughts & opinions. If you have questions or comments, I can always be reached at mark@grey-swan.com. 

Recognizing small cap opportunities (updated)

A post essentially identical to this one was originally published on October 27th, 2020. The original post did not actually disclose the identities of the respective companies at the time, as the primary intent was to explore what signals & information an investor might use to confidently come to an investment decision in one or both companies, given how different they are. The content below is identical to the original post, with only some minor changes to insert the actual company names and ticker symbols. It should be noted that that while some readers did ask what the actual tickers were, only one reader managed to correctly ascertain one (Vitreous Glass).

On December 22, 2000, a brazen mid-day art heist took place at the Swedish National Museum. Three heavily armed men walked in and removed three paintings – one by Rembrandt, the other two by Renoir, one of which (Conversation with the Gardener) is shown above. The men had planned the robbery to the most minute detail, and had created other diversions in the city to distract police. Once they had secured the paintings, the men found their way to a waiting motorboat and proceeded to vanish. 

By all accounts, the robbery was perfect, but there was one nagging issue. The paintings were valued at approximately $30 million US dollars, but the value of art, unlike gold or diamonds, is very specific. A stolen painting cannot simply be sold on ebay, and many people wouldn’t place a high value on it because they simply wouldn’t know what they are looking at. In order for a particular piece of art to have monetary value, one must be able to validate three things: authenticity, history of ownership, and legal title. If one of these is missing (or cannot be determined), then the value is gone – as is the opportunity to recognize a handsome (criminal) profit.  So, this combination of factors meant that the paintings were valued at $30 million – but not in the hands of the criminals. Eventually, all of those involved in the heist were caught and charged, and the paintings were eventually recovered. What first appeared to be a sure-fire opportunity was nothing more than a mirage. 

Fortunately, the investing universe is not quite so demanding, and most people can recognize the opportunities presented by various companies. But when it comes to the Canadian small cap market, there are more than a few situations where investors aren’t sure about a potential opportunity, and are unsure about what brings value to a particular company. This post deviates from our usual theme of profiling a company we have invested in, and instead takes a look at two very different companies currently trading on the TSX Venture. Both have provided opportunities for their respective investors to profit, but in very different ways, and in different time frames. While you won’t have to be an art buff to have an interest in this post, rest assured that for one (or both) of these companies, beauty is in the eye of the beholder.

What is value exactly ? Merriam Webster defines value as “a fair return or equivalent in goods, services, or money for something exchanged”, and as investors, we can interpret this easily. For instance, if one purchases shares at $1.00 and expects a fair return, then the sale of those shares at some later date at a price in excess of the purchase price (and hopefully in excess of risk free rates) would constitute a measure of value. But, as we all know, we are looking for returns above and beyond “normal”, as investing in small caps can be a risky venture. 

So, in the universe of investment, the ultimate value that one derives from the purchase of stock can be derived by a sale of those shares, dividends from those shares, or a combination of the two. On the surface, this sounds pretty straightforward – buy the shares, collect the dividends, and/or wait for the price to move up. The tricky part is recognizing the value in a particular company, and then, validating the specific requirements to ensure that there is value. Without these, there is the risk that we are looking at a “forgery” – an investment that leads us to believe it will be valuable, but ultimately ends up worthless. 

Does the chart signal opportunity ?  While I don’t consider myself an “expert technician” by any stretch, I do believe that charts have their place in the investing process. If nothing else, they communicate market sentiment about a company, and provide some indication of volatility, even if it is in the rear-view mirror. The two charts below are a snapshot of our two respective companies, Vitreous Glass (VCI – TSXv) and Pyrogenensis (PYR – TSXv).

The first thing that becomes apparent from these charts is that one chart puts one to sleep, whereas the other offers few clues as to future success. VCI appears to have zero volatility, having traded almost in a straight line. On the other hand, PYR exhibits more volatility, but has also traded sideways for years. More recently, it appears that both are trading at or below the various moving averages, suggesting future weakness for both. At this point, it’s probably fair to say that while a picture is worth a 1,000 words, the words provided here are inconclusive at best. With this in mind, we dig a bit deeper into the financials. 

The details of the financials provide a better picture.   With the technical picture being somewhat murky, we defer to the financial statements to provide some better clues. Rather than dissecting (and discussing) multiple years of financial statements at length, we boiled down some key information into two comparative tables (below), which provide us some context on why the two charts look the way they do: 

These numbers explain a lot. VCI is the model of consistency. Revenues are generally flat, but it appears that the company knows what it’s doing, as gross margins are consistently around 45%-55%, and the company is always cash flow and earnings positive. Additionally, over the 7 year period shown, the company, which has a market cap of around $22 MM (Canadian dollars) has provided no less than $17.8 MM in dividends, or about 80% of the market value of the company. To put this into perspective, in 2013, when VCI had its worst year, it traded around a high price of $3.00 and returned a $0.30 dividend to investors – a 10% yield. This sort of performance explains the lack of volatility in the chart, as shareholders have recognized the value of a company which can execute its business plan consistently and return capital, year after year. Because of this consistency, VCI hasn’t raised capital in years, and the share count has remained flat, meaning no dilution for existing shareholders. 

On the other hand, PYR is a cash burning machine. Share count has more than doubled over the same period, and it is difficult to discern any trend when it comes to gross margins. Revenues have exhibited some consistency, but net income and cash flow have been negative in all years. There is precious little to get excited about here – the numbers are simply ugly and do not inspire confidence. While the chart provided an inconclusive picture, the financials indicate one area of success – the ability to consistently increase shares outstanding. 

These trends are further highlighted when one looks at the Enterprise value / EBITDA ratio (EV/EBITDA). This ratio is particularly useful because it takes into account a company’s cash and debt levels, and thereby provides an understanding of not only value, but risk. For instance, a company with a market cap of $10 MM and EBITDA of $2 MM would appear to be attractive, as the EV/EBITDA ratio (excluding debt) would be 5x, implying that a purchaser of the company could “buy” $2.0 MM of EBITDA for only $10 MM, a 20% return.  However, if the company is also carrying $25 MM in debt, the EV would increase to $35 MM, and the EV/EBITDA ratio would be much less appealing at 17.5 times EBITDA. This highlights the fact that the debt obligation makes the investment that much more risky, and suggests that the return is closer to 6%. For the sake of simplicity, the market price at year end is used for the calculation of Market cap and Enterprise value. 

Again what becomes immediately apparent is how the EV/EBITDA ratio of VCI falls within a tight range of 5 – 7, suggesting that despite the fact that it has returned a significant amount of capital to investors via dividends,  investors have yet to bid up the shares to lofty heights. By comparison, the EV/EBITDA ratio of PYR is always negative, given that their EBITDA is always negative, and the ratio shows wild swings – which, as you may have noticed, is where the rubber of our story really hits the road. 

Recognizing the two opportunities. At this point, we have explored a common theme, and have come to what appeared to be a clear conclusion. One company (VCI), although offering up little in the sense of “excitement”, provided investors with clear clues. While the chart didn’t immediately scream opportunity, it did signal “lower risk”. An investor who was willing to roll up his or her shirtsleeves and take a deeper dive into the financials would have uncovered the opportunity to recognize a “like clockwork” annual return of somewhere between 7.7% (high price in 2015 of $4.17 with dividend of $0.32) and 14.8% (low price in 2016 of $2.90 with dividend of $0.43). In essence, the ability to “recognize” the opportunity of VCI just takes a little time and effort via a well worn approach. 

The opportunity of PYR is, not surprisingly, opaque. The chart provided little in terms of clues, and the financial statements were less than inspiring. Regardless, in 2020, you may have noticed that the Enterprise Value of PYR increased by a factor of 8 when compared to 2019. This is where “recognizing the work of art” takes someone who is willing to put in a bit more effort, and who can see how the picture is taking shape as it is being painted. 

Back to the charts. If you were looking closely, you’d have noticed that the previous charts for VCI and PYR did not extend through to October of 2020. This was done with intent, otherwise it would have been a lot harder to write this article – and a lot less interesting. In the first part of this analysis, the lack of direction given by the charts compelled us to look (in detail) at the financials, which is how the opportunity of VCI was revealed. Had we included the full charts from the very beginning, we might never have gotten to that point, given that the PYR chart would have gotten all the attention. 

Below are the two charts of VCI and PYR again, but this time they begin in January of 2020 and end as of October 23rd, 2020, the date that this article was penned: 

Here we see the two charts again, but this time there are some distinct differences. First of all, it is clear that while VCI keeps doing what it does best, the chart is not markedly different than the prior one. Since this time period encompasses COVID, we see the price bottom out in March and April of 2020, but then it recovers nicely and comes right back up to where it was. Anyone that purchased VCI during the depths of COVID will be doing very well. Going forward, a purchaser of VCI during the “COVID dip” will be realizing dividends of (on average) $0.30 annually for the foreseeable future, on a purchase price under $3.00 and potentially as low as $2.50.  That equates to collecting a yield between 10% – 12%, which is pretty good if you ask me. Additionally, it stands to reason that at some point the market might actually notice, and VCI might be acquired at some future date, at a premium. 

That being said, as enticing as an ongoing 10% yield is, there is no denying the opportunity that is now clear that PYR has provided. Shareholders who purchased PYR and held it for the longer haul have made very, very significant amounts of money. To be specific, a small retail investor that would have invested $5,000 in PYR at an “expensive” 2019 price of $0.70 could have realized a total pre-tax gain of approximately $38,000 had they sold close to the peak 2020 price at $6.00. Even at the more recent price of $3.50, an PYR investor would have a pre-tax gain of $20,000. Investors who were patient enough and invested earlier (at lower prices) would have held longer, but would have seen some even more extraordinary gains. 

Getting into the depths of the chart. Just as we “waded into the weeds” of the VCI financial statements, we now have to wade into the weeds of the PYR chart. If nothing else, it is clear that these two “artworks” are substantially different. If one were looking at a classic sculpture, it wouldn’t make a lot of sense to try & determine whether or not it was an oil or a watercolor. In the same way, it’s clear that reviewing the charts, not the financial statements, will help us better understand the PYR opportunity. 

There are two significant things worth mentioning about the PYR chart, both of which we will discuss in detail. 

First – what are all of those red dots ? We have all seen the movie where our hero, cornered by villains, jumps into a river to escape. We watch intently, waiting for our hero to surface, but they never do. Death seems imminent, but at the last moment it’s revealed that he (or she) had a hidden source of oxygen – an old water bottle found at the scene provides just enough air to allow them to swim, underwater and undetected, to safety. 

While this example is fairly dramatic, the reality of small caps is slightly less dashing. Companies, large and small, depend on capital to keep themselves afloat. Lack of capital is not unlike asphyxiation – the company will die, either quickly or slowly, if capital isn’t available. For large companies, this is mostly an academic issue. As horrible as the market landscape might be, Enbridge will probably still be able to tap debt markets or issue shares. In the example of our two companies, one of them (VCI) creates more than enough capital from operations, and is able to return excess capital to shareholders. It’s clear that VCI doesn’t need any other sources of capital.  But for PYR, the story is different, as it is far from self funding. The ability to issues shares is key to the survival of PYR, and an inability to do so would have meant a slow death a long time ago.  

On those charts, along with price, volume, and moving average (MAVG) lines, one can see a scattering of red dots. Each one of those dots represents what is defined as a “non-standard press release”. For instance, a standard press release might be: 

  • Announcement of quarterly or annual financial statements
  • Dividend announcements
  • Announcements about appointments of Directors or Senior management
  • Early warning reports
  • Share buybacks or notices of private placements
  • Notices of annual meetings

Therefore, a “non-standard” press release is something that deals with none of these, and is usually an announcement of “ongoing potential contracts” or a “comment on unusual stock trading activity”. The difference in the two charts is striking: on the VCI chart, you have to look hard to see when the press releases occur. In the 46 month period from January 2017 to October 2020, VCI issued a total of 5 non-standard press releases, 4 of which were related to COVID. On the PYR chart, there are so many, they sometimes obscure the MAVG lines. During that same period, excluding all “normal” press releases that one might expect, PYR issued 116 non-standard press releases, approximately 2.5 for every month of the year. 

These press releases have purpose: they keep PYR first and foremost in investors minds. We are all familiar with the idea that if one hears something often enough, it becomes accepted, and this is not lost on public relations departments. You will recall that the two companies were strikingly different when it came to total shares outstanding – one company (VCI) had issued virtually no shares, while the other (PYR) had more than doubled total shares outstanding since 2013. If a company is consistently issuing shares, it is a good idea to do so at the best price possible. By maintaining a consistent flow of communication, it ensures that the company never totally falls off investors radar, and for those investors that are already closely following the company, it provides reassurance that all is going well. In the absence of cash flow and earnings, good communication ensures that the share price never tanks too badly. The fact that the share price never gets “too low” means that even while PYR is diluting the existing shareholder base, it is at least mitigating this process to some degree. Additionally, this ongoing communication has another important function.  At some point, one of the press releases (or a combination of press releases and other events) will eventually provide a catalyst, perceived or otherwise, causing momentum to change – which brings us to our second point. 

Second – we need to view a smaller timeframe. The 2017-2020 chart, while it clearly shows what “has happened”, needs to be distilled into a smaller timeframe so that we can look at it “in the moment”. We need to bring ourselves back to when the opportunity was unfolding to get a better sense of what was happening at that time. To do this, we take a look at two PYR charts (below), both of which encompass the first 90 trading days of 2020. We look at these in detail, as we know that not much was happening in January and February of 2020, but things suddenly took off not too soon afterwards. 

This first chart is typical. We can see that PYR is trading below almost all MAVG lines in the early part of the year. There is a flurry of press releases, beginning in late January, the price dips when COVID is announced, and then the price begins to recover. From the middle of March through to 3rd week of April, the price strengthens, but the improvement in volume is less dramatic. We get the sense the share price is improving, but it lacks conviction – until the price and volume spike in late April, at which point we would be committed to buying in at ~ $0.70 or higher, as opposed to the $.050 – $0.60 range. In essence, it would be nice to have some more fulsome information prior to the spike in volume. This brings us to our 2nd chart, below. 

This chart is similar, but different than the prior one. Like the prior chart, price, MAVGs and press releases are apparent. But the difference we see here is that the bars are no longer measuring volume – we are now quantifying retail investor chatter – essentially, the daily volume of investor discussion. 

For a company such as PYR, momentum and technical factors outweigh fundamentals, as we have seen. In this chart we can see evidence of growing investor “chatter”. Measured by the 30 day average of investor posts about PYR, we can see that interest in February is building. For example, in early February,  the 30 day average of posts is >15/day as compared to around 10/day in early January. The volume of posts level off a bit during the COVID announcement, but then pick up again in early April, then more in late April, and then one can see it pick up significantly in early May. From the period from mid-March (when COVID is announced) through to the 3rd week of April, we see chatter clearly trending upward. Every day, investors were posting and talking more about PYR. This information, in conjunction with all the other information we have, provides that extra bit of confirmation that sentiment is likely to swing significantly in the coming days and weeks. As we know, an investor that would have gone long on PYR any time from late March through to the latter part of April would have done very well, as they would not have waited for the “loud” signal of the price spike on April 30th, which drove shares over $0.70. Once the shares were in full “rocket” mode, daily posts kept growing, sometimes exceeding 400 per day. 

The rest of the PYR story is history at this point. While the shares peaked over $6.00, they have come off their high, but are still significantly above their early 2020 prices. The long term PYR story has yet to play out, and investors who commit capital today are, for better or for worse, buying into some lofty expectations. The market valuation of PYR today has much more expectation built into it than it did 12 months ago. For those who bought in early – and held on – I salute you!

In conclusion, there’s probably a few key takeaways that I think are worth mentioning:

  • The intent of this post was to point out that opportunity exists in small caps in many different forms, which these two companies serve to highlight. 
  • Like fine artwork, for those who value “classic lines”, the TSX Venture does offer up companies such as VCI, the opportunity of which is best recognized via traditional financial statement analysis. 
  • For those who prefer something more risqué, one must adopt more technical tools, as the fundamentals will reveal little or no opportunity. 
  • The ability to weave in and out of both worlds provides more opportunities to uncover, just as speaking more languages allows you to interact with a more diverse (and interesting) group of people. 
  • Lastly, some of the most impactful opportunities may require one to step outside the usual boxes of fundamental or technical analysis. 

In the original post, the identities of the two companies were not revealed. I thought it would detract from the post itself if the actual symbols were provided, as readers would (likely) zero in on the Pyrogensis story rather than read through the entire content of the post. In the meantime, as I always say, these are only my thoughts & opinions. If you have questions or comments, I can always be reached at mark@grey-swan.com. 

Recognizing small cap opportunities (original)

On December 22, 2000, a brazen mid-day art heist took place at the Swedish National Museum. Three heavily armed men walked in and removed three paintings – one by Rembrandt, the other two by Renoir, one of which (Conversation with the Gardener) is shown above. The men had planned the robbery to the most minute detail, and had created other diversions in the city to distract police. Once they had secured the paintings, the men found their way to a waiting motorboat and proceeded to vanish. 

By all accounts, the robbery was perfect, but there was one nagging issue. The paintings were valued at approximately $30 million US dollars, but the value of art, unlike gold or diamonds, is very specific. A stolen painting cannot simply be sold on ebay, and many people wouldn’t place a high value on it because they simply wouldn’t know what they are looking at. In order for a particular piece of art to have monetary value, one must be able to validate three things: authenticity, history of ownership, and legal title. If one of these is missing (or cannot be determined), then the value is gone – as is the opportunity to recognize a handsome (criminal) profit.  So, this combination of factors meant that the paintings were valued at $30 million – but not in the hands of the criminals. Eventually, all of those involved in the heist were caught and charged, and the paintings were eventually recovered. What first appeared to be a sure-fire opportunity was nothing more than a mirage. 

Fortunately, the investing universe is not quite so demanding, and most people can recognize the opportunities presented by various companies. But when it comes to the Canadian small cap market, there are more than a few situations where investors aren’t sure about a potential opportunity, and are unsure about what brings value to a particular company. This post deviates from our usual theme of profiling a company we have invested in, and instead takes a look at two very different companies currently trading on the TSX Venture. Both have provided opportunities for their respective investors to profit, but in very different ways, and in different time frames. While you won’t have to be an art buff to have an interest in this post, rest assured that for one (or both) of these companies, beauty is in the eye of the beholder.

What is value exactly ? Merriam Webster defines value as “a fair return or equivalent in goods, services, or money for something exchanged”, and as investors, we can interpret this easily. For instance, if one purchases shares at $1.00 and expects a fair return, then the sale of those shares at some later date at a price in excess of the purchase price (and hopefully in excess of risk free rates) would constitute a measure of value. But, as we all know, we are looking for returns above and beyond “normal”, as investing in small caps can be a risky venture. 

So, in the universe of investment, the ultimate value that one derives from the purchase of stock can be derived by a sale of those shares, dividends from those shares, or a combination of the two. On the surface, this sounds pretty straightforward – buy the shares, collect the dividends, and/or wait for the price to move up. The tricky part is recognizing the value in a particular company, and then, validating the specific requirements to ensure that there is value. Without these, there is the risk that we are looking at a “forgery” – an investment that leads us to believe it will be valuable, but ultimately ends up worthless. 

Does the chart signal opportunity ?  While I don’t consider myself an “expert technician” by any stretch, I do believe that charts have their place in the investing process. If nothing else, they communicate market sentiment about a company, and provide some indication of volatility, even if it is in the rear-view mirror. The two charts below are a snapshot of our two respective companies, which I have re-labelled with new symbols, “BORE” and “OPAQ” respectively. If I used the actual symbols, this process would be a lot less interesting, and rest assured that the real identities of the companies will be revealed – in time. 

BORE chart for finding value on TSX to March 2020

OPAQ chart for finding value on TSX to March 2020

The first thing that becomes apparent from these charts is that the symbols provide a fitting description, as one chart puts one to sleep, whereas the other offers few clues as to future success. BORE appears to have zero volatility, having traded almost in a straight line. On the other hand, OPAQ exhibits more volatility, but has also traded sideways for years. More recently, it appears that both are trading at or below the various moving averages, suggesting future weakness for both. At this point, it’s probably fair to say that while a picture is worth a 1,000 words, the words provided here are inconclusive at best. With this in mind, we dig a bit deeper into the financials. 

The details of the financials provide a better picture.   With the technical picture being somewhat murky, we defer to the financial statements to provide some better clues. Rather than dissecting (and discussing) multiple years of financial statements at length, we boiled down some key information into two comparative tables (below), which provide us some context on why the two charts look the way they do: 

BORE table 1

OPAQ table 1These numbers explain a lot. BORE is the model of consistency. Revenues are generally flat, but it appears that the company knows what it’s doing, as gross margins are consistently around 45%-55%, and the company is always cash flow and earnings positive. Additionally, over the 7 year period shown, the company, which has a market cap of around $22 MM (Canadian dollars) has provided no less than $17.8 MM in dividends, or about 80% of the market value of the company. To put this into perspective, in 2013, when BORE had its worst year, it traded around a high price of $3.00 and returned a $0.30 dividend to investors – a 10% yield. This sort of performance explains the lack of volatility in the chart, as shareholders have recognized the value of a company which can execute its business plan consistently and return capital, year after year. Because of this consistency, BORE hasn’t raised capital in years, and the share count has remained flat, meaning no dilution for existing shareholders. 

On the other hand, OPAQ is a cash burning machine. Share count has more than doubled over the same period, and it is difficult to discern any trend when it comes to gross margins. Revenues have exhibited some consistency, but net income and cash flow have been negative in all years. There is precious little to get excited about here – the numbers are simply ugly and do not inspire confidence. While the chart provided an inconclusive picture, the financials indicate one area of success – the ability to consistently increase shares outstanding. 

These trends are further highlighted when one looks at the Enterprise value / EBITDA ratio (EV/EBITDA). This ratio is particularly useful because it takes into account a company’s cash and debt levels, and thereby provides an understanding of not only value, but risk. For instance, a company with a market cap of $10 MM and EBITDA of $2 MM would appear to be attractive, as the EV/EBITDA ratio (excluding debt) would be 5x, implying that a purchaser of the company could “buy” $2.0 MM of EBITDA for only $10 MM, a 20% return.  However, if the company is also carrying $25 MM in debt, the EV would increase to $35 MM, and the EV/EBITDA ratio would be much less appealing at 17.5 times EBITDA. This highlights the fact that the debt obligation makes the investment that much more risky, and suggests that the return is closer to 6%. For the sake of simplicity, the market price at year end is used for the calculation of Market cap and Enterprise value. 

BORE table 2

OPAQ table 2

Again what becomes immediately apparent is how the EV/EBITDA ratio of BORE falls within a tight range of 5 – 7, suggesting that despite the fact that it has returned a significant amount of capital to investors via dividends,  investors have yet to bid up the shares to lofty heights. By comparison, the EV/EBITDA ratio of OPAQ is always negative, given that their EBITDA is always negative, and the ratio shows wild swings – which, as you may have noticed, is where the rubber of our story really hits the road. 

Recognizing the two opportunities. At this point, we have explored a common theme, and have come to what appeared to be a clear conclusion. One company (BORE), although offering up little in the sense of “excitement”, provided investors with clear clues. While the chart didn’t immediately scream opportunity, it did signal “lower risk”. An investor who was willing to roll up his or her shirtsleeves and take a deeper dive into the financials would have uncovered the opportunity to recognize a “like clockwork” annual return of somewhere between 7.7% (high price in 2015 of $4.17 with dividend of $0.32) and 14.8% (low price in 2016 of $2.90 with dividend of $0.43). In essence, the ability to “recognize” the opportunity of BORE just takes a little time and effort via a well worn approach. 

The opportunity of OPAQ is, not surprisingly, opaque. The chart provided little in terms of clues, and the financial statements were less than inspiring. Regardless, in 2020, you may have noticed that the Enterprise Value of OPAQ increased by a factor of 8 when compared to 2019. This is where “recognizing the work of art” takes someone who is willing to put in a bit more effort, and who can see how the picture is taking shape as it is being painted. 

Back to the charts. If you were looking closely, you’d have noticed that the previous charts for BORE and OPAQ did not extend through to October of 2020. This was done with intent, otherwise it would have been a lot harder to write this article – and a lot less interesting. In the first part of this analysis, the lack of direction given by the charts compelled us to look (in detail) at the financials, which is how the opportunity of BORE was revealed. Had we included the full charts from the very beginning, we might never have gotten to that point, given that the OPAQ chart would have gotten all the attention. 

Below are the two charts of BORE and OPAQ again, but this time they begin in January of 2020 and end as of October 23rd, 2020, the date that this article was penned: 

BORE chart for finding value full 2020 on TSX Venture

OPAQ chart for finding value full 2020 on TSX Venture

Here we see the two charts again, but this time there are some distinct differences. First of all, it is clear that while BORE keeps doing what it does best, the chart is not markedly different than the prior one. Since this time period encompasses COVID, we see the price bottom out in March and April of 2020, but then it recovers nicely and comes right back up to where it was. Anyone that purchased BORE during the depths of COVID will be doing very well. Going forward, a purchaser of BORE during the “COVID dip” will be realizing dividends of (on average) $0.30 annually for the foreseeable future, on a purchase price under $3.00 and potentially as low as $2.50.  That equates to collecting a yield between 10% – 12%, which is pretty good if you ask me. Additionally, it stands to reason that at some point the market might actually notice, and BORE might be acquired at some future date, at a premium. 

That being said, as enticing as an ongoing 10% yield is, there is no denying the opportunity that is now clear that OPAQ has provided. Shareholders who purchased OPAQ and held it for the longer haul have made very, very significant amounts of money. To be specific, a small retail investor that would have invested $5,000 in OPAQ at an “expensive” 2019 price of $0.70 could have realized a total pre-tax gain of approximately $38,000 had they sold close to the peak 2020 price at $6.00. Even at the more recent price of $3.50, an OPAQ investor would have a pre-tax gain of $20,000. Investors who were patient enough and invested earlier (at lower prices) would have held longer, but would have seen some even more extraordinary gains. 

Getting into the depths of the chart. Just as we “waded into the weeds” of the BORE financial statements, we now have to wade into the weeds of the OPAQ chart. If nothing else, it is clear that these two “artworks” are substantially different. If one were looking at a classic sculpture, it wouldn’t make a lot of sense to try & determine whether or not it was an oil or a watercolor. In the same way, it’s clear that reviewing the charts, not the financial statements, will help us better understand the OPAQ opportunity. 

There are two significant things worth mentioning about the OPAQ chart, both of which we will discuss in detail. 

First – what are all of those red dots ? We have all seen the movie where our hero, cornered by villains, jumps into a river to escape. We watch intently, waiting for our hero to surface, but they never do. Death seems imminent, but at the last moment it’s revealed that he (or she) had a hidden source of oxygen – an old water bottle found at the scene provides just enough air to allow them to swim, underwater and undetected, to safety. 

While this example is fairly dramatic, the reality of small caps is slightly less dashing. Companies, large and small, depend on capital to keep themselves afloat. Lack of capital is not unlike asphyxiation – the company will die, either quickly or slowly, if capital isn’t available. For large companies, this is mostly an academic issue. As horrible as the market landscape might be, Enbridge will probably still be able to tap debt markets or issue shares. In the example of our two companies, one of them (BORE) creates more than enough capital from operations, and is able to return excess capital to shareholders. It’s clear that BORE doesn’t need any other sources of capital.  But for OPAQ, the story is different, as it is far from self funding. The ability to issues shares is key to the survival of OPAQ, and an inability to do so would have meant a slow death a long time ago.  

On those charts, along with price, volume, and moving average (MAVG) lines, one can see a scattering of red dots. Each one of those dots represents what is defined as a “non-standard press release”. For instance, a standard press release might be: 

  • Announcement of quarterly or annual financial statements
  • Dividend announcements
  • Announcements about appointments of Directors or Senior management
  • Early warning reports
  • Share buybacks or notices of private placements
  • Notices of annual meetings

Therefore, a “non-standard” press release is something that deals with none of these, and is usually an announcement of “ongoing potential contracts” or a “comment on unusual stock trading activity”. The difference in the two charts is striking: on the BORE chart, you have to look hard to see when the press releases occur. In the 46 month period from January 2017 to October 2020, BORE issued a total of 5 non-standard press releases, 4 of which were related to COVID. On the OPAQ chart, there are so many, they sometimes obscure the MAVG lines. During that same period, excluding all “normal” press releases that one might expect, OPAQ issued 116 non-standard press releases, approximately 2.5 for every month of the year. 

These press releases have purpose: they keep OPAQ first and foremost in investors minds. We are all familiar with the idea that if one hears something often enough, it becomes accepted, and this is not lost on public relations departments. You will recall that the two companies were strikingly different when it came to total shares outstanding – one company (BORE) had issued virtually no shares, while the other (OPAQ) had more than doubled total shares outstanding since 2013. If a company is consistently issuing shares, it is a good idea to do so at the best price possible. By maintaining a consistent flow of communication, it ensures that the company never totally falls off investors radar, and for those investors that are already closely following the company, it provides reassurance that all is going well. In the absence of cash flow and earnings, good communication ensures that the share price never tanks too badly. The fact that the share price never gets “too low” means that even while OPAQ is diluting the existing shareholder base, it is at least mitigating this process to some degree. Additionally, this ongoing communication has another important function.  At some point, one of the press releases (or a combination of press releases and other events) will eventually provide a catalyst, perceived or otherwise, causing momentum to change – which brings us to our second point. 

Second – we need to view a smaller timeframe. The 2017-2020 chart, while it clearly shows what “has happened”, needs to be distilled into a smaller timeframe so that we can look at it “in the moment”. We need to bring ourselves back to when the opportunity was unfolding to get a better sense of what was happening at that time. To do this, we take a look at two OPAQ charts (below), both of which encompass the first 90 trading days of 2020. We look at these in detail, as we know that not much was happening in January and February of 2020, but things suddenly took off not too soon afterwards. 

OPAQ 90 day Vol chart finding value full 2020 on TSX Venture

This first chart is typical. We can see that OPAQ is trading below almost all MAVG lines in the early part of the year. There is a flurry of press releases, beginning in late January, the price dips when COVID is announced, and then the price begins to recover. From the middle of March through to 3rd week of April, the price strengthens, but the improvement in volume is less dramatic. We get the sense the share price is improving, but it lacks conviction – until the price and volume spike in late April, at which point we would be committed to buying in at ~ $0.70 or higher, as opposed to the $.050 – $0.60 range. In essence, it would be nice to have some more fulsome information prior to the spike in volume. This brings us to our 2nd chart, below. 

OPAQ 90 day Post chart finding value full 2020 on TSX Venture

This chart is similar, but different than the prior one. Like the prior chart, price, MAVGs and press releases are apparent. But the difference we see here is that the bars are no longer measuring volume – we are now quantifying retail investor chatter – essentially, the daily volume of investor discussion. 

For a company such as OPAQ, momentum and technical factors outweigh fundamentals, as we have seen. In this chart we can see evidence of growing investor “chatter”. Measured by the 30 day average of investor posts about OPAQ, we can see that interest in February is building. For example, in early February,  the 30 day average of posts is >15/day as compared to around 10/day in early January. The volume of posts level off a bit during the COVID announcement, but then pick up again in early April, then more in late April, and then one can see it pick up significantly in early May. From the period from mid-March (when COVID is announced) through to the 3rd week of April, we see chatter clearly trending upward. Every day, investors were posting and talking more about OPAQ. This information, in conjunction with all the other information we have, provides that extra bit of confirmation that sentiment is likely to swing significantly in the coming days and weeks. As we know, an investor that would have gone long on OPAQ any time from late March through to the latter part of April would have done very well, as they would not have waited for the “loud” signal of the price spike on April 30th, which drove shares over $0.70. Once the shares were in full “rocket” mode, daily posts kept growing, sometimes exceeding 400 per day. 

The rest of the OPAQ story is history at this point. While the shares peaked over $6.00, they have come off their high, but are still significantly above their early 2020 prices. The long term OPAQ story has yet to play out, and investors who commit capital today are, for better or for worse, buying into some lofty expectations. The market valuation of OPAQ today has much more expectation built into it than it did 12 months ago. For those who bought in early – and held on – I salute you!

In conclusion, there’s probably a few key takeaways that I think are worth mentioning:

  • The intent of this post was to point out that opportunity exists in small caps in many different forms, which these two companies serve to highlight. 
  • Like fine artwork, for those who value “classic lines”, the TSX Venture does offer up companies such as BORE, the opportunity of which is best recognized via traditional financial statement analysis. 
  • For those who prefer something more risqué, one must adopt more technical tools, as the fundamentals will reveal little or no opportunity. 
  • The ability to weave in and out of both worlds provides more opportunities to uncover, just as speaking more languages allows you to interact with a more diverse (and interesting) group of people. 
  • Lastly, some of the most impactful opportunities may require one to step outside the usual boxes of fundamental or technical analysis. 

I indicated earlier in this post that the identities of the two companies would be revealed, and that is true – just not in this post. I thought it would detract from the post itself if the actual symbols were provided, so the identities will be provided when this article is reposted at a later date. In the meantime, as I always say, these are only my thoughts & opinions. If you have questions or comments, I can always be reached at mark@grey-swan.com. 

Continue reading → Recognizing small cap opportunities (original)

Brattle Street Investment Corp.

The fact that the title of this post references one company, and the displayed logo references yet another is likely causing some confusion, so let me explain.

Brattle Street Investment Corp. is a company that has been in transition for some time, and (full disclosure) that I have been long on for some time. For quite a while, I debated creating a post about the company, however, I wasn’t sure what I could say – the company was opaque at the best of times, and basically existed as a shell. I had a hunch that, behind all of the “non-activity”, something was brewing, but that was all I had – a hunch. I kept buying at what I thought was a depressed price, but were I to post something, what would I say ? That something might happen in the future ? With no clear direction, I put it on the shelf for some future time. As it turns out, my suspicions were correct, as the company issued a significant press release as of September 17th 2020. I believe that the share price of the new company, once it starts trading, should improve. Because of the unique nature of this situation, this post is as much about why I continued to hold (and continued to buy), and why I believe there is an opportunity here.

However, before delving into the analysis, it probably makes sense to delve into the past.

A bit of history.  Before it was Brattle Street Investment Corp., the company existed as Inspira Financial, and offered “…a full suite of billing, consulting, and financial services to the substance abuse and addiction treatment industry.” During it’s existence as Inspira, the company enjoyed some success, as it actually paid a dividend for a while, something which usually bodes well for the future. However, good times were fleeting, the financial services business was wound down, and the shares languished. The dividend was eventually eliminated, the shares fell further, and interest in the company became non-existent. One can see from the chart (below), that Brattle Street was essentially dead money.

While this chart suggested a lack of interest, it was exactly this “dead chart” , among other things, that continued to pique my interest. I’ll walk through the factors that compelled me to hold Inspira / Brattle Street, and, as always, I use a green , amber, and red format to hilite specific areas that I believe to be bullish, neutral, or bearish. Readers are also cautioned that as of the time of writing this (September 22nd, 2020), Brattle Street shares are halted, and there can be no guarantee as to what price they will open at once they begin trading again.

This chart was (and is) saying “buy me”.  Yes, I know for a lot of you this chart is saying “I am on life support”, but the truth is that the company never flirted with insolvency (more on that later). More than a few of my successful investments (Athabasca, Macro, Pyrogenesis) have been initiated with charts such as this, as this chart tells me that things have been skipping along the bottom for some time. Unhappy shareholders have sold out of this position a long time ago, and there is very little (if any) negative news left. At this point, this chart is saying “the worst is likely over”. From a technical perspective, this chart doesn’t look sexy, but I believe that in conjunction with other factors, I believe it will start to look much better over time.

No debt, lots of cash.  I know that the first response of many is that the cash (and lack of debt) on the balance sheet is reflective of the past, not the future, and I absolutely agree. The balance sheet will change when the proposed transaction takes place, but it’s always nice to start from a position of strength. Having money in the bank means that there’s more ability to weather any storms, and likely means less dilution in the future. As of Q1 financials (at May 2020), the company had $8.5 MM in cash and a total of $150,000 in liabilities. Based on the 46.8 MM shares outstanding (as of September 2020), this equates to $0.181 per share in cash, meaning that the company is trading at “net-net” status. While it’s clear that there is no intent to liquidate the company, the net-net situation simply highlights that there is very little downside.

Not cash flow positive, but the cash burn is low.  Ideally I’m hoping for a cash flow positive situation, but current cash flow won’t really tell us much, given that the company will change significantly going forward. That being said, the cash burn rate for Q1 is ~ $220,000. While we know this will change significantly in the future, at least we can see that the company hasn’t been on the path of simply shoveling cash out the door. Additionally, to provide further perspective, as of the year end at February 28, 2018, the company actually had less cash ($6.0 MM) and more liabilities ($331,000), and that was over 2 years ago. While the company may have been in a holding pattern, they have managed to safeguard cash during a time when revenues were declining – without issuing more shares.

The company has significant tax pools. Something that you won’t see on the balance sheet (see excerpt below) is the fact that the company has significant tax pools in its back pocket. While it’s unlikely the company will be profitable from day one, once it is, these can be used to shelter income for some time.

High Insider ownership. Two notable insiders, Roger Greene and Michael Dalsin, control 6.5 MM and 6.24 MM shares respectively, which in combination makes up 27% of the total outstanding shares. Both have been buyers at current prices ( ~ $0.12), and both have a history investing in the health sector. Given that they are buyers at these levels, it would be a fairly safe assumption to say that they have a significant interest in seeing the share price move well beyond the current price range. Additionally, given their prior activity investing in the health sector, they likely have developed relationships which should prove beneficial going forward.

No analyst coverage, but some institutional ownership. TerraNova Partners, a private equity firm, owns 4.07 MM shares of Brattle Street, which it acquired when the company was still operating as Inspira. At that time, the relationship between TerraNova and Inspira was rocky at best, as TerraNova had more than a few concerns with the actions of the Inspira board at the time. In any case, regardless of their concerns, TerraNova decided to hold, as they are still listed as a significant shareholder. If we fast forward to today, the company has no analyst or institutional coverage to speak of. With a significant transaction waiting in the wings, this means that this situation is likely to pivot hard in the relatively near term, which means new coverage (and a lot of other eyeballs) will likely be looking at the new entity soon.

No self promotion. The company has issued the bare minimum with respect to press releases over the last few years, so to say that there has been “no self promotion” is diplomatic. While this has been a bane for shareholders who have held (like me), it also means that the price hasn’t been inflated by any stretch of the imagination. This “minimalist” approach to communication only confirms what the chart has already communicated – that the shares have been bumping along the bottom for some time. We expect this lack of self promotion will come to an end once the proposed transaction closes.

No share buyback, but the future share structure will change. The number of shares outstanding has been virtually unchanged since late 2016, but the share structure will change going forward. Current shares will consolidate on a 7.37 for 10 basis, meaning that the 46.8 MM shares will consolidate to become 34.5 MM shares. Additionally, the company is proposing a private placement of 10 MM shares at $0.85 per subscription receipt, which is the most interesting part of this transaction. The pricing of the subscription receipts makes a very strong suggestion that the company is very bullish, at least in the near term.

The sector has interest. Normally I look for value in sectors that are out of favor, but in this case, I have found something of value in a sector (health care) that is arguably front and center. While the new entity doesn’t have a line of sight to COVID directly, the health care sector has seen an increase in interest due to the COVID pandemic. Given that the COVID situation is likely here for the longer haul, it stands to reason that this serves as a tailwind from an investment perspective, as both retail investors and professional money managers look to this sector for opportunities.

Long management tenure. In this section, there are clearly some unknowns. We cannot in good faith make any assertions about a brand new management team, other than to say that they have a blank slate to work with that is, as of yet, untarnished. While the proposed management team certainly has experience in the medical sector, we usually view the associated pronouncements with a grain of salt.

Potentially disruptive technology. We would suggest this section is neutral , as there is nothing to suggest that anything that they will be embarking on will be “game changing”. While they might be able to create a better (financial) mousetrap via some attractive acquisitions, the new entity likely won’t be changing the face of medicine overnight.

Clean earnings & differential between EBITDA and cash flow. Normally, we would look at these factors to determine quality of earnings, and to see if there was anything out of the ordinary with respect to EBITDA and cash flow. However, since past quarters are reflective of the former entity (Inspira) and have been wound down, they are of little use in this instance. With this in mind, we regard these as neutral factors in our assessment.

So – what does all of this mean for the small investor ?  To summarize all of this into the proverbial “ball of wax”, the key takeaways are this:

  • The press release signals a very positive change: The September 17th press release is the catalyst that will start things moving again, as it confirms that “things have been brewing” in the background. It’s the initial whiff of oxygen to the embers of a slow burning fire.
  • The downside on the share price is limited: From a purely technical perspective, the shares have been forming what I call a “saucer bottom” for a long time. From a fundamental perspective, the shares, at their current price, are trading at “net-net” status, which further implies that risk is limited.
  • Bankruptcy is a non-issue: With lots of cash and no debt, the risk of short term insolvency is a non-starter.
  • New interest will move the share price: This company has been ignored for so long, that I would be surprised if anyone is aware of it. The proposed private placement will bring press releases and attention from both small and larger investors.
  • The trick will be to get in earlier rather than later: The shares are currently halted, so buying now isn’t possible. However, there should be some communication in the future as to the new symbol and when it will begin trading on the TSX Venture. This may come with a significant amount of fanfare, so the trick is to keep ones head and not overpay for shares.
  • Keep an eye on insider activity: Insiders are very good signals of what portends, especially in this case, as there is no “history” to draw on.

As I indicated previously, I am already long on Brattle Street shares, and have been a recent buyer at these levels, before the shares were halted.  I believe, given the factors described above, that many of the unique ingredients for a successful small cap investment are in place. Of course, these are only my thoughts & opinions, and it will take some time for this thesis to bear fruit (or not). If you have questions or comments, I can always be reached at mark@grey-swan.com.