Dr. Feelgood

July 17, 2017 10:26 AM


As an investor, my preference is to find long-term macro trends and invest alongside of those trends. Unfortunately, the current market tends to overvalue the companies participating in these trends, giving me fewer opportunities to find attractive trend-based investments. However, that hasn’t stopped me from searching and occasionally finding a real interesting one.

An increasing percentage of the population is aging and this often leads to chronic pain. Treatment with various opioids has led to an addiction epidemic that shows no signs of abating. Of course, there are other methods for treating chronic pain, such as chiropractic treatment, but public acceptance of chiropractors is still in its infancy—particularly amongst people older than 50—the people who often suffer from chronic pain in the first place. I don’t want to debate if chiropractors help or not—what’s important is that many people who have tried chiropractic treatment believe that it helps and have become recurring patients.  

Unfortunately, most chiropractors are not set up to really serve their customers. Their hours and scheduling are inconvenient and rigid, costs of use are prohibitive and procuring insurance reimbursements is difficult for patients. The Joint (JYNT – USA) is a chain of Chiropractors with over 370 locations in the US, that is growing rapidly through a franchise model. The Joint is substantially cheaper at $18 a visit (when on a monthly plan) than most chiropractors, and offers walk-in appointments making it substantially more convenient for patients. This has led to explosive growth with system-wide positive comp sales of 19% in the first quarter of 2017—which is pretty much unheard of for a franchised business. Even 4-year old locations are comping positive 11%. At the same time, the number of locations has been growing at over 20% a year. You basically have two growth avenues, comparable store growth and unit growth—both occurring simultaneously.

the joint

So, why are shares cheap today? New stores are un-profitable during the first year as the customer base grows. Big cash flow doesn’t come until the third year. During 2015, the company started opening corporate stores in addition to franchise stores. Unfortunately, given the young age of most corporate locations, they’re subtracting earning power from the substantial earnings of the overall franchise business. As these corporate stores mature, they will go from losing money, to substantial profit centers and I believe the company’s value will see a very substantial re-rating.

New management has been in place for almost a year now. They have dramatically cut costs and have ceased opening corporate stores—until the existing store base matures and becomes profitable. This is predicted to happen by year end.

Unlike many of my picks, there is some risk here as cash is somewhat tight and the company expects to continue losing money for at least the next two quarters before rounding the corner and becoming profitable. However, I gain confidence in them getting to cash flow positive, as the CEO and CFO have each purchased shares in the past few weeks.

chiro 2

Playing it forward a few years, I don’t see why this business cannot get to 1,000 locations with 15% of them being company owned and the rest franchised. Based on average store economics at the existing base, you have a very profitable business as franchised businesses tend to have rather high returns on invested capital. Meanwhile, company owned stores should have great 4-wall economics.

I don’t quite know how to value The Joint today, as it is money losing, but it does seem to be at an inflection point towards earnings. With a market cap of under US $50 million, I don’t feel like I’m paying much for the existing business that would be quite profitable, if not for the money losing corporate stores. More importantly, I have a rapidly growing, high return on capital business with a huge macro tailwind behind it.

 

Disclosure: Vehicles that I manage are long JYNT

Categories: Current Investments
Positions Mentioned: JYNT
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SNAPageddon

July 9, 2017 10:10 PM


Back in 2000, as the tech bubble was popping, I made a fortune by shorting recent IPOs right as previously restricted shares were unlocked for sale. These companies came public with only a small percentage of the stock sold in the initial IPO in order to create scarcity and an overvalued stock price. 6 months later, a waterfall of stock would hit the market as the rest of the outstanding shares became free trading.

The restricted shares were coming from VC funds and insiders and these individuals often had cost basis measured in pennies or a tiny fraction of the current share price—meanwhile, the insiders knew deep down, that the companies were obscenely overvalued. Therefore, at their first opportunity to sell, they all hit the bid—often with reckless abandon as they were trying to beat all the other sellers out the door.

The result was that over a few weeks period, the share price would collapse. I previously wrote about how this worked at Twitter. The difference was that, at the time, the bubble in all things social media was alive and well—so Twitter shares bounced back after a proper drubbing during the unlock. I believe that the FANG bubble is now in the process of popping. This means that buyers are no longer willing to prop up silly valuations, which will create incredible opportunities as this decade’s unicorns come public and then experience unlocks—much like in the aftermath of the 2000 bubble.

Snap Inc. (SNAP – USA) is the next of these unicorns to unlock. It is also one of the most ridiculously overvalued stocks in the market today. Despite a market cap of $25 billion, it consistently loses more money each quarter. Even the most bullish analysts—the ones who dumped this IPO on the public—do not expect profits until at least 2021. They meanwhile expect losses of approximately $1 billion during the next two years, before these losses slow. This is scary as cash is rapidly dwindling due to ongoing losses and acquisitions—they’re going to need to raise additional capital soon. Even worse, growth appears to be slowing as other social sites introduce competing products. It’s one thing if you’re burning money to rapidly grow your business—it’s a very different thing if you’re having a bonfire and not even growing fast any longer.

snap unlock

In any case, the only reason the share price is where it is, is the fact that the free trading float is currently restricted. That will all change starting on July 29th when the first of 3 unlocks begins and over 1 billion shares become free trading. I suspect that these will be dumped on the market as rapidly as possible, in order to exit positions before next quarter’s bloodbath of earnings.

I do not short stocks any longer, but I occasionally buy puts when it appears like there’s a great setup. This is a crowded trade, but I’m not sure if it matters. I’m long SNAP puts with enough duration to see this waterfall of stock hit the tape. I wouldn’t be surprised if the shares trade for the mid-single digits by year-end.

 

Disclosure: Long SNAP puts (various strikes)   

Categories: Current Investments
Positions Mentioned: none
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Ready, AIM, Sell??

June 13, 2017 9:06 AM


I have spent much of my career looking for strong macro trends that will drive the performance of individual companies. However, over the past few years, I’ve had much more success buying overreactions to bad news, as the makeup of the market has changed and short-term thinking pervades investment decisions. Often, large fund holders sell without even understanding what the news means. Instead, they’re more concerned with showing their investors that they didn’t own a stock that’s down 80%--especially if it’s a well-known company amongst their investor base. Meanwhile, when in sell mode, future bad news is all colored bad and good news is ignored—then the indexes kick you out and more selling comes on top. It’s just a pile-on. On the flip-side, the move from down 80% to even just down 60% is a doubling of the share price and it often happens rapidly when the selling ends. With that in mind, I might as well tell you why I own so much Aimia Inc (AIM – Canada).

Aimia operates and owns loyalty programs. It’s a reasonably good business, in that their partners buy points that Aimia creates. Aimia then give those points to their loyalty members and then at some later date, those members redeem the points for rewards such as free travel or gift cards. In the interim, Aimia has “float” from the cash that’s been paid for points that have yet to be redeemed. Additionally, a healthy percentage of points are never redeemed and Aimia gets to keep that “breakage” as free profit. Over the last few years, the sector has gotten rather saturated, which has somewhat reduced the value of individual programs, but it’s still a good business—even if it is one that’s in slow decline.

aim chart

In any case, I’m not so fixated on the long-term business fundamentals, as I am on the reason that shares of Aimia declined 80% last month. On May 11, Aimia was notified by Air Canada that they would not be renewing their current relationship after it expires in 2020. Canadians, assumed that this was the end of Aimia as Aeroplan is the largest loyalty program managed by Aimia and Aeroplan with its 5 million members, ranks up there with Tim Hortons and maple syrup in the Canadian psyche. As Aeroplan was itself a spin-out from Air Canada, it was assumed by most Canadians that Air Canada was the entirety of Aimia. What these panicked shareholders have failed to understand is that Air Canada represents approximately 11% of the total points purchased at Aimia and while it is the largest redemption partner for points (loyalty members prefer airfare to other options), this spending power can be re-directed in other places where current and future redemption partners are desperate for the $600 to 700 million in spend that comes from Aeroplan. Even more ridiculously, this change with Air Canada doesn’t occur for three years. During that time, Aeroplan will earn enough to pay off all of its debt and dividend almost the entire market cap out in dividends. In fact, the company is going ex-dividend for the first of those quarterly dividends, representing 10% of the share price on Wednesday the 14th.

A lot will happen between today and June 2020 when Air Canada parts ways with Aeroplan. I think it’s likely that longer term, this is good news for Aeroplan (despite what you read in the financial press) as it diversifies Aeroplan redemption options and allows Aeroplan to direct redemptions towards higher margin options. In any case, it’s highly unlikely that I’ll still own the shares as this all plays out. For me, this is a short-term sort of trade where I’m looking for a bounce from a ridiculously oversold condition.

aeroplan

The shares trade at 1.5x current year’s cash-flow guidance and a 40% dividend yield. While there is always risk to any business—especially one in transition, this business has many other components that are doing well. Aimia has huge value in its half ownership of AeroMexico’s PLM program (likely worth about the same as the current enterprise value), along with many existing point purchasing partners for Aeroplan. I expect that point purchases will decline and redemptions will increase over the next three years as loyalty members leave the Aeroplan network. It seems likely that current guidance of $220 million in cash flow is unrealistic, but the magnitude of the miss is hard to guess at. My hunch is that the miss isn’t all that substantial, but without new guidance, it’s just easier for everyone to sell, rather than think it all through.

Basically, I don’t understand how a change that takes place in 3 years, should yield a company with a $300 million market cap if there is $556 million in cash and liquid investments, with only $450 million in debt, while the company will earn $220 million (guidance) for the next 3 years. Even if they miss the number badly, there’s still a huge margin of safety here. That is before considering the other programs outside of Aeroplan that are likely worth more than the entire enterprise value. There has been talk in the media of an increase in redemptions hitting liquidity—I’m sure that’s happening to some extent and the redemption liability is a true liability, but the increased pace of redemptions is not enough to impair the company. In summary, in a situation with limited transparency in earnings over the next few years, along with a change-over in the C-suite, most investors have chosen to sell—rather than actually evaluate the situation. Aimia is simply cheap and you get paid 40% a year to wait for others to realize this fact.

 

 

Disclosure: Funds that I manage are long Aimia (AIM – Canada)

Categories: Current Investments
Positions Mentioned: AIM CN
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Re-Reinventing The Death Spiral

May 31, 2017 5:40 PM


On April 9, I wrote about how certain companies have death spiral financings in place and you could literally short them at will for almost risk free returns. Now, barely 7 weeks later, Dryships Inc (DRYS – USA) is already down by 90% since I wrote that piece. I’ve been shorting DRYS and a few others like it for quite some time and re-loading as the position size declined—hence my returns have been even better than that 90% return. However, based on last Friday’s update, the balance sheet is now;

$220.6 million of cash

$413.7 million of vessels

$200 million of debt

Net book value of $434.3 million.

With 13.778 million shares outstanding, net tangible book value per share is $31.52 and DRYS closed at $2.38, or 7.6% of tangible book value. Additionally, DRYS is likely cash flow positive with the recent vessel deliveries.

This all got me thinking; how would someone with plenty of cash, who controls this situation and has a total disregard for shareholder interests, play his hand? Is it better to dilute shareholders by continuing to raise $4 to $6 million a week that you can abscond with through related party transactions? Or is it better to end the Kalani program through one last large sale to yourself for $50 million worth of shares at $1.00 and effectively own 78% of the company at 3 cents on the dollar of asset value?

The first method will get you additional cash to siphon off, if new buyers continue to show up to get diluted—a questionable assumption based on the rapidly declining pace of recent equity sales—in fact, I wouldn’t be surprised if equity sales trickle to under $50 million of annual run-rate very soon. Isn’t the smarter move at this point, to get a disproportionately large percentage of the $434.3 million of book value at a cost of roughly 3 cents on the dollar and then control a collection of assets for almost no net capital after a 1-time special dividend? That then gives you the most optionality for the next stage of your schemes.

I don’t know which direction this goes, but the recent loan committments, the decline in the rate of share sales and the ridiculous discount to current book value, have convinced me to cover my position and move on. Let’s just say that there are some guys in Greece who are very entrepreneurial with their capital structuring and I wouldn’t be surprised if someone re-reinvented the death spiral by inverting it and grabbing the assets for his own advantage--especially as he controls the price of the shares and the issuances of equity. Hence, it is time to move on and declare victory. In any case, after the past few months of very profitably shorting these death spirals, I’ll always have a warm spot in my heart for unscrupulous Greek shipping magnates.  

Categories: Current Investments
Positions Mentioned: none
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Reinventing The Death Spiral

April 9, 2017 11:47 PM


About two decades ago, some unscrupulous hedge funds began tricking unsophisticated small cap companies into agreeing to “death spiral” converts (convertible debt). These were called “death spirals” as there was no set floor to the conversion price. Rather, they converted at some date in the future based on then market prices. Despite promising not to, these funds immediately began shorting shares with the goal of destroying the share price and converting as low as possible in order to take control of the companies, or at least get large share ownership positions. Oftentimes, a few million dollar “death spiral” convert would end up costing management the majority of their company. Along the way, my fund sometimes shorted these “death spiral” stocks as you knew that the hedge fund owning the paper would keep leaning into it until the conversion date. Furthermore, any intelligent long would sell and move on—as you just can’t do business with someone too stupid to not understand how these things worked. Without logical buyers and a wall of stock on the offer, they were as close to layups as you could get in finance.

Since then, corporate boards have wised up and you seldom see these “death spirals” any longer. Of course, in finance, there are rarely new inventions—rather, creative finance types dust off old tricks and re-imagine them. Therefore, you have to have a certain respect for CEO George Economou from Dryships Inc (DRYS: Nasdaq) as he took the “death spiral” and added a unique spin to it. In the Economou version, he “death spirals” his own stock through an independent party named Kalani. DRYS has now undertaken a few variations of this theme, but the basic underlying trend is that DRYS sells shares to Kalani at a discount to market and Kalani then sells them into the market as rapidly as possible so that Kalani can reload and earn the spread between the price they buy them from DRYS at and what they can sell them for. In the process, the share price of DRYS has been in freefall.

DRYS

Now, you have to be asking the question; why would Economou want to purposefully crash his share price? I don’t think he cares what happens to the share price, beyond propping it up sufficiently to sell more shares. His goal is to load DRYS up with cash from the share sales so that his private entities can extract value through fees and asset sales to DRYS at inflated values. It’s a unique spin on the host-parasite relationship.

Of course, the next obvious question is; who the hell keeps buying this stock if you know that he’s going to keep reloading for a few hundred million dollars in share sales each quarter? Now, here’s where you have to admire Economou, while I’m sure some poor retail guys haven’t read the fine print and got thoroughly abused, my hunch is that most of the buying is coming from various quant funds. You see, these funds are run by computers and they look for underlying fundamental values like; price to NAV, price to cash flow, revenue growth and cash flow growth. These computers aren’t yet smart enough to read the fine print and understand what Kalani is doing—in fact, the various Kalani deals do not look all that different from an equity line of credit, convertible bond or at-the-market offering. Optically speaking, DRYS trades at an obscene discount to NAV and revenue is growing as is cash flow. The computers are short-circuiting themselves to buy this thing as it looks cheap. Even crazier is the lag between when the share sales happen and when they’re reported. If you were buying on Friday, you would have thought that the share count was around 152 million—nope, 36 million shares were sold since the last reported share count and the new share count is 188 million. The computers are using the wrong data inputs as they’re programmed to assume that a company is trying to create shareholder value or at least not destroy it on purpose. Economou’s trick is to sell shares at such obscenely cheap values that it continues suckering new buyers into DRYS shares.

In finance, no lucrative scheme can go on for long before imitators show up. Since DRYS started its “death spiral”, Diana Containerships, Inc. (DCIX: Nasdaq) announced their own version of the “death spiral” using warrants. I’m sure others will follow. I bring this all up because no one should lose money for not reading the fine print—if you own either of these, be wary. Never simply assume that management cares about you as a shareholder. Much more importantly as more “death spirals” are created, there are lots of opportunities to profit on the short side. I don’t normally short stocks, but in these situations that are designed to fail, I cannot help myself. I’m playing small and expecting some epic short squeezes along the way.

I suspect that shorting these "death spirals" will continue to be a lucrative little venture over the next few quarters. Please share with me if you see any new death spirals announced.

Bombs away!!!

Disclosure: I am short DRYS and DCIX.

Categories: Current Investments
Positions Mentioned: none
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