Initial Thoughts on Unilife’s New Debt Financing

Since I started looking at Unilife (UNIS), I’ve been extremely concerned with the company’s liquidity and solvency situation. They’ve been burning through cash like it’s going out of style and operating expenses are already very high and have kept growing at a fast pace. Operating losses every year meant the company already has significant negative debt service coverage ratios (i.e. they burn cash to pay debt service rather than using operating income to pay interest/principal). At the end of the last quarter (Dec 31), they were already highly levered with a Debt/(book) Equity ratio of ~0.74, placing UNIS in an elite group of companies — 0.74% of the 6,795 stocks in the Finviz.com database — with such high leverage and negative margins.
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Unilife, Or: When A “Growth” Pure-Play Isn’t A Smart Play

I come from the school of fundamental value analysis/investing. So when a client asked me to look into Unilife Corp (UNIS) a few weeks ago, naturally, my first reaction was to look at their SEC filings and financial statements. It became immediately clear (as it should to anyone who’s spent more than 60 seconds looking) that this was not a company on which one could perform a discounted cash flow (DCF) valuation or any other traditional fundamental valuation, since their financials are an absolute and utter disaster of the highest order. DCF won’t work – it’d just be adding an enormous degree of false precision/certainty to an extremely uncertain and unpredictable set of financials – and comps are only useful insofar as they not only exist, but have similar activities, capital structures, etc. Option valuation is just another exercise in futility, especially considering the firm’s financial and operating history is all over the place, making any assumptions/inputs useless.

So how then are we supposed to value this company? Continue reading

The Limit of Fundamental Analysis: You

The other day, my friend Eddy Elfenbein wrote a post entitled “The Limits of Fundamental Analysis,” which made some good points (as he most always does), but in so doing, made far too broad and thus inaccurate a conclusion. The premise is (and I welcome Eddy to correct me if I’m off-base) that in some circumstances, fundamental analysis is inappropriate, such as when dealing with transformational businesses like Amazon was (is), cyclical firms, leveraged firms, firms with varying earnings quality, etc. The thing is, we can – and do (try to) – adjust for all of these things – and more – when performing a proper fundamental analysis! I’m going to attempt to show how, by making relatively small changes to a few key assumptions (sometimes even just one number will do!) in a simple DCF framework, we can grossly change not just how much we think a stock is worth, but why it’s worth that price, as well.

Fundamental analysis, by definition, involves examining the industry in which a firm competes, the regulatory/legal environment, the market for a firm’s goods/services, the goods/services themselves, the firm’s financial condition/performance, strategy, capital structure, reliability of financial statements/accounting controls, and several other factors, not only currently, but in the past and, more importantly, the future as well. Fundamental analysis isn’t just looking at a few ratios on Yahoo Finance or Finviz or whatever and concluding a company is a good (bad) investment based on valuation, liquidity, solvency, and/or other metrics. That can be the starting point for narrowing down firms which are more (less) likely to be worth investigating further, given a finite amount of time to allocate to identifying and researching ideas which we hope will help us invest wisely.

A quick tangent: If you’re not in the markets to invest, you are in the markets to gamble. This is not up for debate, it just is; if you find or fancy yourself a gambler, save the trouble and head to your closest casino where they’ll be more than happy to separate you from your presumably hard-earned money quite expeditiously (you may even get some “free” food and drink out of it). If you’re not sure whether you’re trying to invest or gamble, just put your money under your bed until you figure it out, you’ll be doing yourself a favor. If you’re interested in making good investment decisions, this is where the fun starts…

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BOFI: A Diamond in the Rough, Part II

First, apologies for publishing this so late, we had a few hurdles to overcome before we could do so that aren’t worth mentioning, just administrative stuff. Also, yes, I know they’ve reported q4 results (well in an 8k at least), here’s the release, #’s look pretty good, might do another post with new #’s, doubtful though

Anyway, back in March, I first wrote about a stock that we think has great upside potential, Bank of Internet Holdings, BOFI. Since I published that article, BOFI is up ~30%, while the S&P500 is flatish, the Nasdaq Index is down ~2%, the Financial Sector SPDR (XLF) is down ~6%, the Bank SPDR (KBE) is down ~9%, and the ABA NASDAQ Community Bank Index (ABQI) – to which BOFI was recently added – is down ~4.5%.

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Value Investing Lessons From Reality TV (Seriously!)

I just penned an educational/informative article on my Forbes Column, “Value Investing Lessons From Reality TV (Seriously!)“, wherein I discuss some of the most important value concepts like always having a Margin of Safety (as described by Baupost Group’s Seth Klarman in his book by the same name), whether you’re bidding on abandoned storage units, stocks, or any other asset.

I also discuss some of the most common mistakes investors make; abandoning their discipline, chasing returns, following the herd, overconfidence, etc.  I humbly suggest giving it a read, whether you’re a novice or seasoned professional.

My First Forbes Column – So What if Apple Has A Chinese Labor Problem?

Since I haven’t seen it anywhere else (not that it doesn’t exist), I’ve gone and estimated the impact of increased labor (wage and other) costs on Apple’s gross margins in the face of increased public attention on labor practices in China. I’d summarize it, but then I’d be doing you a disservice. Go check it out here!

Rolling Up Our Sleeves on Jos. A. Bank

If you follow me on Twitter or Stocktwits, you’ve likely seen me express significant skepticism about men’s retail/apparel retailer Jos. A. Bank (JOSB) and the many and myriad red and orange flags in the firm’s SEC filings.

Over the past several quarters/years, their filings have become more opaque, an almost certain sign that things are not as rosy as management wants you to believe. (Especially) of late, the firm is generating very little to negative operating cash flows:
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ZAGG: Anatomy of a Stock Market Triple-Team Takedown

While the past 6-12 months have seen a marked increase in the number of “short-seller” reports (or hit pieces, depending on your perspective), seldom have we encountered situations wherein more than one participant or observer highlights warning signs at the same time, or wherein the company releases potentially troubling news concurrent with these reports.

Today is one of these rare occasions where the short-sellers stars align.  The trifecta of pain, in no particular order:

1. (In)famous short-seller-cum-analysis-shop Citron Research released a report on ZAGG, Inc, a maker of cellphone protectors and other accessories raising a number of orange and red flags.  I strongly suggest you read it in its entirety before continuing.

2. Roddy Boyd – author of the authoritative book on the rise and fall of AIGreleased a report on his website highlighting not only the shady past of ZAGG‘s executives and directors, but the firm’s reliance upon one commoditized product to generate HUGE revenue gains and margins in an industry known for razor thin ones.  ZAGG’s balooning inventory balance should be of particular concern, increasing 5-fold year over year and almost 19% in the past three months, as Roddy explains:

It even continued to spike after a sharp revenue drop from the fourth quarter last year to this year’s first quarter, something that made no sense (then or now.) Some growth in inventory is naturally warranted as sales expand but this seems to defy logic. From an investors point of view, the “beauty” of this business is that it’s easy to rapidly produce a large volume of finished product, so maintaining large inventories of raw materials and work-in-progress is unnecessary. [Actually, large inventories are counterproductive for Zagg since the cellphone/mobile-device market is evolving so rapidly that models come and go, often in little more than a year, leaving older shield models virtually worthless. Moreover, polyurethane film is hardly a rare commodity, so storing a ton of it makes little sense.]

The firm also just acquired a maker of earbuds and other similar cell phone/mp3 player accessories, for a whopping $110 million, whopping considering prior to a recent run-up in the stock, ZAGG itself was not worth much more than that (and still isn’t by reasonable comparison).  This acquisition was in no small part financed by a $45 million term loan from notoriously investment firm Cerberus Capital Management and PNC (a $45mm revolving credit facility was also arranged concurrently).

While not unparalleled, firms that are growing revenues 200% and net income 300% per quarter generally don’t 1. (need to) make transformative/material acquisitions, and 2. need significant debt financing (cost of capital discussions aside for the time being).  This is unless, of course, they are hemorraging cash (usually from operations), as ZAGG appears to be doing, specifically in that inventory balance.  In fact a cursory look at their last 10-q indicates had the firm not monetized its receivables, it would have lost significantly more cash than it did.  

3. The company filed a statement of an offering of exempt securities (form D), stock issued to help finance the aforementioned acquisition.  Again, while not unheard of, this filing is sufficiently vague to raise an eyebrow, after all, they disclosed neither the amount of (proceeds from) securities sold nor the investors who bought them, only mentioning that there were 5 investors.  Perhaps there’s some fair explanation in other filings I missed in my cursory read, but considering the warnings raised by Citron Research and Roddy Boyd, I wouldn’t be so quick to just ignore it.

There are possible explanations for these flags, however I don’t think any prudent investor should give the firm (and its management) the benefit of the doubt, quite the contrary you should take a deeper look into the firm’s SEC filings and ask a few questions.

Why, for example, is a firm with such huge revenue and income growth also growing inventories so fast (+19% in q1), while fixed assets (Property, plant & equipment) bare budged (+3%)?  They say they outsource high-volume precision cutting and even some packaging of their products, which makes me wonder what exactly the firm does in its “manufacturing” facilities (which are leased), and what equipment (computer and otherwise) it really needs, short of a few dozen PCs and some relatively affordable warehouse equipment.  $500,000 in computer equipment & software and another $930,000 in “Equipment” at year-end seems a bit high for a firm that doesn’t actually do any real manufacturing or even assembly, no?  Did the firm buy five dozen licenses for every product made by Autodesk (CAD, etc software) instead of the 1 or 2 programs and 5-10 licenses – at most – it needs?  (Perhaps this is how they have – allegedly – products for >5,000 different mobile devices, an absolutely stupid number if true)  Maybe they told their IT guy to go wild and order servers & network equipment capable of supporting a firm 10x this size?

The firm also acquired PP&E of $175,000 in the first quarter of 2011, >30% annualized increase over their gross 2010 year-end balance.  The firm does not provide any further explanation as to what assets it actually acquired.

As Roddy mentioned, their raw materials (primarily polyurethane) aren’t exactly scarce last I checked, and their relationship with what appears to be their sole supplier (repeated use of supplier, singular, in their 10-k) is “on excellent terms,” neither of which necessitate the firm’s raw materials account increasing almost 25% in the first quarter. 


All things considered, I spent about 15 minutes perusing a few of the firm’s recent SEC filings and found more orange and red flags than I’ve seen from any firm I’ve looked at since China MediaExpress Holdings.

Curiously, the stock is up over 1% on the day after being down around 10% earlier.  I’m chalking this up to much of the daily volume being from technical/momentum traders, and not fundamental/value investors.  If I’m one of the institutional investors with millions of dollars in this stock though, you bet your ass I’m scouring over my previous work and seriously considering hedging my long exposure by buying some puts (if I haven’t already).  Maybe the company is legit, but there’s more than enough anomalies in the financial statements – combined with the Boyd and Citron reports – to warrant a much more skeptical look.

Caveat Emptor

Some Perspective on YOKU's Warner Brothers Deal

While something akin to Netflix is still a relatively new concept in China, I think we’re in serious need of taking a step back from today’s ridiculous reaction (judging by the stock rising 35% today) to YOKU’s new deal with Warner Brothers.

China’s Youku Inc (YOKU.N) has agreed with Warner Bros Entertainment’s local joint venture to offer pay per view movies on its newly launched online paid content platform, Youku said on Tuesday.

Under a three-year agreement with Warner Bros, Youku will add 400 to 450 Warner Bros movies to its Youku Premium library.

“People are increasingly willing to pay for high-quality content, and we take the growth of Youku Premium as a sign that the market is improving for paid services,” Dele Liu, Youku’s chief financial officer, said in a statement.

Great, so YOKU is paying (paid) a lot of money for content it now has to try to sell into a market that may or may not exist.  Let me rephrase that: In order for this deal to be break even (let alone be profitable), YOKU has to convince users not accustomed to paying for “premium” content to…pay for it.  Has this strategy worked anywhere in the world?  I can’t think of any examples of any similar size/scale.

Youku Premium, officially launched on Tuesday, began beta testing in October 2010. Since then, the service has processed 200,000 paid transactions for its library of more than 300 movies and 3,880 educational programs.

According to YOKU’s annual report, they had roughly 280 million monthly visitors.  In 8 (or 9) months then, assuming this number hasn’t changed, they’ve had 2,240,000,000 visits. Two point two BILLION.  In that time, their “beta” test of Youku Premium resulted in 200 thousand transactions.  I’m not entirely sure of the scale of the beta test, but only 0.009% of site visits resulted in a transaction. That’s only 8 or 9 out of every 100,000.

While this number will surely increase significantly when Youku Premium is rolled out across the site, I’m FAR less optimistic than other participants.  I’ve been privy to semi-confirmed reports of illegally-hosted copyrighted content not just on YOKU’s competitors’ sites (of which there are many), but on YOKU’s platform, too.  Ultimately, there are two questions investors must ask themselves:

  • Why would Chinese users accustomed to getting content for free pay for it, when it can still be accessed for free with minimal effort/inconvenience?
  • YOKU hasn’t filed a 6-k yet, but from the myriad of news reports I’ve read, this is NOT an exclusive deal, i.e. the content will still be available elsewhere and Warner Brothers is still free to strike similar deals with YOKU’s competitors.  This isn’t even the first such deal Warner Brothers has struck!  Is Youku’s brand strong enough to keep users coming back?

The company is growing revenues at an incredible rate (so they claim), and the market is growing.  But in evaluating how much to pay for the stock, we have to consider more than just headlines.  Is a company worth 35% more because they signed a non-exclusive to sell content into a market not accustomed to paying for it?  I highly doubt it.

At Goldman Sachs, Chinese Tech Companies Apparently Have the Same Risk As U.S. Ones

I’ve been analyzing YouKu.com (YOKU) for the past three weeks, and as I said most recently, I can’t possibly see how the stock could be worth more than about $21/share, using what I think are pretty optimistic assumptions.  I read Goldman Sachs’ – YOKU’s lead cheerleader underwriter – report before I published, and I’m still going through it and finding data, figures, conclusions and other “analysis” I find very puzzling, to put it nicely.  I’d made a note to myself during my first read-through to go back and check GS’s WACC calculation, since their Cost of Capital was only 12%, which seemed pretty low to me considering we’re trying to value a high-growth, relatively high-risk company in China.

Today, I finally went back and checked GS’ work, and what I found is at the very least EXTREMELY confusing, and at worst, deeply, deeply troubling.

Here’s why:

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