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Windlab

SPACS

One of the more interesting companies to launch an IPO in the last few years is Windlab, a windfarm development company that was founded in 2003 to commercialise software developed at the CSIRO. Windlab’s proprietary software Windscape overlays atmospheric modelling on geographical features to identify and evaluate potential windfarm sites. In their prospectus they claimed this software gives them a significant advantage over other windfarm development companies, as it enables them to identify sites with high wind resources without conducting costly and lengthy on-site testing. As evidence of this claim, the two windfarms that delivered the highest percentage of their maximum output throughout 2018 are on sites found and developed using windscape, Coonooer Bridge and Kiata both in Victoria. 

The company listed in August 2017 on the ASX at $2 a share, equalling a fully diluted market cap of $146.3 million. While initially results were promising, with the company making a profit of $9.5 million in 2017, 2018 has seen a complete reversal of that progress, with revenue dropping from $23.1 million to $3.5 million, and the company making a loss of $3.8 million. As a result, the share price has declined steeply, and is now trading at around $1.04, or a market cap of $77 million.
While for the average company a decline in performance of this magnitude would suggest that something is seriously wrong, I don’t think this is the case for Windlab. Like any company that gains most of its revenue from developments, significant swings in profit from one year to the next are inevitable. The company went from reaching financial close on two windfarm sites in 2017 to one in 2018, and while the failure to reach financial close on a single project was disappointing, it is not surprising given the long timeframes required for most wind farm developments.  It is my belief that the market has overreacted to Windlab’s 2018 results due to a misunderstanding or mistrust of the companies operating model, and that at the current share price the company is significantly undervalued.

The Case for Windlab


 Renewable energy is going through a difficult time in Australia, with little cohesion between federal and state governments, and new connection requirements making connecting a renewable energy plant to the grid more expensive. However, if you believe that climate change is real, then renewable energy should be one of the fastest growing industries over the next twenty to thirty years. While growth in the efficiency of solar tends to get more attention, Windfarm technology is also improving in efficiency, and nearly all renewable energy experts see wind farms playing a significant role in the transition to renewable energy. On a much shorter time scale, if Labor wins the upcoming federal election the domestic market for renewable energy should improve markedly. Labor has a policy of 50% renewable energy by 2030, and to achieve this the level of investment in wind farm projects in Australia will need to increase exponentially.

Windlab is ideally placed to take advantage of this, as the development of windfarm sites is perhaps the most profitable part of the wind farm industry. From 2014 to 2017 the company managed an average Return On Equity of 42%, in a time that included significant growth and the cost of listing on the ASX. 

. 2017 2016 2015
Revenue  $                                          24,515,379  $           18,101,100  $         10,012,006
Expenses -$                                          10,098,372 -$            13,023,113 -$           8,524,804
Profit before income tax  $                                          14,417,007  $             5,077,987  $            1,487,202
Income tax -$                                            4,912,534 -$             1,779,491  $                 14,687
Profit  $                                            9,504,473  $             3,298,496  $            1,501,889
Equity at the start of the year  $                                          13,404,230  $             9,207,680  $            7,699,065
ROE 71% 36% 20%
Average 42%

The company is able to achieve this sort of ROE as windfarm developments are sold once all approvals and agreements signed but before construction begins, meaning developing multi-million dollar projects does not require significant capital. For example, take the site of the Coonooer bridge wind farm, a 19.8 megawatt wind farm in North Western Victoria with a total development cost of $48.6 million. After identifying the site with Windscape, Windlab spent only $300,000 in acquiring the land, then spent $2.2 million or research and planning applications for a total investment of only $2.5 million. Windlab then sold 96.5% of the equity in the Coonoer Bridge to Eurus Energy for just over $4.7 million who then funded the construction of the site with help from grants from the state government. In total, Windlab walked away from this transaction with over $4.7 million in cash and a remaining 3.5% stake in the project, a return of over 111% on the initial investment. 

Valuation


While historically Windlab has sourced most of its revenue from wind farm development, the company also has a growing asset management arm of the business, where they provide asset management services to Wind and Electricity farms, in addition to significant equity in operating and soon to be operating Windfarms. Although historically insignificant when compared to the companies development fees, these sections of the business are quickly growing, and seems to be the managements way of ensuring cashflows are a little more predictable in the future.

In order to accurately value Windlab, I have therefore broken down the company into three separate areas.

Inventory (wind farm development projects)

The book value Windlab gives to its inventory as per the 2019 financials is $9.69M, though this is overly conservative as projects are valued at the lower of their cost or net realisable value.  In order to get a more accurate picture of the actual value of Windlab’s inventory, I have tried to assign individual value to some of Windlab’s larger projects.

Lakeland Wind Farm

Lakeland is a 106 megawatt project located in Northern Queensland. While Windlab does not give a breakdown of inventory values, due to its size and stage in the development cycle the Lakeland Wind Farm is probably the single project with the largest value in the companies inventory.  Lakeland is also one of the main causes for the decline in share price over the last six months, as the project was scheduled to reach financial close in 2018 until the primary investor pulled out at the last minute. This delay has meant the project is now subject to new requirements to connect to the electricity grid, which will mean significant additional costs to increase the stability of the connection (this is a change to the nation-wide connection criteria for renewable energy plants designed to address unstable supply).

While these setbacks are undeniably concerning, Windlab claims that the delay has also allowed them to re-tender for more efficient turbines and they have not yet impaired the inventory value of the project, something they have done in the past when projects are compromised. As per their latest announcements Windlab are still confident of reaching financial close on this project in 2019.
If successful, Lakeland will be the largest project brought to financial close by Windlab to date, at 106 Megawatts. For Kennedy, a 56 megawatt project, Windlab received a financial close payment of 5.4 million, while keeping 50% equity in the project. If Windlab is to acheive a similar margin and equity structure for Lakeland, this would result in a payment to Windlab of $10.2 million, with the remaining 50% equity in the project worth at least $10.2 million as well, for a total value of $20.4 million. Given the uncertainty around the project though, a 50% discount would seem appropriate, which gives the project a total value of $10.2 million for our calculations.

Miombo Hewani

Another late stage windfarm project for Windlab is the Miombo Hewani windfarm in Tanzania. This 300-megawatt, $750 million project is Windlab’s first foray into East Africa, and is undoubtedly the companies most ambitious yet. The project received approval from the Tanzanian government in July 2018 and will receive partial funding from the Government of Finland. Windlab have not committed to achieving financial close in 2019 for Miombo Hewani which is understandable given the uncertainty of operations in Africa, but as development approval is already in place as well as some funding arrangements, financial close can’t be too far off. Demonstrating the significant potential value of Miombo Hewani and Windlabs other East African investments, Eurus Energy, a Japanese sustainable energy company that has partnered with Windlab in the past recently bought a 25% stake in Windlab’s east African projects for $10 million USD, valuing Windlab’s remaining stake in their East African portfolio of development projects alone at $30 million USD, or $42.2 million AUD. While this may seem excessive, Windlab stated in their prospectus that their target development margin for Windfarm developments is $250,000 per megawatt of capacity, and from 2015 to 2017 the company had overachieved this, with margins of $260,000 to $490,000 per megawatt. If Windlab was to successfully reach financial close on Miombo Hewani at their target development margin, this would result in a payment of $75 million alone. As a result, adopting the value assigned by Eurus Energy of $42.3 million for the companies East African projects seems reasonable.

Greenwich

The last late-stage development project worth noting in this section is the Greenwich Windfarm in the USA. Windlab officially sold the project in 2018, but will only receive the bulk of their payment of $4 million USD (5.6M AUD) when construction begins. While Windlab have stated they expect to receive this payment in 2019, a group of neighbours have mounted a challenge to the project to the Ohio Supreme Court seeking to dispute the approval given by the Ohio Power Board. . Given the uncertainty of the case, it is probably prudent to discount this payment by 50%, which would mean a value of $2.8 million for Greenwich.


While the projects listed above are the most likely to result in some form of payment in the next 12 to 18 months, Windlab has numerous other projects earlier in the development cycle. These include:
  • 640 megawatts of approved potential capacity across multiple projects in South Africa. (While South African Renewable Energy projects have been on hiatus, it does seem the projects are about to get up and running again after a recent change of government 
  •       250 megawatt project in Northern Queensland that Windlab is intending to submit a development application for in 2019
  •           230 megawatt project in Vedigre USA that Windlab no longer has control over, but is eligible for up to $4.6 million in success payments if the project reaches financial close.


While an exact value for all of these projects is difficult, I have assigned a value of $15 million for the remainder of Windlab's projects.

Excluding Windlab’s asset management business, which I will cover separately, Windlab spends around $6.4 million a year on project expenses, administration and employees. The projects I have listed above are predominantly expected to reach some form of financial close in the next three years, so it seems logical to assign a cost of $19.2 million, or three years of costs to the above calculations. Once a tax rate of 30% is factored in, you are left with a total inventory value of $35.177 as per the below table.

Project Value
Lakeland  $   10,200,000.00
East African projects  $   42,300,000.00
Greenwich  $     2,800,000.00
Other projects  $   15,000,000.00
Total  $   70,300,000.00
Book value  $     9,690,000.00
three years of annual costs  $   19,200,000.00
tax on projected profit  $   12,423,000.00
Value after tax  $   38,677,000.00

Operating Wind Farms

Currently Windlab has significant equity in two large operating or soon to be operating Wind Farms, Kiata, in Melbourne’s North West which has now been operating for just over a year, and Kennedy Energy Park in Northern Queensland that has completed construction and will be connected to the grid in the coming months. Both projects were originally found and developed using Windlab’s proprietary technology Windscape, with Windlab then subsequently selling down equity in the project to help fund development. Windlab owns 25% of the Kiata wind farm and 50% of Kennedy, and combined these two projects have a book value of $43.6 million on the Windlab balance sheet.
Kiata is a 30 megawatt 9 turbine windfarm in Northern Victoria that had its first full year of operation in 2018, with a total profit of $4.57 million for the year. Wind farms are thought to have a useful life of roughly 20 years, after which significant refurbishment costs are needed in order to continue operation. If we discount these future cash flows at a rate of 7%, (which seems reasonable given the relative low risk of an established wind farm) we get a total value for Kiata of just under $43.9 million. This values Windlab’s stake at $10.97 million.

To value Kennedy is a little more complex, as it has not yet begun operation. However, we know that the project is a 56-megawatt project, combining 41 megawatts of wind with 15 megawatts of solar. The plant also has 2 megawatts of battery storage to help modulate supply and allow storage of excess energy in non-peak times. If we extrapolate the annual profit per megawatt of capacity of Kiata in 2018 of $152,353 and assign the same discount rate, we are left with a value for Kennedy of $83.6 million, or $41.8 million for Windlab’s 50% ownership.

Combined, this gives a value of $52.86M for these two projects. 

Asset management

Windlab’s asset management arm is perhaps the easiest to understand and value. Windlab leverages its expertise by providing ongoing management services to existing wind and solar farms, both that the company has an equity stake in, and to third party independent energy farms or resources. This side of the business is quickly growing, with revenue increasing by 27% in 2018 to $2.97 million, with profit before tax of $610,000, or $427,000 after tax assuming a 30% tax rate. The company signed a significant asset management contract in early 2019 for a solar farm, indicating that they are continuing to grow this business. Given both the significant growth of this area and the broader growth potential of the industry, a P/E ratio of 20 seems coservative, which would value Windlab’s asset management division at 8.5 million.

Software

Lastly, As Windlab has demonstrated ability to use Windscape to develop high-performing Windfarms, it seems only fair to give a value to the Windscape software itself. Windlab is continuing to use this software to identify projects into the future, and the company has proven that this software can provide the company with a significant edge on development projects.  While this is a difficult thing to do, $10,000,000 seems like a conservative valuation, considering both Windlab’s historical performance and the likely growth of the energy sector in the future.


Putting it all together

Area Value
Development Projects  $   38,677,000.00
Operating wind farms  $   52,770,000.00
Asset Management business  $     8,500,000.00
Windscape software  $   10,000,000.00
Cash  $   14,622,414.00
Liabilities -$   10,755,130.00
Total  $ 113,814,284.00
Shares outstanding (diluted) 73848070
Price  $                     1.54

If we add together the values as per the above calculations, we are left with a total value of $113.8 million for the company, or $1.54. As the company is currently trading around the $1.02 mark, this suggests the company is significantly undervalued at its current price. 

Does Your Supply Chain Self-Optimize?

Supply Chain & Logistics

In recent years AI and machine learning have had a major impact on how we run our businesses. They have also influenced the way we make decisions in supply chain planning. As a result we are now in a position to have a supply chain planning system that may have enough intelligence to grow and change with the organization on its own!

The post Does Your Supply Chain Self-Optimize? appeared first on Adexa.

Windowless Airplanes: The Future of Flight?

Aerospace
Skip to content Windowless Airplanes: The Future of Flight? Spike Team2022-10-11T16:55:19-04:00 Share This...

Cannabis and Cobalt

SPACS

In terms of top performers, last year was a pretty great year for Australian IPOs. At time of writing there are five companies that listed in 2017 that are more than 500% up on their listing price. The companies provide a good insight into the current zeitgeist of the Australian micro-cap sector. There are two infant formula companies, one exploratory mining company, one medicinal cannabis company and one 3D printing company.


Company Listing price Current price Return
Wattle Health  $                           0.20  $                 2.26 1030%
Cann Group  $                           0.30  $                 2.75 817%
Bubs  $                           0.10  $                 0.72 620%
Titomic  $                           0.20  $                 1.22 510%
Cobalt blue  $                           0.20  $                 1.40 600%


While initially you might think trying to find common ground between such a diverse set of companies would be difficult, there is one thing that all these companies share; low or nearly non-existent receipts from customers. The five companies listed above have a combined market capitalisation of 960 million, yet their combined receipts for the first six months of FY18 is only 2.8 million.  That’s an annualised price to revenue ratio of 172, a ridiculous metric by any stretch of the imagination.

To be clear, each company has their own, potentially legitimate reason why revenue is currently low or non-existent. Cobalt Blue is still in the exploratory stages of assessing mining sites, Titomic is in the process of setting up its operations centre in Melbourne, CannGroup has multiple regulatory and legislative hurdles to pass before it can start selling cannabis and Bubs and Wattle Health are both waiting on their CFDA licenses that will allow them to sell their products in China. 

A cynical explanation for this coincidence is that it is much harder to disappoint shareholders when you are pre-revenue. A pre-revenue company is all possibility: When you are pre-revenue there are no pesky questions about profitability, client retention, or growth rates. No pre-revenue company was ever caught giving misleading statements about new customers or cooking up elaborate scheme s to artificially inflate their quarterly cash flows. A company that is already making money usually needs actual growth to cause an increase in share price, all a pre-revenue company has to do is make vague claims about massive potential market sizes.

While the initial returns may be spectacular, history suggests the ASX can tire pretty quickly of these sorts of companies. You only need to look back at the best performing IPO’s from 2016 to confirm this. Interestingly enough, there are six IPO’s from 2016 that have at some point traded at over 500% return, but as of today only Afterpay Touch is still trading above this benchmark. Get Swift’s problems have been well publicised, but there are others whose drop in value have been nearly as dramatic.

Aurora Labs, a 3D printing company at one point reached a high of $3.93 before additional capital raises and elusive revenue growth pushed the share price down to it’s current $0.55. Creso Pharmaceutical, another cannabis related company (whoever said the ASX is too predictable) has dropped from its high of $1.36 to $0.70

Even without the benefit of history it seems at least some of the 2017 IPO's are pretty overvalued currently. To take Wattle Health as an example, the current market capitalisation is around $210 million vs current sales of $329,000 a month. If Wattle Health was a mature company with normal growth prospects you would expect it to be trading at around 10X gross profit (keep in mind this does not include administrative, marketing or interest costs), which would require sales of $3,017,248 a month at current margins  This means they would need to grow their revenue by 817% just to justify their current share price.  It seems safe to assume a stock with an 817% revenue growth already priced in is a perilous place to have any capital invested.

In summary, I predict the next 12 to 18 months will see a pretty steep decline in the average share prices of these five companies. But the next time you get offered shares in an IPO selling 3D-manufactured cannabis-infused baby powder you can be sure that for the short term at least you are in for a ride.

Buy My Place

SPACS

In December 2015, Killara Resources, an unsuccessful Indonesian coal mining company announced they would be relisting on the ASX as the online real estate sales company Buy My Place. The backdoor listing involved an offer of up to 25,000,000 shares at a price of 0.20 each to raise $5,000,000.  

Unlike some of the more speculative backdoor listings that the ASX is known for, Buy My Place was an actual established business. Launched in 2009, Buy My Place let Australians sell their house cheaply without spending thousands on real estate commissions. For a low fixed cost, they gave you an ad on Domain and the other major property sites, photographed your property, and sent you a billboard for the front of your house. It was a simple model, designed to demonstrate just how overpaid real estate agents are in an age of inflated house prices and increased reliance on online research.

BMP re-listed on the ASX on the 15thof March 2016 at a Market capitalisation of just over $11 million, roughly 11.5 times their pre-IPO annual revenue. In the January – March quarter the company achieved revenue of $288,000, and by the July-September quarter this had grown to $514,000. Not long after that, the share price hit a high of $0.44 on the 28thof October 2016, a 120% return on investment for IPO investors in just over seven months.

While investors didn’t know it at the time, 44 cents was as good as it got. Over the next few months the share price dropped steadily, reaching an all-time low of 15 cents in July 2017. There was no defining moment that can explain this slump in price. Throughout this period updates from the company continued to be positive, promoting record cash-flow numbers with nearly every quarterly report. Reading back through the company announcements, there is nothing to suggest that this is a company losing 65% of its value.

It is only when you look at the Prospectus in more detail though, do you get a sense of how Buy My Place has failed to live up to its own expectations. While there were no forecasts in the Prospectus, the three tranches of performance rights for senior Buy My Place employees gives us an idea of what the company, and by extension shareholders, were hoping for. The three tranches vest if the company achieves 8,000 property listings, $10,000,000 in revenue or EBITDA of $3 million in one financial year by July 2019. As it stands, these goals seem completely out of reach. If you annualize their last quarter numbers, Buy My Place is on track for annual listings of 1676, revenue of $3,668,000 and so far away from profitability it’s probably not even worth discussing. Whether a 10x increase in revenue over three years while retaining profitability was a realistic goal or not, somehow it seemed that this became the standard the company has been judged against.

A slightly more charitable way to look at Buy My Place’s lukewarm first couple of years on the ASX is that convincing someone to sell their own home without a real estate agent is a harder transition than both investors and the company initially realized. People may resent the huge amounts of commission Real Estate Agents pick up with relatively little work, but the step from resentment to taking the pressure of selling a house on yourself is another matter entirely. In February 2017 the company seemed to acknowledge this fact, and launched a full-service package, where for a higher fee of $4,595 home sellers gain access to a licensed real estate for advice, who also manages the whole process. This strategy seemed to be part of a broader re-positioning that happened throughout 2017, where the company sought to increase its revenue per client. In July, Buy My Place announced the Acquisition of My Place conveyancing, an online conveyancing firm they had referred business to in the past. A few months later in September Buy My Place announced a partnership with FlexiGroup, allowing customers to finance both Buy My Place fees and other costs associated with selling their property.

To cap off these changes, in October Buy My Place announced the departure of Alan Heath and the appointment of Colin Keating as CEO, a younger executive who had spent time at American Express and more recently at an investment administration company. The new strategy seems to have also involved a re-focus on revenue growth above all else. For the last two quarters, revenue growth has increased to an impressive 20%+ per quarter, but expenses have grown just as quickly.

Buy My Place - Quarterly cash flows since listing (thousands)













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For a company running at this sort of deficit, the obvious concern is how much runway they have before they will run out of money. At the end of December, the company had $800,000 in cash, plus an unsecured, zero interest credit facility with the investment/bankruptcy firm Korda Mentha of $1,000,000. Given they are currently running at a deficit of roughly $750,000 a quarter, it seems highly likely the company will need to go through another capital raising round in the next six to twelve months.

While normally the knowledge of an impending capital raise is enough to make me lose interest pretty quickly, the current share price seems close to the floor of any potential future equity raise. In December 2017, Buy My Place raised $400,000 from sophisticated and professional investors at a price of $0.16 each. In addition, the company secured a zero interest credit facility with the finance firm Korda Mentha of $1,000,000 in return for the issuance of 6,250,000 options with an excise price of 16 cents. With this in mind, It is unlikely these investors (Korda Mentha is also a major shareholder) will allow any future equity raise at less than $0.16 cents a share, given that announcements since then have generally been positive. With shares currently trading around the $0.16 mark, future equity raises should be at or above this price.

The competition


Although there are a number of online sites offering online house sale services in Australia, the elephant in the room in any discussion of Buy My Place is Purple Bricks. The UK low cost real estate agent expanded to Australia a couple of years ago, and with revenue of more than double Buy My Place in Australia and a market capitalisation of over $900 million pounds internationally, they represent the biggest competition by a few orders of magnitude. With this in mind, I thought it might be useful to compare the two companies’ latest half year reports for Australia only.

Buy My Place and Purple bricks H1FY18 (Millions)

Purple Bricks PB costs/revenue Buy My Place BMP costs/revenue
Revenue 6.8 1.57
Cost of sales -3.2 47% -0.53 34%
Gross Profit 3.6 53% 1.04 66%
Administrative expenses -3 44% -2.97 189%
Sales and marketing -5.7 84% -0.87 55%
Operating loss -5.1 75% -2.80 178%

The thing that immediately jumps out is Buy My Place’s much higher administrative expenses as a percentage of revenue compared to Purple Bricks. This can partially be explained by some one-off costs Buy My Place had regarding the appointment of their new CEO and acquisition of MyPlace Conveyancing, but it does look like these are costs that need to be reined in. You would also expect this ratio to improve as Buy My Place’s revenue grows. However, the overall picture suggests that these are two companies operating in broadly similar ways. The fact that Purple Bricks has managed to hit profitability with this model in the UK should be seen as a positive for potential Buy My Place investors. Purple bricks entrance to the Australian market should also help familiarise people with low cost real estate agent options, opening up more potential customers for Buy My Place.



Valuation and Verdict


At its core, Buy My Place is an idea that I really believe in. There is no reason for a Real Estate Agent to take in tens of thousands of dollars in commission to sell a house, in an age where buyers are increasingly comfortable doing their own research and the same handful of online sites are used by everyone when searching for a house.

With a market capitalization of just under $10.8 million dollars at time of writing and annual revenue of $1.53 million as per their latest half year accounts, Buy My Place is currently trading at 3.53 times annual revenue. For a company that has managed to sustain 20%+ quarterly growth for the last six months this seems like a pretty enticing deal. While some of this can be chalked up to the Buy My Place’s rather precarious cash position, it seems that at least part of the companies relatively cheap price can be explained by the short attention span of the market. Micro-cap investors are quick to move onto the new thing, and after failing to live up to their initial hype, it seems many investors have simply lost interest in Buy My Place.

I bought a relatively small investment in Buy My Place at $0.155 cents each last week. I will be watching the coming 4C closely due in just over a month’s time, and if they can start reducing their loses I will likely add to that position.

Xinja

SPACS
A couple of weeks ago, the first six AFS licenses for crowdfunding were issued, paving the way for Australian companies to raise money from retail investors without listing on the ASX. While I usually restrict this blog to reviewing initial offerings of publicly listed companies, I thought it might be interesting to review one of the first crowdfunding offers in Australia to mark the occasion. There’s something to be said for reviewing a company that doesn’t have a public market for its shares, as you are less likely to end up looking like an idiot.

While a few of the crowdfunding platforms are still in the process of setting up their first offers, Equitise seem to have got the early jump on the competition. Their crowdfunding campaign for Xinja, a start-up digital or "Neo" bank, is already live and at time of writing $1.3 million into their 3 million dollar raise. 

Xinja has ambitious goals. With the recent weakening of laws regarding setting up banks in Australia, they intend to set up a fully functioning Australian bank, complete with deposit accounts and mortgages.

Just in case you forget this is a crowdfunding offer as opposed to your usual boring IPO, they have put together a pitch video, replete with flashy animations and bubbly tech muzak in addition to the standard offer document and financials. Once you look past the executives in torn jeans and distressed-paint walls, you quickly conclude that the pitch seems entirely devoid of anything original. Xinja’s main claim is that they will be the first “100% digital bank,” offering fully online services with no branches, but ME bank has been offering deposit accounts since 2003 in Australia and has never opened a branch. Another big focus of their pitch is that they will develop tools that nudge customers to make better financial decisions, which seems pretty similar to an advertising campaign NAB has been running for years. While the idea of a new digital bank in Australia is in itself is somewhat interesting, it is a shame that this is as far as they have got in terms of originality. Watching Xinja’s pitch video I’m reminded of that old Yes Prime Minister joke, about how boring speeches should be delivered in modern looking rooms with abstract paintings on the walls to disguise the absence of anything new in the actual speech. These days the modern equivalent I guess is a converted warehouse office space and vague references to blockchain.

What makes this paucity of orginality a particular concern is that the challenge faced by Xinja is enormous. There are good reasons why Australia has been dominated by the same big four banks as long as anyone can remember, and it’s not because no one has ever thought of making banking work on your phone. The pitch seems to promote this idea that the big banks are old tired institutions, with needlessly slow and cumbersome processes, just waiting to be pushed aside by some new start-up. As someone who works in the finance industry I know this is far from reality. Banks are obsessed with innovation and change, and are constantly sinking huge amounts of money into technology to stay ahead of the curve. The simple reality is that banking is one of the most heavily regulated industries in Australia. More often than not, what you find frustrating or slow about a bank’s processes is down to legislative restrictions rather than the banks ineptitude or unwillingness to change.

A lot is made in Xinja’s pitch video of the involvement of the founder of Monzo in Xinja. Monzo is another digital/Neo bank that was set up a few years ago in England. In the pitch Monzo is held up as an example of the success of Neo Banking, but this seems like a ridiculously premature thing to say. While Monzo has been through multiple capital raises at increasingly higher valuations, the reality is Monzo’s revenue for 2017 was a paltry $120,000 vs a loss of 6.8 million. It’s true that Monzo has some interesting ideas and managed to pick up an impressive half a million customers thanks to their zero fee pre-paid cards, but it is still far too early to hold them up as some sort of success. If I started handing out free cup cakes at Flinders Street Station I’d probably run out of cup cakes pretty quickly, but it’s hardly proof of a valid business.

The example of Monzo also gives us a good example of just how much capital is needed to start a bank. According to Crunchbase, since June 2015 Monzo has raised a total of 109 million, and given how far they are off profitability more funding rounds are probably on the cards. At each raise the business valuation has increased, but it does demonstrate just how long the road ahead is for Xinja.

Valuation


While it might be considered a bit boring to talk about something as mundane as valuations and financials in the crowdfunding world, it is probably worth noting that Xinja is raising its $3 million dollar campaign at a $43.1 million dollar valuation, higher than the last 5 ASX IPOs I have reviewed on my bl og.
To be blunt, the $43.1 million market capitalisation is completely ridiculous. Reading the “achievements to date” section of the prospectus it is hard to believe someone was able to write this with a straight face. While bullet points like “we have assembled a committed and exceptional team” and “we have completed 80% of our app” might be acceptable when putting together a slide deck at a hackathon, for a company valuing itself at over $40 million dollars it is downright obscene.

Not only does Xinja have no revenue from customers to date, they don’t even have trial products with customers or a license for any type of banking activities in Australia. They have only raised $7.8 million dollars before this crowdfunding campaign, which means that somehow investors are meant to believe that the other $32.3 million of their valuation has been created by coming up with a company name and hiring a few people.

Even Monzo, which seems to have ridden the hype train of ridiculous valuations pretty well, has been more restrained in their valuations. In October 2016 when Monzo valued itself at $50 million pounds, they had already been granted a restricted banking license and had a prepaid cards with a fully developed app out to 50,000 people. Earlier on, Monzo raised 6 million at only a $30 million valuation in March 2016, but at that time had a working trial pre-paid card out to 1,500 people. In contrast, Xinja has not only not yet released the beta version of their prepaid card, they still don’t even have a banking license.

To provide just one more example of how ridiculous the Xinja valuation is, it is worthwhile to look at the ratio of book to market equity. Banking has always been a capital-intensive business, and post-GFC regulations have only made it more so. This means that profits always require significant amounts of capital. The CBA, for all its market advantages from to being the largest bank in Australia has a book to equity ratio of $0.43. This means for every dollar of CBA shares you purchase, you are getting an entitlement to the earnings of $0.43 cents of equity on the CBA balance sheet. For the Xinja crowdfunding campaign, a bank with no license, revenue or market share, that ratio is only $0.22 cents.

On the Xinja Equitise crowdfunding campaign, the offer is described as a bank job. What they don’t tell you though is you’re the one getting robbed.

Simble

SPACS
I’ve been distracted by a few other things lately, so my apologies for the lack of posts. I also started a few posts before realizing I didn’t really have much to say about the company. There are certain IPO’s in technical fields where if you aren’t a subject matter expert in whatever area the company operates in its hard to offer much in the way of useful commentary.


As it looks like my investment in Bigtincan is finally paying off, it seemed like a good time to review another SaaS (Software as A Service) IPO.

Background


I’m having a little difficulty properly understanding the history of Simble. The Prospectus states that Simble was created as a merger of Incipient IT, an international technology venture group and Acresta, and Australian Software company. What doesn’t make sense though is that according to the Prospectus Simble was created in September 2015, yet the acquisition of Acresta and Incipient IT only occurred in September 2016. The prospectus doesn’t give much information on what exactly was happening with Simble during the 12 months between being created and acquiring Acresta and Incpient IT, but whatever they were doing they managed to rack up over 1 million in expenses during that time. 













Just to be clear, these are statutory figures so are actual expenses for Simble, not of Acresta and Incipient IT before they were acquired. One possible explanation is that these expenses could have had something to do with purchasing the two companies, but that seems like an awful lot of money to spend on due diligence, and doesn’t explain the $86,000 marketing expenses. A more likely possibility is that Simble initially had some other business venture that they have since discontinued that the prospectus is neglecting to mention.

After doing a bit of digging around, it does seem that Simble has been involved in a few different areas that they don’t bother mentioning in the prospectus. Type Simble into the Android app store or Google and you find a bunch of results, some a little more hairbrained than others.  There’s Simble Kids, a website for finding children’s activities in the United Arab Emirates (Google that one at your own risk as the website has an expired security certificate), a booking platform for small businesses (this one appears to be functional at least) and Simble Live, which was apparently a social commerce app again based in the Arab Emirates (I still have no idea what a social commerce app actually is). All these businesses seem to have largely been abandoned though, so I guess they decided it made a cleaner narrative to leave them out of the prospectus.

As an outsider, the merger between Acresta and Simble initially doesn’t make much sense. The little information I was able to find online about Incipeint IT shows that it was operating as a software venture capital firm and incubator before being acquired. Incipient IT was Co-founded by Phillip Shamieh, who may be familiar to Australian Small-Cap investors from his Australian stock research company Wise-Owl. (More Controversially, Shamieh was also involved in the now defunct sandlewood company Quintis. Wise-Owl was criticized in Glaucus Research’s now famous short report on Quintis for posting buy recommendations on Quintis Stock without disclosing Shamieh’s involvement in the company).
Acresta on the other hand, are an Australian software company with a focus on providing automation services to government and businesses.

What exactly the synergies are between an Australian Software Company and an Asian Business incubator is not that clear, but it seems that the business has been organized to maintain Incipient IT’s coding and software team in Vietnam, while keeping Australia as the businesses base of operations. Economically at least this makes sense, due to the lower costs of maintaining a development team in a country like Vietnam. I have seen a number of different businesses work with a similar model. The executive structure seems to largely reflect the merger between Incipient IT and Acresta. The CEO Fadi Geha was a co-founder of Acresta, and the next highest paid executive is the Commercial Director Phillip Shamieh from Incipient IT.

Products


Simble has two main business arms. There’s Simble Mobility, a business process automation service largely carried over from Acresta and Simble Energy, a more recently developed electricity management service.


Simble historically has received the bulk of its income from Simble Mobility. A good example of Simble Mobility’s work is the App they developed for Barwon Health’s Cancer Centre for patient registration and booking.

Simble will typically work with an organization to develop an electronic solution for a business process and then develop the software. It is important to note that for a lot of these projects Simble does not actually own the platform that they work on. Instead, Simble has previously used a platform developed and owned by Blink Mobile, another small Australian software company. Simble has an agreement in place to use Blink Mobile’s platform, but is does not look like its exclusive which is a bit of a concern. 

From an investment perspective, this is all pretty unexciting. A large proportion of Simble’s clients in this space seem to be Not-for Profit and government organizations. Having worked previously selling products to local government I know from experience that this can be a slow moving, uninspiring slog with products that are hardly at the cutting edge of technological development. It is also an industry with little prospects for rapid growth, as each organization is likely to want their own customized products that need to be developed individually.

Perhaps unsurprisingly then, the prospectus spends a lot of time promoting the growth potential of the Simble Energy Platform. This is a recently developed platform for businesses seeking to better manage their energy use. In addition to monitoring energy consumption, the platform is able to remotely turn on and off different circuits and appliances to take advantage of lower energy prices, or sell back surplus energy to the grid when prices spike. This is achieved via an Internet of Things hardware solution that needs to be installed on the relevant appliances and machines on-site. Simble gets revenue both from the initial installation of the hardware and the monthly subscription fee to use their software.

While the Internet of Things element is a recent development for the company, Simble and its predecessor Acresta have been providing energy management services for quite some time. You can old case study for carbon monitoring services that Acresta provided back in mid-2015 to Jurlique here.

On the face of it, the Simble Energy Platform seems like a solid business idea. There’s been an increased focus lately on the variability of energy demand on grids, and the rollout of smart metres presents significant savings for businesses able to match their energy demands to off-peak times. The Internet of Things element makes a lot of sense as well, as it transforms the platform from a purely monitoring service to one that can provide real savings.
On the negative side, it doesn’t look like Simble is the only company operating in this space. Simble seems to be initially focusing on the UK for its energy management business, and the Prospectus lists a few different companies already operating in this market. More worryingly, IBM also looks like they are providing a similar solution, with both an energy monitoring and Internet of Things element. One of the biggest fears for tech start-ups is that some giant company starts offering a similar service before they are able to compete, to the extent that “what happens when Google gets involved in your business” is a standard question Venture Capitalists ask when interviewing start-ups. While IBM doesn’t quite have the reputation of Google for moving into industries and quickly destroying the competition, they are still a pretty formidable competitor for a business barely able to clear $2 million of revenue a year.

Financials



Mid-January is typically a pretty quiet time in the IPO world. It’s an awkward time to list as one month or so later you would be able to include results for the 2018 calendar year, yet as it stands you are left with financial information that is over six months old. This is a particular problem for the Simble IPO, as a pessimistic interpretation of their balance sheet from June 2017 suggests they could be bankrupt by now.


In June 2017, the business had only $182,000 in cash, vs $1,650,000 in payables, $309,000 in employee benefit liabilities, and just under one million in unearned revenue. For a company with negative net cash flows for the six months until June 2017 of -$951,000 this is a pretty major concern. Deloitte seems to have been of the same opinion, as they submitted an emphasis of matter statement regarding the troubling net working capital position when they signed off on the HY16 and and HY17 financial report.



From a revenue perspective the situation isn’t much better. Below is the normalized profit and loss for Simble, which incorporates both Acresta and Incipient IT figures from before the merger.













The labelling is a bit confusing, but the first three are all Calendar years 2014-16, then HY16 is July-December 2016 and HY17 is January-June 2017. This is due to the business recently changing to a December end of year. It’s a hard table to look at, as it switches from 12 month periods to 6 months. By subtracting the HY16 numbers from the CY16s, I was able to work out the figures for the first half of 2016, giving me 3 6 month profit and loss periods.


$000 jan - Jun 2016 Jul - Dec 2016 Jan - Jun 2017
Revenue  $                1,090  $               1,629  $                1,160
Cost of Sales -$                  340 -$                  810 -$                   359
Gross Profit  $                   751  $                  819  $                   801
Other Income  $                   300  $                  455  $                   348
Operating Expenses  $                      -  
General and Administration -$& nbsp;              2,243 -$               1,823 -$               1,637
Marketing -$                  164 -$                  359 -$                     62
Total Overhead expenses -$               2,407 -$               2,182 -$               1,699
EBITDA -$               1,355 -$                  909 -$                   550
Depreceation and Amortisation -$                  366 -$                  407 -$                   462
EBIT -$               1,721 -$               1,316 -$               1,012

As you can see, there has been a negative trend in revenue from a high of $2.9 million in 2015 (or 1.45 Million every six months) to only $1.16 in the six months to June 2017. The prospectus mentions that the business is currently went through a restructuring period prior to listing, and it seems they are yet to see much revenue growth from their new energy platform. The jump to $2.2 million in operating expenses in the six-month period before the acquisition of Incipient IT and Acresta is also interesting. Around $1 million of these expenses are from Simble’s statutory accounts, so this does seem to confirm Simble was doing something else at that time other than simply getting ready to purchase Acresta and Incipient IT. It gets especially weird when you look further down at the cash flow statements and see that the business capitalized $4.711 million in development costs in the second half of 2016 as well.











 In total, this means the business spent around $9 million in 12 months on operating expenses and software development, a phenomenal amount for a business this size. This seems to suggest the current management team is not exactly frugal, which isn’t great news considering they will have less than $7 million in net cash to play with post-listing.

Valuation




Simble made a statutory loss before tax of $1.25 million for the six months to June 2017, so any traditional valuation method as a multiple of earnings isn’t going to be possible. Instead, as seems standard for SASS companies, the main metric we can use to evaluate the company is a multiple of revenue.


With a maximum market capitalisation of $17.98 million, Simble is valuing its IPO at 7.75 times revenue. If you subtract the money that is to be raised, the pre-IPO value is $10.48 million or 4.52 times revenue. For a SASS company this is pretty reasonable. Bigtincan, a SASS company I invested in that was at the low end for SASS valuations listed at 6.6 times revenue and is now up over 50% on its listing price. On the negative side, Registry Direct, another SASS company that I invested in listed at 31.7 times revenue and now is trading around 40% lower than its listing price. However, what both these companies had which Simble doesn’t is impressive revenue growth. At the end of the day, the only reason investing in a company currently losing money makes any sense is because you think it is going to grow rapidly. The fact that Simble is currently shrinking makes this a much harder sell. If they had been able to wait long enough to show actual revenue growth from the Energy Management platform the valuation would be much more compelling, but I guess given the dire state of their balance sheet waiting six months probably wasn’t an option.



Verdict


While the idea at least of the Simble Energy Management platform seems compelling, at this stage there is too little actual evidence of real growth of this platform for me to justify an investment. In six months’ time if they can show some revenue growth it might be worth picking up some shares even if you need to pay substantially more than $0.20, but without seeing that growth the investment seems like too much of a gamble. I’ll waiting for something a little more compelling for my first investment of 2018.

Appetise

SPACS
Appetise are a food ordering website that are seeking to raise between 4.8 and 6.8 million dollars. While they are listing on the ASX, they are so far only located in London, and have no connection to Australia. In a trend that has been growing lately, they seem to have chosen to list in Australia purely due to its lower compliance regulations and associated costs.

Background



By numbers alone, Appetise looks like one of the worst value IPOs I have reviewed on this blog. To explain, let me give a few simple facts presented in Appetise’s own prospectus:



After starting in 2008, Appetise was acquired for only $230,000 in May 2016 by Long Hill, an American investment company. After acquiring the business, Longhill poured $2,260,000 into Appetise to improve the company's website and increase the number of restaurants on the platform. However, despite these investments, revenue decreased from $91,715 in FY16 to $49,172 in FY17. This IPO now values Long Hill’s stake at $9 million, with total market capitallization on listing between 13.8 and 15 million, more than 200 times their 2017 revenue.  If the IPO is successful, this will be a 261% return on investment over 18 months for Long Hill, despite no measurable improvement in Appetise’s performance. If you are getting flash backs of Dick Smith right now, you’re not the only one.


Management




When Long Hill bought Appetise they did the usual private equity thing of installing a completely new management team, getting rid of the original founder in the process. The newly appointed CEO, Konstantine Karampatsos, has had experience both setting up his own online business as well as a stint at Amazon, and the CFO Richard Hately has had a number of senior roles at both start-ups and established businesses. While the CEO and CFO both seem like logical choices, appointing such an experienced management team to a company of this size leads to some pretty ridiculous statistics.

Konstantine Karampatos will have an annual salary of $204,050, post listing, plus a bonus of $122,430. Richard Hately, the CFO, will have a salary of $195,888, and will receive a listing bonus of $81,620. The marketing director will receive a salary of $138,750, though no listing bonus. All up, this is an annual cost of over $700,000 for the three highest paid employees, for a company that had less than $50,000 in revenue last year. Even if Appetise’s FY17 revenue increased by 1000% in FY18, it would still not come close to covering the salary of its three most senior executives.

This is a perfect demonstration of why a public listing at such an early stage is a terrible idea. A $50,000 revenue company should be being run out of a garage or basement somewhere by a few dedicated founders on the smell of an oily rag, not burning through cash on highly paid executives.



This cost has real consequences too. Under their proposed allocation of funds, with a minimum $4.8 million raise, Appetise will spend $1.55 million on executive and head office expenses, vs only $2.15 million on marketing. Given that their primary goal over the next few years is to raise their profile, this seems like a ridiculous allocation of capital.

Product


As Appetise is currently only operating in England, the closest I could get to testing Apetise’s product was spending some time clicking through their website. Overall, it was a pretty underwhelming experience. There are three large tabs that block a significant part of the page, which makes scrolling through options difficult, and the colour scheme and overall design feels a little basic. 











On the positive side, they seem to have invested some time into making the mobile experience work well; if anything the site actually seems to work and look better on a mobile phone. It is also worth mentioning that while the prospectus mentions that the business has a national footprint on numerous occasions, their coverage in London is pretty minimal, and at this stage they seem to be focused solely on the city of Birmingham.



The company’s social media presence is similarly disappointing. The prospectus talks a lot about social media engagement through their loyalty scheme, where users can get credit by sharing Appetise on their social network but so far they have failed to get much traction in this area. The Appetise Facebook page seems to only post bad food puns, and each post gets around 2 to 7 likes on average





















(I also noticed that a company director and their marketing executive are two of their most common Facebook fans.) Compare this to Menulog’s page, an Australian food ordering and delivery service, where you’ll see content featuring available restaurants, slightly funnier puns, and as a result much higher engagement with customers. While Facebook posts might seem like a trivial thing to be hung up on in a company review, one of the key things that will affect Appetise’s success is how easily they can build an online following. The fact that so far they have demonstrated little nous in this area is definitely a cause for concern.

Market


Online food ordering is an industry with massive growth potential, and this is probably the main reason Long Hill felt they could get away with the prospectus valuation they have gone for. Appetise has a different model to the likes of Menulog or Deliveroo though, as Appetise does not take part in deliveries, instead, restaurants featured on the Appetise platform need to deliver the food themselves. The idea is this will allow them to scale more easily and not get bogged down with logistical complexities. While I don’t doubt this approach might work in the short term, (and Just Eat, a successful UK company with the same model as Appetise has proven that it can) in the long run an Uber Eats type model of flexible contractors, that can be sent wherever there is demand seems much more efficient. As websites like Uber Eats become more popular and economies of scale start to kick in, I feel there would be an incentive for restaurants to fire their delivery drivers and move from an Appetise type platform to an Uber Eats one.

Appetise makes the argument that their patform is currently cheaper, as Uber Eats charge delivery fees to customers, but just like with Uber, you would assume that these charges will eventually decrease as the site grows in popularity.

Verdict


Appetise’s response to a lot of what I’ve said here would be that the company is uniquely placed to experience explosive growth in the near future. They have a workable website platform, and their only major competitor in the UK Just Eat has demonstrated that there is money to be made in this market. While a $50,00 revenue company with a board of directors looks ridiculous now, if in 12 months’ time their revenue is closer to $1,000,000 no one will be complaining. The problem I have with this argument though is it requires a lot of faith with not much evidence. If Appetise is really uniquely placed to grow so quickly, why not hold off on the prospectus for a few months so they can demonstrate this? Appetise runs on a March end financial year, so their first half FY18 figures should be available now. Once again, the cynic in me thinks that if revenue was actually growing, these figures would be included in the prospectus. 

Even in a growing industry you need to be ahead of the curve and have a clear point of differentiation to succeed, and after reading the Appetise prospectus and looking over their website I simply don’t see this for Appetise. In one of the easier decisions I’ve had to make with this blog so far, I will not be investing in the Appetise IPO.



Sienna Cancer Diagnostics

SPACS

Overview


Sienna Cancer Diagnostics are seeking to raise 6 million dollars, with an indicative market capitalization based on full subscription of just under 37.5 million. Shares are being offered at 20 cents each.

Sienna was originally founded in 2002. The company’s focus is the development of diagnostic tools for cancer, and more specifically using tests that look at levels of Telomarese in the body to aid in diagnosis. I spent around 10 minutes clicking on links on Wikipedia trying to understand what exactly Telomarese is, but I quickly realised it goes well beyond whatever I can remember from year 10 science. Instead, as usual I will do my best to evaluate the Sienna IPO using the tools available to an average investor.

IPO’s in the biotechnology space can be broadly broken down into two categories: Pre-revenue, where all the company has is an idea and maybe some patents, and post-revenue, where the company has a proven method of generating revenue, and is now looking to ramp things up. Sienna Cancer Diagnostics falls awkwardly somewhere in the middle. While technically Sienna has been receiving revenue from product sales since 2015, if you exclude research and development expenses, revenue for the first six months of FY2017 was $291,588. There are small café’s that turn over more money than that. It’s an unusual time to list, as the immediate question is why Sienna didn’t hold off until the listing until they had demonstrated their growth potential.

Background


Like many companies, Sienna’s past does not seem to be as straightforward and linear as the Prospectus would like you to believe.

In January 2015, Sienna Cancer Diagnostics announced their first sales agreements with a Major American pathology company. Kerry Hegarty, the CEO at the time gave an interview to The Age, where she explained that “ …Sienna has succeeded where other cancer diagnostic ventures have failed because it has been able to stay an unlisted company so far.” Hegarty goes on to talk about the flexibility of being an unlisted company when you are still in a pre-revenue stage.

4 months after giving this interview Hegarty left Sienna Cancer Diagnostics.  Later that same year in September, Street Talk reported the company was planning a 10 million-dollar IPO with Pac Partners as lead manager. Did Hegarty leave because she felt that the company’s decision to list was premature? I have no idea.


For whatever reason, the 10 million-dollar IPO with Pac Partners did not eventuate, and the company is now listing 18 months later raising only 6 million with the much smaller lead manager Sequoia Corporate Finance.  A CEO leaving a company and an IPO being delayed aren’t exactly unusual occurences, but it would be interesting to get some background on why both these events happened.

Financials


As mentioned earlier, Sienna has largely relied on government rebates and Australia’s very generous research and development tax incentive program for revenue. I take the view that if the company is going to achieve long term success, it will need to eventually stop relying on government handouts and therefore these revenue streams should be excluded from any analysis.

 The worrying thing is though, once you take this money out revenue has gone backwards from 2016 to 2017. In 2016, Sienna’s first full year of receiving product revenue, the company had annual revenue of $640,664 excluding government rebates, or $320,332 every six months. The first six months of FY17 saw revenue of only $291,588, a pretty sizeable decrease at a time you would naturally expect revenue to grow.

While there may be legitimate reasons for the decline in revenue, it is not addressed anywhere in the Prospectus that I could find. The decline in revenue also puts into question Sienna’s chosen listing date. August is an interesting time to list, as it means the prospectus does not include the full FY17 numbers, even though the financial year is over by the time the offer closes. The cynic in me says that if the FY17 numbers were any good the IPO would be delayed a couple of months, as strong FY17 numbers would make the IPO a much more straightforward process.

To further illustrate the odd timing of the listing, the balance sheet as of January 2017 showed over 1.5 million dollars in cash, vs annual expenses of around $570,000. Whatever was behind the decision to list before FY17 numbers were available, it wasn’t because the company was about to run out of money.

Shareholders


Sienna have not put any voluntary escrow arrangements in place, so a key question for any potential investor is who the existing shareholders are, and how likely they would be to dump their shares as soon as the company lists.

Earlier articles about Sienna mention the ex-CEO of Macquarie Allan Moss as one of the main shareholders and backers. Interestingly enough, his name does not appear in the current prospectus, so either he has sold out completely, or now holds less than 5% of the company. Why a shrewd investor like Moss would sell-out before an IPO is another question a prospective investor should probably think about.

Instead, the current largest shareholder is now someone called David Neate, who owns just over 10% of the company. I was immediately curious about who this person was, as I could not find him listed on the board or the senior management team of the company. After digging around online, the only information I could find on him was in regards to Essential Petroleum Resources Limited, a now delisted oil and gas exploration company that someone called David Neate (and I’m aware it might not be the same guy) held 12.6% of in October 2007. 

There is an October 2008 Hot Copper thread where someone wondered why Neate was unloading so many shares in Petroleum Resources Limited. A few months after the post in January 2009, shares fell to below 1 cent following unfavourable drilling announcements  and the company delisted later that year.

Of course, there are perfectly reasonable explanations for a major investor deciding to offload shares, but it’s not really the sort of information you want to find when you start googling the major shareholder of a potential investment.

Verdict


As this is an IPO in an area where I have no technical knowledge, I am acutely aware that I could be completely off the mark with my analysis. If using Telomarese to diagnose cancer proves to be the next big breakthrough, this could easily be the IPO of the year. However, if I’m going to invest in a company that’s actual product revenue is less than one fiftieth of the indicative market capitalisation, I would at least want to see revenue growth, not revenue going backwards. Furthermore, the small amount being raised does make me wonder if the IPO is more about existing shareholders unloading stock than actually raising capital. Contributed equity is listed on the balance sheet as only 16.6 million, which means at least some initial investors would still be making significant profits if they unload their shares well below the initial listing price.

While I may well live to regret it, this is one IPO I will not be taking part in.

Moelis Australia

SPACS
Overview

Moelis Australia is the Australian offshoot of Moelis & Company, an American investment bank founded in 2007. Moelis and Company have made a name for themselves as one of the leading “Boutique investment banks,” smaller specialised investment banks that have become increasingly popular since the GFC largely thanks to their perceived ability to give more independent advice. In one of their most impressive wins to date, Moelis and Co was recently announced as the sole lead on what will probably be the biggest IPO in history, the giant Saudi state owned oil company Aramco.

In Australia, Moelis has been similarly successful, though not without controversy. While they have been involved in numerous successful IPO’s, they were also the lead manager for the botched Simonds Group IPO in late 2014, with shares now trading at less than a quarter of their floating price. More recently they have made the news for apparently buying up Slater and Gordon debt at significant discounts, supposedly for some debt for equity scheme they are planning.

After the IPO, Moelis & Co will retain a 40% stake in Moelis Australia and a partnership between the two entities will remain with Ken Moelis himself, the founder of Moelis and Co taking a seat on the board.

IPO details

25 million of a total 125 million shares will be sold through the IPO at $2.35 per share, raising $53.8 Million once the costs of the offer have been taken into account. The Market capitalisation at listing price is $293.8 million, making it one of the biggest Australian IPO’s this year to date.

CEO

The CEO of Moelis Australia is Andrew Pridham, more famous for his role as Chairman of the Sydney Swans and his occasional spats with Eddie Mcguire than for his career as an investment banker. Pridham’s career has been impressive; he was appointed the Managing Director of Investment Banking Australasia for UBS at only 28 and has also held senior roles at JP Morgan before helping start Moelis Australia in 2009. He has been less successful in his ventures into the art collecting world though, making headlines a couple of years back when he purchased what turned out to be a forged painting for 2.5 million dollars. When Melbourne radio hosts started making fun of him about this, Pridham’s response somehow managed to go from victimhood to snobbery in one sentence.

“It’s extremely disappointing but notsurprising these radio jockeys find it appropriate to make fun of any victim ofcrime — me or anyone else. It is of some comfort to me that it is highlyimplausible anyone will ever have the opportunity to defraud any of them of$2.5 million.”


However, as long as Pridham doesn’t decide to turn Moelis Australia into an art gallery, his dubious taste in Australian art shouldn’t trouble potential investors, and overall he seems like a pretty capable and intelligent guy. Also, for the CEO of an investment bank worth nearly three hundred million dollars his salary is quite reasonable, at only $450,000 a year plus bonuses. That he is looking to make most of his money through performance bonuses and increases in the share price is a positive for investors, and something that other recent listings (Wattle Health anyone?) Could learn from.

Expansion plans.

One of the things that worries me about the Moelis Australia IPO is the 44.2 million of the total 58.8 million raised  that will be set aside for the vague purpose of “growth capital.” This is expanded upon in another section of the Prospectus with the below statement:

"Moelis Australia is actively assessing a number of strategic asset and business acquisitions. None of these opportunities are certain of proceeding at the date of this Prospectus. Any one of, or a combination of, these acquisitions could result in Moelis Australia applying a substantial part of the Offer proceeds to fund the acquisitions of potential assets or businesses being assessed."

While some investors will see this as a growth opportunity, something about the combination of a CEO with no shortage of self-confidence, a professional services business and statements like this make me a little nervous. As any financial academic or Slate and Gordon stockholder will tell you, business acquisitions by listed companies have a tendency to destroy rather than create shareholder value, and I doubt Pridham is going to be able to sit on his hands for long with $54 million in his pocket. While it’s possible he might make the deal of the century, it’s also possible he might end up biting off more than he can chew.

Significant Investor Visa Funds Program

Another thing that concerns me with the Moelis IPO is its involvement in the Significant Investor Visa Funds Program. This is a program the federal government introduced a while back where Investors who invest over 5 million dollars in approved Australian investments are able to gain an Australian Visa.
These sorts of visa programs have come under a lot of criticism both in Australia and internationally, and in the USA in particular have become a target for fraudulent activities.

Canada cancelled their own program after finding it delivered little benefit and an Australian productivity commission report in 2015 advocated scrapping the program as well, arguing that it led to too many visas being granted to elderly people with limited English skills.

 While the current Liberal government appears to be committed to the scheme, you would imagine that all it would take is a change of government or a few highly-publicised scandals for things to change. Moelis themselves appear to be well aware of the risks this would pose to their business, as evidenced by this detailed response of theirs to the 2015 productivity commissions report.

Moelis does not break down the revenue for each separate sector, though the prospectus does state that average assets under management grew from 161 million to 624 million in 2017 largely thanks to this program, so we can assume that if this program was to be cancelled it would have a significant impact on the business.

Valuation

Looking around at most investment banks, they seem to cluster around a P/E of just under 15. Goldman Sachs is currently at 13.96, JP Morgan Chase is at 14.1, and Morgan Stanley is at 14.53. The big four Australian banks have similar P/E ratios. Moelis Australia are no doubt aware of this, and have presented an “adjusted” Price to Earnings ratio of 14.6 in the prospectus. On the surface this makes the valuation seem like a pretty good deal. As a relatively small player, their growth prospects are more significant than the larger banks, so to be priced at the same discount rate would represent a great opportunity. However, this is a good example of when it pays to do your own research before trusting adjusted ratios cooked up by investment bankers. When I divide Moelis Australia’s profit from the 2016 calendar year (9.8 million) by the post-listing market capitalisation of 293.8 million I get a price to earnings ratio of 29.97, more than double the ratio quoted in the prospectus. Although you might think this is because my calculator isn’t as fancy as the ones used at Moelis Australia’s head office, Moelis have actually made two rather questionable adjustments to get this lower ratio.

To start with, while P/E ratios are almost always calculated using previous earnings (trailing twelve months). in Moelis Australia’s adjusted P/E ratio, they have instead used their forecasted Pro Forma earnings for the 2017 calendar year of 16.8 million. While for a small growing company it may make sense to use forecasted earnings in a P/E ratio if the business is just starting, I fail to see how it is justified for an established investment bank with a proposed market capitalisation in the hundreds of millions. Moelis Australia are not planning to change their operations significantly in the next twelve months, so their reason to use forecasted earnings simply seems to be so they can get a more attractive P/E ratio.

The other adjustment they have made is to the price side of the P/E formula. Moelis Australia have taken the odd approach of subtracting the net offer proceeds of 57 million from the market capitalisation for the adjusted formula. This is supposedly justified because their acquisition plans are not included in their projected earnings, though as a potential shareholder, the actual market capitalisation is how the market will evaluate the stock, and the total shares outstanding will determine your share in any future earnings. While P/E ratios are based on earnings from the past and the market value today, by some odd form of wormhole accounting Moelis have ended up presenting a ratio based on future earnings and a market value from the past. 

Of course, I’m sure Moelis Australia could wheel out to a batch of highly paid accountants who would explain why the adjustments they made are reasonable and their P/E ratio is accurate, but then again Goldman Sachs had maths PHDs that could explain how CDOs were a great idea in 2006 and we all know how that ended up. I would argue that any future investor would be much better served using the 29.97 figure I calculated when deciding if Moelis Australia is a good investment, as this is how P/E ratios for other companies are quoted.

Verdict

When you use the actual P/E ratio of 29.97 to evaluate the deal, the Moelis Australia IPO looks reasonable, but hardly exciting. If you think that Moelis Australia is a great up and coming Corporate Investment Bank with a proven track record and that Pridham is a genius who will be given the new freedom of 50 odd million dollars in free cash to launch some amazing acquisition, then a P/E ratio double that of the larger investment banks is perhaps reasonable. From my perspective though, the Significant Investor Visa Program is not something I would want any investment of mine relying on long term, and with what I know about the track record of acquisitions, I would probably rather have the cash on the balance sheet invested in an index fund than whatever plan Pridham has cooking up.

The Fat Prophets Global Contrarian Fund

SPACS

 Overview
If you’ve heard of one hedge fund manager from the last ten years there is a good chance it’s Michael Burry. The eccentric investor made millions on his bets against the housing market during the Global Financial Crisis and was immortalized in the book and later film The Big Short. What is less well remembered about Burry’s story is that before the housing market blew up countless panicked investors withdrew their money from his fund, worried by Burry gambling so much money betting against a housing market in the middle of a boom. While Burry still made millions from his bet, it was less than it could have been, and the stress and frustration of the whole process led to him deciding to close his hedge fund.

Burry’s story highlights a fundamental issue with hedge funds: investors in hedge funds can withdraw their money whenever they like. It is often precisely when a hedge fund manager sees the most opportunity, for instance when the market is falling or in Burry’s case when a bubble is about to burst, that investors want their money back.

It is for this reason amongst others that Listed Investment Companies (LICs) have gained in popularity in Australia over the last decade or so. LICs are basically a hedge fund or managed portfolio that is publicly traded on the ASX. Unlike a hedge fund though, when investors decide to they want their money back from an LIC they simply sell their shares, which doesn’t reduce the money available to the manager of the LIC. This means that LIC managers are less beholden to their investors, and, the theory goes, therefore more able to concentrate on maximising returns.

The Fat Prophets Global Contrarian fund is the latest such LIC to list on the ASX, with their 33 million dollar IPO at $1.10 a share expected to close on the 10th of March. Fat Prophets was started in the year 2000 by their founder Angus Geddes as a subscription based investment advice and funds management company. Investors who sign up to their service are given access to a daily newsletter, as well as reports on certain stocks with buy and sell recommendations. Since inception the organisation has grown to over 75 employees and 25,000 subscribers, and now provides stock picks for a range of different markets and sectors. The Fat Prophets Global Contrarian fund is the first time Fat Prophets has branched out into the LIC world, and it will be run by Angus Geddes and his team using the same contrarian investing principals that has made Fat Prophets a success.

Pros

The Fat Prophets track record
Fat Prophets impressive growth over the last 16 years has been largely due to a record of stock picks which would be the envy of most fund managers. Since their inception in 2000 until the end of 2016, the annual return of an investor who followed all their Australian equities stock tips would have been 18.49%, against an All Ordinaries return of only 7.96%. They have had similarly impressive success in their other sectors. On the Fat Prophets website all of their past stock tips from 2006 to 2016 are publicly available, and reading these you get a good sense of the company and how they have achieved this level of success.

Each stock tip is thoughtfully written, with impressive amounts of detail about each company and its market outlook.  If you want to gain an understanding of their investing rationale and style, have a look at their buy recommendation for Qantas shares in August 2014.
                                                                               
The post goes to painstaking lengths to break down Qantas’s market position, their recent challenges, and why the Fat Prophets team felt the struggling airline could turn things around. Not only did the recommendation prove to be spot on, with the share price more than doubling over the next twelve months, but they were even correct about how it happened. They correctly predicted that a decrease in flight volumes along with the cost savings of Alan Joyce’s restructures would help bring the company back into profitability. Of course, not all their recommendations ended up being as spectacular as this one, but in all their tips they display a similar level of knowledge, discipline and intelligence. The opportunity of being able to get in on the ground floor with a team like this as they embark on a new venture is definitely an appealing prospect.

Minimal Restrictions
Reading through the prospectus, one of the things that jumps out at you is the loose rein Angus Geddes has given himself. While most LICs typically restrict themselves to certain sectors, areas or assets types, the prospectus makes it clear that Angus Geddes and his team are going to invest in whatever they feel like. They reserve the right to trade in everything from equities to derivatives, debt products and foreign currencies, and to go from 100% cash holdings all the way to 250% leverage. While some might see this as a risk, to me this makes a lot of sense. If you believe that Geddes and his team are worth the roughly $400,000 annual fees plus bonuses they are charging to run the fund, it makes little sen se to restrict them to a sector or investment type. With this level of freedom, Geddes can go after whatever he feels will give the most value, and there will be no excuses should the fund not perform.

Cons
Listing price
As a new entrant with a smaller Market Capitalisation than the established LICS, fees are inevitably higher than some of the more established listed investment companies. The Fat Prophets Global Contrarian Fund will charge 1.25% per annum of their net assets in fees. In addition, a quarterly bonus will be paid each time the portfolio ends a quarter on a historical high of 20% of the difference between the current portfolio value and the next highest historical portfolio value. By contrast, Argo and AFIC, two of the largest Australian Listed Investment Companies charge fees of under 0.2% of their net assets per annum. It should be pointed out though that both Argo and AFIC regularly underperform their benchmark indexes, so perhaps in the LIC world you get what you pay for.

Net Tangible Assets
After the costs of the offer are paid for, the Net Tangible Assets of the Fat Prophets Global Contrarian Fund based on a maximum subscription will be somewhere around $1.08 per share. Listed Investment Companies usually trade at a relatively small discount to the net value of their portfolio, as the market prices in the fees an LIC charge. This means we can assume the shares actual market value will be somewhere around $1.05 to $1.07 after listing, versus a purchase price of $1.10. While this is the same for every newly listed LIC, it does mean that any investor thinking of participating in this offering needs to be in it for the long haul, as there is a good chance the shares will likely trade at below listing price for at least the first couple of months.

Wildcard

Loyalty options
Every investor who participates in the Fat Prophets IPO is issued with a loyalty option for each share purchased. From 12 to 18 months after the listing date, shareholders will have the option to buy an extra share in Fat Prophets for $1.10 for each share they own, regardless of what the actual stock price is. These loyalty options are forfeited if an investor sells their shares in the first year and are not transferred to the new owner. Initially this seems like a great deal, as you can double your holding at the listing price if the fund performs well, however the fact that everyone participating in the IPO is issued with the same loyalty options negates most of the benefit. In fact, in a simplified world where the stock price equals the net assets and no one sells their shares in the first 12 months, the loyalty option provides no benefit at all.  
To understand this, imagine that based on these assumptions the shares are trading at $2.20 after 12 months. Initially you might say the loyalty options now give each shareholder a bonus of $1.10 per share, as they could buy shares for $1.10 then immediately sell them for $2.20. However, this overlooks the fact that every other investor would also be exercising their options, doubling the number of shares on offer. At the same time, the company assets would only increase by a third from the sale of the loyalty options, from $66 to $99 million. With $99 million of net assets and now 60 million shares on issue, the share price would now be $99,000,000/$60,000,000 = $1.65. This means that not only would shareholders only make 55 cents per loyalty option, their original shares would have also lost 55 cents in value at the same time, giving a net benefit of zero for the option.
Of course, the real world never plays out like the textbook. Some shares will inevitably change hands in the first 12 months, reducing the number of options available and therefore providing some value to those who still have their loyalty options. However, any investor thinking of participating in this offering should make sure they have the funds available to exercise their options after 12 months if the share price is trading above $1.10, as otherwise they risk seeing the value of their shares reduced by other investors cashing in their options without being able to benefit themselves.

Summary
If you are looking to for an IPO that is going to double your money in six months, this isn’t the one for you. Any gains here are likely to be in the long term. Nor is this an IPO in which to invest your life savings, as the freedom Geddes and his team have given themselves mean that the risks could be considerable. However, if you are looking for a good long term investment opportunity for a portion of your portfolio, investing in this IPO could make a lot of sense. The Fat Prophets team have proven they know what they are talking about when it comes to investing, and if they can get anywhere close to their previous success the fund will do very well.

Personally, Geddes track record is too good to pass up, and I will be making a small investment.

Tianmei Beverage Group Corporation Limited

SPACS
Overview

Tianmei Beverage Group Corporation Limited is a Chinese company based in Guangzhou with two arms to the business. The first is as a distributor and promoter of packaged food products, placing different suppliers’ goods at convenience stores and supermarkets. The second is a bottled water company that sells water produced by a Chinese water processing plant they have a contract with. They are using the Prospectus to raise 10 million dollars, selling 25% of the company in the process. The money will be used to buy the water bottling plant they currently source their water from and to start importing Australian food products to China and promoting it at their contracted stores.

Valuation

From a pure valuation perspective, Tianmei China is a fantastic deal. According to the Prospectus they made a profit of over 4.3 million dollars in the first half of 2016, and the IPO values the company at 34 million, meaning the Price to Earnings (P/E) ratio is well under five if you annualised those earnings. On top of this, both arms of the business are in massive growth areas: The bottled water market in China has seen double digit annual growth due to pollution concerns and the growth in demand for Australian food and health products in China has been astronomical. You can see this in the impressive premiums that the market places on any Australian company that is exposed to Chinese consumers: Bellamy’s was trading at a P/E of 40 a little while ago, and even after sacking their CEO and concerns about their accounting, the share price has only shrunk to a P/E of 10. The A2 Milk company is trading at a massive P/E ratio of 68 and Blackmores is trading at a P/E of 20 largely thanks to growth potential in China.

It’s basically impossible to come up with a valuation that isn’t higher than Tianmei’s listing price using a discounted cash flow analysis. Even if you put a ridiculously high discount rate of 20% and assume a conservative growth rate of 6% for the next 8 years before levelling off to 1%, you still end up with a company value of over $40 million. The way I see it then, if you are evaluating this stock, investigating the exact growth rate of the bottled water market or Chinese supermarket conditions is a waste of time, as whatever you come up with is going to show the stock is a good buy. Instead, the simple question for any potential investor is can we trust this company? As a relatively unknown company operating in a country that doesn’t exactly have a spotless reputation for good corporate governance, it is hard not to be suspicious. The story they are selling through their accounts is one that anyone would want to invest in. The question is, is this story true?

Personnel

According to John Hempton, a role model of mine and someone who inspired me to start this blog, the best way to find out if a company is dodgy is to look at the history of the key management personnel. Hempton’s hedge fund Bronte Capital does just that, following people who they believe have been involved with companies that were fraudulent for potential targets to short sell.


Unfortunately, it’s hard to find nearly any English information on most of the key people in the company and I don’t speak Mandarin, so the only person I can really look into is the chairman, an Australian guy called Tony Sherlock. Tony Sherlock has been around for a long time in the M & A and finance world. He was the chairman of Australian Wool Corporation, worked at PWC in the risk division for ten years and co-founded Bennelong capital, a boutique corporate advisory firm. Judging by his Linkedin profile he looks like he is in his late sixties at the youngest, as he finished a Bachelor of Economics in 1969. Would a guy nearing the end of a successful career working risk his reputation promoting a company that wasn’t above board? It seems unlikely. He’s built up a solid reputation for himself over the years and it would be strange for him to risk it that late in his career. Of course nothing is certain, and it’s possible he’s got some secret gambling condition that makes him desperate for cash or simply doesn’t know that the company is fraudulent, but overall it seems like a positive sign that he is the Chairman.

History

One of the initial things that made me suspicious of Tianmei is its age, as according to the prospectus the company only started in 2013. Trying to unpick the exact history of Tianmei China is a painstaking undertaking, as there are a ridiculous amount of holding companies that have been created along with business name changes. As far as I can understand it though, it looks like the Tianmei business was created in 2013 by Guangdong Gewang, a Guangzhou based business started in 2010 that sells supplements of selenium, a chemical element that Guangdong Gewang claim is vital to human health. While I was initially suspicious of a company selling a supplement that I’d never heard of, after doing some research it actually looks legitimate. Although selenium deficiency is very rare in the West, apparently it is a problem in some parts of China due to crops being grown in selenium deficient soil. During a restructure in 2015 Guangdong Gewang separated the selenium supplement business from the water and FMCG businesses, and as a result created Tianmei. Interestingly enough, Guangdong Gewang is applying for admission to the Nasdaq for their own IPO currently. Guangdong Gewang still hold 22.5% of Tianmei through Biotechnlogy Holding Ltd, a company incorporated in the British Virgin Islands. (Both these companies seem to have a real love of the British Virgin Islands, Tianmei’s ownership also is funnelled through a British Virgin Islands company.) While the history isn’t exactly stable, there are no obvious red flags I could find to turn me off investing in Tianmei.

Ownership

One of the things I like about this IPO is that the initial listing at least isn’t just a way for the owners to cash in. As a jaded, though still cautious believer in the theoretical benefits of capitalism, it’s nice to see an IPO doing what a stock market is meant to do; allocating capital to a business that wants to grow.
A strange thing about the ownership structure is that the equal largest shareholder with 22.5% ownership is a woman called Han Xu, an Executive Director who from her photo looks to be in her mid-twenties. How does someone who finished their bachelor’s degree in 2011 and a Masters of International Finance in 2013, afford 7.2 million dollars’ worth of shares in the company? Perhaps a more basic question is how can someone who left university three years ago and never studied law end up as the ‘legal expert’ and executive director of a soon to be publicly listed entity, when fully qualified lawyers of her age are still working 70 hour weeks as Junior Associates? The most obvious explanation would be she is the daughter of someone important. After doing some digging around I found that one of the co-founders of the original Selenium supplement company was a guy called Wei Xu. While I don’t know how common the Xu last name is in China, it seems reasonable to assume that they could be related.
Is this potential Nepotism enough to be a concern? I don’t really think so. While she might not be the most qualified person for the job, If anything it’s reassuring that the co-founders of the company are maintaining their holdings. The third largest shareholder of Tianmei is a guy called Mengdi Zhang, whose father Shili Zhang was another initial co-founder of the Selenium business according to Guangdong Gewang’s filings for their Nasdaq IPO.

Verdict

Overall I think this looks to be a pretty good IPO. While of course there are always risks with investing in a company this young and especially one operating in a foreign country, the price is low enough to make it worthwhile. It seems the listing is about both raising capital as well as creating a link with Australia so they can start importing Australian foods, which perhaps explains why they have listed at such a low price; the benefits for them isn’t just the capital they intend to raise. If the market gains confidence that Tianmei is legitimate, the company could well double its market capitalization in the next 12 months and I will definitely be along for the ride. 


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