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Aurora Labs
Aurora Labs is one of a long list of ASX pre-revenue IPO’s that achieved massive gains before crashing when the much-hyped revenue failed to materialize. Listing in August 2016, the stock peaked at just under $4 in February 2017 for a nearly 20X return and then lost 90% of its value over the next year. Recently though, Aurora has been staging somewhat of a comeback. Their shares were trading at around 36 cents in September of this year when they began to release announcements regarding progress with their Large Format Printer. The market reacted with predictable over-exuberance and within a few weeks the stock was back over 90 cents. That investors have willingly jumped back into bed with a company like Aurora is a pretty sad indictment of the Australian small cap market. Aurora’s brief history on the ASX is a tale littered with failed targets, unclear communication and a steadfast refusal to own up to any of their mistakes. It is also a story worth knowing for anyone interested in investing in pre-revenue stocks.
Aurora labs was founded in August 2014 by David Budge, an engineer and product designer from WA when he posted on Facebook that he wanted to start a rocket company. The rocket idea didn’t last long, and the company quickly switched to 3D printing. If you are to believe the official company version of events, within 18 months of that Facebook post Aurora labs developed three separate revolutionary techniques for 3D metal printing with major implications for reducing costs, increasing speed and managing 3D printing software. What exactly these inventions were has never clearly been articulated, but with a message as enticing and marketable as this a public listing was inevitable and by June 2016 Aurora had launched their prospectus to raise $3.5 million.
While the prospectus was largely focused on returns far in the future, a key point in their initial pitch was their Small Format Printer. This printer was designed to be substantially cheaper than their competitors and was apparently already in beta testing with 31 secured pre-sales. The Small Format Printers price was listed in in the prospectus at between $40,000 and $43,000 USD each, so this was a significant amount of sales for such a young company.
The shares listed on the 12thof August 2016 at $0.20 cents and shot up in value quickly. In December 2016 they announced that they were shipping their first unit of the Small Format Printer to customers and by the 10th of February 2017 the share price had reached a staggering $3.93, representing returns of just under 1,900% since listing and a market capitalization of over $216 million.
As is the story with many pre-revenue companies though, it was when the revenue was supposed to materialize that the wheels fell off. On their quarterly activities report on the 28th of April 2017 the company announced that they were now ready to focus on sales, as they had completed the necessary certifications and testing to sell the Small Format Printer internationally. Despite these assurances, cash flows from sales for the March to June period was only $103,000 and dropped to $6,000 for the next quarter. For a company whose product was apparently market leading with a strong order bank of pre-sales this made no sense. How could a company selling 3D printers for $40,000 USD each take revenue of only $6,000 a quarter when they apparently had an order bank of 30 pre-sales to fill?
Investors looking for an answer had to wait until November 2017, when the company finally admitted via a market update that the much-vaunted pre-sales had been sold at a fraction of the current prices. Instead of the $40,000 USD listed in the prospectus, the pre-sale prices were for prices between $7,000 and $9,000 AUD. Given the retail price had now risen to USD $49,999, Aurora labs was now deciding to cancel their pre-sales and refund the prospective customers their deposits.
It is hard to understand how Aurora got away with this announcement without a slap on the wrist from the ASX. Until this announcement Aurora had given no indication that their pre-sales were for anything less than their current proposed price, if anything they had worked hard to give the opposite impression.
The below is a direct screenshot from the prospectus, these two sentences come one after the other:
Any investor reading the above sentences would have naturally assumed the pre-sale prices were somewhere around $40,000 USD. In addition to this quote the pre-sales are mentioned on 6 other occasions in the prospectus, and not once is the fact that the pre-sales were sold at heavily discounted prices disclosed.
After listing, the company continued to mention pre-sales in their announcements. In a January 2017 announcement the company stated that:
For a product that’s main selling point is its cheapness compared to its competitors, how does a sale at less than 25% of the current market price indicate demand from “all corners of the globe?” It is the equivalent of a new phone company using sales of $200 smart phones as evidence for demand of an identical model at $800.
Another obvious question is why Aurora waited until November to dishonour their pre-sales. At the time of their prospectus their retail price was already considerably higher than the pre-sale prices, yet the company waited more than 12 months before deciding to cancel the pre-sale orders. The obvious explanation that they were keeping their pre-sales on the book as long as possible to maintain their share price is hard to overlook.
Even leaving the pre-sales aside, Aurora has made some dramatic promises regarding their Small Format Printer that have failed to materialize. In April 2017, the CEO David Budge gave a speech at an investors conference where he said:
A lot of investors took notice of this statement, as if true it meant the company was close to achieving annual revenue of $18 million USD a year from the Small Format Printer alone.
However when their annual report for 2017 was released more than 15 months later, revenue was only $329,970, indicating sales of not even 1 device per month. In typical Australian small cap fashion, not only does the annual report fail to explain why sales were so far off this forecast, it doesn’t even acknowledge that this forecast was made.
You might be wondering at this point why I’m bothering to write about this. Another Micro Cap company played the PR game and managed to pump the share price to a ridiculous valuation with a bunch of promises that they never delivered on. Hardly a unique occurrence for the ASX. It matters because too often the companies getting funding on the ASX seem to be bad companies with good PR departments. A central promise of capitalism is that money can be efficiently allocated from those with money to those who need it. At it’s best, the share market is an effective vehicle for getting money from investors into the hands of companies with great ideas and limited funds. The reality is every dollar spent funding or purchasing a stock of a hype company is a dollar not going to a legitimate pre-revenue company, and there are a lot of legitimate pre-revenue companies out there that desperately need money.
The tendency of companies to make wild predictions also puts pressure on other small business owners looking for investment to be equally optimistic. A friend of mine owns a growing business that has achieved impressive growth of around 40% a year for the last couple of years. Their latest forecasts for 2019 increases this growth to nearly 100% for FY18, yet investors so used to seeing forecasts like Aurora’s remain unimpressed and have asked if there are any ways to increase this. For the industry my friend is in, growth at more than 100% would likely have serious affects on his margins and risk profile, but this is a difficult point to make to investors habituated to start-ups promising multi-million dollar revenues in years.
As investors, we have a responsibility to be more critical when presented with the next slick presentation light on detail but big on promises. If this is asking too much then at the very least we need to ensure that executives of small companies are held accountable for their promises. When a CEO says that he is intending to sell 30 devices a month, he shouldn’t be able to release an annual report 15 months later showing total sales of less than 10 for the year without even bothering to address what went wrong. And when that same CEO starts making chest beating announcements about their latest product, the market’s reaction should be a little more suspicious.
Oliver’s Real Food
I've changed jobs recently which has kept me busy, and with the Oliver’s Real Food IPO only open for two weeks I thought I would have to publish my review after the offer closed. It was with some relief then that I checked my email Friday night and saw they had decided to push things out by a week and reduced the share price from 30 to 20 cents in response to limited interest from institutional investors. The reduction in the share price isn’t as dramatic as it initially looks. Oliver’s has increased the number of shares at the same time, so while under the original offer the maximum subscription was to sell 30% of the company for 15 million at 30 cents per share, this has now been adjusted to 35.8% for 15 million at 20 cents a share. Although the share price has gone down by a third, the actual reduction in pre-offer valuation has only gone down by 25% thanks to the increase in the number of shares.
This last-minute drop in price and wrangling of share numbers puts you more in mind of a fishmonger trying to move some dodgy prawns than a multi-million dollar IPO offering. Pricing an IPO is meant to be a precise and scientific exercise, developed through numerous meetings with fund managers and other institutional investors to accurately gauge the market. Wesfarmers recently put a pin in their Officeworks IPO plans precisely because they failed to hear much enthusiasm from institutional investors at this stage of the process. For Oliver’s to be forced to drop their price at the last minute suggests that they either their fund manager skipped this step, or that Oliver's management didn't listen to the advice that was given to them.
Overview
Putting this last-minute price drop aside, Oliver’s Real Food is one of the more interesting IPO’s of 2017. The business runs a chain of healthy fast food options on major arterial roads on Australia’s eastern seaboard. While healthier fast food chains have been around for a while (Sumo Salad are rumoured to be planning an IPO of their own), Oliver’s is the first healthy fast food business that is targeting the highway service station market. As anyone who has ever tried to get a meal on a freeway can tell you, your meal choices are typically restricted to KFC, Mcdonalds, or a dodgy cafe with burgers and chicken wings sitting in bain-maries, so there does seem to be an opening for a healthier and more expensive alternative.
Management
Jason Gunn, the main founder of Oliver’s is your classic new age guru. You can watch videos of him online talking earnestly about his love of transcendental meditation (17% of Oliver’s staff apparently are now practising transcendental meditation thanks to Jason, one statistic that was left out of the prospectus) and one of his go-to quotes is that Oliver’s is the first business that he has run that “satisfies his soul.” He also seems to have gone all-out on the photo shop options for his Prospectus photo.
While it might be tempting to dismiss Jason as some snake oil peddling charlatan, he does seem to genuinely believe in the stuff he talks about, and he has successfully built a business around a set of values that seem to work for him. He also is balanced out by his co-founder Kathy Hatzis, who has held senior marketing positions in the finance sector and seems to the more down-to-earth of the duo. The only thing I could find by her online was a much more mundane article about managing brands that manages to not mention meditation, vaccines or enlightenment. Overall, they seem like a good pair of founders, and exactly the sort of people you would want to be leading a health food chain with a new age vibe.
Growth plans
One potential cause for concern is that growth has been slower than originally planned. In March 2015, Jason Gunn told The Australianthat he expected revenue to grow to 30 million per year within 12 months, yet even the projected figures for the 2017 financial year show revenue of only 21 million. More interesting still, is that in the same article Jason stated that he was aiming for an annual revenue of 30 million before proceeding with the IPO. I’m not really as concerned about this as I perhaps would be in other cases. After reading and watching a few videos on or by Jason, overestimating growth rates in a conversation with a journalist seems to be exactly the sort of thing he would do. As long as there are more sober minds around him this potential character flaw shouldn’t really be a problem. What’s more, Oliver’s growth is largely a factor of the number of stores they open, and this seems to be pretty reliant on when the big petrol stations have leases coming up. Store growth seems to have stagnated somewhat in late 2015/early 2016 with the number of company owned stores going backwards in the first half of FY2016 from 8 to 7. However, more recently things seem to have gotten going again, with 12 company owned stores at the time of the prospectus, and firm plans to increase this to 1
9 by the end of FY2017.
Longer term, Oliver’s have 60 sites in total they have identified for potential store locations in Australia for the next 4 years, which indicates the business has a lot of room to grow.
Financials
One of the things I like about the Oliver’s prospectus is the lack of massive pro forma adjustments to the financials. Too often, you flick through pages of rosy pro forma figures in the financial section of a prospectus only to find a few brief lines of statutory figures that show the company has actually been making massive losses. With Oliver’s the first figures presented in the financial section are the statutory profit and loss statements, and the only pro forma figures I could find were in the balance sheet. The numbers also seem to stack up pretty well. Margin over cost of sales has been steadily in the mid-thirties, and margin plus labour expenses has been consistently around 75%. While Oliver’s did make a small loss in the first half of 2017, for a company going through an IPO and growing this quickly it’s actually impressive the loss is this small.
In order to get a sense of what Oliver’s could look like as a more mature business, I projected two scenarios of a future Oliver’s profit and loss based on 40 stores here. In the first more conservative scenario, I projected that Oliver’s revenue per store would be the same as in 2015 at just under 1.6 million per year (I didn’t want to use the 2016 numbers as I wasn’t sure who store openings affected the figures), and that labour and cost of sales would stay steady at 75% of revenue. I increased the head office and general administration budget to what I feel is a generous 4 million and all other costs were simply based on the 2015 figures increased to reflect the higher number of stores. With these rather conservative estimates, the business would make just over 2.6 million per year after tax.
In the second more optimistic forecast, I projected a growth in sales per store by 20% to just over 1.75 million based on the assumption that increased brand recognition and familiarity would lead to more customers per store (Mcdonalds in Australia apparently averages over $5 million in sales per store so this is far from being unrealistic). I also used a lower cost of sales + labour to revenue ratio of 65% on the assumption that the higher revenue per store and supply chain efficiencies of having a larger business would help drive these costs down. With a slightly more optimistic leaner head office budget of £3.5 million, this shows a projected profit after tax of just under 9 million.
The indicative market capitalization based on a maximum subscription is $41.9 million at the revised offer price. The fact that a business like this has such a clear path to a profit of 9 million, while at the same time a more pessimistic model still shows profitability is a promising sign.
Food
You can pore over the financials until you are the blue in the face, but at the end of the day if you are thinking of investing in a restaurant chain It probably makes sense to actually eat in the place. For this reason, I drove down to the nearest Oliver’s to me in the Melbourne outer suburb of Scoresby last Sunday afternoon. The Oliver’s was located in a BP service station on a freeway next to an business park, with a KFC and Mcdonalds for competition. At 3:50pm on a Sunday Trade wasn’t exactly brisk. In the 20 minutes or so I was there only three other customers came into Oliver’s while the other two fast food restaurants probably served around 12 people each.
My meal of a chicken pizza pocket, one of Oliver’s trademark cups of green beans with salt and an Oliver’s brand non-alcoholic Organic Tumeric Beer came to a pricey $22.75 (the organic turmeric beer was an amazing $6.95 for 350mls, if Oliver’s can sell enough of them they should have no issues hitting their profit margins).
Pricing aside, I was pleasantly surprised with the food, the Pita wrap was fresh and tasty, and a cup of green beans flavoured with nothing but a little bit of salt is less boring than you’d think. I wouldn’t get the turmeric beer again, but I’m sure it is to some people’s taste.
Conclusion
Overall, there’s a lot to like about the Oliver’s IPO. While the last minute price change does potentially reflect badly on management, the rare opportunity of listing in a business that has both a proven track record of achieving profitability and great growth potential is too good for me to give this one a miss.
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