Friday File: “The Fat Pitch” for 2015?

By Travis Johnson, Stock Gumshoe, August 18, 2015

Interested in fiber optics? We’ve gotten a few questions from readers about this ad, which has been running for a month or so and teases a “fat pitch” for the year in a stock that’s related to fiber optics installation/expansion.

And this is not new — today, dear readers, we’ve got a rerun… but it was a Friday File the first time it ran, on July 17, so it will still be new to the vast majority of you. It’s a tiny stock, but it has been pretty flat for the past month… so this newsletter is apparently not big enough to dramatically impact a stock yet… and not much has happened in that time — they consummated the acquisition that was already underway last month, but that’s about it.

There’s also a bit of big picture blatheration for you, if you’re interested in that sort of thing — what follows is the full Friday File from July 17, I haven’t edited or updated anything, just took off the “members only” lock. Enjoy!

—from 7/17/15—

It’s been a wild few weeks in the markets as I’ve spent much of the past month traveling — it makes me think I should take time off more often, since it helps to avoid making rash decisions… there’s something very, very powerful about stepping away from your computer and not looking at the prices of your stocks every single day.

Greece implodes (again), gold suffers more as the dollar continues to climb, interest rates bump around and rise a little bit, and at the end of the month my personal portfolio is up about 2%. Sometimes when you get sucked into the day to day activities, you react far too much — particularly if you watch CNBC or read too many investment teasers, both of which are unhealthy activities I’m prone to — and make foolish decisions because you have “a feeling.” Remember: the media, whether the Wall Street Journal or CNBC or Stansberry or the Motley Fool or Agora exists to create a strong bad (or good) feeling. Tepid doesn’t sell subscriptions or drive circulation or viewership, panic and greed do.

Which isn’t to say that nothing bad will happen — the market probably will crash someday. And after that, it will probably recover and come back, as it has after every other crash. It might be different this time, but my only rational response to fear and worry is to stay diversified, ensure that no one segment or stock getting crushed will destroy my portfolio, and, since the market is not objectively “cheap” and has been running up for so long, to let the cash position build gradually as I look for possible corrections that might bring buying opportunities.

Oh, and to all those who are asking about the “calamity of October” or the “beginning of the end” collapse teases — no, I haven’t dug into most of them in detail or analyzed them, but on the whole they’re the same pitches that were previously made about this past January, or April, or other times in the past. They are assertions that as soon as the Federal Reserve starts to raise short-term interest rates, the market will collapse and, in the most macabre and hype-filled predictions, that it will be part of a smowballing debt crisis that destroys fiat currencies and sends us back to if not the stone age, then at least the coal age because the massive debt overhang (private and public) around the world will cause mass bankruptcies and defaults when interest rates rise.

That sells a lot of newsletters, and the underlying possibilities of crisis are undoubtedly real — the world is a complex organism, and the economic world is so interconnected now and so fast that there are an almost infinite number of possible outcomes. If those kinds of ads and prognoses strike you as at all logical — and many of them seem somewhat reasonable at least in their basic assertions, even if the hype is a bit much and the same logic would have meant that we shouldn’t have recovered from the 2008/2009 crash — then do something sensible that’s the financial equivalent of the “disaster preparedness box” you should have in your basement somewhere: hold some cash, hold some gold, maybe plant a garden if you like doing that. Don’t start to panic about getting a second passport and opening a $10,000 savings account in Panama unless you really like travel and complicated hobbies and want to spend a lot of time in some other country, and don’t bet your whole portfolio on the collapse of western civilization.

What have I been doing lately? Not a lot, though I have indeed let the cash balance float up a little. I did do one simple and pretty inconsequential transaction today, in response to the fantastic quarter at Google (GOOG) that created a big sentiment swing (suddenly the market is convinced that the new CFO is going to really rein in spending, and they cut hiring a bit during the quarter, so investors are hoping that Google will stop spending so much and will, therefore, increase cash flow and earnings faster). That helped to increase the price differential between the C shares and the A shares, so I sold my voting shares (GOOGL, the A shares) to buy more non-voting shares (GOOG, the C shares) at a 5% discount.

My position ends up the same, with the same number of shares in the corporation, but the (very small amount of) extra cash I ended up with as a result of giving up those voting rights (which weren’t and will never be worth anything, anyway — the founders are nowhere near giving up effective board control thanks to their super-voting non-traded B shares) went to increase my Facebook (FB) position by just a tiny bit, keeping the money in the “internet advertising” bucket where stocks are pricey but I continue to see great long-term opportunity. Not a big deal, it won’t impact my portfolio in any real way — but it saves a few bucks, gets me a little bonus that makes me feel good, and the little dopamine rush from doing something probably helps me to avoid doing something bigger (and probably stupider). Know thine self.

For what it’s worth (not a lot, probably), Facebook is now my single largest equity holding — overtaking Apple (AAPL) fairly recently, thanks to Facebook’s rapid ascent and a bit of softness in Apple. My five largest individual stock positions are still Facebook, Apple, Markel (MKL), Berkshire Hathaway (BRK-B), and Altius Minerals (ALS.TO, ATUSF), and the two that have been increasing in prominence in that list are Facebook and Markel, which has been on an incredible run largely because investors have simply started liking it more — partly because of M&A activity among their competitors. It’s not that Markel’s numbers have been outlandishly better this year, but suddenly the stock has gone from trading at 1.3X book value, where it was most of the time early this year, to 1.55X book value… I suspect a lot of that comes because Chubb (CB) is getting bought out by ACE (ACE) at something like 1.7X book value, that buyout came at a 30% premium and has helped to drive MKL shares up 10% or so since the deal was announced at the end of June.

I suspect MKL will come back down, but I love owning this value-compounding machine and have no intention of selling it — I’ve sat through some huge declines in MKL shares since I first bought a decade or so ago, buying here and there along the way at lower prices (I overpaid for my first few shares in 2005 or 2006 when it was above $400), and I think holding it for the long term will be very profitable… I’d never tell anyone not to nibble on MKL at any price, but I wouldn’t make big buy bets on it at this valuation. Markel can underperform for very long periods of time after it gets richly valued compared to its peers, particularly if they have any operational setbacks or the market drops — the shares were over $500 in 2007 and it took five years for them to again breach that level after getting clobbered in the crash. This is the first time MKL shares have traded above 1.5X book value for more than a few minutes since the Fall of 2008.

Since I’m mentioning this group, I should tell you that Google (GOOG) would be in that “top personal holdings” group as well if I hadn’t intentionally limited my exposure, I’ve owned it since the first post-IPO dip in 2005 and I consider it to be worthy of being a very long-term core holding — but for me it’s sort of like owning stock in your employer, Google is an important source of advertising revenue for Stock Gumshoe so I don’t want to be overly exposed to that one company… real diversification has to take into account your income sources as well as your portfolio. For what it’s worth, GOOG isn’t cheap after the big surge today but is still an important hold — particularly if they’re going to be more cost conscious — and worth buying on dips, or nibbling on in the form of GOOG if the price gap with GOOGL stays wide. Why anyone would want to pay extra to get a meaningless vote is beyond me — GOOG and GOOGL should trade within 1-2% of each other, and I expect they’ll do just that eventually (it might take years).

So with that quick update out of the way, what shall we look at today?

Well, several readers sent in a pitch from Keith Schaefer at Oil and Gas Investments Bulletin — but it’s not really for his OGIB newsletter, it’s for a small cap non-energy newsletter that he started up with Paul Andreola and Brandon Mackie called Smallcap Discoveries. The letter will run you $249/quarter (no refunds), and Keith is pitching the letter with a little teaser ad about a Canadian fiber optic company. Here’s how the ad goes, to get our hints out there for the Thinkolator:

“Paul and Brandon have found a company and a stock that doesn’t just have great potential–this company is actually realizing its potential as we speak.

“And the Market is waking up to the story.

“I’m not going to give you a big sales pitch–in fact I’m going to tell you mostly what the pitfalls are IMHO (#1 being that the stock has already had one good move up).

“But I think the stock has a long way to go, and as it hits news highs today I realize the time to tell you about it is now.”

(We first saw the forwarded ad on June 23, to be clear — so keep that in mind. Though in the four weeks since then, the stock has stayed close to that “new high.”)

What’s the reason to buy it? More from Keith:

“The company has a unique fibre-optic technology that can be installed in less than half the time and at one-fifth the cost than anything else out there today. It’s already installed in the City of London (UK), in Central Park in New York and other high profile locations.

“Revenue doubled last year and will likely jump 10x in the next two years. Google has used the service. Verizon has. NTT in Japan has. And one un-named large telco in Canada has.”

Other clues? We’re told that it’s listed on the Canadian Securities Exchange, which usually means it’s very illiquid and very small, maybe even smaller than all those heavily hyped junior miners on the Venture exchange. CSE stocks often can’t even be traded directly by US investors, even those whose brokers give them access to the Toronto and Venture exchanges… though there’s usually an OTC version traded in the US.

And we’re also told that Paul Andreola has been “involved with the company for years” and owns stock at the “seed” level. And one bit of excitement from Keith to close out the sales pitch:

“I’m so convinced that this is The Fat Pitch for SCD for 2015–particularly with its latest news release–that I wanted to introduce you to it today.

“Brandon has put together a comprehensive report on the company, and its industry, which is Fiber-to-the-Home, as in fiber-optic.

“I’ve personally met the management team. I’ve touched the product. I understand the business opportunity. I’m excited. I think they have something that’s leading edge, and has the beginning orders from some very big telecommunications companies—orders that could scale up very quickly. That’s what we’re hoping for.”

So what’s the “Fat Pitch?” This is almost certainly a little company called Lite Access Technologies (LTE on the CSE, LTCCF OTC in the US), which did indeed have a substantial press release on June 22 about their acquisition of fiber optic installer DSG.

Lite Access has only been public for about six weeks — they went public on the CSE on June 1, with a private placement at 25 cents at the same time, and starting trading over the counter in the US a few weeks later. The Canadian price has ranged from about 50 cents to C$1.30, and it’s been within 10% or so of that C$1.30 price for almost a month, ever since the US OTC trading started.

And yes, Paul Andreola has been involved with the company since before it went public — his venture/investment firm (for lack of a better word) Brisio Innovations (which is also publicly traded on the CSE at ticker BZI, NTCEF OTC in the US) helped LTE to go public and invested $50,000 in the firm six months early, in January, to buy a few hundred thousand shares (and some warrants). Yes, that’s $50,000 — no missing zeros. This is tiny, tiny stuff we’re talking about.

So the company has raised money so far this year at 15 cents and at 25 cents, and it’s now trading around $1.30 (all those numbers are Canadian — C$1.30 is almost exactly US$1). I browsed through the filings, such as they are, and it looks to me like they have about 28 million shares outstanding now (about 15 million “transaction shares” that they used to buy Lite Access, plus the four million shares that existed before the IPO, and the private placement of 7.4 million shares. They should have about $1.5 million in cash, and they have two full time employees and say they have retained contractors as well.

Lite Access, before the acquisition of DSG, had revenue of about $850,000 in the fiscal year ended September 30 of last year, which was indeed a (more than) doubling of the 2013 sales of $405,000. They posted income from operations of $2,346, so pretty much break-even after losing $54,000 the previous year. That’s about all the detail they provide. So before DSG the valuation is in the neighborhood of 30X trailing revenue.

In order to acquire DSG Communications, they’ll be spending one million in cash paid out over the course of the year, plus $1.5 million worth of shares at the pre-announcement price, presumably something around 80-90 cents (so that would be just shy of another two million shares). Call it 30 million shares outstanding when this is all done. DSG Communications is a private company, and they didn’t announce what their sales numbers were in the press release.

Lite Access sells their “microduct” fiber optic cabling, which is largely made by another company, and the value of that is apparently that it can be installed in much less space, more efficiently, than the current standard of fiber optic cabling because they lay a smaller duct then use compressed air to push the fiber optic cable through, which makes it less expensive to extend “fiber to the home” and add fiber optic cable through neighborhoods. DSG Communications is a fiber optic service and installation company that uses micro-trenching that is shallower and thinner, sometimes only an inch or two thick, and can be patched quickly and easily with asphalt so they’re not tearing up streets for a long period of time. They’ve been installing Lite Access’ microduct products as a partner and will now be part of the same company, but they’re not particularly huge — from their website it looks like they have one trenching machine and a half dozen service trucks, and have completed work for several substantial telecom companies in Canada.

So it sounds like an auspicious business combination. I don’t have any idea what the sales figures are for DSG, but they can’t be all that huge if they’re willing to sell the company for C$2.5 million. So there are now about 30 million shares outstanding, and at C$1.30 that means a market cap of about C$39 million (US$30 million). Since we don’t know what DSG’s sales are, nor even what the potential sales are from Lite Access pre DSG, it’s pretty hard to make wild guesses about what the company should be worth — they are doubling sales, at least they were last year, so if that continues and they paid 1X sales for DSG (that’s a guess, it could be very wrong), then it’s possible that they could have $4 million in sales in the coming year ($1.5 million from Lite Access, plus $2.5 million from DSG), and if they’re able to keep growing rapidly, well, you can make your guesses from there. I have absolutely no idea what sales level they’ll need to hit to become profitable, since it’s very likely that if they’re going to do marketing and grow the sales force and grow the installation workforce to increase sales then their costs will obviously also go up, and we don’t really have a picture of their finances that goes very deep. They have announced some contract wins, but the announcements don’t really come with any numbers, so I have no sense of what it means to their bottom line (or top line) when they get a contract to connect a few buildings in British Columbia to a fiber-optic network, for example. There are plenty of stories about the viability of the microduct/microfiber/microtrenching solution, including this one about a harsh environment application, but those don’t get much into numbers either.

The key questions, I guess, are whether the micro-ducting product sold by Lite Access is unique and only available from them (they don’t manufacture it, they say it’s a proprietary design but don’t mention patents), and whether they can rapidly win new business and invest in growth through their now more vertically integrated operation of material supplier and installer — including taking advantage of the continuing rollout of more “fiber to the home” by folks like Google (though others, like Verizon, are investing less in expanding fiber networks now). And of course, the big question is always, if we assume that they are a going concern, what are they worth? Do you pay 30X sales, or 1X sales? A lot more? A lot less? How much growth do you assume is possible? I don’t think I’ve ever come across a public company that does exactly this kind of work, it’s much more likely to be done by small local contractors, so even for the sector as a whole the information vacuum is quite large on this one — particularly so for Lite Access itself, as you would assume from what is essentially a brand new company that hasn’t yet issued any detailed quarterly filings and went public indirectly through a reverse merger.

The folks who know the details about it are, presumably, people like Paul Andreola who have been involved with the company for more than a few weeks and who were involved in private placements so presumably have seen more financial details than the rest of us are privy to through the public filings. Andreola’s investment company, Brisio, if we assume they exercise their warrants, will end up having paid $100,000 for 500,000 shares, an average cost of 20 cents per share (still Canadian money we’re talking about here). Should it be worth 20 cents? Five cents? A dollar? Ten dollars? I have no idea — without knowing more about it than is in the filings, and without knowing anything more about fiber optic installation than “it should be a pretty busy sector,” this would just be a wild speculation. I guess there’s nothing wrong with such things from time to time, if you feel the need to “do something” — but keep ’em small, and remember that you’re being sold an idea by someone who already owns the stock and knows a lot more about it than you do… and it’s extremely illiquid, so if anything bad happens to the company, there’s every chance that you won’t be able to sell at what you consider to be a fair price — if you’re someone who relies on things like stop losses to control you risks, forget it. Illiquid companies laugh at stop losses — if you insist on reducing your potential loss in this kind of stock to 20% with any degree of certainty, then you need to just invest 20% of what you normally might invest in a new idea and leave the rest in cash. I’ve harped on teensy weensy companies before, and microcaps are very dangerous — but hope springs eternal, and the lust for “getting in early” is palpable. Heck, sometimes it probably even works… whether or not Andreola is any good at picking the best microcap ideas for you I don’t know, and the difficulty any newsletter with more than a dozen subscribers will have in fairly covering such tiny companies without becoming the story themselves — particularly when the editors or publishers might own the stock as well — is reason to go into these kinds of ideas with a very heavy dose of skepticism. Enjoy!

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2 Comments on "Friday File: “The Fat Pitch” for 2015?"

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Myron Martin
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Thanks Travis, This might be a good fit with Valdor, will run it by Management.
Nothing wrong buying a .20 IPO stock going to $1.30 for patient investors willing to give the company time to prove itself, as long as you keep the initial allocation small. Every successful Company has to start somewhere.

pjwa
Irregular
39
pjwa

Can I ask, Myron, if you have any update on Valdor? Are you still comfortable with their prospects?
Thank you,
Patrick

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