Terrible Business Through Multiple Reinventions Now Hyping Drones: Originally a dotcom darling named Wireless Facilities that IPO’ed in 1999 with hopes of being the leading provider of outsourced services for wireless networks, the Company collapsed and later took a large accounting restatement when material weaknesses were revealed. Under new management, a name change to Kratos in 2007, and a divestment of businesses, the Company started focusing its efforts on products and solutions related to Command, Control, Communications, Computing, Combat Systems, Intelligence, Surveillance and Reconnaissance (“C5ISR”). After failing to execute on these opportunities, Kratos is now promoting its billion dollar opportunities in unmanned systems (drones) in the hopes of finally turning the corner to sustain profits and free cash flow, both of which have been forever illusive for shareholders
Warning About Management History Associated With Past Scandal: Kratos is led by Eric DeMarco (CEO) and Deanna Lund (CFO) since 2003-2004. These executives joined from Titan Corp, where DeMarco was COO and Lund was Titan’s Controller. Titan was a tainted defense contractor that in 2005 paid the largest fine in history (at the time) to settle criminal and civil charges that it violated the Foreign Corrupt Practices Act. Lockheed Martin aborted a takeover of Titan Corp after conducting its due diligence on this matter. According to shareholder lawsuit documents, Titan engaged in a scheme to inflate revenues and book fictitious receivables. Titan used “middlemen” and “private consulting companies” with ties to foreign government officials to secure business. The litigation says confidential witnesses claim DeMarco knew about the corruption and DeMarco was responsible for transferring funds to Benin, the African country involved. DeMarco was also allegedly the source of the “percentage of completion accounting techniques learned from the ‘Andersen school of accounting’ that allowed Titan to either overstate or prematurely state revenues at the company.”
Beware History of Failure To Meet Expectations, Cash Flow Struggles More Evident: Bulls are buying into Kratos story that it can reach $800m of revenues (pre PSS divestiture) at 10% EBITDA margin, while generating positive free cash flow. Our analysis of its ability to hit its financial targets (especially free cash flow) suggests investors should brace for disappointment. In addition to recent executive turnover in key positions (chief accountant, drone president, and CIO), Kratos quietly started disclosing a large loss accrual on contracts, rising 500% between 2015 and 2016. Its business mix has deteriorated (declining backlog and highest % of fixed-price, high risk contracts in its history). Its historical backlog definition is very aggressive, so take it with a grain of salt. However, most alarming in Q3’17 Kratos materially increased its cash burn estimate, cut drone capex in Q4’17, has DSOs rising to multi-year highs, and unexpectedly sold its PSS segment at a depressed value to raise cash
Analysts See +29% Upside, A Terrible Risk/Reward Considering We See 40%-70% Downside: Kratos has among the highest valuation in the aerospace and defense sector (20x and 70x 2018E EBITDA and P/E), despite having weak margins, poor management that cannot prevent activities that run afoul of laws, suspect accounting that doesn’t depreciate corporate segment assets, and a history of failure. Its valuation is at a multiyear high, based on the hope that this time is different. Analysts are bullish, and some arbitrarily pencil in a few dollars per share for “future potential drone opportunities.” Many long-term fundamental Kratos holders have ditched the stock, leaving rules-based indices to buy. Valuing Kratos at a discount to peers on EBITDA, free cash flow, and book value we estimate 40%-70% downside ($3.15-$6.30/sh)
The Allure of Rising Magic Dividends: Realty Income (“O Realty” or “the Company”) promotes itself as “The Monthly Dividend Company®” and preaches“The Magic of Rising Dividends” – it even goes so far as to market itself differently to retail investors vs. sophisticated institutional investors. The Company is very dependent on issuing stock at inflated prices to fund its acquisitive growth strategy, keep its cost of capital low, and consistently raise its dividend. The model has worked well for years when times were good, but we believe this magic cycle is about to break down as investors reassess O Realty’s growth profile amidst deteriorating tenant quality, rising interest rates, and a more volatile and discerning capital market backdrop.
Deceptive Same Store Property Reporting: Our forensic accounting work indicates that the true underlying economic performance of O Realty’s properties, as measured by Same Store Rents (SSR) are declining vs. the company’s promotion that it is growing. The Company disclosed its SSR growth rate of 1.2% in 2016. Our industry normalized definition of same store property performance suggests that that SSR declined by 0.8% in that period – an astounding 2.0% overstatement. Once investors come to grips with our irrefutable conclusion, we expect a major revaluation in O Realty’s share price. There are ample case studies to show 40%-50% share price declines when investors revalue a REIT’s declining performance. For example, Wall Street has penalized a few REITs (DDR, BRX, KIM) that own retail properties where the same store growth profile has swung from positive to negative growth. We believe that O Realty is the next REIT that is going to be penalized for a deteriorating growth profile by investors.
Investors Should Be Concerned By Background of Management and Audit Committee Oversight By Board: We find that O Realty’s executive management team is comprised almost entirely of ex-investment bankers, trained in the art of financial engineering. It should, therefore, come as no surprise that O Realty could use financial magic to embellish its performance. We have little faith in the Company’s audit committee raising any objections or concerns about management’s practices. We find that the audit committee is comprised of a PGA golf professional, and former executives from Wells Fargo and KPMG, two of the most scandal-ridden financial and accounting organizations in recent history. Given all the factors we have noted, it makes sense that insider ownership trends are at all-time lows, and lowest amongst its REIT peers.
Tenant Quality Deteriorating As Retail Landscape Changes: We conducted a deep dive into the tenant quality and find that O Realty has outsized risk exposure to drug stores, grocery stores and movie theaters — three retail subsectors facing disintermediation. Drug stores (O’s largest sector exposure) are consolidating their retail footprint (i.e. Walgreens purchase of +2,000 Rite Aid stores), while SSS performance at the store front is down. Even worse, headlines such as Amazon teaming up with Berkshire Hathaway and JPMorgan to disrupt the healthcare business present a now tangible long-term risk that the traditional drug delivery value chain through a retail footprint could move increasing online.
Ballard’s stock had a tremendous run in 2017 (+167%) based on strong revenue growth, margin improvement and a perception that the commercialization of fuel cells is on the horizon (i.e., “hype”). This improvement occurred despite Ballard’s portfolio largely consisting of businesses in run off (e.g., backup power, materials handling), experiencing uncertainty (portable power) or in very early stages of development (e.g., drones). The primary force underpinning recent growth and future expectations has been Ballard’s China partnership efforts with Synergy Ballard JV (customer/partner) and Broad Ocean (customer/distributor). At current valuations an investment in Ballard with an intermediate time horizon is essentially a bet on China Heavy-Duty Motive (“HDM”) success. We have conducted on the ground due diligence in China and believe that Ballard’s Chinese growth ambitions are likely to fail from weak partnerships with Broad Ocean and Synergy, and a market that is not developed enough to support fuel cell vehicle growth; Déjà vu, Ballard’s last China deal with Azure resulted in a contract breach and revising guidance lower in early 2015; investors should brace for similar disappoints this time around too
China Industry Challenges
Unfortunately, the Chinese hydrogen fuel cell market is still in very nascent stages of development. We believe there are currently only 36 licensed fuel cell vehicles on the road in China, only six refueling stations (one is public), and limited planning being devoted to hydrogen sourcing and transportation. In Spruce Point’s view, the lack of refueling infrastructure, confusion around refueling subsidies and abysmal refueling station economics pose the greatest threat to fuel cell vehicle (“FCV”) commercialization. Not surprisingly, there are only two scale auto manufacturers of hydrogen fuel cell vehicles today and we expect this number to grow to only six by the end of 2018. At this point, it still remains highly uncertain if China will develop the fuel cell vehicle market beyond an experimental phase
As it pertains to Membrane Electrode Assemblies (“MEA”)/Stack/Engine production in China, the focus area for Ballard, there are actually two (rarely discussed) competing “value chains”. We believe that Ballard’s partners, Yunfu City Government (Synergy) and Broad Ocean, are relatively weak given their lack of network into the central ministries of China and their limited success to date in partnering with the State-Owned Enterprise’s (“SOE”) that are the primary agents for delivering on policy
Ballard Partner Specific Challenges
It wasn’t long ago that Broad Ocean was a humble manufacturer of electric motors for appliances (e.g., air conditioners). As the US property cycle peaked, Broad Ocean decided to diversify itself with the purchases of Prestolite (auto electronics) and Shanghai Edrive (electric vehicle power trains) in 2014 and 2015, respectively. When Broad Ocean announced the Ballard deal in 2016, it had no prior hydrogen fuel cell experience, but likely hoped to leverage the company’s local connections with automakers in the electric vehicle space. Unfortunately, Broad Ocean has failed to deliver partnership opportunities to Ballard with the likes of BAIC (Shanghai Edrive’s largest customer) and Yutong (leader in Chinese bus production), both of whom have chosen Sinohytec despite relying heavily on Shanghai Edrive for electric vehicles
Matthews Int’l (Nasdaq: MATW) is comprised of three unrelated businesses in the death care (“Memorialization”), branding and packaging services (“SGK Brand Solutions”), and Industrial Technologies. In our view, each business is mediocre and struggling from a variety of issues, resulting in organic sales to decline in aggregate.
Serious Financial Control Issues and Governance Concerns:We have little reason to trust MATW’s ability to maintain financial order. Setting aside the fact that Schawk had previously restated financials, reported material weaknesses, and received a Wells Notice from the SEC, in July 2015 MATW revealed a material weakness of financial controls when it disclosed theft from a long-time employee of nearly $15m, making MATW the subject of Western Pennsylvania’s largest corporate embezzlement in history. This event came after another MATW employee was sentenced to jail in Jan 2015 for running a fake invoicing scheme. By Nov 2015, MATW declared its Material Weakness had been solved, and changed auditors from PwC to E&Y in December 2017. Spruce Point believes that investors should be extremely cautious in light of our own findings that MATW:
1) incorrectly accounts for dividends and share issuance in its equity accounts, 2) has taken frequent and large charges that don’t reconcile between its SEC filings and investor presentations, and have not resulted in meaningful cash flow gains, and
3) management’s compensation has risen at a 30% CAGR during this same period of mediocre performance
Mounting Evidence of Dubious Financial Results:MATW has taken classic measures to obscure its problems such as realigning segment reporting and promoting highly “adjusted” figures. MATW has reported $176.8m of pre-tax charges since 2012 (with ~$165m related to acquisitions and strategic cost reductions). Charges have totaled a whopping 16% of its deal costs. When put into context of other successful calls Spruce Point has made identifying companies struggling to integrate targets (eg. NCR, ACM, ECHO, CECE, GEF), MATW is the worst we’ve ever seen! When we look closer at its operational footprint, we find little evidence that it has accomplished anything. SG&A margin is rising as are other fixed cost of operations. Not surprisingly, management is now touting “adjusted free cash flow” metrics, which we think overstates 3yr cumulative cash flow by nearly 30%. With sales slowing, and accounts receivables ballooning, Matthews quietly initiated an accounts receivable securitization facility in April 2017; in our view, a tacit admission by the Company its cash flow isn’t as robust as it appears
Sum-of-Parts Valuation Gets Us To 55%-65% Downside: We believe MATW should fire management and split up the Company. However, we believe this would expose MATW’s extreme overvaluation. Shares might “look” cheap at 1.6x, 10x, and 14x 2018E Sales, EBITDA, and P/E but it’s because Street estimates take management’s highly adjusted results at face value, and pencil in low single digit growth. Even management doesn’t seem confident in its outlook, and only says adjusted earnings will grow at a rate consistent with FY2017, without further elaboration. Yet, the analysts covering MATW see 48% upside to nearly $78/sh – a major disconnect! Given our evidence that adjusted financial results appear dubious, we base our valuation on GAAP results, assume no growth, and apply peer trading multiples at a slight discount to reflect MATW’s mediocre businesses and below average margins and growth. Our sum-of-the parts valuation implies $18.50 – $24.50 or approximately 55% – 65% downside
Echo Global Logistics (“ECHO” or “the Company”) was founded in 2005 to roll-up the transportation logistics / brokerage sector.
Our Initial Concerns About ECHO From September 2016 Proved Prescient: In our initial report entitled “Logistical Nightmare”, we warned about ECHO’s terrible management, failed roll-up strategy in the transportation logistics sector, aggressive use of Non-GAAP results, and its inability to maintain its competitive position in an increasingly technology-centric environment, would all lead to severe disappointment. ECHO’s analysts were calling for a $29 price target at the time, but with shares at $27, we argued the risk/reward was skewed towards 50% – 60% downside. With successive earnings disappointments, and mounting evidence that ECHO’s acquisition of Command Transportation in 2015 was a bust, ECHO suspended long-term guidance and its acquisition strategy in July 2017. ECHO’s share price reached a low of $13.00, hitting our long-term price target range.
Command Deal Increasingly Looks Like A Bust: Our initial report warned that ECHO significantly overpaid for Command Transportation, and encumbered its assets with $230m of debt for a people-intensive asset light business. ECHO hyped $200 – $300m of revenue synergies, and an integrated technology platform that would provide significant earnings leverage. After millions spent on integration costs, capital expenditures and even a fancy new headquarters, ECHO has failed to come even close to its revenue synergy target.
AeroVironment (Nasdaq: AVAV) is a defense contractor that sells small unmanned aircraft systems (“UAS”) –colloquially known as drones –to the US and allied governments (~90% of its business) and also operates an unrelated business tied to electric-vehicle charging (“EES” ~10% of business). Our fundamental and forensic research suggests looming disappointment and 30% -50% downside ($24 -$34 per share).
AVAV Nearly Identical To Our iRobot Short, Another Over-Hyped Play On A Laggard In Its Industry:Spruce Point conducted an extensive evaluation of AVAV, and find it to be a nearly identical stock promotion to iRobot. AVAV is being hyped as a play on drones, but its products are stagnant and being out-innovated by peers. Like iRobot, we find: 1) Foolish stock promoters, including a former one tied to a notorious Ponzi scheme, 2) Poor governance + unjust insider enrichment, 3) Continuous insider selling,4) Poor capital allocation, 4) Frequent accounting errors + warranty revisions, and 5) Nonsensical and distorted valuation
AVAV’s Drones Fail In Real-World Conditions; Its Technology And R&D Have Fallen Behind:While hope springs eternal that AVAV will one day broaden its horizons by selling its drones to businesses and not militaries, the market has overlooked the evidence that its drones work poorly even for military uses. An internal Department of Defense document released via FOIA request shows that one of AVAV’s key products “did not meet key performance parameters,” calling into question its usefulness in actual combat. Problems included poor landing accuracy (with a 44% failure rate), an inability to cope with high winds (a feature that was supposed to be designed into the product), and an unexpectedly heavy and fragile carrying case. Military test operators used words like “chintzy,” “cumbersome,” and “horrible” to describe AVAV’s drones.
Stock Promotion Runs Deep At AVAV, Valuation Can Correct 30%-50% As Disappointment Looms Large:Insiders have consistently sold shares (47% post IPO to 11% ownership currently), while a laundry list of rogue brokers have relentless pumped AVAV since its IPO (remember Stanford Financial or Jesup & Lamont?). Also don’t be Fooled when Mr. Motley says “buy” -recall they have also relentlessly promoted iRobot. True to form, AVAV has exhibited terrible FCF generationand margins, high management turnover, unwillingness to engage activist investors, and limited long-term share price upside until recent ETF buying. Even typically optimistic sell-side analysts don’t currently recommend AVAV, with zero buy ratings and an average price target of $40 (implying 17% downside). AVAV’s valuation current peak valuation of approximately 3x and 30x 2018E Sales and EBITDA will eventually normalize with defense industry peers and with its own historic valuation. As a result, we see 30%-50% downside in its share price, or $24 to $34 per share, representing a terrible risk/reward.
Tootsie Roll Industries (NYSE: TR) is a producer and marketer of candies and lollipops under the brands Tootsie Roll, Blow Pops, Junior Mints, Andes Candies and others. For years, the bull case has assumed Tootsie’s brands were iconic and “hope” that its founders would eventually sell the Company at a rich premium. Based on extensive fundamental and forensic research, Spruce Point sees flaws with this thesis and 25% – 50% downside once investors evaluate our compelling research.
Tootsie dates back to the early 1900s and its brands are withering along with its core customers. Sales haven’t grown in 6yrs and we estimate it is losing market share in North America. Our channel checks reveal it uniformly receives the worst product placement on the shelves (esp. during key Halloween selling season). Tootsie’s products fail to address consumer demand for healthier products, and it has resisted industry self-regulatory movements to limit marketing to children. Early adoption of new FDA labeling requirements show Tootsie has shrunk its serving size, an implicit acknowledgement consumers are eating less candy. Enhanced sugar disclosure requirements now show significant added sugar content to its products. Families and kids take notice: we estimate a box of Junior Mints, a popular Tootsie product, contains 185% of daily added sugar needs.
Tootsie is notoriously secretive about its financials: it doesn’t hold investor conference calls, invite analyst coverage, and has a minimalistic IR website. Its SEC filings omit significant information material to investors’ understanding of its business including: 1) product mix and pricing trends, 2) commodity cost impact to margins, 3) R&D expenditures. Tootsie also inflates its gross margins in a material way by excluding shipping, warehousing, and freight costs. This leads to an 800bps gross margin overstatement. Compare Tootsie’s adjusted gross margin of 31% with peers Hershey and Mondelez at 46% and 39%, respectively, and it’s easy to see that Tootsie is running an inferior candy operation. Even worse, we believe Tootsie has inflated operating cash flow by ~$50m since 2012 though early termination of its split dollar life insurance policy. In essence, Tootsie lent money to these policies for the benefit of its executives, and is now tapping the cookie jar to reclaim funds and boost cash flow.
In our opinion, Tootsie is run for the benefit of insiders, while taking advantage of common shareholders through lavish compensation and excessive perks. Its dual class share structure allows Class B shares controlled by insiders to limit common stock voting control, while the Board is stacked with the CEO’s allies, none of which have experience in the food industry. Insiders have rigged the bonus structure in a way that virtually guarantees the maximum bonus every year, while allowing the top 6 executives to extract ~19% of adjusted SG&A in annual compensation (and grow comp more than 3x the rate of sales). Tootsie offers none of its employees equity or stock options, which virtually guarantees that no one will care about maximizing the share price Download the report to read more.
Envirostar (NYSE/MKT: EVI), formerly known as DRYCLEAN USA, is a distributor of commercial and industrial laundry and dry cleaning equipment. With its shares up >600% since 2016, it has become one of the most overvalued microcaps in the stock market as index funds blindly pile in. Investors are ascribing nonsensical multiples to its recent acquisitions, and failing to exercise caution.
Spruce Point has been a dogged proponent against investing in roll-up strategies, which are often just financially engineered plays designed to game index funds into overpaying for stocks, with little focus or incentive for management to create organic growth or value creation through operational improvement. We made early and successful calls identifying problematic roll-ups across many industrial sectors, AMETEK (test equipment), Greif (packaging), CECO Env’t (pollution control) and Echo Global (logistics). We view Envirostar as one of the worst + most speculative roll-up stories we’ve seen; already three quarters post closing its biggest deal of Western and EVI’s margins, profits, and cash flow are contracting
Envirostar is the most expensive and financially weakest roll-up stories we’ve ever evaluated. Be careful: Envirostar has paid an average of 0.5x sales for recent deals, yet public investors are overpaying now by 5x. At the current enterprise value of $320m, the market is ascribing a value of 2.2x, 32x, 61x to our estimates for CY2018 sale/EBITDA/EPS results. Blue chip industrial distribution peers with significantly higher margins trade at 1x, 11x and 21x, respectively.
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- Shark entered the robotic vacuum market as we predicted in June, a major negative!
- We believe SharkNinja strives to be the #1 or #2 leader in markets it enters. Based on its track record in traditional vacuums and blenders, we believe SharkNinja is a credible threat to iRobot
- SharkNinja’s displacement of Dyson in vacuums was a result of a laser-like focus on the consumer, and its ability to engineer a superior product at a value price point. As an organization, Linkedin data shows that SharkNinja employs more engineers than sales or marketing people
- We believe Dyson failed to gain traction with its robotic vacuum because its price point of >$1,000 was simply too high, and it did not deliver meaningful performance advantage to the customer. Simply stated, Dyson could not offer a compelling value proposition while SharkNinja appears well positioned to do so
- Given SharkNinja’s marketing prowess stated to be $130m annually (2014 figures), we wouldn’t be surprised to see it spend at least 10% or more of this annual budget to ensure the success of its debut robotic vacuum series
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Spruce Point is pleased to release its report on TSO3 Inc. (TSX: TOS and OTC: TSTIF)
TSO3 Is Just Another Canadian Healthcare Promotion: The Canadian markets are littered with recent examples of healthcare stocks in need of urgent medical attention, wounded from over-promotion, questionable practices, and poor performance. Short sellers made early warning calls on many names down >80%: Valeant, Concordia, Nobilis, CRH Medical
Disclosure Issues & Obfuscating Its Actual End Market Sales: TSO3 is not disclosing its installed base and the reason is obvious – if it did, investors might see just how poor its product’s end market acceptance actually is. In Q3’16, TSO3 suggested it would provide clarity on its installed base in early 2017 – investors are still waiting…. TSO3 even stopped disclosing consumables sales in Q2’16. It currently recognizes as revenues shipments to Getinge, its 3rd party distributor (183 units since Q1’16). However, our math and field checks suggest at best 10 units are actually installed at end customers (95% difference to shipments).
TSO3 Using the “Partnership” Playbook To Hype Its Potential: Déjà vu, TSO3 is repeating a twice failed playbook. Recently from 2009-2013, alongside of 3M: TSO3’s single product cycle ended with no material sales, termination of their partnership, and a legal settlement in favor of 3M. TSO3’s prior two generations of this product also failed (the current 3rd generation VP4 appears eerily similar to the 2nd generation – not surprising given the low R&D spend).
TSO3 Overstating Its Total Addressable Market (TAM): All good promotions involve baiting investors with big addressable market opportunities. TSO3 appears to have overstated its true market potential by >30% units and C$170m. We provide evidence of the Company playing fast and loose with its numbers.
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Spruce Point is pleased to release its updated report on iRobot Corp (Nasdaq: IRBT)
New research into iRobot’s recent distributor acquisitions further calls into question the reliability and accuracy of the Company’s financial guidance. If iRobot cannot give further clarity, we believe its guidance should be suspended.
Distributor acquisitions need to be heavily scrutinized given the related-party nature of the transactions. Its Japanese and European distributors act as exclusive agents for iRobot with nearly 100% of revenues from iRobot products.
•The 2017E sales implied from Robopolis from iRobot’s incremental margin contribution forecast doesn’t make sense
Further evidence of issues with the Japanese distributor acquisition emerge from our research. Download the report to read more.
Dorman Products (Nasdaq: DORM) is an aftermarket auto parts distributor stuck between a rock and a hard place as it sells both through Amazon, which is seeking to grow further into online auto parts distribution, and through the biggest brick and mortar retailers (Adv. Auto Parts / O’Reilly / AutoZone), which account for a majority of its sales, and are struggling with slower growth and margin pressure. Spruce Point has conducted a deep fundamental and forensic accounting review of DORM and believe its opaque disclosures, aggressive accounting, and precarious industry positioning do not warrant its significant share price outperformance and premium valuation relative to peers. As a result, we see above average risk of continued earnings disappointment and meaningful share price correction.
Revenue growth has slowed from a 13% CAGR (2009 to 2015) to less then 6% in 2016 (adjusted for extra week). Furthermore, if you look under the hood, DORM’s net revenues are an estimate and therefore subject to significant manipulation. Our adjusted gross sales estimate (we define as total product places on the shelves of customers) slowed to an abysmal 1.5% in 2016. Analysts expect DORM to continue growing top-line sales at 7% which we believe to be difficult given its largest customers are growing low single digits.
We believe DORM’s earnings leverage is waning. Revenue and gross profit from active accounts slowed to low single digits in 2016. The weakening of the Chinese Yuan has been a hidden tailwind to gross margins in the last three years since DORM sources products heavily from China/Taiwan. We estimate that DORM’s gross margins benefited by ~350bps cumulatively from 2014-2016. DORM doesn’t discuss any of these FX benefits in its MD&A, and now the Yuan is on a strengthening cycle. DORM also embarked on an ERP implementation which was 163% over budget, and allowed it to capitalize $38m of costs from 2011-14. DORM has not amortized any of these costs, thereby inflating its earnings per share by $0.07c by our estimate
DORM portrays itself as debt-free, but is heavily dependent on factoring receivables, which we believe should be evaluated as debt. The % of revenues that are factored annually has risen from 21% in 2009 to 65% in 2016 and exposes DORM to the increasing interest rate env’t. DORM’s working capital to sales ratio is at a multi-year high, while operating cash flow in 2016 abnormally increased from inventory declining – suggesting it liquidated or deferred new purchases to generate cash. DORM is also shifting its business strategy to invest in many undisclosed JV/minority investments, while opaque related-party purchases are increasing
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Gentex (Nasdaq: GNTX) is a supplier of dimmable mirrors for the auto and airline industry. Its products are commoditized and require nothing more than plastic moldings, mirrors, chemicals, printed circuit boards, and other inputs such as compasses. Its financials suggest it to be a wildly profitable company, yet our forensic analysis uncovers numerous red flags to suggest otherwise.
Gentex’s IPO in the early 1980s is littered with red flags. Its dimmable mirror was a carrot to bail out its struggling smoke detector business, and its management put no capital at risk. Gentex’s success has defied all the odds: it now commands a $5bn market cap and claims >90% market share. Its lead IPO underwriter and banker, OTC Net founded by Juan Carlos Schidlowski, was a notorious penny stock promoter who was later charged by the SEC and fled the country.
Gentex’s 40% gross margins are vastly superior to all global auto suppliers and are likely overstated by 2x. We believe it’s aggressively leaving costs in inventory (inventory growth is 3x revenue growth) while inflating capex through nonsensical projects (e.g. its North Riley Campus is 90% over initial budget). We commissioned a product tear down by IHS, an automotive expert, to examine its components. In our view, Gentex’s rhetoric pertaining to its mirror’s level of proprietary components and vertical integration is likely exaggerated. We also have documented proof of capex misstatement.
Despite margins and profitably that dwarfs auto supply peers, Gentex policies that are touted as shareholder friendly are not what they appear. Its dividend growth has been well below the rate of its reported free cash flow growth, which is likely overstated, and its share repurchases are mostly to offset dilution. Gentex has amassed an abnormal amount of cash on its balance sheet, and has irregular Level I and II classifications. We believe Gentex has shunned M&A to avoid outside scrutiny. The only acquisition of note in its history was of HomeLink, a related-party deal where we find issues.
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Spruce Point is pleased to release its updated report on iRobot Corp (Nasdaq: IRBT)
With iRobot’s share price up 300% since 2016, investors are cheering the re-acceleration of sales and earnings growth following years of disappointment, and ascribing a peak valuation to plateauing earnings. Spruce Point believes the financial improvement reflects temporary factors and may not be sustainable. We expect new competition to storm the market, and challenge iRobot’s US market share dominance.
iRobot’s recent financial performance reflects restocking of its supply chain after years of false starts, the removal of the struggling military business, and the acquisition boost from its Japanese distributor. We believe these factors will create very difficult comparisons for iRobot to lap in the future, and create headwinds for future share price appreciation. Furthermore, we believe recent gains are a result of lowering the price of its Roomba to move down market, which we believe is a long-term negative on margins for a technology hardware company with a narrow product focus
Investors are overlooking financial control issues tied to iRobot’s recent acquisition of its Japanese distributor. The Company suspiciously retracted certain statements made about Japanese sales growth (reversing big gains to declines), and made revenue and earnings revisions which don’t add up. Spruce Point has previously pointed out early warning signs at Sabre and Caesarstone, both which made related-party distributor acquisitions ahead of extreme financial revisions. Market observers will note that Valeant’s attempt to buy Philidor was another canary in the coal mine. Download the report to read more.
RADIANT LOGISTICS INC. (“RLGT” or “the Company”) is a company that specializes in transporting unique or difficult shipments.
Radiant’s CEO Bohn Crain and first General Counsel Cohen were executives at Stonepath Group (AMEX: SRG / OTCBB SGRZ), whichcrumbled when it admitted financial and accounting irregularities tied to revenue overstatement / expense understatement. An SEC inquiry commenced, allegations of fraud were made, and Stonepath was delisted, and faded to the pink sheets and insolvency
The SEC has already questioned Radiant’s accounting, and it has made the scary disclosure that its margin method, “Generally results in recognition of revenues and purchased transportation costs earlier than the preferred methods under GAAP which does not recognize revenue until a proof of delivery is received or which recognizes revenue as progress on the transit is made.”
Don’t expect Radiant’s minor league auditor named Peterson Sullivan to spot problems, Radiant pays them minuscule audit fees and three Peterson employees (2 partners) have been cited in less than two years for professional misconduct by the PCAOB and SEC
WIX.com (Nasdaq: WIX or “the Company) is an Israeli based technology service provider offering a free website solution that depends on upselling customers on additional features. With WIX’s share price up approximately 300% in the last twelve months, we believe investors are overlooking many issues that could cause a substantial price correction:
WIX’s “unicorn” model appears too good to be true and there are emerging cracks beginning to appear in its financial statements including subtle revenue and tax restatements, and anomalies in its cost structure. WIX portrays itself as a well oiled machine with world record gross margins at 85% and that it will have spent ~$30m on capex from 2010 – 2017 to accumulate >100m registered users, engineer a negative churn business that produces $400m of revenues, $1.4 billion of collections, and is worthy of a $4bn market cap. Based on our analysis, these results merit scrutiny (e.g. try finding another negative churn business or capex efficient model). The SEC recently issued comment letters to WIX questioning its aggressive Adj. EBITDA presentation and its pace of revenue recognition and expense deferral. After two EBITDA revisions already, investors should be suspicious, but we believe more revisions may come. WIX is dropping subtle hints in its 20-F that because it is no longer an “emerging growth company” under Section 404 of Sarbanes Oxley, it will face stricter financial control.
WIX insiders have incentives to heavily promote its shares and left clues to suggest it intends to dilute with 2-3 million new shares We estimate its two founders are sitting on $225m of option gains needing to be monetized. Options under the 2013 plan start becoming fully vested in 2017. Early venture backers (Benchmark, Insight, Bessemer) have exited and only one initial backer remains. None of WIX’s top shareholders are Israeli funds. WIX has lured in retail investors and US funds through repeated Cramer Mad Money episodes. Now that WIX Is claiming it has reached a cash flow positive inflection point, and has ample cash on the balance sheet, we find evidence of pending dilution
PTC’s Conversion Story From Perpetual Licenses To Subscription Model Is Late To The Game, And An Excuse For Management To Explain Away Poor Results And Deteriorating Economics. Its Conversion Uses Gimmicks And A Questionable Value Proposition To Compel Users To Subscribe.
Investors Are Ignoring PTC’s Weak Financial Results In Favor of Dubious Metrics Such As “Bookings”, “ACV” and “Unbilled Deferred Revenue” – Read The Fine Print, They Have No Correlation To Future Revenues. We Even Spoke With PTC’s Former EVP of Sales To Ask His Opinion What These Metrics Mean, And He Couldn’t Explain Them. We Can’t Even Find Evidence That PTC’s $20M Mega Deal With The Air Force (It Booked And Said Closed In Q4’16) Even Exists With PTC As The Prime.
PTC’s 5 Yr. Recurring Restructuring Odyssey Appears To Be An Elaborate Accounting Scheme To Sell Investors On Meaningless Non-GAAP Figures. We’ve Done A Deep Dive Analysis And Are Shocked By PTC’s Overstatement Of Office Locations, And Irreconcilable Employee Headcounts. Are They Just Firing And Re-Hiring People To Expunge Expenses? We Believe Its Restructuring Directly Violates SEC Guidelines Given Its Inability To Make Reliable Estimate. PTC’s CFO Was Chief Accounting Officer At Autodesk During A Period It Had an SEC Investigation And Said Its Financials Could No Longer Be Relied Upon.
While All Analysts Say “Buy” Six Insiders Have Stock Sale Programs, And They Only Own 1% Of The Company. Analysts’ See Upside To $60 (+12%), But We See 50% – 60% Downside As Our Long-Run View. This Represents A Terrible Risk/Reward For Owning PTC’s Shares. PTC Is Trading At Peak Valuation With Little Covenant Cushion; Careful Investing To All…
Spruce Point is short CECO Environmental (Nasdaq: CECE, “CECO” or “the Company”), a poorly constructed roll-up serving the environmental, energy, fluid handling and filtration industrial segments. Based on our forensic financial analysis, insider behavior, and anticipated changes in the regulatory environment driving its business, we believe CECO is at high risk of a covenant breach in 2017.
CECO has been touting to investors that it has been successful in delevering its balance sheet post-PMFG acquisition, and that its current Net Debt to EBITDA ratio is down from 3.6x to 1.6x as of 9/30/16. On the surface, this appears impressive, but the picture is not so simple. CECO should be pointing investors to is “Leverage Ratio” covenant per its credit agreement which looks at gross leverage (not net of cash) and includes significantly more debt obligations beyond just its term loan…
MGP Ingredients (“MGPI” or “the Company”) Is A Commodity Ingredient and Alcohol Producer Now Being Spun As A Sexy Transformation Story Into A Premium Producer of Branded Whiskey and Bourbon. MGPI is a simple story to understand. It operates two businesses: an ingredients business run from Kansas and an alcohol distillery in Indiana. Both of these facilities are old assets and prone to substantial operational hazards. Most recently, MGPI has experienced fires, work outages, and chemical disasters requiring the hospitalization of innocent people.
MGPI’s shares have appreciated 1,000% since 2014 as investors have cheered the Company’s decision to hire new management, reprioritize its businesses away from commodity ingredients, and focus on “higher margin” premium alcohol beverages. MGPI has also recently benefited from a temporary, yet unsustainable, increase in earnings from its 30% joint venture with Seacor (NYSE: CKH) called Illinois Corn Processing (ICP).
On the surface, the Company’s transformation strategy appears wildly successful. Its EPS has risen from a loss of ($0.29) in 2013 to positive earnings of $1.50 per share in the LTM 9/30/16 period. Over the same period, sales have essentially been flat, but gross margins have expanded from 6.4% to 18.1%
Spruce Point Believes Investors Should Be Cautioned Not To Extrapolate Recent Earnings Performance. We Believe There Are Numerous Business Risks And Cracks In The Growth Story That Are Not Being Adequately Discounted…
Our interest in Ultimate Software (“ULTI” or “the Company”) was initially peaked when a little-known firm called Soapbox Research published a skeptical report highlighting aggressive software development cost capitalization, potential revenue exaggeration, bloated stock compensation expense, and corporate governance concerns.
One of our most successful shorts in the past few years was Caesarstone (“CSTE”), an Israeli quartz counter top manufacturer. We noted that its margins were suspiciously higher than its peers, and raised concerns about the potential for cost capitalization related to its U.S. plant expansion. We also worried about the governance structure, and influence of the Kibbutz (a communal / family-like structure). To support our short thesis, we conducted deep fundamental analysis and received the Company’s quartz supply contract (through a Freedom of Information request) to illustrate why we believed its margins were unsustainable. The parallels between Caesarstone and Ultimate Software are striking:
Burlington (“BURL” or “the Company”) Is An Old School Retailer Now Being Spun As A Sexy New Growth Story Amidst An Intensifying and Ultra Competitive Retailing Environment.
Burlington Stores (formerly Burlington Coat Factory) is an “off-price” discount retailer based in Burlington, NJ that sells men’s and women’s clothing, home furnishings, and accessories. It competes with the likes of TJX Companies (T.J. Maxx, Marshalls), Ross Stores, and countless other retailers offering shoppers a discount to the M.S.R.P.
Burlington Has Been Touting impressive Comparable Store Sales (“CSS”), Gross Margin, and EPS Gains, While Shrinking Same Store Inventory. We Don’t Think It Can Last. Spruce Point Has Identified Numerous Financial Presentation, Accounting, And Business Issues That Could Be Signaling A Slowdown In Future Financial Results.
Echo Global Logistics (“ECHO” or “the Company”) was founded in 2005 to roll-up the transportation logistics / brokerage sector. Founded by the same people behind Groupon, and another public company noted originally by Barron’s in 2007, Echo has yet to be fully exposed until now. Led by Eric Lefkofsky and his partner Brad Keywell, these inter-related, yet distinct publicly traded businesses share the same founders, business address, auditors, and same modus operandi of hyping “proprietary” and “disruptive” technologies capable of earning “massive” profits in large, fragmented markets. In our opinion, time and results have shown these predictions have failed to live up to initial expectations, and have lead to large shareholder losses to post IPO investors, but enriched its founders and early backers who quickly dumped stock.
AECOM (“ACM” or “the Company”) is a global engineering and construction firm based in Los Angeles, and is an enormous roll-up that came public in 2007. Bowing to pressure from an activist to maximize shareholder value, URS Corp (URS) sold itself in October 2014 to AECOM (for approx. $5bn –a cash/stock deal which included the assumption of $1bn in URS debt). The URS deal is the largest in AECOM’s history.
The URS deal was touted as giving AECOM “heft” in the oil and gas market, at exactly the wrong time! As shown by the investor presentation, URS also added exposure to the mining and industrial sectors –other areas that have shown persistent weakness since 2014.
Spruce Point has been following AECOM, and has generally viewed its post-deal financial results with skepticism. Our view was fortified when on Aug 10, 2016 after reporting Q3’16 results, AECOM filed an amended 10-K/A.
Sabre Corp. (Nasdaq: SABR) is a travel tech company with a core business of operating a Global Distribution System (“GDS”), a platform that facilitates travel by bringing together content such as inventory, prices, and availability from a broad array of travel suppliers for a range of travel buyers such as online/physical travel agents and corporate travel departments. As a middleman between buyers and suppliers, Sabre’s biggest risk is disintermediation, whereby its consumers bypass its network, through emerging threats from Google, or even worse, suppliers imposing fees to customers for using it (e.g. Lufthansa).
As a result of underlying business pressures, we believe insiders were likely aware that revenue and earnings estimates would not be met in 2015… Download our report to learn more.
Questionable Business Strategy with Unachievable Revenue Goals: The fitness industry is intensely competitive, subjecting Planet to the whim of changing consumer preferences (yoga, boot camp, barre burn, adventure courses), potential technology disruption from wearables, and rife with examples of chains that over-expanded and failed (e.g. Bally Total Fitness, Curves, Town Sports). Planet Fitness (“Planet” or “PLNT”) tries to differentiate itself with a “no judgment” model for the casual fitness user that doesn’t want to be “gymtimidated,” at no-commitment, and a low entry price of $10/month (plus initiation fees). On average, its clubs have 6,500 members, and it needs both densely populated markets and members who won’t use its gyms to make its financial model work! Furthermore, we believe Planet’s revenue targets and growth rate are unrealistic and likely to disappoint current expectations. Download our research report to learn more…
In our opinion, Tower is a collection of old semi foundries cobbled together from acquisitions, which produce significantly below industry average GAAP gross margins (from 2012-2014 Tower 9% vs. 23% peer average). Having gone through numerous financial restructurings in the past, Tower promotes large revenue goals reaching $1bn, and a large Non-GAAP EPS headline of questionable merit, but has amassed ($695m) of negative cumulative free cash flow since 2004! Not having the capital support or free cash flows to fund the large capex requirements to compete in the semiconductor manufacturing industry, Tower spends just 15% of sales on capex vs. peers at 40% of sales. Download our research report to learn more…
Formed from Canadian shell companies, Intertain has completed four acquisitions, each of which has gotten larger and fed Intertain’s ‘growth at any cost’ mentality which is likely to end in disaster. Intertain’s initial transaction was with Amaya Inc (a 2.7% owner), whom is currently being investigated (by FINRA) for insider trading (the largest investigation ever in Canadian history). Intertain acquired Amaya’s InterCasino brands for C$70m. Amaya acquired these assets through its acquisition of Cryptologic (where Intertain’s CEO was General Counsel). Our diligence suggests Cryptologic paid a ‘nominal amount’ for the Malta’s InterCasino gaming license. Our research closely explores Intertain’s acquisitions and finds significant issues for a majority of the deals, notably the Gamesys acquisition.
Spruce Point is pleased to release its latest report on IRSA Inversiones y Representaciones S.A.(NYSE: IRS), Cresud S.A.C.I.F. y A. (Nasdaq: CRESY), and IDB Development (Tel Aviv: IDBD). IRSA is a Latin American real estate company. IRSA recently invested $300m+ in IDB Development Corp. (TLV: IDBD), an Israeli holding company with interests in real estate, communications, agricultural products, insurance and technology. IDBD is burdened with $6.7 billion of net debt, going through a restructuring process, and has a “going concern” warning from its auditor. It is dependent on further capital injection commitments from IRSA of approximately $185m through 2016…
Since Spruce Point’s initial report on Caesarstone (Nasdaq: CSTE or “the Company”), which highlighted many fundamental issues facing the Company, along with potential accounting irregularities. In our opinion, many of the open questions remain inadequately addressed, or completely ignored, by the Company and its group of supporting analysts. Spruce Point’s follow-up report reiterates open questions and delves deeper into the issues we believe are facing Caesarstone.
This report will highlight additional potential accounting issues which are related to capital expenditures.
Spruce Point is pleased to release its latest report on CAESARSTONE SDOT-YAM LTD. (NASDAQ: CSTE). Caesarstone’s (CSTE) price recently corrected after Q2’15 earnings beat Wall St. estimates, but it cut its sales guidance from $515-$525m to $495-$505m, while maintaining its EBITDA guidance. We believe this is the canary in the coal mine, and CSTE is at continued risk of missing its goals in light of flat import tonnage growth and rising competition. CSTE trades at 3.4x and 13.5x 2015 Sales and EBITDA, respectively, a substantial premium to building products peers at 1.3x and 12.0x on the premise it can maintain share and grow sales 15% p.a. We believe CSTE should trade at a discount to peers of 8x – 10x EBITDA given our concerns about product and earnings quality, its shares would be worth $11 – $29 (~40% – 75% downside) on a normalized 10-20% EBITDA margin range. Since its 2012 IPO, its controlling shareholder has reduced its ownership from 79.0% down to 32.6%; we expect continued stock liquidations by its majority owner
Spruce Point is pleased to an updated report on NCR Corp.(NYSE: NCR). In our follow-up report, we will profile a blatant example of poor judgment and capital allocation to support our opinion that NCR’s shareholders should demand immediate change at the executive level. But first, let’s review NCR’s recent quarter and further dispel any notion that value enhancing alternatives are imminent and that NCR had a stellar quarter where it “Beat” street estimates.
Spruce Point is pleased to release its latest report on GREIF INC (NYSE: GEF/GEF.B). Greif (GEF) is in the business of industrial packaging products and services. Its businesses appear largely commoditized, are capex intensive, and under severe pressure from FX headwinds ( Venezuela, Brazil, Russia, Europe) and slackening demand tied to pressures in various end markets ( e.g. energy ). Overall, the company is experiencing deflationary-like pricing power and very low single digit / declining volumes.
Spruce Point is pleased to release its latest report on AMETEK Corp (NYSE: AME). With Limited Organic Growth, Ametek is Under Pressure as its Strategy Appears to be Hitting a Brick Wall. It Underinvests in R&D and Buys What it Cannot Develop. This Strategy Inherently Benefits its Margins and EPS, Which We Have Evidence that Suggests Are Overstated By Up to 600bps.
Spruce Point is pleased to release its latest report on iRobot Corp (Nasdaq: IRBT). Media Hype of a Robotics Revolution (Similar To 3D Printing Craze) Is Overblown. IRBT Is Hyping Its IP Portfolio, But Lacks A Monetization Strategy. The Hype Is To Divert Attention From Its Core Problems
Prescience Point is pleased to release its latest report on LKQ Corp (Nasdaq: LKQ). The 122 page report outlines extensive research into the companies financial reports and we believe the following: LKQ is an ineffective roll-up, they are caught in a massive margin squeeze, problems with their new growth story, dramatic overvaluation, and previous fraud and failures.
We believe shares of Fleetmatics Group PLC (“the company”, or “FLTX”) are grossly overvalued, reflecting few, if any, of the serious risks that warrant questioning the credibility of the company’s financial statements.
Just Energy (NYSE: JE / TSX: JE) is a company that U.S. consumers and investors are quickly realizing has become toxic to their wallets through deceptive energy marketing practices, and harmful to their brokerage accounts.
We believe shares of InnerWorkings, Inc. (Nasdaq: INWK or “IW”) are grossly overvalued and poised to collapse by as much as 55%. We believe the company is inflating its revenues in violation of GAAP principles by misapplying gross revenue accounting, placing it in violation of its credit agreement.
Prescience Point follow-up report on Boulder Brands’ (Nasdaq: BDBD), consisting of a deep-dive look at the company’s Q4’2012 results and management’s 2013 guidance. In short, the story does not add up and we expose the red flag components of its missing pieces.
Amidst a storm of investor distaste for U.S.-listed Chinese equities, and with its shares trading at a fresh 5-year low earlier this year, AsiaInfo-Linkage, Inc. (ASIA) followed the precedent of numerous other Chinese companies in announcing it had received a “Go-Private” proposal on January 20, 2012.
In this report, we explore United States Antimony Corp (Amex: UAMY) which made its graduation from the bulletin board to the AMEX on May 21st at approximately $4.00 share, giving the company a $275 million valuation.
On February 23rd, Bazaarvoice (Nasdaq: BV) raised $114 million at its initial public offering by selling 9.5 million shares at $12 per share. The expected pricing range was $8.00 – $10.00 per share, and the shares ultimately closed at $16.50 on the first day of trading. At today’s price of $17.00, the company’s fully diluted enterprise value is approximately $1.1 billion.
LQMT is a highly promoted penny stock with a market cap that exceeds $125 million, and highly speculative business prospects. However, a little due diligence reveals a company with a troubled past, as highlighted in an earlier article written by StreetSweeper in 2010, a convoluted capital structure, and a virtually insolvent business.
Global Sources Ltd. (Nasdaq: GSOL) is perhaps the original and oldest existing China RTO Company in the US stock market. In March 2000, Global Sources exchanged 100% of its shares for a 95% stake in Fairchild (Bermuda) Ltd., a subsidiary spun‐off from the now bankrupt Fairchild Corp. Through this deal, Global Sources obtained a public listing on the Nasdaq in order to provide liquidity to shareholders and a venue for raising additional source of funds for expansion.
A closer look into Camelot Information Systems (“CIS”) and their position in the Chinese Information Technology industry reveals numerous question marks investors should consider.
All around the world, biodiesel is a challenging business with high capital costs, cyclical gross margins and returns on capital. There are limited barriers to entry as production processes to make biodiesel are well understood and can be accomplished by specialty chemical plants of all sizes.
ZST Digital Networks (OTCPK:ZSTN) came public in October 2009 and raised $25 million by offering 3.1m shares at $8 per share. The offering was led by Rodman & Renshaw and Westpark Capital, two ubiquitous underwriters in the market for bringing Chinese companies public in the U.S. through reverse takeovers (RTOs).