Archive for August, 2010

Ikanos: Lessons Learned

August 25, 2010

Ikanos (IKAN, $1.00) is a stock that has lost half of its value since my previous article on June 4th. The overall positive article seemed to make sense, and was supported by meetings with top management. The shares appeared attractive at the time with EV/Revs 0.4x, P/E of 9x 2010 and 5x 2011 EPS (non-GAAP), a large net cash position, and a reversal of fortunes with positive non-GAAP earnings in the last few quarters.

So, What Went Wrong? And Where Do We Go From Here?

A few lessons learned:

1) Value investing in technology is very tough. Value investing requires more certainty in numbers. Technology, however, is dynamic and more uncertain than most sectors. Thus, the numbers should not be overly relied upon as I did with Ikanos.

2) Know what you don’t know, and maximize what you do know. As a research-focused institutional investor, perhaps I knew 10% of what was happening. That still leaves 90% that I did not know. I should have known more and not taken short cuts. I should have walked the floor at some trade shows where I could have talked to the sales people, competitors, and customers. This would have increased my “understanding” to a hypothetical 20%, still not 100%, but would have improved my perspective and lowered my stock-specific risk. The other 80% is really beyond one’s control; creating the need for a diversified portfolio (and if possible, a long-short portfolio, which we have done with our Quan Technology Fund).

3) Respect the tape. IKAN’s market action was weak since April, and I did not respect the tape. It did not help that I rationalized that the stock was too cheap to sell when top management was let go.

On August 4th, the new management team dropped the bomb, announcing a projected Q3 $15M revenue shortfall versus Q2 (and related restructuring charges to accommodate the lower expected revenues). The stock tanked.

What am I doing now:

I have learned more about what is going on at Ikanos, and have added to our fund’s position recently. There is no short-term fix to some of the problems that Ikanos has had in the marketplace. But the correct measures were implemented, and I am comfortable with the team and the path they are taking.

I am taking a long-term view. In the interim, the stock may weaken more despite today’s extremely low valuation. Investors always overreact on the downside as well as the upside. Furthermore, the Rule of Three says that there is never just one bad announcement, but a series of three. So, there could be more bad news ahead. While I am tempted to say that it is in the price, rule #1 above, makes me less adamant.

It is also possible that IKAN can move up in the months ahead. The lower opex and higher gross margins milestones should begin to appear in Q4, which may create stock support. The revenue growth measures will take longer to implement.

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Let’s Go Fly A Kite Update: CareView Communications Is Still Flying

August 15, 2010

This is a follow up on our CareView Communications (CRVW) note written April 25th (see my Let’s Go Fly A Kite article via link http://seekingalpha.com/instablog/608449-edward-schneider/65133-let-s-go-fly-a-kite).

CRVW’s price has dropped from $2.34 since our April article to $2.04 (as of August 13). But the market cap remains bloated near April’s levels at $258M including 10.6M shares issued at $0.52 per share in the second quarter. This 125.5M share count excludes the effect of 7M in warrants with a strike price of only $0.52, or the effect of potential payment-in-kind shares.

CRVW provides video monitoring of hospital patients, that can then be linked into local area networks or internet feeds with medical staff and patients’ families. There is not any real proprietary technology. A service business model plans to charge a monthly service fee of $60 per month to the hospital and $13 per day to the patient plus a transaction fee. But no material revenues have been generated yet.

In fact, CRVW’s financial performance continues to be abysmal, first-quarter 2010 revenues were a measly $42k, net loss was $3.1M, but cash from operations was only negative $0.6M due to major non-cash expenses such as using shares as payment. Over the twelve months ended March 2010, revenues were $0.1M with a net loss of $8.2M.

So why has CRVW stock rocketed 94% year-to-date despite the weak financials? The company accelerated its equity raise with $5.5M in additional capital early in the second quarter, which replenished a cash balance that was down to $33k on March 31st. Supposedly, this caps the equity offering. The downside is that it was done at a 75% discount to the current stock price.

A second reason for CRVW’s positive market action so far in 2010 was the company had positive news releases this year: a lease financing agreement with Fountain Partners, a US East Coast distribution agreement with Foundation Medical, an irrelevant release on a filing of a bed sore patent (based on moving the patient around using its monitoring system – that does not sound novel or defensible), and a China JV announcement. However, the China JV announcement may be a bit premature. It is only a signed letter of intent to enter into a joint venture, subject to execution of definitive contractual documents, which if executed would give Weigao Holding an exclusive license to manufacture and distribute the CareView System in China. Thus, providing no more than a royalty stream to CareView, if the agreement is ever executed and honored. In sum, these news items were more fluff than substance.

But suppose I am wrong, and there is more to these announcements than meets the eye. What are the chances that revenues will reach the $100M+ revenues and $10M+ profits with the current share count to justify today’s $258M market cap? Can management completely reverse its losing streak of nominal revenues of under $200k for each of the last five years, with negative gross margins since 2008, and net losses doubling each year to the current bloodbath of $8.2M? The probability is extremely low that management will be able to penetrate that many hospitals, and then charge and maintain these prices, for a low-tech video surveillance service despite the attached marketing bells and whistles (e.g. Baby View, Movie View, etc.).

The answer to the question of why CRVW has nearly doubled year-to-date to such a bloated market cap does not lie in fundamental analysis. It lies in the nature of the OTC retail market where news and stock prices can move in exaggerated swings, and that for technical reasons, some of these technical upswings can be maintained for longer-than-expected time periods.

Specifically, there are some powerful backers of CRVW including Chairman of the Board – Tommy Thompson. Mr. Thompson had served as the Secretary of U.S. Department of Health and Human Services under President George W. Bush, and prior to that was the Governor of the State of Wisconsin for 14 years. T2 Consulting owns 13% of CareView. Other Board members include Craig Benson, the former Governor of New Hampshire, and some other well-connected businessmen. These deep-pocketed insiders can provide the cash funding and connections to keep the stock price at elevated levels for some time. Secondly, April’s cash replenishment should also delay bankruptcy risk for a few quarters, providing quasi-fundamental stock price support. Third, the hyping of news flow amongst retail investors of the OTC markets creates short-term price momentum. Finally, the nature of the OTC bulletin board and pink sheet exchanges which disadvantages short sellers also lends stock price support (for more details, please see my Gravity article dated March 24th at http://seekingalpha.com/instablog/608449-edward-schneider/60401-gravity).

Technical support factors in the end will be trumped by the tens of millions of shares owned by insiders at a fraction of the current market price that will be coming out of lock-up in the coming quarters. Even if Board members continue to restrain themselves from realizing tens of millions of dollars in paper profits, the wider base of retail investors and vendors that participated in the more recent large financings should be rushing to exit anywhere near the current price of $2.04 with a cost of 52 cents a share.

Fundamentals should also bring CRVW down to earth. Unless there is a complete reversal of financial results, CRVW will be facing bankruptcy risk over the medium term, and then will likely have to resort to issuing shares like candy to remain solvent, at the expense of current shareholders.

You would think that investors should make a bundle in shorting extremely overvalued stocks with no fundamentals like CRVW. But if it were that easy, then these ridiculous valuations would not exist in the first place.

Disclosure: Short CRVW