2 Year-End Tax Bounce Investments

Includes: DCTH, GNOLF
by: Tyson Halsey, CFA

Two year-end tax bounce candidates with potential good news kickers in the New Year were made for one of our portfolios.

Every year investors who have more realized gains than losses comb through their holdings and sell losers on their books, so as to avoid paying capital gains tax by April 15. This creates unusual selling pressure on the worst performing stocks of the year at year end, as tax selling adds additional pressure to a company stock that is tax related and not economic. As we move into the New Year, there will be an abatement to that tax selling—as this tax selling largely occurs between November 15th and December 15th--and these stocks, known as “tax bounce candidates” can experience a tradable move of 10%.

I am highlighting two stocks I bought for a portfolio as tax bounce candidates. They are Delcath Systems Inc. (NASDAQ:DCTH) and Genoil, Inc. (OTCPK:GNOLF). Both stocks are off about 75% on the year and both should see important positive news announcements in the January timeframe. If those news events occur, the upside in both stocks could be significantly higher than that of the tax bounce opportunity on its own.

Delcath Systems, Inc. is a development stage pharmaceutical and medical device company. It has received a CE Mark to sell its liver cancer chemosaturation product in Europe and sales should commence in the first quarter of 2012. It has developed a second generation blood filter, which improves this first product, and it hopes to receive a CE Mark for this filter in the first quarter 2012. Following a meeting with the FDA, in January 2012, regarding its data submission, DCTH hopes to submit a NDA based on its completed phase 3 clinical trials in the US for a similar application. These events are important milestones toward the commercialization a significantly improved liver cancer treatment system that will be available in the EU, Asia, and the US in the next two years with multibillion dollar market potential.

In February this year, the FDA sent DCTH a “refuse to file” letter regarding its NDA submission and requested all data from all patients at all hospitals be included in the NDA filing. We see this as a technical and administrative issue and not one of efficacy or of side effects. In 2005, the FDA did fast track this product and DCTH has had very compelling data in subsequent clinical trials. I believe the product’s promise remains bright, though FDA submission and approval can be a challenging and nonlinear process.

DCTH’s chemosaturation technology isolates an organ (e.g. the liver) so that blood flow into and out of the cancerous organ is stopped and up to a 100x fold dosage of a chemotherapeutic agent can be given to a specific cancerous organ without the side effects of generalized chemotherapeutic treatments. I like the idea of the technology in that they are taking proven drugs and enhancing their efficacy and side effect profile. This approach seems far more likely to produce a positive outcome than if a biotechnology company were simply developing a new drug.

Their technology is a “platform device” adaptable to a wide range of chemotherapeutic agents that can increase the efficacy of a particular drug and reduce its side effect profile. The company is exploring various partnerships with pharmaceutical companies whereby, in combination with Delcath’s chemosaturation technology, it can create new and more effective chemotherapeutic solutions based on existing drugs.

Delcath is down from $11.88 a share to $1.89 on Friday’s close. The company’s market capitalization in is $91 million dollars with $48 million in cash as of the close of the third quarter. The company is burning about $3.2 million a month, which is about $10 million a quarter. However, DCTH hopes to have the first sales in late January of 2012, and then the cash burn should begin to shrink as the rollout begins to generate revenue.

Given Dendreon’s (NASDAQ:DNDN) 1.1 billion dollar market capitalization versus Delcath’s current cash adjusted market capitalization of about $50 million, Delcath Systems could see some really significant upside if it successfully submits the NDA and effectively rolls out the systems throughout 2012

Genoil Inc. is a development stage company with a heavy oil upgrading and desulfurization technology and an oil water separation technology for bilge cleaning and other environmental applications. The company stock is down from $0.33 to $0.08 cents. Its market capitalization is $27 million and has a going concern auditor’s note.

Several years ago, North Sound Capital, then a $4 billion Tiger cub, hired four Bechtel engineers to evaluate Genoil’s upgrader, and then they became 13 D filers owning 35 million shares. Then the hedge fund had a bad year, the analyst who contracted the studies left, and they dumped about 17 million shares in the open market following its peak at $1.68 per share as the hedge fund had had to meet liquidation demands and they were liquidating stock positions across the board. The other 17 million shares of stock were later sold to an early stage investor who merged the two that became Intuitive Surgical. This professional investor has continued to invest in the company and has provided some investment banking services for Genoil.

This September, the company announced outstanding results for its “Crystal Sea” bilge cleaner on a 2 million barrel crude oil carrier it had been testing for nine months. The results showed a potential savings of $16,000 a year with its novel filter-less bilge cleaner, a 75% price reduction relative to competitive products, and less than 1 part per million oil-water purity. These results compare favorably against the 15 parts per million maximum requirement for U. S. Coast Guard approval. Genoil received US Coast Guard Approval for its Crystal Sea product in September. Genoil received ABS approval for its Crystal Sea in November, which gives them an international approval to market their product. Lastly, the ship, which is testing the device, has removed the rubber tubing connecting the unit and replaced it with metal piping, which suggest that Genoil may soon get its first revenue generating order.

Genoil’s Crystal Sea product is expected to sell for $37,500 to $50,000. Given the $16,000 operating savings from not using a filter medium, Genoil’s product could, in theory, pay for itself in two to three years. Further, the product it may be replacing costs about $140,000, on this particular ship. There are about 200,000 ships which could be outfitted with Crystal Sea Oil Water Separators. At 5% conversion per year, that is about 10,000 ships per year, and revenue potential of $375,000,000 per year if Genoil were to become the industry leader with its Crystal Sea product. There are not many two million barrel oil tankers and, consequently, we believe that the potential client is a first class reference name in the shipping industry.

The former North Sound Capital analyst described the Genoil Hydroconversion Upgrader or GHU as the “lottery ticket.” The GHU potential is astronomical. Genoil has announced that it is finalizing a contract with a major sovereign oil company in the Middle East. Genoil’s GHU’s novel attribute is that it can desulfurize oil 70% more cheaply than competitors H-Oil and Lumus. The target market is the conversion of flowing sour crude—high sulfur—into synthetic light sweet crude. Sour crude oil destroys the metal in refineries as one of the byproducts of the sulfur is sulfuric acid which melts the metal. Most refineries cannot process sour crude and that is why we saw the spike in Brent crude prices once the Libyan sweet oil exports of 1.6 million barrels a day were cut off during the Libyan civil war earlier this year. Europe was the primary buyer of that light sweet. Brent, from the North Sea, then became subject to a bidding war.

Saudi Arabia, in particular, is seeing oil wells begin to decline in production. For Saudi Arabia, and other Gulf Coast Countries, converting flowing sour crude to synthetic light sweet is a $40-50/barrel spread opportunity. Saudi Arabia has approximately 100 billion barrels of flowing crude oil (the Manifah field is estimated to be between 10-40 billion barrels), Kuwait and the UAE have approximately 20 billion in flowing crude oil each. The market potential over the next few decades could be 140 billion times the spread, which is currently $40-50 and could rise if peak oil and Hubbard curve theorists are right.

Genoil is hoping to announce a 300,000 barrel per day commercial desulfurization upgrader upon completion of its preannounced contract. That project is expected to cost $2.5-3 billion dollars. Assuming a $2 per barrel profit to Genoil, profits could be $219 million per year once the construction is completed in three years. Saudi Arabia produces 8.6 million barrels a day. The addition of one 300,000 barrel upgrading project could be the first in a series of modular expansions that could eventually lead to the conversion of millions of barrels a day and provide the hydrocarbons demanded China’s booming economy in the future. China surpassed the number of new cars sold in the US for the first time ever this year.

CEO David Lifschultz is the largest shareholder. He has run the company with a going concern for nine years and the company has no analyst coverage. Before buying a controlling position in Genoil, David Lifschultz had turned around a family business, Lifschultz Industries, which was close to bankruptcy. After a reverse split, the stock of Lifschultz Industries rallied from below $2 to $22 and was sold to Danaher. Lifschultz Industries was also run with a going concern.

Should Genoil get a contract with the VLCC or another oil water separation deal, Genoil could get a nice lift. If Genoil delivers on a 300,000 BPD upgrader with a major Middle East oil company, Genoil’s stock could trade to $1-$3 per share based on our estimate of 60 cents in operating earnings in three years.

In the case of both Delcath Systems Inc. and Genoil, Inc. there appears to be good reason to expect a tax bounce going into the January. As the month of January progresses, there are real prospects that both companies might enjoy meaningful fundamentally important milestones or contracts, which could make what starts out as a single, a double or a home run. To make good money in the market, it helps to start with a good entry point. I believe both of these tax bounce candidates represent attractive values at present levels relative to their potential markets. What is especially appealing, in both cases, you could hold both a month or two and risk little additional downside--as these stocks appear to have little hope built in—but possibly see a significant asymmetric price improvement if certain milestones or contracts are announced.

Disclosure: Clients of Income Growth Advisors, LLC own Delcath Systems Inc and Genoil, Inc. I own Genoil Inc. and have recieved options for consulting services for Genoil in the past. GNOLF.OB, GNO.V

Disclaimer: The information expressed in this note and on our website is based upon the interpretation of available data. The data being presented was obtained or derived from sources believed to be accurate, but Tyson Halsey, CFA and Income Growth Advisors, LLC cannot and does not guarantee the accuracy of these sources which may be incomplete and/or condensed. The data and information presented is provided for informational purposes only, and is not offered as a basis for trading in securities nor is it offered for that purpose. Readers and potential investors should conduct their own independent investigation before making any investment or business decisions with respect to Delcath Systems Inc., Genoil Inc., Dendreon Corp. or other securities presented on this website. Tyson Halsey CFA and Income Growth and Advisors assume no liability in communicating this information. Nothing contained herein should be construed as a recommendation to buy or sell any securities. Both Delcath Systems Inc and Genoil Inc should be considered speculative investments and loss from investment in these securities is possible.