Blue Calypso Update: Selloff Creates Huge Return Potential For Patient Investors

| About: Blue Calypso, (BCYP)

Summary

KIOSentrix roll out will continue to support over 100% top line expansion.

Strategic investment from Hal Brierley is a sign of confidence from an industry titan.

Balance sheet cleanup and improving cash flow profile will stifle dilution.

Settlement terms with Groupon are still unknown, but could be substantial.

Near term price target is $5 as revenue grows and technical pressure ends.

Introduction

Purging of Blue Calypso (OTCQB:BCYP) stock by myopic investors has divorced price from fundamentals, creating an opportunity for a 5-10x return for the patient investor. The company has continued to make progress in its core business, but Fish & Richardson's conservative approach to managing the company's IP, alienated near-term catalyst driven investors. This is an update to my original article, which can be found here. I recommend reading it before proceeding.

KIOSentrix

Blue Calypso's focus is now almost entirely on the KIOSentrix product. KIOSentrix aims to help brick-and-mortar retailers regain their footing as e-commerce has disrupted the business. The app engages shoppers through loyalty programs, price comparisons, wish-list management, allows QR scanning, and is compatible with NFC and iBeacons. It's billed on a per location basis, so a 1000-location retailer at $100 per location could throw off $1.2mm of high margin revenue per annum. Contracts with brand managers could reach 7-figures as well, for those that manage large portfolios of products.

The product was completed in early 2016, and is now being fully rolled out. The product was introduced into 4k retail locations through its marketing partnership with IntegraColor. The company also partnered with the minor league baseball team, the Salem Red Sox, for fan engagement on the platform. This represents a huge long-term opportunity. The product could be used to deliver information, product promotions, and advertisements to stadium visitors. It functionality could also incorporate food orders and other services that would be valuable to both stadium operators and fans.

Increasing pressure on retailers and the incorporation of mobile devices to in-person shopping and live events will be a major tailwind for Blue Calypso. This gives BCYP a wide-open runway for long-term growth, evidenced by a 128% increase year over year in Q1 2016. The company is finally growing its base of reference accounts, which will be supportive as well.

In the conference call, CEO Andrew Levy discussed the successful proof of concept through its Monrovia partnership. The wholesale plant grower provided a gateway into Loew's and other retailers, and highlights the importance of relationships with vendors and brand managers, as opposed to just retailers. Proving the product's efficacy has opened the door for many more contracts, some of which could be in the 7-figure range according to Levy.

The ability to gather POS data is extremely valuable to both retailers and manufacturers. This information plays an integral role in e-commerce, but is a market previously inaccessible to the brick-and-mortar players. KIOSentrix data can allow stores to optimize their merchandising, promotions, and ultimately drive better performance. Retailers can use data to plan promotions and manage their product offerings, and manufacturers can use it for targeted marketing. The growth dynamic here is important, as one retailer can introduce KIOSentrix to hundreds of brands, and one manufacturer can expose it to many retailers.

Admittedly, my initial analysis could've been better in some respects. My focus was too much on the litigation, which took up much of management's time, detracting from the growth potential of the core business. However, I'm glad I continued to follow the company, as it gave me the opportunity to witness its continuing strong execution, and be attentive when the gap between value and price widened.

Brierley Investment

Hal Brierley is a very successful marketing entrepreneur, who cofounded and led Epsilon Data Management (now worth over $2b), founded Brierley & Partners (sold to Nomura in 2015), and taught a course at Harvard Business School. Brierley has deep connections in the industry, and if you need more information on his impressive background I recommend that you consult Google.

Hal recently invested $1mm in Blue Calypso, in exchange for about 610k shares, and 610k warrants exercisable at $2.13. In addition to finishing the company's balance sheet cleanup, this aligned Blue Calypso's interests with those of a connected and knowledgeable partner, and is a sign that there is more value than the market is currently pricing in. Brierley was also granted the right to nominate an individual to the company's board, although it's not yet clear if that will be Hal, one of his partners, or a third party.

Groupon Settlement and IP Update

Concurrent with the results of Q1 2016, the company announced that it entered into an undisclosed settlement with one of the ongoing litigants, which was apparently Groupon and marks the 6th settlement so far. The lack of disclosure is a sign that it was likely substantially enough to incentivize GRPN to keep it private, but it's likely far below a $30mm settlement that many event driven investors (including myself) had hoped for. I expect a similar deal to be reached with Foursquare.

Fish & Richardson is being paid on contingency, so their incentive is to maximize the long-term monetization potential of BCYP's intellectual property. There are a number of large cap companies that could be infringing. By settling the ongoing cases, Blue Calypso avoids a ruling in court so that it can wait until a more favorable IP environment to swing big.

The primary reason for the unfavorable IP environment is the current interpretation of Alice Corp. v. CLS Bank 2014, which I highly recommend reading into for any IP-interested investors. The current interpretation of this decision is threatening a massive volume of software patents, and is being fought by companies such as Google (NASDAQ:GOOGL), Facebook (NASDAQ:FB), Amazon (NASDAQ:AMZN), and Microsoft (NASDAQ:MSFT). Experts expect this ruling to be dealt with and for the environment to become more favorable in the future, but the timing of this is unknown. At the end of the day if legislators fail to protect American tech companies against infringement, we will begin to see an acceleration of the decay of the position of American companies in the global economy.

I view the company's IP portfolio as a completely unappreciated long-dated option, which could be worth hundreds of millions down the road, or could be simply worth the present value of the settlements that have been made to date. My last article goes into more detail about the IP portfolio.

Updated Valuation

Blue Calypso generated $263k of revenue in 2016. The company has cited a lot of interest for its products, and for the reasons discussed earlier I expect it to continue growing rapidly. It's very difficult to even ballpark how much business the company will do next year, but I think it could reach a $3mm revenue run rate by 2017. Applying a 6x sales multiple, the core business is worth $18mm. The IP option is even more difficult to value, but I think $20mm is conservative as well.

At the end of Q1 2016, there were 5,522,146 shares outstanding. Assuming Hal exercises his warrants, and another 500k shares of options are exercised, by 2017 the share count could be about 7.2mm. This implies a per-share value of $38mm / 7.2mm = $5.28. From the current price of $0.78, this represents a profit of 576% in one year. The actual numbers will likely be far different than this, but at a market cap of approximately $4.3mm, there is a massive margin of safety.

Reasons of Selloff

There are psychological and market-related forces that have created this opportunity. For one, the Groupon settlement is likely much smaller than what many event-driven investors may have expected. This probably caused them to race for the exits, creating an opportunity for long-term oriented investors.

Delayed Q's typically foreshadow bad news, and in the time following the filing of the 10-Q for Q1 2016 the market reacted accordingly. However, the filing was delayed to flesh out details of a settlement, and this was likely the wrong reaction.

There are other factors as well. As catalyst-driven investors exited liquidity dried up, making the stock prone to aggressive swings. The long-term decline is as much related to increasing share count than these forces, but I believe the timing with respect to business fundamentals and capital structure mitigate this risk for the time being, so market cap normalization would drive a stock price increase.

Hiring of MZ Group

In the first quarter, BCYP hired MZ Group to run a strategic investor relations campaign. There is a two sided benefit to this arrangement. First, with a small team much of management's time was likely consumed by communicating with investors, or related activities. With MZ Group handling IR and the litigation-related time consumption on a stay, Levy and his team can focus on creating organic growth.

Secondly, I believe increasing the attention this company receives is likely to narrow the gap between price and value. This isn't only an important point to traders: it impacts fundamentals. For company's financed with equity, a higher stock price means less dilution, protecting the value of the outstanding shares. Hopefully no more equity raises will be necessary, but if they are the impact could be reduced.

Balance Sheet

In the first quarter, Blue Calypso eliminated the rest of the convertible debt overhang, and finished with $212k cash. This was before Brierley's investment of $1mm, and should eliminate the need to raise capital again in the near future. This will allow the value of the business to grow substantially without another issuance, setting the stage for strong performance. The company's cash flow generation ability is also likely to increase in the near term. This is driven by two factors. First, core business growth with minimal incremental costs will drive higher margins. Second, the settlement revenue was previously being paid out to Fish & Richardson until they recover their incurred expenses. This should be done soon, which should result in royalty income from prior settlements being split evenly between BCYP and F&R.

New Patent

Despite a success rate below 10% for recently filed patents (according to Law 360 and referenced in the Q1 2016 BCYP conference call), the company had a patent approved for its "mobile sponsor gamification family". I'm not familiar enough with the product or market opportunity to conclude that this adds any value, so I ignored it in my valuation. I intend to address the new patent family in the future, so stay tuned.

Sources: EDGAR Filings, Q1 2016 Conference Call, PACER Filings

Disclosure: I am/we are long BCYP.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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