Last February, a reader suggested I take a look at Commerce Planet (OTC:CPNE), a profitable little e-commerce company that had rallied over 500% to top $2.75. Since then, it has pulled back to $1.07, and I decided the potential upside warranted taking a position.
Commerce Planet sells e-commerce software as a service, but it is on the very low end of the spectrum. It doesn’t sell enterprise software, or web 2.0 anything. Instead, the company generates most of its revenues selling a basic membership service that provides tools to help fledgling entrepreneurs run auction businesses, and matches those entrepreneurs with a network of distributors that will drop ship products on their behalf.
Hard to believe, but the business model makes money. Last quarter, the company earned $.08 per share on revenues of $13.2M. CEO Michael Hill stated,
I am very pleased to report another quarter of outstanding performance to our shareholders. Our quarter over quarter performance from the fourth quarter of 2006 to the first quarter of 2007 represents exceptional growth. We are excited to see our efforts continue to yield significant returns.
While President Charlie Gugliuzza attributed the solid results to “infrastructure we put into place over the past year,” the 10-Q raises concerns regarding the quality of those earnings:
As we closed the year in 2006 and began 2007 we generated record volumes of sign-ups from orders generated through our affiliate networks which partially contributed to membership revenues during the three months ended March 31, 2007. We also experienced a large amount of poor quality sign-ups and a higher than normal level of potential online fraud in conjunction with the record sign-ups, resulting in increases in both our return rate and our chargeback rate.
In response, we have reduced our advertising related to these programs as we implement preventative measures and analyze the results of these measures. We expect that our gross transactions will decline but that our return rates and charge back percentages will return to normal levels, and that the conversion rate from sign-up to billable membership will improve as a result of our actions. It is not clear how much the second quarter’s performance will be impacted by these changes, but revenues generated from this source will likely be reduced at least temporarily.
Modeling Commerce Planet’s future revenues and earnings is difficult, if not impossible, in light of these concerns. Two other caveats investors should consider:  in June, a registration statement became effective allowing holders from various private placements to sell shares; and  the company had low tax rates in the past due to operating loss carry-forwards. Those tax benefits are nearly used up and, if positive operating results continue, the company will begin to pay normal tax rates this year.
As a stock, Commerce Planet has the traits microcap traders have come to know all too well: the potential that continued good results could double or triple share prices, glaring flaws that threaten to bring it down, and a knowledge vacuum that forces market participants to weigh these rewards and risks in an atmosphere of patent uncertainty.
My take, which is nothing more than an educated guess, is that the rewards adequately compensate investors at current prices for taking on these substantial risks. A few factors help tip the balance. First, the company has about ten cents per share of cash on the books. Backing that out, the stock should perform well even if the company’s operating profits drop in half for the next few quarters. Second, Commerce Planet has an emerging lead generation business [and here] that with just a little growth could contribute meaningfully to the bottom line.
Disclosure: Long CPNE.OB.
CPNE 1-yr chart