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Copperfield Research is the pseudonym of a research team focusing on publicly traded equities. As of the publication date of our articles, we may have long or short equity positions in the companies covered. We do not discuss unpublished reports, or provide any advanced warning of future reports... More
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  • BBSI: Tick-Tick Boom

    After the close on 10/28/2014, BBSI reported a net loss of $5.27 per share, driven by an $80 million pretax increase in workers' comp reserves. In our previous report "Barrett Business Services (NASDAQ:BBSI): A Tick-Tick-Ticking Time Bomb" we highlighted the systematic overstatement of earnings due to persistent under accruing of workers' comp reserves. We also highlighted the consistent trend of prior period adjustments, which in our opinion, blatantly violated U.S. GAAP accounting rules. The result of the accounting irregularities was a further overstatement of earnings. BBSI's $80 million pretax charge effectively wipes out the past five years of pretax earnings. Further, the charge represents a 70% increase in workers' compensation reserves compared to Q2'14. Said another way, our thesis that BBSI has been writing economically unprofitable business (despite reporting accounting profits) over the past few years, now appears incontrovertible.

    As we highlighted in our original report, most of BBSI's sell-side analysts had minimal insurance experience. As such, it our understanding the sell-side has been relying on management's commentary to shape responses to our original report. We believe the sell-side has been suggesting to institutional clients that a charge between $5 and $10 million was a possibility. Considering the $80 million bombshell BBSI just dropped, it is understandable that the previously promotional analysts may feel slightly misled. Further, in no way, does this charge reset past mistakes.

    Demonstrating management's condescending treatment of the investment community, they provided an "adjusted EPS" figure that excludes the all-important reserve charge. Make no mistake, the reserve charge reflects a true-up for years of pre-tax earnings that were overstated. To "adjust" out the most important and volatile cost of BBSI's business is akin to a utility excluding its cost of generating electricity.

    Even more disturbing, management provided a 12-month revenue outlook that included high single-digit same store sales growth, despite apparently having minimal basis to conclude the business they are underwriting is even profitable. It is clear to us that this management team has limited visibility into its insurance exposure. Management's suggestion that they will continue to grow exposure despite having no ability to ensure that exposure is even profitable, unequivocally tells us BBSI management is more concerned with investor perception than right-sizing its future liabilities.

    On top of the catastrophic reserve charge is BBSI's disclosure that "several quarters" of "normalized" claims data will be necessary to "provide a clearer indication of potential liability." Despite a previously unimaginable $80 million charge, BBSI management appears to be confessing that future reserve increases may still be needed. The culmination of all of this "sudden" bad news appears to be BBSI's disclosure that it has entered into discussions with its bank to "meet the liquidity needs of the company." Based on our analysis, much of which was shared in our original report, we would not be surprised if BBSI had insufficient cash to collateralize its business with ACE. By extension, we believe the $80 million charge (with more seemingly to come) could result in ACE re-evaluating its fronting arrangement with BBSI. Despite the concerning statement regarding liquidity, BBSI still had the audacity to buy a token amount of stock, for reasons we can only guess are perception-based.

    After the $80 million reserve charge, BBSI's shareholders' equity has been reduced to a paltry $4.80 per share, while tangible equity declined to a NEGATIVE $13.4 million. While we look forward to hearing their strategy to address any liquidity challenges, it is our opinion that BBSI may ultimately require a distressed equity raise.

    It seems clear to us that management was very much aware of the implications of its reserve deficiencies. Between its "pro-forma" report, token buyback, completely irresponsible growth projections, and "off-line" discussions with sell-side analysts, our guess is that many investors will see through the ruse. Unfortunately, investors were not given the opportunity to sell after-hours. Past earnings reports had been released by BBSI approximately 10 minutes after the market had closed (4:10 PM ET). Perhaps a mere coincidence, but with a high probability of pissed-off analysts and distraught shareholders, we believe management again displayed poor judgment by waiting until 8:17 PM ET to release its report - after most investors had gone home and after-hours trading had stopped.

    In our original report, we generously reached a $29 fair value estimate for BBSI, which assumed BBSI DID NOT take a massive reserve charge. With an $80 million charge, an opaque suggestion of liquidity issues, and shredded credibility, it would not surprise us to see an SEC accounting inquiry and/or justifiable class action lawsuits. Considering all of our past concerns, combined with the possibility of legal woes, we think the probability of BBSI being a zero is now well north of zero.

    Disclosure: The author is short BBSI.

    Tags: BBSI
    Oct 29 9:19 AM | Link | 6 Comments
  • Barrett Business Services (BBSI): A Tick-Tick-Ticking Time Bomb

    Today we shared our research and opinion on Barrett Business Services (NASDAQ:BBSI). Highlights of our opinion/report are below, with our full opinion found here:

    IMPORTANT - Please read this Disclaimer in its entirety before continuing to read our research opinion. You should do your own research and due diligence before making any investment decision with respect to securities covered herein. We strive to present information accurately and cite the sources and analysis that help form our opinion. As of the date this opinion is posted, the author of this report has a short position in the company covered herein and stands to realize gains in the event that the price of the stock declines. The author does not provide any advanced warning of future reports to others. Following publication of this report, the author may transact in the securities of the company, and may be long, short, or neutral at any time hereafter regardless of our initial opinion. To the best of our ability and belief, all information contained herein is accurate and reliable, and has been obtained from public sources we believe to be accurate and reliable. However, such information is presented "as is," without warranty of any kind - whether express or implied. The author of this report makes no representations, express or implied, as to the timeliness or completeness of any such information or with regard to the results to be obtained from its use. All expressions of opinion are subject to change without notice and the author does not undertake to update or supplement this report or any of the information contained herein. This is not an offer to buy any security, nor shall any security be offered or sold to any person, in any jurisdiction in which such offer would be unlawful under the securities laws of such jurisdiction.


    We believe Barrett Business Services (BBSI) operates with a precarious business model and substantial reserve deficiencies, which has created immense blow-up risk for public market investors. The combination of aggressive growth into the pernicious California workers' compensation market and minimal transparency regarding a recently disclosed reserve study has created an un-investable stock. Our work suggests BBSI has systematically under reserved, which has resulted in materially overstated earnings and a high probability of a massive reserve charge. With only three covering sell-side analysts (none of whom appear to have any insurance domain expertise based on a collective coverage universe that includes movie theatres, executive staffing, water dispensers, and ecommerce solutions), the combustible issues at BBSI have largely escaped investor scrutiny. That should change with our report, which includes a compendium of forensic issues, as well as background on BBSI's model and end markets.

    Based on our analysis of 2013 incremental adverse development (applied to 2012 claims expense), we believe BBSI may have overstated earnings by 57%. Depending on the degree to which BBSI's reserves may be inadequate, there are scenarios discussed herein which would completely wipe out BBSI's previously reported profits. In addition to arguing our belief that BBSI has overstated past earnings, we outline why BBSI appears to be in blatant violation of U.S. GAAP accounting. Our accounting concerns are amplified by a 2014 lawsuit brought by a long tenured branch manager accusing BBSI C-Suite executives of "effectively cooking the books to create inflated profit margins to entice interest in BBSI stock in violation of SEC regulations."[i] Unsurprisingly, we have been unable to find any disclosures in BBSI's public filings about the existence of the lawsuit and associated incendiary charges. BBSI's auditor is tiny Moss Adams, who does not even list insurance as an area of expertise on its website.

    It is well understood that insurance companies can hide long-term economic liabilities for extended periods of time. However, a recently announced reserve study should act as the catalyst to publicly expose the magnitude of BBSI's reserve hole. The dramatic shift in IBNR and case reserves are additional red flags, with the latter inexplicably increasing from $51 million to nearly $93 million in BBSI's most recent quarter. Based on our analysis, if BBSI simply matched the reserve coverage of other PEOs and insurance companies, a charge between $69 million to $280 million would be required. For perspective, BBSI's shareholder equity at 6/30/14 was just $74 million. A reserve charge representing just a fraction of our estimate would likely eliminate years of pretax earnings, while creating uncertainty over BBSI's profitability and ongoing business model.

    Adding even more asymmetry to BBSI's stock is the new fronting agreement with ACE. Should the reserve study (or other issues discussed herein) cause ACE to non-renew its fronting agreement, BBSI's corporate profile could be impaired with no replacement to renew its California business.

    Under a rosy scenario analysis that assumes BBSI is somehow able to delay reserve charges, we still believe the stock will revalue significantly lower to account for balance sheet risk and incremental earnings pressure from regulatory changes occurring on January 1, 2015. Generously assuming benign outcomes for many of the issues identified in this report, we still believe fair value for BBSI's stock is $29.00 per share, which is 50% below its recent price. The $29.00 per share scenario assumes the company is NOT required to take significant reserve charges to address its thin reserve position, has no negative changes in its ACE fronting agreement, and no restatement of past results for inappropriate reserving practices occur. On the other hand, if we are correct about the considerable hole in BBSI's reserve, we believe there are a plethora of long-tail scenarios that could cause the stock price to go much, much lower. We encourage all shareholders (and sell-side promoters) without insurance expertise to consult an insurance expert to independently verify our analysis and conclusions.

    Our report contains several sections focused on relevant background information on BBSI, workers' comp, as well as the California PEO dynamics. Other sections are specific to the problems we have identified at BBSI, including detailed analysis examining BBSI's reserving practices and business/financial models. For those with time constraints, we would encourage you to jump directly to sections 4, 6, 7, and 8, which provide the most specific analysis and discussion into the significant risks and "meat" of our BBSI opinion. If you can only read one section in its entirety, please see section 6 ("Severely Inadequate Reserves May Require a Significant Charge"). Sections 1-3 provide relevant, yet admittedly boring background. The following segments are covered in this report:

    1) Investors Should View BBSI as an Insurance Company - BBSI is a PEO with a small staffing business. The PEO represents approximately 95% of gross revenues. BBSI competes in the challenging market of providing workers' compensation insurance for blue collar employers. Further, most of its exposure growth has come in California, which now represents roughly 74% of net revenues. Over the past three years, the new management team more than doubled the company's exposure to this risky market.

    2) A Brief Background on the Seedy History of PEOs - The PEO industry has a tumultuous history that is marred by extensive fraud. In recent months, officials tied to several PEOs were sentenced in one of the largest insurance fraud cases ever, misappropriating $133 million of their clients' money. According to the FBI, "Workers' compensation insurance accounts for as much as 46 percent of small business owners' general operating expenses. Due to this, small business owners have an incentive to shop workers' compensation insurance on a regular basis. This has made it ripe for entities that purport to provide workers' compensation insurance to enter the marketplace, offer reduced premium rates, and misappropriate funds without providing insurance."[ii]

    3) California Bans PEOs - Under Senate Bill 863, all California PEO licenses, including BBSI's, will be revoked on 1/1/15. This provision passed due to concerns related to the financial stability and/or solvency of the industry following PEO bankruptcies in the State. BBSI's core PEO business will effectively be banned on 1/1/15, likely resulting in a significant growth and/or earnings hit.

    4) BBSI Losing Its License = Possible Collapse of Growth and/or Earnings - In response to getting its license revoked, BBSI entered a fronting agreement with ACE, a rated and admitted insurance company. We believe management has misled investors on the financial impact of this fronting agreement. After initially describing it as "earnings neutral," management recently revised the estimated potential drag to 25 to 30 basis points. A 25 to 30 basis point hit relative to gross revenue would have cut 2013 earnings by as much as one-third. BBSI's second quarter 10Q suggests the fronting costs may already be 2x management's updated estimate, with approximately 66% of its clients still not transitioned to the more expensive policy forms. We expect significant earnings pressure as the remaining two-thirds of clients transition to the ACE fronting arrangement.

    5) A "Reserve Study" By Any Other Name Would Smell as Rancid - On July 30, 2014 BBSI's management disclosed that a third party actuary had been hired to conduct a reserve study of its insurance reserves. Two similar reserve study announcements (GNW and TWGP), both with similar workers' compensation exposure, resulted in significant stock price declines. It is unclear why BBSI is conducting a reserve study now, but we believe ACE, BBSI's new fronting partner, may be the driver. While management has provided minimal transparency or detail into the reserve study, based on our reserve analysis, we believe it is reasonable to assume ACE may not be comfortable with BBSI's existing reserve. Our suspicion is that one of ACE's preferred actuaries (Milliman or Willis) is conducting the study. If the third party actuary results are not addressed appropriately, it is possible ACE will not renew their fronting agreement with BBSI. A non-renewal could shut-down BBSI in California post SB 863.

    6) Severely Inadequate Reserves May Require a Significant Charge - We believe the ongoing reserve study will reveal a large hole in BBSI's reserve position. Our in-depth review suggests BBSI may be required to recognize a material charge to substantially increase its loss reserves. We analyzed five significant red flags at BBSI: 1) persistent prior year reserve development, 2) exposure, revenue, and claims payment growth well in excess of reserve growth, 3) irreconcilably low short-term reserves, 4) extremely thin IBNR levels, and 5) reserve levels well below paid claims. Each of these red flags suggests BBSI has severely inadequate reserves. Further, our analysis suggests BBSI met their earnings guidance in the second quarter 2014 by dramatically under accruing claim expenses. Based on BBSI's low level of short-term reserves, and the decline of short-term reserves as a percentage of overall reserves, we believe BBSI will need to take a charge of at least $30 million. Our analysis concludes a charge of this magnitude would be required to simply increase short-term reserves to a level that would cover claim payments over the next twelve months. Additionally, BBSI's SEC filings illuminate a dramatic shift in IBNR and case reserves, with the latter inexplicably increasing from $51 million to nearly $93 million in the most recent quarter. Generally, IBNR makes up a substantial portion of long-tail insurance reserves. However, IBNR constitutes just 24% of BBSI's reserves. BBSI will need to take a charge of approximately $63 million to move its IBNR inline with a comparable group of workers' compensation insurers. We show how BBSI's run-rate of paid claims would deplete their reserves significantly faster than the comp group, despite BBSI's rapid exposure growth (and the backward looking nature of paid claims versus the supposedly forward looking nature of reserves). According to our analysis, matching the reserve coverage of other PEOs and insurance companies would require BBSI to recognize a charge between $69 million and $280 million.

    7) BBSI's Reserving Practices & Accounting Appear to Violate GAAP Resulting in Overstated Earnings

    Management's public description of its reserving practices appears to violate U.S. GAAP accounting, specifically FAS 60. Management recently explained its accounting approach, which indeed matches BBSI's historical financials. Neither their explanation, nor the historical financials appear to conform to U.S. GAAP. We clearly analyze how reserve accruals related to prior accident years constitute an inexplicably large percentage of the total reserve accrual. The consistently high accrual for prior years is inconsistent with other PEOs and insurance companies. As a result of its unorthodox accounting, we believe BBSI has dramatically overstated past earnings. Applying the incremental adverse development in 2013 to claims expense the prior year, suggests that 2012 EPS was overstated by 57%. We believe an accounting restatement may be required, which would result in substantially lower historical earnings. BBSI's auditor is Moss Adams, who does not appear to audit other insurance companies, or even list insurance as a practice area.

    8) Insurance Subsidiary Inconsistencies & a Lawsuit Accusing BBSI of "Cooking the Books"

    Results within a BBSI statutory insurance subsidiary show deteriorating growth, earnings, and a miniscule reserve position. These results filed with state insurance regulators are inconsistent with reported consolidated trends. Ecole Insurance, which is wholly owned by BBSI, discloses contact information and addresses that do not appear to match any of BBSI's disclosed offices. Further, it appears Ecole shares an address with a Home Warranty Insurer, while listing a "Statutory Statement Contact" that appears to be a Beecher Carlson employee based in Hawaii. Further adding to our overall suspicion, a recent lawsuit filed by a 10-year branch manager accuses BBSI's CEO and the company of "manipulating the bottom line to avoid paying bonuses to managers," and "effectively 'cooking the books' to create inflated profit margins to entice interest in BBSI stock in violation of SEC regulations." We have been unable to corroborate these accusations, however taken with numerous other management misrepresentations that we believe exist, the litigation raises incremental flags.

    9) California Workers' Compensation Destruction (brief background) - The California workers' compensation market has a treacherous history, with numerous stock market examples of investor losses in companies tied to this market. In the last downturn, carriers representing nearly 1/3 of the market failed due to significant reserve issues.[iii] More recently, investors in TWGP, MIG, EIG, and QBE AU have experienced steep losses following reserve issues tied to California workers' compensation. We believe BBSI investors will follow in these footsteps.

    10) Deterioration of California Loss Trends Should Pressure BBSI - California workers' compensation insurers have reported a deterioration in underwriting results. A recent state insurance authority report found ominous trends in frequency and severity of loss costs. EIG recently took a large reserve charge related to its California workers' compensation business, warning, "We believe these [deteriorating] trends are an issue for us and for any workers' compensation insurance company doing business in California." BBSI has 74% of net revenues in California, with a heavy risk concentration in the exact areas experiencing increasing adverse claim trends.

    11) ObamaCare & California State Fund = Risk of Large Client Departures and Negative Growth - It is unclear if the employer mandate under the Affordable Care, which goes into effect 1/1/15, will define large employers (50 or more) at the PEO level or the client level. If at the PEO level, we believe BBSI could lose a significant number of its clients. We are unable to reconcile BBSI's assertion that a high percentage of its clients offer healthcare. Our rudimentary analysis leads us to believe management may be taking liberties with certain qualitative commentary. After nearly eight years of contracting premiums and ceding market share, the California State Fund appears to be increasing its competitive positioning. After a major restructuring and new tiered pricing, California's largest workers' compensation insurer grew premiums by 23% in 2013. With a more competitive State Fund, insurance companies and PEOs focused on the low end of the market (like BBSI) should find growth much more challenging.

    12) Normalized Valuation Suggests Substantial Downside - Sell-side analysts and investors utilizing cash flow and/or EV/EBITDA multiples to value BBSI are fundamentally erring in their valuation approach. These irresponsible valuation methodologies, which ignore the long-tail of workers' compensation coverage and are wholly inconsistent with traditional insurance valuation analysis, have been used to justify BBSI's lofty valuation. If we apply aggressive growth assumptions, generously assume BBSI can lower its fronting costs from the implied Q2'14 levels, and apply a 15% premium to the earnings multiple of a comparable insurance group, BBSI would trade at $29.00 per share, representing 50% downside. Our $29.00 fair value estimate assumes none of the myriad of long-tail risks discussed in this report materialize, which could create substantially more downside to our $29.00 estimate.

    [i] Todd Krug vs. Barrett Business Services Inc. (14-2-00405-6)



    Disclosure: The author is short BBSI.

    Sep 16 12:41 PM | Link | 71 Comments
  • Points International (PCOM) - Don't Be Fooled By This Former Canadian Penny Stock

    Today, we shared our opinion and research on Points International. Below are the topics covered in our full report. The full report can be found here:

    Points International (NASDAQ:PCOM) - Don't Be Fooled by this Former Canadian Penny Stock

    A misunderstood, grossly mis-valued, low-margin reseller being promoted as an e-commerce platform

    Fair Value - $5.50 per share, 75% downside


    IMPORTANT Disclaimer - Please read this Disclaimer in its entirety before continuing to read our research opinion. You should do your own research and due diligence before making any investment decision with respect to securities covered herein. We strive to present information accurately and cite the sources and analysis that help form our opinion. As of the date this opinion is posted, the author of this report has a short position in the company covered herein and stands to realize gains in the event that the price of the stock declines. The author does not provide any advanced warning of future reports to others. Following publication of this report, the author may transact in the securities of the company, and may be long, short, or neutral at any time hereafter regardless of our initial opinion. To the best of our ability and belief, all information contained herein is accurate and reliable, and has been obtained from public sources we believe to be accurate and reliable. However, such information is presented "as is," without warranty of any kind - whether express or implied. The author of this report makes no representations, express or implied, as to the timeliness or completeness of any such information or with regard to the results to be obtained from its use. All expressions of opinion are subject to change without notice and the author does not undertake to update or supplement this report or any of the information contained herein. This is not an offer to buy any security, nor shall any security be offered or sold to any person, in any jurisdiction in which such offer would be unlawful under the securities laws of such jurisdiction.


    We believe Points International's (PCOM) business model, economics, and value proposition have been misrepresented by management and are grossly misunderstood by its retail investor base. The company's history is littered with red flags, dubious accounting, and a promotional management team prone to making misleading statements. It comes as no surprise that many of these issues have been obfuscated by ticker changes, multiple listings (OTC to OTCBB to NASDAQ), a reverse stock split, financially conflicted sell-side analysts, and a Canadian headquarters. Based on our deep dive, forensic analysis, we believe PCOM's intrinsic value is closer to $5.50 per share, or nearly 75% below its current trading price. And this price target generously ignores PCOM's $243 million of off-balance sheet liabilities. The significant downside should be realized as the PCOM discussion refocuses on the facts, and away from "grossed-up" revenue and customer pipeline hype.

    PCOM claims it is the global leader in loyalty currency management. The company says it brings "years of industry experience, technological expertise, and a one-of-a-kind loyalty commerce platform to the world's top loyalty brands."[i] While this sounds impressive, we believe PCOM is nothing more than a simple reseller. Nearly every metric the company reports (and some it tries to hide) resembles a low-margin, value-added reseller. For example, in Q1'14, PCOM reported gross margins of just 14.2%. A Bloomberg screen found just 10 other technology companies with gross margins this low, and nearly every one of the companies operates as some form of value-added reseller.

    It is our opinion PCOM's business model has been meticulously designed to permit the company to "gross-up" its revenue, resulting in financial reports that appear to the investing public many times larger than its actual economic size. As we discuss later, PCOM's accounting and disclosure previously came under the SEC's microscope. According to FASB ASC 605-45, we believe PCOM should be forced to restate its revenues, potentially cutting previously reported numbers by up to 80%.

    In addition to overstating its revenue, we believe PCOM has utilized aggressive accounting which should spook any investor familiar with Groupon's infamous Adjusted Consolidated Segment Operating Income (CSOI). We believe the company is in direct violation of SEC Regulation G regarding pro-forma accounting, and we believe based on our report, an immediate investigation into PCOM's "grossed-up" revenue and inflated adjusted EBITDA is warranted.

    Based on the hype of new contract wins, sell-side analyst cheerleading, and "gross" revenue growth that screens well for quants, PCOM's stock has nearly tripled since 2011. Yet over the same time period, PCOM's consensus earnings estimates have been cut by at least 50%. Additionally, the company has never produced any meaningful profit (despite management boasting high contribution margins), and we believe EPS estimates are set to fall further in 2H'14 and 2015.

    Finally, we believe PCOM's promotional management team has mischaracterized organic growth, hidden substantial customer concentration, and promoted new partner wins that will have minimal actual impact on the business. This aggressive story-telling has coincided with management selling stock via the Canadian marketplace, thereby avoiding customary disclosure to the American investing public.

    We believe this report will start the re-valuation process and remedy the multitude of misperceptions and hype surrounding PCOM. The following sections are covered herein, highlighting:

    The Birth of PCOM and its Sell-side Partners

    PCOM is a former Canadian penny stock that has masked its true appearance with multiple ticker changes, a capital raise at $0.68, and a reverse stock split needed to up-list from the Bulletin Board. The company added the Principal owner of one of its investment banks to its Board of Directors, and he promptly resigned four months later. Multiple financial conflicts exist with several of PCOM's sell-side analysts, while others have used dubious valuation techniques to justify "buy" ratings and price target increases.

    PCOM is not a Platform / SaaS business

    Despite buzz words and an obvious desire to be compared to ecommerce platforms, PCOM's financial profile looks nothing like the purported comps. In its most recent quarter, PCOM reported gross margins of just 14.2% and EBITDA margins 90% lower than a platform comp set. Out of nearly 2,500 technology related businesses that trade on a US exchange, there are only 10 companies with a market cap over $100 million and gross margins below 15%. At best, PCOM is a technology-enabled value-added reseller (NYSE:VAR), which greatly alters the "story" management and analysts have created.

    PCOM reported revenues actually represent gross transaction volume

    We believe PCOM reporting revenues on a gross basis is a violation of FASB ASC 605-45. Platform companies typically report revenue "net" of the total volume of goods or services sold through its system. Platform companies receive a transaction fee that is generally reported as revenue. PCOM actually includes aggregate transaction volume in its revenues, which we believe has led to an approximate 650% overstatement of revenues compared to net revenue accounting. This specious revenue recognition technique distorts the actual scale of the business, and makes the revenue multiples the sell-side use appear baseless. The SEC previously requested information on PCOM's decision to report other metrics on a gross basis.

    Gross margins are imploding

    Most platform companies increase gross margins over time as revenues scale over fixed platform costs. In direct contradiction to a platform business model, PCOM's gross margins have declined by 860 basis points, from 22.8% to 14.2%. Our analysis indicates PCOM management has misled investors regarding the contribution margin and economics of its large Southwest deal, including a slide in the investor deck insinuating Southwest margins that don't reconcile with our calculations. We also show management's comments about organic growth appear irreconcilable outside of its top four customers.

    Profitless Revenue Growth - i.e. Negligible Contribution Margins

    PCOM management appears so obsessed with being perceived as a growth company that new partner revenue has been essentially profitless. In 2013, PCOM grew its grossed up revenue 45%, with a contribution margin of just 1.8%. PCOM's contribution margins are a fraction of its purported platform peer group. Further, the perpetual out-year story has already seen consensus EPS estimates fall by 48% in the last two quarters. We believe revenue is not only overstated, but it actually carries de minimus contribution margin.

    Revenue concentration risk (an important topic for the next section)

    While PCOM boasts in its investor marketing materials that it works with "approximately 50 partners worldwide,"[ii] the company neglects to mention in the slide deck that ~88% of revenue is derived from just four customers. Customer concentration is increasing, making the potential loss of any large customer far more material than its misleading marketing materials suggest.

    History of customer loss and burning shareholders

    In 2009, in the middle of a 3-year contract with PCOM, Delta abruptly restructured its deal and vastly reduced its relationship. Management not only gave zero warning about the Delta debacle, they actually provided multiple communications suggesting the relationship was strengthening. Until Delta restructured its contract, management did not even disclose Delta was a top partner, let alone approximately 67% of the company's revenues. PCOM lost 60% of its market value after the Delta confession. Based on recent comments from American Airlines' CEO, we believe history may be repeating itself.

    Mischaracterized organic growth and a European Tall Tale

    Management has repeatedly stated PCOM's organic growth is 10%-20%, excluding the launch of new partners. Based on our analysis, this level of "same store sales" growth across its existing customers is grossly overstated. As detailed later, we believe organic growth outside of its top four customers may actually be negative. Further, management publicly claimed Europe is returning to a "fairly significant growth phase."[iii] Yet, public documents show revenue from Europe has declined in each of the last three quarters, and European business declines accelerated to negative 35% year-over-year in Q1'14.

    Profitability overstated, a likely violation of SEC Regulation G, and a pattern of missing guidance

    In 2013, PCOM surreptitiously altered its EBITDA calculation, excluding certain investment spending from the company's reported EBITDA. We believe these operating expenses are recurring in nature, which management confirmed on a recent earnings call. As such, PCOM is directly violating SEC Regulation G. Further, their profit definition is similar to Groupon's notorious CSOI. The net result is that PCOM has effectively over-stated its Adjusted EBITDA by 50%.

    The Value of recent partner wins & pipeline are overstated and misunderstood

    Two drivers of the bull case for PCOM hinge on recent partner wins with MasterCard and Hilton. We believe the impact of these deals is greatly overstated and revenue generated will be minimal. MasterCard will generate zero direct revenue while adding to expenses. Hilton will contribute only ~ 1% to PCOM's 2015 revenue based on our analysis. Further, PCOM's highly touted pipeline, which was selectively disclosed at a recent sell-side conference, is a mirage based on several years of hype and hyperbole. Even in the unlikely event PCOM were able to convert 100% of its "pipeline," the stock would still be trading at 20x EV/EBITDA.

    Is PCOM already facing major secular challenges?

    We believe PCOM's CEO made an ominous confession on a recent earnings call regarding a shift in reward program redemption structures. Despite minimal focus from the sell-side, most major airlines began devaluing their reward currencies this year, creating confusion in the market and increasing the number of points required for award redemption. The likely result will be lower transactions (and revenues) for PCOM.

    The misrepresentation of PCOM's balance sheet strength

    PCOM management and its sell-side friends consistently highlight a strong financial position, emphasizing the company's significant cash position with no debt. However, the company generally neglects to mention its large "payable to loyalty partners" liability, which creates a working capital timing benefit that overstates cash by nearly 80%. Further, PCOM has an enormous off-balance sheet revenue guarantee of $243 million, which we believe is analogous to debt.

    Insiders quietly heading for the exit

    Because PCOM is incorporated in Canada, insiders are not technically required to file Form 4's. While publicly touting recent wins and a strong financial position, management has quietly been selling stock on the Toronto Stock Exchange without the customary disclosures U.S. investors would likely view as red flags. In the last two weeks of Q2'14, the Chairman of the Board sold over $1 million of stock, at a time insiders should have presumably been in a blackout window.


    Based on our analysis, we believe PCOM is unequivocally a generic value-added reseller, and not a high-margin platform. PCOM should trade at revenue and EBITDA multiples inline with its actual peer group. Using more appropriate multiples on the actual underlying economics of the business, we believe PCOM's fair value is between $4.89 and $5.86, representing roughly 75% downside.



    [iii] Q4'13 earnings call, 3/5/14



    [iii] Q4'13 earnings call, 3/5/14

    Disclosure: The author is short PCOM.

    Tags: PCOM, EBAY, OPEN
    Jul 28 11:03 AM | Link | 9 Comments
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