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John H. Ford
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For the past 30 years, I have been involved in startups, as a founder, and active investor. My first company was purchased by Johnson & Johnson, which set the foundation for future investments. My level of trading escalated after graduating from college, primarily as a result of my... More
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  • USell: Why This $2 Stock Should Be Trading Above $6 Today

    Summary:

    • uSell just reported 40% year-over-year revenue growth for Q2 and Q4 results could be considerably better.
    • uSell's business model has been validated by partnerships with Fortune 100 corporations.
    • Recent insider and institutional buying confirm undervaluation.
    • NASDAQ up listing will be a positive catalyst for shareholders.
    • Strong cash position and no debt amplify undervaluation.
    • 92% gross margins and low overhead give this company tremendous profit potential.
    • uSell has grown so rapidly that it is now receiving more unique visitors to its website than its prime competitor.
    • The company's total addressable market exceeds $100 billion annually.

    I am long uSell, (OTCQB:USEL), an undiscovered, undervalued and rapidly growing competitor to eBay (NASDAQ:EBAY) and Gazelle.com. USell just reported 40% year-over-year revenue growth for Q2, and I expect revenue growth to accelerate later this year. The company's business model has been validated by partnerships with Staples (NASDAQ:SPLS), and TracFone (NYSE:AMX).

    USell is currently valued at $20 million, fully diluted, but I estimate the company should be valued above $60 million today, and could be worth considerably more within 12 months if the current level of revenue growth remains on track.

    Right now Wall Street knows nothing about this company or its 92% gross margins, low overhead, and partnerships with Fortune 100 companies. But that will change, and I expect the share price to more than double once investors discover this unknown gem.

    70% quarter over quarter growth in orders placed

    While 40% year-over-year revenue growth is impressive, the number that really highlights uSell's undervaluation is the 70% quarter over quarter growth in orders placed. Orders placed during the quarter ended March 31, 2014 were 85,000. That number grew 70%, to 146,000 orders placed for the quarter ended June 30, 2014.

    Orders placed is a direct indicator of future revenue, and quarter over quarter orders placed growth of 70% confirms that uSell is capturing market share from competitors.

    IPhone 6 release could accelerate growth even further

    I expect the iPhone 6 and 6 plus to be two of Apple's most successful products, and millions of customers will be converting to these new devices. When that happens, they will need to sell their old smart phones, and uSell should be able to capture a large percentage of this business. As a result of the iPhone 6 release, I wouldn't be surprised to see quarter over quarter revenue growth to go beyond the current 40% level. With growth like that, uSell should be trading at a premium, not a discount.

    Why I like uSell

    USell gives customers a way to sell their electronic devices instantly, in a completely hassle free environment. USell's largest competitor is eBay, a great company valued at $65 billion. Like eBay, USell doesn't hold products in inventory, it's platform just connects buyers and sellers. USell generates revenue by charging a commission for each transaction.

    But from a customer perspective, some aspects of uSell's business model are superior to eBay's which is a prime reason uSell's revenue growth is so impressive. Customers are recognizing that when it comes to selling devices, it's much easier to do so with uSell. This also makes uSell a buyout candidate for eBay.

    Here are some additional reasons I have invested in uSell:

    Number 1: USell's global cell phone total addressable market exceeds $100 billion annually. When you include tablets, laptops and a myriad of other retail devices, this market is substantially larger.

    Number 2: Since uSell is a software-based business, the company is capable of massive scaling, with minimal additional costs. As uSell grows, leverage amplifies what is applied to the bottom line.

    Number 3: Both uSell and the market it is addressing, are in very early stages of development. As is always the case, investors who get in early, reap the greatest rewards as long as the company is effective with its execution.

    Number 4: Dr. Phillip Frost bought 9.99% of the company (most of my Frost investments have provided returns in excess of 100%). This is just one more validation of the company's technology, because the level of due diligence Dr. Frost and his team are capable of conducting is high.

    Number 5: Michael Brauser owns over a 9% position in uSell and is chairman of the board. Mr. Brauser is a well renowned entrepreneur who has developed and sold numerous tech companies for a combined total approaching $2 billion. The presence of Mr. Brauser (along with Dr. Frost) indicates that uSell has valuation potential far beyond where it is trading now.

    Why I prefer uSell to eBay

    When I buy electronic devices, eBay is generally my first choice. It's fast, easy and price competitive. For buying, I love eBay.

    But I just tried to sell a device on eBay, and it was a nightmare. I didn't like the hassle of taking photos, writing up a description, filling out forms, monitoring the auction for 7 days, dealing with PayPal problems, and answering buyers' questions. Without going into the details, I spent numerous hours trying to conclude this transaction with a difficult buyer, and PayPal didn't make it any easier by putting a 21 day hold on the buyer's funds. Ultimately the transaction was canceled.

    My uSell experience

    In order to evaluate uSell, I decided to sell an iPad on uSell's website. The process was effortless. It took me less than 2 minutes to conclude the transaction. I was offered a fair price. No photos or descriptions were needed, and I didn't have to monitor the auction process or answer buyers' questions. It was so simple.

    I especially appreciated the fact that uSell sent me a postage-paid shipping kit so I didn't have to deal with packaging or postage. Selling a device on the uSell website was actually a pleasant experience. In my opinion, when it comes to selling devices, uSell's business model is far superior to eBay's. I will be a repeat customer.

    But I am not the only happy customer. I went to resellerratings.com and uSell had over 1300 reviews, with an average rating of 8.7 out of 10. Resellerratings.com is Google's trusted third-party review site, and in my opinion it's the best rating site.

    From my experience it became apparent that uSell puts a lot of emphasis on customer service, which is key in the online environment. For myself, it's gotten to the point where customer service is a prime factor when choosing between products that I buy.

    If you're considering investing in uSell, visit the company's website

    USell is a relatively new company, so not many people are aware of the advantages of selling through this website. But that will change. I am not the only person frustrated with trying to sell on eBay, and as awareness spreads, I expect uSell to continue to take market share from eBay. If you're thinking about becoming an investor, I highly recommend going to uSell's website.

    Interview with uSell founder and CEO Daniel Brauser

    I wanted to learn all I could about the company, so I initiated a series of conference calls with founder and CEO Daniel Brauser. Following are excerpts from those interviews:

    Q: How did you come up with the idea for uSell?

    Daniel Brauser: Individuals find eBay a really easy way to buy products, but selling products has become extremely cumbersome. The reason for this is that eBay has geared its business towards professional sellers, or "power sellers", so that they can control the quality of the buying experience. We saw that this created a major void in the market and developed our model around the concept of providing an alternative for sellers: we offer the "Sell It Now" option, much like eBay provides the "Buy It Now" option. We are providing the same instant gratification experience for sellers that buyers receive on eBay. Additionally, since not a lot of individuals are selling products on marketplaces like eBay and Amazon, power sellers that focus on selling used products have found it increasingly difficult to find enough inventory. We provide a solution by offering these merchants a way to source inventory directly from consumers.

    Q: Can you please elaborate?

    Daniel Brauser: Many of the merchants that buy in bulk through our platform are also eBay power sellers. So we're really solving two problems, we are making the selling process easier for individuals, and we are providing inventory to professional sellers.

    Q: What kind of feedback are you getting from customers?

    Daniel Brauser: Customers praise the speed of the service, ease-of-use, and the price they're able to sell their devices for. The fact that we offer a marketplace where buyers compete to buy devices really helps our customers maximize value. We also take all the risk out of the transaction for the consumer, because we only deal with reputable buyers. Problems can always arise; however, if a customer has an issue, we step in to mediate the transaction. If a buyer has a history of complaints, we cut them off. In the last six months we have cut off four buyers, but not a single one has left voluntarily.

    Q: Do you have any other competitors other than eBay?

    Daniel Brauser: Our other major competitor is a VC backed company called Gazelle.com. But in one sense we don't really consider them competitors because Gazelle is a direct buyer of goods. Not only do they have to market their service to consumers, but they also receive and inspect devices, pay customers, package devices for resale, and then sell through either retail or wholesale channels. uSell, rather, is a marketplace. We leverage the power of the marketplace and control the experience by tying the different pieces of the value chain together with technology

    Q: Is there any competition doing it exactly like you are, without holding inventory?

    Daniel Brauser: No, there's not. The only real comparison would be eBay. But eBay has significant flaws if you are trying to sell products. We give them all the credit in the world, especially with eBay's "Buy It Now" option. But they don't have a "Sell It Now" equivalent. That's what we provide.

    Q: Since you fill a void that eBay doesn't provide, wouldn't you be an ideal buyout target for eBay?

    Daniel Brauser: While I know little about what eBay looks for in acquisition targets, it's easy to see how uSell could be a complimentary service for any larger ecommerce site like eBay's user base.

    Q: With all the expenses related to inventory, I would think that you will ultimately be more profitable than a company like Gazelle.

    Daniel Brauser: I would agree. We do not operate any warehouse facilities nor do we have to deal with the logistics of receiving devices, grading them, inventorying them and selling them or the cash constraints that go along with all of that. The biggest advantage we see here is that we get to focus all of our attention and energy on two things; marketing and customer experience. In other words our mission is to activate the market and then deliver a great service so the word spreads and customers keep coming back. But I value the competition because it validates the size and potential of the market. Our understanding is that Gazelle has raised over $60 million of VC money, so a lot of people are taking this space seriously.

    Q: I saw one of Gazelle's TV commercials last night, and it was good. Do you think that Gazelle's advertising could bring customers to you?

    Daniel Brauser: We know that this is a huge market that has been largely inactive historically. Advertising dollars spent, even by our competitors, helps to activate it. Practically speaking, this means that more people will be searching for terms like "sell my iPhone". Our track record with customers has catapulted us to the top of most of the relevant Google search results. Because our prices are generally better than competitors, we are confident that we will continue to win a meaningful share of the increasing pie.

    Q: Since your business model is software-based, can you expand without occurring much additional cost?

    Daniel Brauser: Our business model, which is similar to marketplaces like eBay, Uber, and AirBNB doesn't require significant fixed overhead outside of the expenses required to employ a team of A players. It doesn't require buying property or equipment, or any other significant infrastructure costs as the business scales. It takes advantage of the throughput of the entire market, and therefore we have ultimate scalability, with limited cost increases.

    Q: How strong is your IP protection? In other words, would another company be better off trying to replicate your business model from scratch, or just buying your company?

    Daniel Brauser: The IP behind our seller's marketplace is significantly nuanced with several highly specialized refinements. The learning curve that we encountered in the process of developing it to where it is today would take similar time and experience for someone else to replicate. Therefore, we feel that regardless of the resources available, if another company wanted to get into the space, the quickest way would be by acquiring us versus attempting to replicate what we have built. Being that we are in a young and rapidly evolving market, we feel this time advantage is a significant asset of ours.

    Q: What's your growth potential?

    Daniel Brauser: We believe that we can build uSell into a multi-billion dollar business. We designed our service to be vertical agnostic and have proven our ability to launch new and disparate verticals with our recent addition of new categories such as textbooks and gift cards. Our focus still remains on smartphones; however, as we feel that it is critical to build liquidity in one vertical first, much as Amazon did when they focused on textbooks for the first four years of their existence.

    Q: Can you talk about your marketing expenses in relation to revenue?

    Daniel Brauser: Our marketing efficiencies have been consistently growing since the inception of the business. What we have shown is that when we first started marketing we would spend one dollar in marketing, and we would get less than one dollar back in revenue. Over time, that ratio has reversed itself. We spent the next dollar in marketing, and it drove in one dollar in revenue. Then the next dollar in marketing drove in over a dollar in revenue. We've gotten to the level where we are now generating a nice positive return on those marketing dollars spent. This is why word-of-mouth and repeat transactions are so important because they allow the business to grow, without spending additional marketing dollars. If you don't have customers coming back and transacting with you again, then you're only as good as your last transaction, which means every dollar you spend in marketing creates a fixed ratio in terms of return. What we've done is proven that the ratio is expanding. We credit our focus on making sure to deliver an excellent customer experience here. We are receiving increasing amount of positive customer feedback, which is lining up nicely with increasing repeat transaction rates and word of mouth traffic.

    Q: When you expect to be profitable?

    Daniel Brauser: We could be profitable today. We are generating profit on every transaction, and high margin on every transaction. But we believe that investing in marketing and our technology to better serve our customers at this stage while postponing profitability is the most efficient means of becoming a multibillion-dollar company. Marketplaces are unique businesses. At this stage in a marketplace, it is absolutely critical to focus growing Gross Merchandise Value. In other words, we must focus on growing the total value of transactions that are processed through the marketplace. We have seen huge growth in this number. In Q2 of 2014 alone, we processed close to $5.8M in merchandise value. Investors that pay close attention to our progress are thrilled by the magnitude of this number. They realized that it is the one metric that measures the true value of our marketplace to buyers, sellers, and to us.

    Q: Who are your buyers?

    Daniel Brauser: We have buyers that are authorized retailers for carriers like Verizon, AT&T, and Sprint. We have other buyers that are eBay power sellers. Others are selling to international wholesalers, or the domestic warranty and insurance companies. They are basically smaller versions of Gazelle. Gazelle is larger than our buyers largely because it has raised the most capital. This space is seeing a tremendous amount of activity and a lot of investment. This is one of the hottest segments in the Internet space right now.

    Q: Why is there so much activity in this space?

    Daniel Brauser: This is a huge market. If we only look at the cell phone market, we have over 300 million cell phone users in the United States. The most recent stats show that smart phones have over 60% market penetration. These devices have significant value. An iPhone for example is a $700 plus retail device that consumers buy a lot cheaper because they get it on a two-year contract, so they don't always realize the full value. These devices are built to last for 5 or 6 years but nobody keeps their smart phone for that long. As long as Apple, HTC and Samsung keep creating new products the turnover rate will continue to increase. At this point, the trend is for people to get a new smart phone every 18 months. So you have a significant amount of value that is left over in these devices that are no longer being used. The carriers are also implementing changes that are allowing customers to get new phones even faster. What we are most excited about is that the industry is coming to life. We know that we have a very efficient business model to take advantage of this new trend that's developing in this space. Best of all as activity in this space accelerates, we have the ability to ramp up without much increase in cost.

    Q: How big is the used smart phone market?

    Daniel Brauser: Around 150 million new smart phones are sold in the US now each year. What you have to think about is that for every new phone that is sold, there is likely a used one that would be available to be sold. The average secondhand price of one of these used smart phones is about $100. That would equal a total addressable market of $15 billion annually just in the United States. Also, there's nothing to say that this business model won't work equally well on a global scale.

    Q: How many new smart phones are sold globally?

    Daniel Brauser: Global smartphone sales are expected to reach 1 billion units this year.

    Q: So that would give you a global total addressable market of $100 billion?

    Daniel Brauser: Yes.

    Q: How do you get paid?

    Daniel Brauser: The buyer pays a transaction fee.

    Q: Can you disclose what that fee is?

    Daniel Brauser: We can charge a different transaction fee for each device listed on the platform, and we can modify these in real time. One of the advantages of reCommerce is that our fee is already baked into the price that the seller sees on the website. This is because sellers are not interested in how much we make; they simply want to know how much they are getting. For example, if a buyer bids $100 for a device, we may decide to show the seller a price of $80. When the buyer pays the seller, we would take $100 from the buyer, pay $80 to seller, and pocket the difference. As far as the seller is concerned, she got exactly the price that she saw on the website. This is all that matters to her. This ability to obscure our fees enables us to set a different fee for each product based on the conversion elasticity for that product. This is a huge advantage for us.

    Q: Who pays for the shipping?

    Daniel Brauser: The buyer.

    Q: Your business is very eco-friendly because you could be recycling hundreds of millions of phones that would otherwise end up in landfills. Do you have any idea how many phones you could recycle on an annual basis?

    Daniel Brauser: To date, we have kept over 350,000 devices out of landfills. We actually have a counter on the bottom of our homepage that shows this statistic.

    Q: Can you comment on the Staples and TracFone deals?

    Daniel Brauser: Both these deals really validate the value of our technology and it continues to validate this rapidly developing industry. You have Fortune 100 businesses that are deciding to get involved in this industry because they see that this is something that their customers want and need. Because of the platform and the marketplace that we have built, they see us as best in class. Even more importantly, it's allowing us access to their existing customer bases, which can be very profitable for us because these existing customer bases don't have acquisition or marketing costs. TracFone has over 20 million subscribers and Staples has 30 million unique visitors per month going to their website, so the economic potential for both these partnerships is tremendous.

    Q: How did you get the Staples deal?

    Daniel Brauser: They came to us.

    Q: Why do you think they chose uSell over Gazelle?

    Daniel Brauser: The reason they chose us over anybody else in the space is because we are the only true marketplace. Our marketplace approach is the only approach that is going to aggregate the largest number of SKUs and create an environment of best pricing for the seller. We believe they wanted to make sure that they were going to provide the best in class experience for their customers as well as the best possible prices. They believed uSell could deliver on both those fronts. Our technology fueled marketplace approach delivers that better than anybody else in the industry.

    Q: I found that when I compared prices, uSell always delivered the highest prices when compared to Gazelle. Do you think that impacted Staples and TracFone's decisions?

    Daniel Brauser: Yes.

    Q: Can I assume that there are other potential partnerships in the works similar to Staples and TracFone?

    Daniel Brauser: Absolutely. While this is a distribution strategy for us, our focus is kept on growing our core business and brand and that is where we are most excited about the traction we are making.

    Q: Can you comment on what kind of revenue these deals could generate for uSell?

    Daniel Brauser: I'm reluctant to do so because it's really early in the process. These 2 deals are very meaningful for us because they substantiate an entirely different distribution channel for us that is very low cost that continues to leverage the asset value of the technology we've created. It's highly scalable because this is tapping into existing user bases.

    Q: Who are some of your other potential partners?

    Daniel Brauser: The first obvious group would be any company that is involved in mobile, in any form. But it actually extends further than that, because uSell is a reCommerce marketplace, and many products can be sold. I don't think there's much in the way of limits in terms of where that can go.

    (At this point the interview was concluded).

    Interview summary:

    Here are some of the key points from the interview:

    Number 1: In my opinion, uSell will prevail over Gazelle because it can offer customers higher prices based on the marketplace model. USell should be more profitable than Gazelle because of Gazelle's infrastructure and inventory expenses. For example, Gazelle will be investing $22.3 million into its Louisville Kentucky facility. USell will not have those type of infrastructure costs because it is a software/marketing company, and all the heavy lifting is done by buyers and sellers, in much the same way eBay's buyers and sellers support eBay. The simplest way to view this is that with uSell, the buyer and the seller are doing all the work, and uSell simply takes a commission.

    Number 2: This portion of the Internet space is in its infancy stage, and will see explosive growth in the next couple of years. USell is providing a service that people need and providing it in a way that will drive revenue through word-of-mouth, and repeat customers. My largest returns have come from making investments early in the development stage.

    Number 3: CEO, Daniel Brauser understands the entire landscape, knows what needs to be done, and appears to be more than capable of developing uSell into a multibillion-dollar corporation. After hours of conversations with him, I was impressed with his intelligence and foresight, and he was one of the primary reasons I established a long position in uSell.

    Number 4: This is a business that will have a long life cycle because device recycling will only accelerate as more of the world's population becomes device users. The long life cycle ensures a large opportunity for profitability and growth.

    Number 5: USell's expansion potential is large, given that many different types of products can be sold on its platform. Remember, Amazon started off selling only books, but rapidly expanded to cover most types of products.

    Number 6: I am a big fan of software-based business models. Large expansion campaigns can rapidly be conducted at relatively little cost, which adds considerable leverage to a company's bottom line.

    Number 7: One factor that will drive new customers to uSell's site is the ability to find out what your device is worth. You can do this in approximately 30 seconds. You can also do this on eBay, but it's a lot more work. In my opinion, eventually a large percentage of these visitors will be converted into customers.

    Number 8: USell could be profitable today, which offers some downside protection because the company ultimately has control of its balance sheet. But I agree with Daniel Brauser, that taking the Amazon path, and postponing profitability while gaining larger market share, will provide the greatest shareholder value.

    Number 9: I would not be surprised to see buyout offers over the next 12 months. If Best Buy (NYSE:BBY) or eBay wanted uSell's platform, it would be much easier to buy uSell rather than try to develop the platform from scratch.

    Number 10: The next obvious partnerships would be with OfficeMax (NYSE:OMX), and Office Depot (NASDAQ:ODP). The fact that Staples and TracFone chose uSell, should make it easier for uSell to begin negotiations with other partners.

    Who will prevail, uSell or Gazelle?

    Sellers will choose the company that offers the highest price. As I stated earlier, I believe that uSell's marketplace model will prevail, because this model has been able to give customers the highest price, and that should continue to be the case.

    For the top 38 products that had offers from Gazelle and uSell,uSell's prices were 58% higher on average than Gazelle's.With such a dramatic price differential, it's easy to see why uSell should ultimately capture most of the market.

    But that makes sense, because uSell's cost structure is considerably lower than Gazelles because uSell isn't having to deal with inventory and all the related expenses.

    Also, while Gazelles website is functional, uSell's website is less cluttered, and much easier to use. Even if I could receive the same pricing from either company, I would still choose uSell, because of its website.

    Let me be clear; Gazelle is running a viable business. If uSell didn't exist, I would sell my devices on Gazelle's website. Gazelle has raised over $60 million in VC capital, which is no small feat. I just expect uSell to be more profitable as a result of the company's non-inventory based business model, and for that reason I think uSell makes a better investment.

    Gazelle is not yet publicly traded, but an IPO is expected. Since this sector is heating up rapidly, I may participate in an IPO trade.

    Who is winning the race now, uSell or Gazelle?

    When I began my research about 12 months ago, Gazelle was clearly ahead of uSell. But that has changed, and uSell is now surpassing Gazelle in terms of unique visitors. This can be confirmed by going to compete.com and comparing uSell to Gazelle. I expect this trend reversal to accelerate, as uSell continues to gain traction. As long as uSell continues to offer sellers the highest price, it should continue to gain market share.

    What is uSell worth today?

    The best way to estimate uSell's valuation, is to compare it to the closest competitor; Gazelle. Gazelle generated $116.1 million in device revenue for 2013. With a 3X multiple, low for this high growth sector, that would give Gazelle a valuation of $348.3 million, today. In my opinion, a 3X multiple is conservative, and given the growth rate, a 5X would probably be more appropriate, giving Gazelle a valuation well over $500 million. A well orchestrated IPO could take this valuation substantially higher.

    In order to value uSell, we need to understand the difference between Gazelles reported revenue, and uSell's reported revenue. Gazelle is reporting revenue for devices sold. In other words, if a device sells for $100, Gazelle reports $100. USell on the other hand is reporting revenue for commission on devices sold. USell is simply acting as a broker, and not actually handling each device. If a device sells for $100, uSell is taking a commission of approximately 20%, or $20 per device sold and reporting $20 as revenue. This is how uSell is able to generate gross margins above 90%. To summarize, if Gazelle sells one device for $100, it reports $100, if the same device is sold through uSell for $100, it reports $20.

    In order to compare Gazelles revenue to uSell's revenue, we need to estimate uSell's device revenue, because uSell reports commission revenue, ($20), and Gazelle reports device revenue ($100).

    USell has managed the sales of about 350,000 devices since the beginning of 2012 at an average price of at least $65 per device for a total of nearly $23 million paid to sellers. This can be confirmed by going to the bottom of uSell's homepage, and looking at the ticker count which displays the total number of devices sold and dollar amount paid to sellers. It is important to note this is the price paid to the sellers from the buyers. This is not device revenue. The buyers would then go on to resell this device to an end-user for approximately $100, which would equate to device revenue.

    For further clarification, when comparing this $65 number to Gazelle, this would equate to their cost of goods sold as it is the price paid to acquire the inventory. The revenue that they book is when they turn around and sell these devices back to end users. If Gazelle bought a device for $65, and sold it for $100, the $100 number would be device revenue.

    In order to calculate uSell's device revenue, we take the 350,000 devices sold since 2012, and multiply it by $100 per device, and that gives us a total device revenue of $35 million. This $100 per device is the device revenue that the end-user ends up paying.

    This $100 figure is comparable to what Gazelle gets when it sells a device and books revenue, in other words device revenue. Our goal is to compare device revenue from uSell to device revenue from Gazelle.

    If we look at uSell's reported revenue for 2012 and 2013, we see that approximately 66% of the total revenue for those 2 years was reported in 2013. This can be confirmed by looking at the relationship between uSell's reported revenue, (commission revenue) for 2012 and 2013. If 66% of uSell's device revenue was generated in 2013, that would equate to over $23.1 million in device revenue for 2013. In other words, 66% of $35 million is $23.1 million.

    With uSell's $23.1 million in 2013 device revenue, and using the same 3X multiple, that would give uSell a valuation of $69.3 million, today. Some would consider that a conservative valuation, because a 3X multiple is low for a company with such a high rate of growth in a rapidly expanding segment. Many would argue that a 5X or 10X multiple would be more appropriate. But even with a conservative 3X multiple, uSell is still worth more than 3 times today's valuation.

    Since uSell will probably always be able to offer the highest price to device sellers, it's logical to conclude that uSell will ultimately have the larger market share. I know that if Gazelle were publicly traded today, I would buy uSell, not Gazelle (except for a quick IPO trade).

    However, if Gazelle is able to run a successful IPO, that will only help uSell, by bringing increased awareness to this sector, and potentially bringing high valuations to all involved. And it won't take Wall Street long to figure out that uSell provides the more profitable business model.

    NASDAQ up listing will increase uSell's value

    The company has stated it intends to up list to the NASDAQ exchange. The timing on this is uncertain, but an up listing will definitely be a positive catalyst for shareholders.

    Insider buying confirms my investment thesis

    Company officers and directors have been buying on the open market lately, and an institutional investor, Robert Averick just purchased a large block on the open market.

    http://ir.stockpr.com/usell/all-sec-filings/content/0001140361-14-035139/form4.html

    Robert Averick and the fund he manages own more than 10% of uSell and this additional buying is a positive indicator. From what I understand his due diligence has been thorough and all-inclusive.

    USell's financial position

    According to the last 10-Q, uSell had over $1,000,000 in cash, and no significant debt. The company has since raised $4.65 million in a registered direct offering. But what's most important is that in the past 12 months, the company has made progress in the following areas:

    Number 1: The company has grown volumes by over 75% when comparing transactions completed in the first 6 months of 2014 to the same period of 2013.

    Number 2: The company has reduced its cash used in operations from $1,222,000, to $964,000, in the same period comparison.

    Number 3: The company has reduced the marketing expense to revenue ratio from 107% to 88%, when comparing 2013 to 2012. This is a very important metric, because it has a powerful impact on profitability.

    Number 4: uSell has decreased working capital deficit from $1,269,000 on December 31, 2013 to $256,000 on June 30, 2014.

    If uSell can continue to improve in these areas, the company's inherent value will continue to increase.

    Why Michael Brauser's chairman of the board appointment is important

    Michael Brauser's presence at uSell is extremely important. He is a large shareholder with over a 9% position. Here is a short list of some of his accomplishments:

    • 1995: Sold Kertz Security Systems to Wayne Huizenga for $28 million.
    • 1998: After a series of rollups in the security business, sold company to Ameritech for $660 million (now known as ADT).
    • 2001: Sold Naviant, an internet company he built to Equifax for $135 million.
    • 2004: Sold Seisint, a data fusion company that he co-founded in 1999, to Reed Elsiver (Lexis/Nexis) for $780 million.
    • 2009: Sold 5 to 1 (an internet company) to Yahoo for $28 million.
    • 2010: Sold Interclick (an internet ad network) that he founded in 2007 to Yahoo for $280 million.

    You will notice that Michael Brauser is well-versed in developing and selling Internet companies. He would not be investing his time with uSell unless he was confident of the company's success. In my opinion, his experience, track record, and guidance will be instrumental in developing uSell into a thriving corporation.

    Why is uSell so undervalued?

    The primary reason uSell is undervalued, is that Wall Street is completely unaware of this company, or the new market uSell is serving. Investors also know nothing about the Staples or TracFone partnerships, because no announcements have been made, probably at the request of the larger companies. Most investors are also unaware of Dr. Frost's or Michael Brauser's large positions or the fact that the company has overtaken Gazelle in terms of unique visitors to the website.

    But when a company is addressing multibillion-dollar markets, and growing revenue at 40% annually, at some point, investors take notice. This is only the 2nd Seeking Alpha article on uSell, and I would expect more analyst coverage in the near future. As Wall Street realizes the value of this company, and just how much interest there is in this sector right now, the share price will rise to a more appropriate level. This is the type of opportunity that could develop from undervaluation to overvaluation within a very short time frame.

    The risk

    As with all early-stage companies, there is risk. Even though the future looks bright for uSell, there is no guarantee that management will continue to execute. We have all invested in companies that showed tremendous promise but failed because of management's inability to deliver. Michael Brauser's involvement as chairman of the board de-risks the situation some, but as with all early-stage micro caps, diligent monitoring is required.

    Gazelle's success in the marketplace presents competitive risk, but as Daniel Brauser stated, at this early stage of the cycle, Gazelle's success could actually help uSell. Competitive risk will become more of a factor as this segment of the Internet industry becomes more developed.

    From what I can determine, most investors have a cost basis higher than where uSell is currently trading so I don't see much selling pressure at this low level. This should provide a reasonable level of downside protection.

    I don't see any risk of a near-term financing, the company doesn't need cash. Since I can't predict when uSell will choose to be profitable, there could be financing risk down the road.

    Conclusion

    USell presents a particularly attractive business model, based on scalable software, no inventory expenses, and minimal infrastructure. I expect the company's 40% year-over-year revenue growth to continue and possibly accelerate. With a market cap of just $20 million, the company is deeply undervalued considering the multibillion-dollar total addressable market, and the company's ability to seamlessly expand into multiple markets. The extreme level of undervaluation and ability to turn profitable at any time, provides significant downside protection

    If uSell continues its current growth rate and is able to establish itself as the primary "Sell It Now" website, the long-term potential is staggering. Daniel Brauser believes he can build uSell into a multibillion dollar company. I agree.

    These factors, along with the presence of Dr. Frost and Michael Brauser provide investors with an ideal asymmetrical trade, significant upside potential, with limited downside risk.

    It is probable that the author and his associates have a position in the subject security consistent with the opinion expressed in this article and they reserve the right to buy and/or sell the security mentioned in this article, at any time without further notice. For complete disclosure and disclaimer information please click here.

    Disclosure: The author is long USEL.

    Sep 17 11:16 AM | Link | 6 Comments
  • Marathon Update: Shareprice Could Double Again

    When I first began writing about Marathon (OTCQB:MARA) last year, the stock was trading in the $4.50 range. By the time Seeking Alpha published my first Marathon article, it had run up to $6. It recently hit $16, and with just one large settlement announcement, it could more than double again. Here's what I like about Marathon:

    • The company has one of the best business models in the IP sector.
    • Marathon subsidiaries collectively own 128 patents and contract rights for 10 patents.
    • Gross margins are typically 45%-55%.
    • Marathon has one defendant currently scheduled for a Markman Hearing in 2014 and twenty-nine for 2015.
    • Marathon has seventeen defendants currently scheduled for trial in 2015 and four defendants currently scheduled for trial in 2016.
    • Revenue and profitability are increasing.
    • Marathon subsidiaries have 87 active defendants.
    • The company has a very low fully diluted share count of about 7 million of which half is held by insiders and affiliates.

    Marathon is entering the big leagues

    In some regards, Marathon reminds me of my VirnetX (NYSEMKT:VHC), trade. I was introduced to VirnetX by an investment banker, when it was trading at $2 a share. I established a position at $5, published my first VirnetX article at $12, and the shares rose to $40. I traded VirnetX profitably for about 2 years.

    At this point I like Marathon better than VirnetX, because not only is Marathon generating revenue and profits, but I just uncovered the fact that one of its patent portfolios, the Signal IP portfolio has estimated damages for the 13 defendants named so far to be $1.4 billion to $1.6 billion. Here's the breakdown of the preliminary damages estimate:

    Kia $133-148M

    Mazda $63-70M

    Mitsubishi $6-7M

    Nissan $151-167M

    Subaru $28-31M

    Chrysler $154-170M

    Ford $304-336M

    Volvo $13-14M

    Jaguar $20-22M

    Mercedes $120-133M

    BMW $104-115M

    VW $132-146M

    Porsche $23-25M

    Total: $1.4 billion to $1.6 billion

    Marathon has suddenly gone from a company generating profits through relatively small settlements and licensing agreements, to a company that could be generating some very big wins. The game has now changed completely. With such a small number of outstanding shares, just one big win could propel Marathon well beyond today's level.

    Positive developments in the Apple Siri case

    Additionally, the Apple Siri case has seen some positive developments recently. For example:

    • Plaintiff's motion to compel Apple's assessment of Siri's value is granted.
    • Plaintiff's motion to compel Nuance and speech recognition agreements is granted.
    • Plaintiff's motion to compel information on Apple's deferred revenue and estimated selling price related to Siri is granted.
    • Apple's request that the Court limit the number of asserted claims is denied.
    • Plaintiff's motion to compel Apple documents, statements, and testimony concerning Siri's value from the Apple versus Samsung litigation is granted.
    • Apple is sanctioned for its failure to present a witness for topics one, 2, 9, and 10.

    I am a big fan of speech recognition and use it every day. I believe this market will become larger than anyone ever expected, giving Marathon even more blue sky potential.

    The number one reason I invested in Marathon

    But with all Marathon has going for it, I invested in the company for one primary reason:

    Eric Spangenberg has become one of Marathon's largest shareholders.

    Eric is considered one of the most proficient patent monetization experts in the United States and is the founder and CEO of IPNav.

    But what's really significant is how Eric became one of Marathon's largest shareholders:

    Eric exchanged portions of his patent portfolio for Marathon stock.

    Eric obviously believes that Marathon stock will provide a greater return than his lucrative patent portfolios. His investment in Marathon is probably the greatest validation of the company's business model.

    The other reason I invested in Marathon

    Another primary reason I am a Marathon shareholder, is based on the experience and track record of Marathon CEO, Doug Croxall. After meeting with him and conducting numerous conference calls, I feel confident he can continue to lead Marathon in the successful manner that he has already demonstrated.

    Why Marathon could hit $75

    I've been adding to my position even after this huge run-up, because in my opinion Marathon could hit $75 within 6 to 12 months. Here's my analysis:

    The Signal IP portfolio has damages estimates of about $1.5 billion. If Marathon is able to monetize 10% of this number, that would generate $150 million, at least half of which should go straight to the company's bottom line. With only 7 million shares outstanding, and $75 million in earnings, that would generate about $10.71 per share in earnings. With a conservative PE of 7, that would give Marathon a shareprice of $75, just for the Signal IP portfolio.

    Part of what makes a $75 shareprice possible is Marathon's very low share count of just 7 million. Just to put things in perspective, Acacia (NASDAQ:ACTG) and VirnetX each have share counts above 50 million, more than 7 times Marathon's share count. For example, if VirnetX had a share count of 7 million, it's shareprice today would be $105.

    If we include the Apple case, the potential becomes larger, but I don't know the damage estimates for that case so I'm not including that in my estimate. And of course it's important to remember that Marathon owns 128 patents so the Signal IP portfolio will not be the only source of revenue.

    How realistic is a $75 price target? It all depends on whether or not you believe Eric Spangenberg and his team can monetize 10% of the $1.5 billion Signal IP damages estimate. Given Marathon's impressive performance thus far, some of you may argue that 10% is too conservative, and much larger numbers could be achieved.

    In terms of timing, given the experience, track record and expediency of the Marathon team, we could see multiple large settlements within the next 6 to 12 months. With 87 active defendants, settlements are inevitable. In general I consider 12 months an eternity, however if the share price goes from $14-$75 within a year, I would consider that a home run with the bases loaded.

    Conclusion

    After more than a 2X return, it's tempting to sell, but I believe Marathon could be trading above $30 by year-end. All we need is one large settlement. With minimum downside risk, and upside potential of over $75 per share, Marathon makes an ideal asymmetrical trade.

    In my opinion Eric Spangenberg, Doug Croxall, and the Marathon team could surprise investors with some large settlements and licensing agreements, and if that happens, Marathon shareholders will benefit. This team has already demonstrated its ability to monetize its patent portfolio, and given the recent developments, now we could see monetization on a much larger scale.

    Disclaimer and disclosure: It is probable that the author and his associates have a position in the subject securities consistent with the opinion expressed in this article and they reserve the right to buy and/or sell the securities mentioned in this article, at any time without further notice. For complete disclosure and disclaimer information please click here.

    Disclosure: The author is long MARA.

    Sep 16 12:31 PM | Link | 10 Comments
  • Google's And Facebook's Drone Investments Make Drone Aviation My Top Pick

    Summary:

    • Drone Aviation is extremely undervalued when compared to peers.
    • The company has already acquired the largest and most desirable customer in the world; the US government.
    • An extremely low float could significantly amplify share price appreciation.
    • Drone Aviation has a strong cash position, and has grown revenue above 100% annually.

    When Google (NASDAQ:GOOG), and Facebook (NASDAQ:FB), recently began acquiring drone companies, I took notice. When Amazon's (NASDAQ:AMZN) drone story was featured on 60 minutes, my interest was amplified. When I saw a television commercial that featured Target (NYSE:TGT), delivering products with a drone, I knew I needed to establish a position in drone technology. Google, Facebook, and Amazon have proven successful in predicting future trends, and I believe drone technology is about to demonstrate an aggressive growth cycle.

    One of the most successful investment strategies I garnered from my venture capital investment days was to establish positions early, before companies became household names. With some investments that strategy provided greater than 10X returns.

    I am revisiting that thesis with my recent investment in US-based Drone Aviation (OTCQB:DRNE). Not only do I expect drone technology to demonstrate explosive growth over the next couple of years, but I believe Drone Aviation will continue to be at the forefront of this technology.

    Why Drone Aviation could be the best drone investment

    After over 2 months of research I've determined that Drone Aviation's products are in many ways superior to the competition, both in terms of price and performance. But most importantly, Drone Aviation has already acquired the most desirable and largest customer in the world, the United States government. The most recent defense budget is $821 billion and Drone Aviation has already captured a portion of that. The US military could place more orders this year based on the September budget deadline, and this would add substantially to Drone Aviation's bottom line, and share price.

    But what really makes this a particularly attractive trade is that Drone Aviation represents one of the only primarily pure play publicly traded drone companies. You can invest in drone technology by buying shares of Boeing (NYSE:BA), or Northrop Grumman (NYSE:NOC), but these are not pure play drone investments, and you will not be able to reap the benefits of near-term exponential drone growth. Given the pent up demand for shares in a pure play drone company, newly listed Drone Aviation could be trading at much higher levels within the next few weeks.

    With all Drone Aviation has going for it, you would think the company would be trading at a premium. But Wall Street is not yet aware of this company, and it is currently extremely undervalued when compared to peers. We could see significant share price appreciation over the next few weeks as investors become aware of this attractive trade.

    Drone technology basics

    There are 2 types of drones; tethered and untethered. An untethered drone is probably what you are most familiar with. It's basically a remote control airplane or helicopter. These devices can range from hundreds of dollars per unit to over one hundred million dollars per drone.

    The problem with this technology, is that the wireless signals can be jammed or can fail, and the drones crash. If you spent millions on a drone, and it crashes, that's not a good thing. If it crashes into a commercial airliner or a crowded metropolitan area, the results are catastrophic. Given the risks involved with this type of technology, the FAA has generally banned use around populated areas. However, if you can operate in an unpopulated area, and need to cover a lot of ground in a short amount of time, untethered drones can be very effective. Even with its limited geography, this technology is here to stay.

    The other type of drone technology features tethered drones, in which a drone is connected to a base station via a high strength tether. This is the technology that Drone Aviation's products use. The advantage of this system is that communication cannot be interrupted between the base station and the drone, so the risk of crashing is greatly reduced. Additionally, since power and communication is supplied from the ground through the tether, tethered drones can potentially stay airborne for days, rather than minutes or hours, as is the case with untethered drones.

    But perhaps the most important advantage is that due to the power being supplied from the ground, not from batteries, a tethered drone can produce more lift and also carry more weight, which means that a much higher quality camera can be used. Since a primary purpose of drones is providing visual feedback, the quality of the camera is very important. Generally speaking, the heavier the camera, the better the quality of the video. And if you're in an Army platoon looking for improvised explosive devices or snipers, high-quality video can save lives.

    According to everyone I spoke with, for many applications a tethered drone is far superior, due to the high camera quality, the ability to stay airborne for longer periods of time, and the greatly reduced likelihood of crashes. And, contrary to popular belief, tethered drones are mobile, as has been demonstrated by Drone Aviation.

    Drone Aviation's product lineup

    Drone Aviation currently has 2 product lines; tethered aerostats and tethered multi-rotor copter drones. The first product line is a helium aerostat, which is currently being used by the military, police departments, and other government agencies. You can view this product line by going here. It's really quite ingenious, and its simplicity is one of its greatest assets, because simplicity increases reliability.

    The 2nd product line which will be released later this year, are tethered multi-rotor copters, which will provide significant advantages in remote areas because they will not require helium. Both of these products have a base station that is on a trailer, so the units are mobile. Drone Aviation provides the only mobile tethered drones on the market that have been procured by the Department of Defense.

    I expect tethered copters to be a big hit with major news organizations such as ESPN, CNBC, etc., because since untethered copters are not legal in major metropolitan areas. The tethered copters would provide a whole new level of video coverage. This could provide another large market opportunity for Drone Aviation.

    Why has the military chosen Drone Aviation's products?

    Drone Aviation's products provide 2 distinct advantages which probably explain why the military likes these products so much. First, the tethered drones are preferable over untethered drones in many military situations because of the ability to maintain control and the superior camera systems. But even more importantly, Drone Aviation's military tethered drones sell for about $300,000, considerably less than the multi-million-dollar untethered drones that the military has been using.

    Why Google and Facebook want drones

    Both Ascenta (Facebook's drone acquisition) and Titan Aerospace are focusing on high-altitude drones which cruise close to the edge of the Earth's atmosphere and could provide Internet connectivity to remote areas of the world. Google will be using Titan Aerospace's expertise to contribute to Project Loon, the balloon-based remote Internet delivery project it's currently working on.

    But that's not all the Titan drones will do for Google. These drones will also take high-quality images in real time that could help with Google's Maps Initiatives, as well as contribute to areas like disaster relief. But the main goal appears to be the ability to spread the reach of Google's network. I believe Facebook has similar goals with its drone program.

    Google recently demonstrated how its Loon prototype balloons could circumvent the globe in a relatively short period of time, but the use of Titans drones could give Google even greater coverage. Ultimately Google may use some kind of hybrid system that incorporates Titan technology with Loon technology.

    Or if you really want to speculate, perhaps Google will acquire Drone Aviation, and include tethered drones in its robotic pipeline. That would certainly be beneficial for Drone Aviation shareholders.

    Drones could reduce distribution and warehousing costs

    I predict one of the next uses of drone technology will be warehouse management. If large retailers began using hybrid tethered drones, which would include helium and copter technology, these companies could replace forklift operators, conveyor belts, and a large number of personnel. A hybrid drone that used helium technology for lift, and copter technology for mobility, could move fairly heavy payloads, at a significantly reduced cost to the currently used systems.

    Let's say you had to move a 50 pound item from the back of the warehouse to the shipping department, you could simply program your request into a computer, and the robotic drone would collect and deliver the item rapidly and efficiently. By using tethered drones and brushless motors, this operation could go on 24 hours a day, at very little cost to the company beyond the initial investment.

    As this technology unfolds, I expect other drone applications to develop, and ultimately I believe many areas of technology will become involved. Amazon and Facebook are only the first companies to receive public exposure, but over time we should see many other high-tech names involved.

    Since Drone Aviation will soon have copter technology available commercially, the next logical product would be a hybrid drone. If Drone Aviation enters this arena, which in my opinion it could, this would add one more channel to the company's revenue stream.

    Dr. Phillip Frost has validated my investment thesis

    Drone Aviation just announced that Dr. Phillip Frost has invested in the company, and agreed to be chairman of the strategic advisory board. This is good news for 2 reasons. First, some of my most profitable investments have been a result of investing in companies that Dr. Phillip Frost has also invested in. For example, Dr. Frost took a significant position in MusclePharm (OTCQB:MSLP), at $4, as did I, and within a fairly short time frame, the stock went on to trade above $14. Dr. Frost recognized that MusclePharm was a solid company with a promising future, and his early stage investment paid off. I've also done well with ChromaDex (OTCQB:CDXC), another Dr. Frost investment which more than tripled following my initial investment.

    But his chairmanship of the strategic advisory board could be an even more important factor for investors, given his experience at Northrop Grumman. For 13 years Dr. Frost served as a director for Northrop, a $25 billion corporation that is also involved in the drone sector.

    Drone Aviation CEO Felicia Hess, had this to say: "His extensive government and military relationships during his 13 year tenure as a Director of Northrop Grumman, combined with his capital market expertise, make him an ideal Chairman to lead our newly formed Strategic Advisory Board." I agree with her completely. Drone Aviation is a fairly new company, and Dr. Frost's guidance should accelerate the company's growth trajectory.

    It's also important to note that Dr. Frost also joined the advisory board of MusclePharm (OTCQB:MSLP), and while is difficult to predict how much Dr. Frost had to do with MusclePharm's success, we can assume that he had significant input.

    But what I like most about this announcement is that Dr. Frost's investment in Drone Aviation confirms my investment thesis. Dr. Frost would not have invested in Drone Aviation unless he believed it was a promising company with a bright future.

    You can imagine the level of due diligence his team is capable of conducting, and given his connections within the industry, his investment validates Drone Aviation's business model on many levels, and de-risks my investment considerably.

    I especially appreciate the fact that Drone Aviation was trading in the $.80 range when Dr. Frost invested at $.75, basically at par. There was very little discount, and no warrant coverage, which bodes well for the strength of the company.

    Why now could be the best time to invest in Drone Aviation

    With quality companies, generally the earlier you can invest, the better. Investing in completely undiscovered companies has proven to be one of my best investment strategies. When I first provided my analysis on MusclePharm, the company was totally under Wall Street's radar. Few investors had heard of MusclePharm, and the stock was trading very thinly in the $4 range.

    You can now buy MusclePharm products in Costco, as well as other major outlets, and the company is rapidly becoming a household name. Remember, the time to invest is well before a company becomes a household name.

    22nd Century (OTC:XXII), provided a similar opportunity. When I wrote about this company, it was an unknown microcap, trading at $1 with very thin volume. Within 4 months, the story got out, Wall Street jumped on board, and 22nd Century traded above $6. Investors are now aware of this company, but those who got in early have experienced the greatest profits.

    Other examples include Isoray (NYSEMKT:ISR), which went from $.75 when I first wrote about it, to $3.77 recently, or another microcap I covered, Neuralstem (NYSEMKT:CUR), which went from a very thinly traded $.60 to almost $5 recently.

    Investors are being given a similar opportunity with Drone Aviation, because this is an established company that very few investors are aware of. In my experience, this is often the best time to buy, while volume is low and most investors are completely unaware.

    Drone Aviation has evolved significantly since its inception in 2009

    Even though Drone Aviation just began trading publicly through a reverse merger IPO, it is not an early-stage startup. It was formed in 2009, and the first 3 years were spent developing the company's product line.

    The next 2 years were focused on marketing to the US government, and that started to pay off last year when the government began buying systems. The US government is a very difficult customer to gain access to, and the fact that Drone Aviation was not only successful at this level, but was able to begin selling systems to the government, is a major coup for the company. That combined with the positive feedback coming directly from soldiers in the field, is a strong indicator of Drone Aviation's future success.

    The interview

    I wanted to learn more about this cutting-edge technology, so I initiated an interview with Drone Aviation COO Dan Erdberg. Here are excerpts from that interview:

    Question: What's your most important objective right now?

    Dan: Right now our primary focus is to grow the revenues of Drone Aviation.

    Question: How are you going to increase revenue?

    Dan: To date, most of our revenue has been generated without a lot of sales and marketing investment or personnel. We believe increasing our sales and marketing campaign will have a very positive effect on revenue growth. We would like to increase penetration into the commercial space, security, numerous federal agencies, homeland security, customs and border patrol, departments of transportation, police departments and fire departments. We also want to increase our presence for security during large gatherings, concerts, major sports events, NASCAR etc. These are all areas that we plan on pursuing, and we have already begun to penetrate some of those markets.

    Question: It sounds like a very small sales and marketing division could handle these highly concentrated targets, which leads me to believe that your sales and marketing expenses would be minimal, compared to the potential revenue. Am I correct in assuming that your customer acquisition costs are low relative to the potential revenue?

    Dan: That's correct, we do have relatively low acquisitions costs compared to the potential revenue from a single customer although our sales cycle can often be long, and when we do acquire a customer, it can potentially drive large revenue.

    Question: What kind of sales reps will you be hiring?

    Dan: Our ideal sales rep would be a military veteran or a government agency employee who has knowledge and contacts in our intended spaces, has security clearance, and instant access to large customers. We expect to also use security experts to market our products to police departments, large public events and other security driven customers.

    Question: Do you have any idea how big your sales staff will be?

    Dan: Initially our plan is to rely on our distributors. Some of our distributors have over 50 sales reps and these distributors have recently added our products to their line. We are currently meeting with those distributors and educating the sales reps on our products. At the same time, we plan to independently hire a small initial sales staff of our own.

    Question: So the bottom line is that your direct sales and marketing expenses will be fairly low initially.

    Dan: We believe so.

    Question: Who is your biggest distributor?

    Dan: Currently one of our largest distributors is ADS Inc., and we look forward to expanding our relationship with them

    Question: Who will this distributor be selling to?

    Dan: Military, state and federal government agencies, FEMA, homeland security, customs and border patrol, the Army, the Marines, the Navy, special operations. That's their customer base.

    Question: Who is your biggest potential customer?

    Dan: The US Department of Defense including the Army, Marines, Navy and special forces. From our field experience with soldiers, we believe that our systems could be a Company or platoon level asset. While there are potentially a thousand platoons in the military that could use our systems and each platoon may use more than one system, we know supplying every platoon is unrealistic. If we can secure even a small piece of the platoon or Company level market, we would still be looking at a large number of systems just from the military.

    Question: Who is your next biggest customer?

    Dan: We recently were awarded a contract from a State Department of Transportation for a specific region within that State. If we look across the various State regions and across the fifty States, that can provide a very large opportunity.

    Question: How much do you think this market is worth?

    Dan: If you look at the large metropolitan markets alone that could potentially be users of multiple systems, the overall market size can be quite significant.

    Question: Are there any other potential customers?

    Dan: Yes - there are many applications for our products both in terms of surveillance but also communications, so state and federal agencies represent large potential customers for us.

    Question: How can your system be used for security?

    Dan: Our systems can be used for surveillance to detect suspicious activity. Following what happened at the Boston Marathon, there is a heightened need for security at large events, where on the ground resources are not sufficient. We've been working with contractors who have used our devices for NFL and NASCAR events, as well as large concerts and other large gatherings. We're just starting to penetrate these security markets.

    Question: How could your product be used by homeland security?

    Dan: We believe there is definitely a need for increased surveillance and security on both our southern and northern borders. There are tunnels being used for transporting personnel, guns, and narcotics to the United States. We believe our products can help solve that issue.

    Question: How are most people illegally crossing the border?

    Dan: They just run across. There is such a large area to be watched that with the limited resources border patrol currently has, it's impossible to detect all of the even simplest crossings let alone the more sophisticated options.

    Question: What high-tech solution is homeland security using now?

    Dan: Recently homeland security began looking at multi-million dollar tethered aerostats that came from the Department of Defense. Those are currently being evaluated. The big advantage that tethered aerostats provide is a persistent eye in the sky. The disadvantage is that the Department of Defense aerostats are very large and expensive to operate, they are run by a team of outside contractors, and they are also not mobile. Our product is not only very tactical but also mobile. It can be pulled behind a truck while it's in the air. It can survey a large area on the go. Also, it can be run by 2 government employees, as opposed to a large group of outside contractors. And most importantly our military version products cost about $300,000, as opposed to millions. For those reasons we feel homeland security and border patrol could find our products attractive.

    Question How far can your system see?

    Dan: Several kilometers, which on the border is quite far. Many times you just want to see several hundred feet, or less than a kilometer when you're looking for activity.

    Question: How big of a factor is mobility?

    Dan: We believe that mobility is very important. You can hook our aerostats up to a truck and drive while it is still in the air doing its job. There is no other tethered aerostat on the market today that is also mobile that we are aware of that has been procured by the Department of Defense.

    Question: Why is mobility important on the border? Can't you just find a place where people regularly cross, and leave your system there? Why do you need to move it?

    Dan: After smugglers start getting caught in a particular area, they move. The fact that we can move also, gives us a big advantage. The other big advantage is that by constantly moving our systems, smugglers never know where they are, and even if the system isn't in a particular area, smugglers realize that it could be, which could help deter crossings.

    Question: In terms of patrolling our borders, how cost-effective is your system compared to what's being used now?

    Dan: When you look at what's being used now, which would either be a large Predator Drone or small Cessna airplane, or a helicopter, the cost of operation could be thousands of dollars per hour in addition to their high acquisition costs. And then you have the Department of Defense's multimillion dollar tethered aerostats that are very expensive to run because it takes a whole team of contractors to support them. Outside of the resources they currently have, there are limited alternatives right now. According to FAA rules, untethered drones cannot fly legally unless they are granted permission, which is rare. That's why we believe we are in such a sweet spot right now. The cost to buy and operate one of our systems is a mere fraction of what's currently being used.

    Question: How many systems would it take to cover the entire southern border?

    Dan: It's hard to say as the border is vast and expands across several States. A well coordinated network of our systems connected with ground infrastructure we feel would be a useful solution.

    Question: Are there any other potential customers you haven't mentioned?

    Dan: Military and other similar agencies to those discussed above from other countries could provide a large customer base as well. All of our allies provide an opportunity for us. In general, all military and all these similar agencies are potential customers. And this doesn't even begin to touch on potential commercial customers/applications.

    Question: Have you sold any systems to police departments yet?

    Dan: Our systems are being used by local police departments for anything from monitoring traffic to monitoring crime scenes. They can also use it for any security application. Another overlooked application is prison security.

    Question: If we take our top 100 metropolitan cities, how many of your systems could each Police Department use?

    Dan: We could potentially estimate approximately 1 dozen per large city, and the smaller cities will have a need also, but on a smaller scale, perhaps only needing 3 or 4 units.

    Question: Could your system be helpful in a natural disaster like hurricane Katrina or hurricane Sandy?

    Dan: We believe FEMA could use our systems following a natural disaster, because you could reestablish a communications system immediately. Most people don't realize that natural disasters like hurricane Katrina or hurricane Sandy temporarily disable all cellular communication, at a time when it's needed most. Our system could help address that. In addition, our systems could help find victims either trapped in rubble or on rooftops of houses waiting to be rescued.

    Question: Physically, how large is your product?

    Dan: When deflated, it all fits in one small trailer - when inflated, it can be towed by any small truck. It's a self-contained system that can be launched from scratch within 15 minutes.

    Question: Can you talk about your product lineup?

    Dan: We have 2 product lines right now (ranging from military versions to commercials versions), the first which is commercially available, tethered aerostats that we've been talking about. These are the ones currently being used by the military, police departments and State Department of Transportation. The 2nd product that we will be launching later this year is a multi-rotor drone that is tethered. It uses a lot of the same technology that our first product line uses. The only difference is that the muli-rotor drone does not require helium. This will be important for remote locations where helium is not readily available and we plan to miniaturize the systems to allow mass markets to use them.

    Question: How safe is the multi-rotor copter?

    Dan: The advantage of multi-rotor drones, is that if one goes out, the copter can safely land with the other motors. And of course the fact that it is tethered, gives it a big safety advantage over any untethered drone.

    Question: What's the advantage of the multi-rotor copter over your helium product?

    Dan: The biggest advantage with the multi-rotor copter is that you don't need helium canisters. If you're in the middle of an Afghanistan desert and you don't have access to helium, the multi-rotor copter would be a better solution. The other advantage is that it's less expensive to launch a multi-rotor copter than it is a helium aerostat, the cost of which averages about $1000-$1500 for the initial launch. Once it has been launched, you don't need to fill it up again unless it's been deflated.

    Question: Will untethered drones ever be widely adopted?

    Dan: I believe untethered drones are inherently dangerous, because they are on their own in the air and either onboard malfunction or ground communication between the base station and the drone can be interrupted, either intentionally or through technical failure. When that happens, the drone can go wherever it wants, and there have been some instances where these out-of-control drones have almost hit commercial airliners.

    Question, Do you think that untethered drones will ever be legal?

    Dan: Yes, for certain applications in certain unpopulated locations. But in populated areas, with commercial air traffic, I think the dangers are too great for legalization but I guess we'll have to wait and see. In those cases, tethered drones would be preferable.

    Question: Could you describe how the military will be using your system?

    Dan: The military can use our tethered drones either for ISR or for enhanced communications. A fairly typical military application could be aerial surveillance of a remote operating base. Our system could provide 360° visual surveillance for several kilometers. Another application would be when you are moving troops into a hostile area and you don't know what's ahead of you. Our system could determine whether or not roadside bombs were being planted ahead of the troops. We could also detect snipers and hidden troops. Our system could help the military clear routes because it can see several kilometers out. One of the most promising applications is detecting IED's, improvised explosive devices, which have been so damaging to our troops. Our systems also can extend the range of communications among soldiers on the ground making it easier to coordinate strategies or activities.

    Question: Why can't the military just use small untethered drones?

    Dan: They do and they use a lot of them, but small untethered drones are not that effective for military use because they can't handle the weight of a high-quality camera, so the visual information provided is limited. They also can't stay up for very long, so they need to be landed and refueled or swap batteries fairly regularly. And these things are so hard to control that for around every 5 takeoffs, one is lost. With hundreds of takeoffs, a lot of untethered drones get lost, which ends up costing the military significantly. The soldiers we spoke with all preferred a system like ours because of the high quality camera, and because it could stay up in the air for long periods of time and didn't need to be retrieved after a landing. From what we heard, one of the most dangerous jobs is to retrieve a crashed drone because soldiers can be potentially injured or killed during that retrieval process.

    Question: So let me get this straight, the soldiers you spoke with said they would prefer your system to the untethered drone system they were currently using?

    Dan: That's correct, they said they would have liked to have our systems while they were deployed

    Question: Can you elaborate on your relationship with the US military?

    Dan: Last year our products were put in the hands of various arms of the military. They passed the safety clearances and were given all the rights and authorities to be used by soldiers in training and evaluation. These products were purchased and delivered to the military. The military is putting these products through extensive test procedures and providing feedback as to changes for future orders. We hope the military is not investing all this time and money just for a handful of units. We believe they're doing this so that they can say we put your unit through the paces, we've made the required change requests, and now we feel this is ready to be fielded. At that point we potentially could have a larger order. So what we believe will happen is that if a few platoons start using our products, it will create demand from other platoons. The Army has published information talking about how significant our system is for them and how useful it is. This information was published by the Army without our knowledge. We are hopeful about the future with the military and we want to support our soldiers through larger procurements in the future.

    Question: Is there anything else you can tell me about your relationship with the military?

    Dan: We believe the relationships we have with our Army customers are very good as these relationships have been built over the years. We have received repeat orders from each of our Army customers for additional parts and supplies while they continue to evaluate and operate the systems. What we believe is an advantage is the fact that over the course of our workings with these customers, they have requested several enhancements to the system to fit their needs and we believe these have been successfully integrated. By spending time with soldiers at bases and in military installations who are running the systems hands on, we receive their feedback, turn around and implement those ideas and concepts to make the systems more effective in theatre - we believe this is a strong asset.

    Question: What kind of feedback have you received from the military?

    Dan: Based on what was published by the Army and all of the feedback we have received, our system works and they like it.

    Question: Are there any near-term events we should know about?

    Dan: We recently completed the US Army's NIE 14.2 exercise with the WASP systems which are operated by SMDC. Additionally we completed the delivery of a system purchased by a State Department of Transportation, which was recently demonstrated for State officials from various agencies. We will also continue to support and work on additional procurements with the Army at Fort Polk, LA where they operate two BiB 250 systems to train soldiers during rotational exercises

    Question: How are you able to get the military to become one of your main customers?

    Dan: We try to be fast and effective at supporting their requests and we hope the more the systems are used in tests and training, the more exposure they will receive and that could lead to more soldiers wanting the capability

    Question: Does the military have any budget spending deadlines that would lead you to believe that you could receive orders by a given date?

    Dan: Typically the Government fiscal year ends at the end of September, so funds budgeted for procurement this year would be awarded prior to the end of September.

    Interview concluded here

    Key points from the interview

    • The total addressable market appears to be well over $5 billion.
    • The US military is a great customer, given its $821 billion defense budget and practically unlimited access to capital.
    • With the government's fiscal year ending in September, Drone Aviation could see new orders before that deadline. Given that the initial orders were probably small, follow-up orders could be significantly larger. In other words, the government tends to sample first, and then place larger orders.
    • For many applications, tethered drones are superior, particularly in metropolitan areas and in the battlefield.
    • Drone Aviation could help solve the currently unsolvable border control problem.
    • One of the company's large distributors already has customers which include state and federal government agencies, FEMA, homeland security, customs and border patrol, the Army, the Marines, the Navy, special operations. Given that this distributor already has its foot in the door, sales into any of these areas are probable and could dramatically increase Drone Aviation's top line revenue.
    • Drone Aviation provides the only mobile tethered drones on the market that have been procured by the Department of Defense. More importantly, these products could help save countless lives in the field.
    • With a $300,000 military version price tag and $100,000 commercial version price tag, Drone Aviation's products are significantly less expensive than most of the other multimillion dollar alternatives. On top of that, it appears the soldiers like Drone Aviation's product better than the more expensive products.
    • The company has managed to sell systems to the US government, with practically no sales or marketing department. Once the company begins aggressively pursuing sales and marketing, we should see a significant ramp up in revenue.

    How large is Drone Aviation's market?

    I can only estimate market size for a couple of Drone Aviation's market segments, but those markets alone are sizable. For example, on the military front, a platoon has anywhere from 30 to 60 soldiers. I estimate that each platoon could have at least 4 systems. With a total of 3000 platoons, that provides a potential market of 12,000 systems. With an average cost of $300,000 per system, that is a total addressable market of $3.6 billion. Even if Drone Aviation could only capture 10% of that market, that would still be $360 million in revenue.

    Another fairly easy market to estimate would be systems used by police departments. If we take the top 100 metropolitan cities, I estimate that each city could use at least one dozen units, or a total of 1200 systems. Since these cities wouldn't need the $300,000 military versions, at a cost of $100,000 per system, this would produce a total addressable market of $120 million, just for the large cities.

    The smaller cities would probably only use 3 or 4 systems, but we could count on another 1200 systems for the smaller cities, at a bare minimum. This would bring the total addressable market for police departments to $240 million. 10% of that number would be $24 million, which could go straight to Drone Aviation's top line. Ultimately I believe Drone Aviation will achieve much greater than 5% penetration.

    The other addressable markets are more difficult to estimate, but I believe the total addressable markets should exceed at least $5 billion. For example, monitoring our borders would definitely require a large number of systems, but it's impossible to estimate just how large that number would be.

    Drone Aviation's strong revenue growth

    Drone Aviation, taking into account its recently purchased subsidiary, achieved revenue growth exceeding 100% from 2012 to 2013. Drone Aviation is on track to produce significant revenue growth for 2014. Here are the adjusted figures taken from recent SEC filings:

    • 2012 revenue $390,000
    • 2013 revenue $848,000
    • 2014 revenue first 6 months: $613,000, ($354,000 revenue plus $259,000 in deferred revenue. Deferred revenue represents units sold but not yet delivered).

    Drone Aviation is on track to generate revenue above $1.2 million for 2014, and if the US government moves fast enough to get orders in before the September deadline, 2015 revenue could provide year-over-year revenue growth well beyond 100%.

    Drone Aviation is severely undervalued when compared to peers

    There are no publicly traded primarily pure play drone companies other than Drone Aviation, so the best comparison is Google's recent purchase of Titan Aerospace which was private at the time of acquisition. We don't know what Google paid, but we do know that Titan turned down a $60 million offer from Facebook, so we can assume Google paid significantly more than $60 million, since it actually got the deal done. My guess is that Google valued Titan above $80 million. But to keep estimates conservative, let's say Titan is only worth $60 million. By the way, Facebook didn't give up, it went on to buy another drone company, Ascenta, a development stage company which is developing solar powered drones.

    But where it really gets interesting is that when you look at Titan, it appears that it could be a company with nothing more than some very bright engineers with a concept. There are no products sold commercially, and I've been told that a successful prototype has not yet been developed, although there has been no public confirmation about the level of prototype development. It's a private company, so information is sparse. Google's Titan drone is a great idea, and will certainly hit the market someday. I love the concept! But it appears that commercialization or even a working prototype could be years off.

    Another private sale occurred a few years ago when Boeing bought Insitu for a reported $400 million. Insitu is a drone developer and manufacturer based in Oregon. The company has developed an impressive lineup of products, however they are all untethered, so applications are limited to unpopulated areas.

    If Titan, a pre-revenue and possibly pre-prototype company is worth at least $60 million Drone Aviation should be given a higher valuation than Titan given that Drone Aviation is successfully selling products now. Commercial companies are usually valued at steep multiples when compared to pre-commercial or pre-prototype companies like Titan.

    When we use Insitu as a comparison, and its $400 million valuation, we could also draw the conclusion that Drone Aviation should be valued considerably higher than its current $18 million valuation.

    Drone Aviation's current valuation of $18 million is ridiculously low.

    According to the most recent company presentation, there are currently 17.7 million common shares outstanding. At the current share price, that gives Drone Aviation a market capitalization of about $18 million.

    That's unbelievably low given the potential growth of this sector and the rate at which the company is growing revenue. With peer comparisons valued between $60 million and $400 million, I believe once Wall Street becomes aware of this company, its valuation will rise to a more appropriate level.

    What's appropriate? One could easily argue that Drone Aviation should be given a valuation above Titan's $60 million. If Drone Aviation announces some large sales to the military this summer, we could see a considerably higher valuation.

    Why is Drone Aviation so undervalued?

    The primary reason Drone Aviation is so undervalued is that Wall Street is completely unaware of this company. The company just completed a reverse merger IPO and is often the case with new companies, it takes time for Wall Street to take notice.

    That will change. Once investors realize the level of undervaluation and that Drone Aviation is growing revenue in a new and promising sector, buyers will come in, which could drive the shareprice to a more reasonable valuation. It would not be surprising to see Drone Aviation trading at a premium.

    Drone Aviation's low float could reward today's investors

    With a float of just 2.7 million shares, Drone Aviation's shareprice could rise significantly if just one institutional investor begins to establish a long position. I prefer low float investments, because with a limited supply, once investors become interested in a company, it's common to see short-term share price appreciation well beyond 100%.

    Look what happened with low float Marathon Patent Group (OTCQB:MARA), one of my recommendations last year, when it went from $4-$12. The same thing occurred with low float Organovo (NYSEMKT:ONVO), which also went from $4-$12 within a very short time frame. Low float amplifies potential share price appreciation.

    Drone Aviation's cash position

    As of the most recent SEC filing, Drone Aviation has $1.728 million in cash. The company's only debt is a $110,000 note payable to the Oklahoma Technology Commercialization Center.

    Here are the links to the most relevant SEC filings:

    http://ir.droneaviationcorp.com/all-sec-filings/content/0001013762-14-000969/0001013762-14-000969.pdf

    http://ir.droneaviationcorp.com/all-sec-filings/content/0001013762-14-000958/0001013762-14-000958.pdf

    http://www.sec.gov/Archives/edgar/data/1178727/000101376214000506/form10q.htm

    http://www.sec.gov/Archives/edgar/data/1178727/000101376214000657/form8k.htm

    With an estimated $1 million maximum burn, and no income, the company is financed for at least one year. Of course in reality, the company is generating revenue, so I don't foresee near-term financings.

    5 reasons Drone Aviation's shareprice could rise short-term

    Number 1: Drone Aviation is the only primarily pure play publicly traded drone company. With all the media attention drones have been getting lately, I believe there is a high level of pent up demand for drone investments. Once the word gets out, particularly with major media exposure such as the Wall Street Journal, CNBC, or Bloomberg, we chould see a substantial rise in Drone Aviation's shareprice.

    Number 2: With the Government fiscal year ending in September, last-minute spending could bring additional revenue to Drone Aviation. If any of these orders are large, this would have a very positive effect on Drone Aviation's shareprice. Most importantly, this is a catalyst that would occur before the end of September.

    Number 3: Given the high level of interest in drone technology, I expect other analysts to come on board with buy recommendations. This could also drive Drone Aviation's share price higher.

    Number 4: With such a low float, any level of interest could drive the share price significantly higher.

    Number 5: The level of undervaluation is so extreme, that with any level of Wall Street awareness, the share price should rise to a more appropriate level.

    Why Drone Aviation could be a good long-term investment

    After many hours of conference calls with COO Dan Erdberg, I feel confident in his ability to grow this company. He is smart, cautious, and conservative and in my opinion, he will deliver.

    Currently Drone Aviation is in the infancy stage of commercialization and has already attracted a very large customer, an ideal combination. This is the time in a company's development cycle where exponential revenue growth and extraordinary share price appreciation are common. If Drone Aviation continues to receive US government orders, at some point these orders will increase in size, and Drone Aviation could be trading at a large multiple of today's shareprice.

    What's the risk?

    While it appears that the government could be placing more orders this year, those orders could be delayed, maybe smaller than anticipated, or may not occur at all.

    As the restricted shares become tradable, we could see some selling pressure, which could cap the share price.

    Drone Aviation provides the only mobile tethered drones on the market that have been procured by the Department of Defense, but given the interest by the US government other companies could develop similar products and provide competitive pressure. This is a long-term risk, because product development would take years, and establishing a relationship with the US government could take even longer.

    As is the case with all startups, great products do not guarantee success. Management still needs to execute, and given the very nature of startups, one cannot predict whether or not management will succeed.

    Conclusion

    Google and Facebook's drone investments should not be ignored by investors. Both companies have proven successful at predicting future trends and I believe drone technology is at the beginning of its growth curve.

    Drone Aviation has a game changing product which captured the attention of the largest customer in the world, the US government. You have to remember that the government is a customer capable of placing extremely large orders, due to its practically unlimited access to capital. If the US government continues to buy products from Drone Aviation, just one large order could catapult Drone Aviation's shareprice well beyond today's level.

    Drone Aviation is extremely undervalued when compared to peers. Most investors don't know about this company yet, but as awareness spreads, I expect the company to be fairly valued, or even valued at a premium. We are in the early stage of the drone commercialization cycle, and I expect strong growth going forward.

    Since Drone Aviation is the first publicly traded primarily pure play drone investment, CNBC, Bloomberg, the Wall Street Journal, or other major media outlets could publicize this opportunity. This is a great story given the recent investments and interest shown by Facebook, Google, and Amazon. This could create demand for shares, and would amplify any share price appreciation. I have established a long position in anticipation of a near-term rise in Drone Aviation's share price.

    Disclaimer and disclosure: It is probable that the author and his associates have a position in the subject securities consistent with the opinion expressed in this article and they reserve the right to buy and/or sell the securities mentioned in this article, at any time without further notice. For complete disclosure and disclaimer information please click here.

    Disclosure: The author is long DRNE.

    Tags: DRNE, goog, fb, amzn, tgt, noc, ba
    Sep 03 10:05 AM | Link | 23 Comments
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