Updating A Speculative Idea And Sharing A New One

by: Alan Brochstein, CFA

While speculative stocks are certainly not my main focus, I run across interesting ideas all the time. I shared some basic guidelines for speculation in February, when I declared that "speculation isn't inherently bad." Here were the thoughts I had about smarter speculation:

  • Restrict speculation to a limited amount of available capital
  • Restrict position sizes within speculative part of portfolio
  • Make sure risk/reward is understood in some sort of analytical frame-work
  • Remember stocks aren't pieces of paper
  • Make sure that the company is capitalized adequately
  • Look for insider ownership
  • Look for signs of smart management
  • Try to avoid "all-or-nothing"
  • Look for signs of excessive investor interest (bubble)
  • Avoid speculating on margin

In that same article, after explaining each of these points, I shared an example of Vringo (VRNG), which was a formerly overly-hyped speculative name that failed to live up to the billing but that I think has a reasonable shot at another run. It's a binary event for the most part, and waiting for it to play out has sapped investor interest. In fact, it fell almost every single day since I shared my perspective on it, until suddenly spiking on Thursday:

This sharp move, which I will explain, serves as a reminder that things can change very quickly. The news that hit the market wasn't even a press release. Instead, Benzinga posted an alert on the name with a link to a court document indicating that VRNG is in settlement talks with Microsoft (NASDAQ:MSFT). If you have any doubt, check out the one-minute chart:

Benzinga posted the document at 1:08 ("Vringo, Microsoft Discuss Settlement), which followed a 12.57 headline of "Vringo Spikes Higher". I had posted the MSFT lawsuit as one of the catalysts, though the Google (NASDAQ:GOOG) lawsuit is obviously the most important. I think that investors were excited because of the potential for not only potential cash coming in but also perhaps how it might impact GOOG. Fellow contributor "Patent Plays" suggested that MSFT may even be in the process of buying the company in an attempt to compete better. I think that this is probably a stretch, but the bigger picture is that perhaps investors have a greater appreciation for VRNG's potential.

I also wanted to share publicly my view that I think VRNG is more than a one-trick pony (the GOOG litigation). Of course, how that plays out will have a very large effect on the company, but, having listened to the Q4 conference call a few weeks ago (no transcript available on SA yet), I have to say it was a major, major improvement from the prior conference call. I continue to get the impression that the team, including both management but also directors, is top-notch here. VRNG is setting itself up for future opportunities. This is why Nokia (NYSE:NOK) selected them, and I believe that successful resolution of the MSFT litigation would further boost their reputation in the IP space.

I recently encountered another speculative idea that I find quite interesting, PLC Medical (OTCPK:PLCSF). Unlike VRNG, this one is totally off the radar screens of most investors. PLC is tiny: According to the 10-K, the company has about 55mm shares outstanding, giving it a market cap of just $8.8mm (though I think that it is actually 65mm shares after an additional financing). Now, ordinarily I wouldn't pay attention to such a tiny company and would assume that it should be left to individual investors due to its size, it's worth noting several large institutional investors participated in a recent equity offering, including Brio Capital, GRQ Consultants, Alpha Capital Anstalt and Genesis Capital Advisors. Before I share some thoughts on these institutions and why they are bothering with such a tiny company, let me share some background on PLC.

The company, based in the Boston area and founded in 1981, is focused on preventing a very narrow disease known as contrast-induced nephropathy {CIN}, which can result from a reaction to angiographic imaging procedures. In plain English, about 10-20% of patients, who tend to be older and to have had prior kidney damage, can be hurt or even killed by the toxic contrast agents used in the 7mm cardiac or vascular imaging procedures done in the world each year. The consequences can include death or costly hospitalization and can result in the need for a kidney transplant.

The good news is that these at-risk patients can be easily identified though a blood test. The problem is that there really isn't a good standard of care, and there is no FDA-approved device or drug to prevent CIN. The methods used, primarily hydration, are ineffective. This is where RenalGuard, PLC's solution comes in:

The device facilitates a high rate of urine output, which prevents the contrast agents from clogging tubules and limits exposure to the kidneys. Because it's automated, it reduces side effects associated with too much or too little hydration and is easily incorporated into the Cath Lab. While the largest near-term opportunity upon FDA approval would be in cardiac imaging tests, the device has some other applications, like imaging for TAVI (the new heart valve technology pioneered by Edwards Life Sciences (NYSE:EW)), chemotherapy, sepsis, and kidney transplant.

In many ways, PLC is a binary investment, as the company's success hinges upon getting FDA approval. It is currently enrolling patients in a pivotal trial. They suggest it could be another two years before the trial is complete, but there will be updates along the way as interim data becomes available, perhaps later this year. One never knows how the FDA will ultimately conclude, but I believe that there are lots of reasons to be optimistic. The company was approved for sales in Europe, and there has been data shared at medical conferences and published in peer-reviewed medical journals. PLC actually has sales outside the U.S. through distributor relationships, though without FDA approval, I don't expect that clinicians will rapidly adopt the technology. Still, their recent press release detailed impressive growth, with RenalGuard sales growing 157% in Q4 to $485K as the company entered Brazil. Disposables grew 27%. For the full year, RenalGuard sales grew 96%. It seems that the device is safe and works, reducing the incidence of CIN rather dramatically, perhaps as much as 70% according to the previous studies. Hopefully the current trial will confirm this experience.

If you are interested in looking more closely at PLC, a good starting point is their investor presentation. What I really want to discuss is the "jockeys" rather than the "horse", though the "horse" sounds like a great opportunity. With 15% incidence, one can project a possible 1mm tests a year, and this doesn't take into account the other potential applications. At roughly $500 per procedure, the market could total $500mm per year. It is clearly this large opportunity that is attracting institutional investors. Even if they get only 10% penetration and end up valued at 3X sales, the company would be worth more than $150mm.

Before I discuss why investors might want to figure out why these institutional investors are getting involved and how they might help the company progress, I want to briefly mention management, as this is an area that I think plays a role in attracting these outside investors. CEO Mark Tauscher is an industry veteran who has been running PLC since 2000. He had previously held marketing and management roles at Quinton and Marquette Medical Systems after spending 21 years at Hewlett-Packard Medical. CFO Greg Mann joined in late 2011 having previously served as a divisional CFO for publicly-traded Virtusa. He worked at Acusphere, an contrast-agent company, so he knows the industry to some degree. Susan Papalia, VP, Clinical Affairs, is now on her 4th emerging medical device company and began her career at Boston Scientific. She joined in 2011 too and has 25 years of clinical trial experience. The Scientific Advisory Board consists of 5 MDs with expertise in interventional cardiology and nephrology, with three focused specifically on CIN prevention.

One of the challenges for PLC is that it often comes to market to raise funds for its research efforts. Most recently, the company announced a $4mm financing in February. You can see the details here, but approximately 27mm shares along with approximately 27mm warrants (.20) were sold at .15 per share. The buyers have an option through 11/21 to increase their purchase by 50% on the same terms. Key investor GCP IV, LLC (Genesis Capital) restructured $5.25mm of debentures, returned 12.5mm previously issued shares and increased the number of warrants it holds by over 30mm. This is rather complex, but potential investors should consider two sides of the coin. On the one hand, there could be substantial dilution ahead, though in a way that brings needed cash to the company in the future. On the other hand, Genesis appears to be very committed after getting involved in 2011, when it made an initial $4mm investment.

Genesis, which is run by Ethan Benovitz, Daniel Saks and Jaime Hartman, also provided $1mm financing last July. It's worth noting that they have been involved with InspireMD (NYSEMKT:NSPR). What's interesting is that they invested there before Sol Barer, the founder and Chairman of Celgene (NASDAQ:CELG), showed up and was elected as Chairman in late 2011. While the stock has run into trouble lately, one has to wonder how bringing in a well-known director might impact the perception of tiny PLC.

Someone who knows well the importance of people is Barry Honig of QRQ Consultants, who announced a position on March 25th. He isn't permitted to own more than 9.99% of the common stock (blocker provision), so not all of his securities can be converted currently, but the filing describes 3.83mm shares, 1.12mm shares convertible from a 5% senior secured convertible debenture (.10) and 9.38mm warrants personally. GRQ holds 1mm shares, 1.68mm of the convertible debenture and 15.5mm warrants. Honig got involved with Neuralstem (NYSEMKT:CUR) last summer. The stock more than doubled when he disclosed his 10% stake and still trades substantially higher than when he became involved:

I say that Honig knows the value of management because of what he did at Pershing Gold (NASDAQ:PGLC), another interesting speculative company that has done quite well of late:

That doesn't look like most gold-miner charts! He has brought in outsiders with significant operational experience to run Pershing. Fellow author "Devon Shire" conveyed this quite well when he discussed Pershing as a "bet on the people". Further, some may be aware that legendary investor Phil Frost has at times followed Honig's lead, and Dr. Frost, of course, is very interested in the Health Care sector.

I mentioned two other holders as well, including Brio Capital (Shaye Hirsch), who is also "blocked" from the potential full conversion, but disclosed a 9.99% position of 6.4mm shares. Similarly, Alpha Capital Anstalt (Konrad Ackermann) of Liechtenstein disclosed a 6.34mm share position. Insider ownership will be updated more clearly when the proxy is filed in April. Beneficial ownership in the proxy a year ago was 2.89mm shares, but this didn't include options that hadn't yet vested. The company listed in its 10-K last week that there are 5.6mm options outstanding with an average exercise price of .21. As you can see, that's in the ballpark:

The stock has traded as low as .07 and as high as .35 in the past two years, so it is closer to the low than the high. In all fairness, though, the market cap and enterprise value have increased somewhat as the share-count, warrants outstanding and convertible debt have all increased.

So, tying it all together, I find it very interesting to see so much institutional involvement in a tiny company like PLC. As the company notes, it will need more funds to make it through the clinical trials. The current capital structure, with warrants and convertible debt, could provide some liquidity, but it appears that the several institutional investors involved are prepared to see the clinical trial process through as more funds become necessary. While any company whose destiny is so dependent upon FDA approval makes it a highly speculative investment, it might make sense to explore further what these investors see in PLC. Having just seen some exciting news come out of nowhere on VRNG, I am reminded that surprises can happen and can move the stocks dramatically. If I had to read between the lines here, I would suggest that we might see involvement by a more strategic investor. Even if not, though, for patient investors, PLC could provide nice returns later this year if the interim data from its pivotal trial reinforces the safety and efficacy of previous studies.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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