This is a case study on one investment that wiped away a significant amount of my savings, and this is also an attempt to formulate and crystallize my thinking going forward as an aspiring investor. Needless to say, I've learned a great deal about myself and my investing over the course of this dreadful year.
A Naïve Investor
During my junior year of college, I came across a company called Integrated Environmental Technologies (OTCPK:IEVM). The stock was trading at a mere $0.05 per share and had an enterprise value of ~$11 million. During this time, I was looking to invest in a company that had a 50 to 100-bagger potential, as I had read extensively on Benjamin Graham's success in investing in a little known small-cap called GEICO.
From the get-go, IEVM looked like a good setup: It was written up on valueinvestorsclub.com by a contributor with a good track record; the capital structure seemed flexible compared to its peers; a few institutional investors were involved, and management had good experience (the CEO was the ex-chairman of the board of directors of Hologic, Inc. (NASDAQ:HOLX), a $10 billion medical device company. He is also the founder of a boutique investment bank, as well as a venture capitalist).
What did I find so attractive about IEVM? The company operates in the oil and gas space by providing E&Ps a biocide called Excelyte. Excelyte kills hydrogen-sulfide (H2S) producing bacteria that is fatal to oil field workers and corrodes expensive equipment. As oil prices plummeted from $100 bbl to $50 bbl, and then from $50 bbl to the high $20s bbl, the management team at IEVM pitched its company as having an inverse relationship with the price of oil. According to the company, low oil prices translate into a lack of production, and a lack of production translates into idle equipment that is vulnerable to H2S, therefore driving the demand for Excelyte. The company's investor presentations gave very sexy projections about the future of near-term revenue growth, and it justified the growth based on the prices Excelyte was clearing at, as well as the number of E&Ps that had the potential to benefit from the biocide.
The issue (and a very significant one at that) was the company's lack of cash flow generation. I, however, glanced over that issue and took management's words at face value: it was headed to cash flow breakeven, it wasn't facing any competition and would be able to grow its customer base significantly, yada yada yada. I happily built a financial model based on its optimistic projections of customer acquisitions and prices…and ta-da! I had a company that was about to grow its earnings power significantly in the coming years.
The Due-Diligence Process
I made it a goal to contact management, employees, institutional investors, and potential end-users. As this was a concentrated position, I had to try to contact these people to have conviction in my investment.
The first call I did was with the CFO. His direct-line was listed on an old press release, and I had already put off calling him for a few days. I ran over what I had rehearsed, quickly dialed the number with my shaking hands, and slammed the phone to my ear. The phone began to ring and my heart began to race.
After the second ring the CFO answered.
The beginning of the conversation went something like this:
"Hi, my name is Anthony Thorpe and I'm an investor who's interested in learning-"
"Are you reading from a script?"
"It sounds like you're reading from a script - what company do you work for?"
"No one, I'm a private investor."
Eventually he accepted my questions. I wanted to understand the competitive landscape, especially concerning the big oil service companies. I also wanted to gather more color on the roll-out process and obtain information on the customer acquisition front. Aside from the beginning of the conversation, the call left me feeling good about my holding.
After that, I began reaching out to IEVM's customers. I found out the email structures of the customers and began sending out an army of emails (about 40 in total) asking about Excelyte. Not one person replied to my emails, but luckily I was able to get the opinion of an engineer who seemed positive on Excelyte and the entire movement toward "green fracking" (Excelyte also disinfects water used in the fracking process). Another engineer whom I met at a party (his girlfriend studied at my school) told me the H2S problem is essentially the "cancer" of oil and gas. Ultimately, in hindsight, I doubt many of the people I reached out to had heard of Excelyte before.
I then reached out to the newly hired vice president who had a great public track record operating a subsidiary of one of IEVM's competitors. While he likely found me to be very annoying in my attempts to contact him, he eventually told me that the product worked well but that the sales cycle was very long (not good for a company that generates insignificant sales and burns cash hand over fist).
London Bridge is Falling Down, Falling Down…
After connecting with one of the institutional shareholders, I shared my thesis with him and we connected on a call the next day. In the first minute of our conversation, it was clear that he was not happy about his investment, and for good reason. I learned that the management was acting without a "sense of urgency," and for a company that was just rolling out its flagship product, urgency is all that matters. A lot of eye-opening things were said on the call, and afterwards I felt dead…absolutely dead inside.
The red flags continued to amass themselves: the VP left the firm; restricted covenants started to be added to the debt; a long-time member of the board suddenly left (although I was told he left due to old age), and it was clear that my investment was in danger.
I didn't sell a single share even as the bad news continued to pile: all the red flags, the horrendous earnings reports, the fact that my original thesis was barely (if at all) intact. The only thing that was intact was my faith, and even that was wavering.
I became depressed; homework was tossed aside; classes were skipped; afternoons became my mornings; I couldn't sleep; friends became a distant memory. The more I stared at my brokerage account, the deeper I fell into the bottomless pit.
The Way Forward
I eventually sold my position with a loss exceeding 50 percent. A few days later, the CEO resigned and the stock plummeted further.
While failures of this magnitude are indeed painful, they can be a very valuable source of education.
Some things that I've learned:
- The better the "story," the worse the investment return;
- never let your discipline diverge (i.e. don't invest in "sexy" cash-losing companies that management touts as being on the verge of a turnaround - especially if their ownership is mostly in the form of options);
- the more financial modeling you must do to justify buying the stock, the better off you are not buying it;
- the more binary the catalyst, the less concentrated your position should be;
- when material bad news comes your way, sell the stock, especially if it discredits your thesis;
- capital structure can worsen at the stroke of a pen;
- when management doesn't have the right industry experience, be very wary;
- when you start justifying your investment with faith, sell the stock; and
- when the investment worsens your health, sell the stock.
Disclosure: I/we 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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