Fund.com - Peculiar Legal Opportunity With Activist Catalyst

Summary

• This company which owned the URL fund.com and several unrelated assets used to be operated by a notorious fraudster, Mr. Jason Galanis.
• During his time, FNDM was misused and treated as a shell for the benefit of Mr. Galanis. After his conviction, Thomas Braziel became FNDM’s receiver and restarted several legal processes.
• These lawsuits could yield an interesting upside as there are a number of opportunities for the shareholders to start benefiting from previously owned and misused assets.
• Most importantly, the company is yet to receive roughly $2.2 million from AdvisorShares, an ETF manager which FNDM used to have a stake in and which it sold several years ago.
• This amount is not disputed and creates the initial upside as the current market capitalization of FNDM is around $1.7 million. At the very least, it presents a margin of safety.

Investment Thesis

I believe that investors should benefit from initiating a statistical position in Fund.com, Inc. (OTC:FNDM) (or at least have the stock on a watchlist) due to the following points:

• The previous management has misused company’s assets and mainly operated FNDM for its own benefit. It bought a stake in an ETF manager, a URL (Fund.com) for $10 million and several smaller assets for the purpose of creating a company focused on investment management, but that business plan never realized and instead, FNDM became part of a fraudulent activity purported by the previous management headed by Mr. Jason Galanis.

• Mr. Galanis was sued (and ultimately jailed) for the connected fraudulent activity, and thus FNDM was left unoperated and without a proper care for the interests of minority shareholders. That was until late 2016 when Thomas Braziel, a fund manager focused on unique investment opportunities (bankruptcies, receiverships etc.) got himself assigned as a receiver (‘substitute management’) and started to investigate potential claims that FNDM could assert due to its checkered past.

• Thomas discovered several opportunities that could create an upside in the stock. Most importantly, it is the settlement with AdvisorShares which arose after FNDM launched a lawsuit alleging that AdvisorShares wanted to nullify FNDM’s investment in the ETF manager. The settlement stipulates that FNDM should receive additional $2.2 million to the $2 million already received in the last two years (but distributed to the previous management). This amount is not disputed by AdvisorShares and is highly likely to be received sooner or later. This could already create an upside in stock as the current market capitalization is only $1.69 million.

• Other opportunities include the URL (fund.com) that FNDM originally bought for $10 million. The asset changed ownership several years ago, and FNDM currently does not ‘own’ the URL, but Thomas launched a lawsuit regarding the change of ownership as he alleges that this was part of the fraudulent activity purported by Mr. Galanis and that the URL still belongs to FNDM. Should the lawsuit be successful, which I believe is likely to occur as the merit of the lawsuit seems reasonable, given the history of entities connected to Galanis, and should Thomas be able to monetize the asset, this could provide additional significant upside (possibly at least 66%) for the shareholders. Other than that, there could also be an opportunity for recovery of several minor assets bought by FNDM in the beginning of the operations. Finally, there is also the possibility of Thomas suing the previous management in order to regain some of the money lost in the fraudulent process.

Of course, the main risk here is that the URL lawsuit fails and that Thomas is unable to recover any other asset, but that would only mean that FNDM is going to receive ‘only’ around $2.2 million as the amount outstanding connected to the AdvisorShares settlement is not disputed and will have to be paid one way or another (with interest if paid in cash).

This then creates a certain margin of safety as investors are not just buying a shell with some outstanding litigation and as they can currently buy the stock at a discount to the amount outstanding (current market capitalization is $1.69 million). Even if the legal expenses should be material going forward, the worst case scenario is not likely to yield significant downside.

Brief History of Fund.com

As mentioned in the thesis, the company was first organized as a public business focused on investment management. It started to trade on the market through a reverse merger in early 2008, and after that, FNDM bought a 60% stake in AdvisorShares, now a manager of several listed ETFs with $1bn in AUM. It also purchased URL ‘Fund.com’ for $10 million and several other minor assets such as Whyte Lyon Socratic (developer of online education) or Weston Capital (an asset manager).

This received interest from the investors, but Mr. Galanis who stood behind FNDM started to showcase that the company is hardly a legitimate business. In 2009, FNDM said that its financials are unreliable and that they need to be restated. It continued with dubious actions such as ‘sale’ of the URL asset, and it finished with Mr. Galanis being sued for fraud in a number of lawsuits (unrelated to FNDM) for which he was ultimately jailed and forced to start to repay his illicit gains.

This meant that the entity was without a controlling member as the directors were out of the picture, yet the company was already involved in a lawsuit against AdvisorShares connected to FNDM’s stake in the ETF manager.

For a while, the lawsuit was run by a lawyer connected to Mr. Galanis, but as we will see later on, he likely did not have the interest of all shareholders at heart. Thus, Thomas Braziel became involved and filed for receivership so that he can oversee what is going on and ensure that whatever assets are left they are going to be distributed fairly to all shareholders.

AdvisorShares Settlement

After Thomas got involved, he understood that there are outstanding claims that FNDM can assert and from which shareholders can benefit. The most important one being the amount connected to the settlement of FNDM with AdvisorShares. This settlement was brought about as a result of a lawsuit initiated by FNDM against the ETF manager. The initial complaint of FNDM was revolving around action undertaken by AdvisorShares in 2011 when it decided to nullify a large portion of FNDM’s stake in the company. This should have been due to a default on a required payment by FNDM (as a part of the investment).

The protracted lawsuit ended in 2015 via a settlement under which AdvisorShares need to pay $4.2 million to FNDM. The precise details are though unknown to the public as the settlement was sealed after the parties reached an agreement.

When Thomas became a receiver, he gained access to documents possessed by the lawyer (David Berke) who was in charge of the lawsuit. He learned that $2 million was already paid by AdvisorShares to FNDM but that the payment was routed to people and entities connected to Galanis and was mostly used to pay his and the group’s legal fees. This action was likely unlawful and in order to learn more Thomas moved to unseal the settlement agreement.

The motion to unseal the settlement is now the main effort of Thomas regarding the settlement. The docket for this motion can be seen here. The last action was in February 2017 when both parties were at a hearing. While we still do not know anything certain, the invoices that Thomas issued regarding his (and his law firm’s) activity can provide a bit of a hint.

In these invoices, Thomas and the engaged law firm specify what exactly they were doing during the invoice period and thus the following is of interest;

Note: Mr. Garbutt is connected to AdvisorShares.

It seems that there have been several offers regarding the outstanding amount due to FNDM (part of which is now past due date - as per ‘payment default’) and that Thomas and the law firm had a chance to look at their financials and had a discussion regarding interest charged on the amount past due date.

While this means that AdvisorShares is currently unable to pay, which could be troublesome, one has to remember the size of the firm might not be as significant as one could think given AUM of $1bn which is on the low end. Thus, it might naturally struggle to have sufficient working capital to pay off such a claim. Moreover, as per the invoices, it seems that both parties are able to have a discussion and that there is certainly some movement.

In the end, I believe that it does not matter much if Thomas is ultimately successful in unsealing the settlement. As long as he is in charge of collecting the outstanding amount and is not facing any significant challenges, FNDM is likely to receive the $2.2 million (alongside possible interest) as there is no dispute regarding that amount, just about sealing of the settlement. Once the money would be received, it is likely to be redistributed to the shareholders. There are also speculations regarding the possibility that if AdvisorShares are unable to pay, FNDM could regain the ownership of the stake, although this should be discounted until we will see the settlement details.

I was also able to access the latest invoices that Thomas filed with the court (they are still missing on the website but can be bought through the court site), which also suggests that the two parties might be close to an interim settlement which would confirm my previous points.

Finally, I also believe that Thomas could even start a lawsuit against Galanis regarding the $2 million already sent to FNDM but ultimately received by entities connected to him (due to loans that are now regarded as subordinated to Class A shares). Though the recovery of that amount is uncertain given the fact that Galanis is now in jail and whether he has sufficient funds to repay the amount.

URL Lawsuit

The second opportunity that Thomas has unearthed is the URL (fund.com) purchased in 2008 for $10 million which the company currently does not have at its disposal. Thomas alleges that the ‘change’ in ownership which occurred in 2014 was unlawful and was not even consummated properly, thus FNDM is still the owner of the URL. The docket connected to the case can be seen here and the newly updated complaint can be accessed here.

If he is right and I believe that it is likely that he is given the company’s history filled with fraud and because of the ‘common sense’ arguments raised in the complaint, then shareholders could possibly benefit if FNDM sells the URL or somehow monetizes it. I believe that it is unlikely that the value of the URL is still $10 million given the technological change and, in my opinion, change to quality content-driven websites, but it could still provide a material upside. A conservative estimate could be around $1 million. Thomas is also suing for legal expenses which could expand the upside slightly.

The next step in the lawsuit is a conference which was delayed until August, but the defendants are now trying to further postpone any action as they demand that Thomas obtains a formal recognition of the receivership (ordered in Delaware) in New York as mentioned in this docket filed by the defendant. This seems to me as an attempt to stall the action, but there does not seem to be any material argument connected to the fundamental basis of the case.

Other Assets And Liabilities

Apart from the two main assets, FNDM also purchased stakes in smaller businesses, but only one seems to be of any possible interest to investors and that is Weston Capital Management, an asset manager. While the firm seemed to have its own fair deal of fraud, Thomas seems to be in contact with the management of the asset manager, and once again, the invoicing revealed an interesting detail.

First, Thomas describes Weston as a ‘former sub of FNDM’ as seen below.

But then, later changes the description to a ‘100% sub of FNDM’ as seen below.

This could mean that FNDM still owns the asset manager, although as of now it is hard to estimate any kind of value of this possible subsidiary.

There are also a couple of other opportunities. Firstly, the company was likely capitalized with a $20 million certificate of deposit. The previous management did say that this will need to be written down but never published anything precise about the deposit. It could be that Thomas might be able to unearth something connected to this.

Secondly, as aforementioned, Thomas could also ‘go after’ the previous management and not only for the $2 million connected to the settlement, but for the general losses incurred by the business which could be material. In connection to this, one needs to point out that Thomas has been in contact with Mr. J. Jacob (as per the invoices) who has been dealing with fraudulent management himself at Veltex Corporation (OTCQB:VLXC). Veltex was successful in suing the former management and won over $100 million in judgments. The company did not yet receive anything, but interestingly was able to use some of these judgments as NOLs. It could be that Thomas is thinking about employing a similar strategy which could strengthen the upside.

On the other hand, I need to point out that there are also two claims raised against FNDM and which could diminish some of the upside. The first claim is by Mr. Gentile a former employee of FNDM who has claimed $0.5 million. This claim allegedly originates from the contract that he had with FNDM. Thomas though is currently disputing the claim.

The second claim is from New Millenium PR Communications Inc., likely a PR firm that was handling news regarding FNDM. It claims $0.1 million as per contractual obligations by FNDM. It also claims an immaterial amount of Class A shares. Thomas is again disputing the claim.

I believe that given the fact that Thomas is disputing both cases it is unlikely that, they should be successful.

Valuation

Tying all the above together, I came up with the following estimates of recovery.

Note #1: The share count can be seen here.

Note #2: I estimated the legal expenses through the first application for compensation by Thomas which can be seen here and amounted to roughly $0.09 million for two months. My logic is that the expenses are likely to come down after the settlement lawsuit has ended or at least the majority of the action has subsided. While this could be an optimistic assumption, the new compensation request was for $0.06 million for four months and thus in line with my expectations.

As you can see, it could be that AdvisorShares settlement could present a strong margin of safety if not an upside and the worst-case scenario is currently presenting a bearable downside (and I believe that it is highly unlikely given the nature of the two claims). If we include the potential value of the URL, investors could already see almost 66% return. Thus, there is a high degree of ‘low-cost’ optionality here.

One though has to remember that all this is a conservative estimate. I am not willing to assign much value to the URL (as I believe that nowadays the content on the site counts for more), I am skeptical of the retrieval of the $2 million that was already paid to entities connected to Galanis and the same applies to any other opportunity.

Conclusion

While the upside is material and certainly worth having exposure to, one has to remember that it will take some time to realize the upside, and that the stock’s actual value can fluctuate significantly in between as seen below.

Given this, I believe it could be beneficial to initiate only a statistical position for now and have spare capital ready to be deployed in case of any positive fundamental news (which are unlikely to be immediately reflected in the price) or in a case of an unreasonable downturn due to trading.

P.S. Those who follow my OTC Bi-weekly column will know that Thomas was one of the people responsible for my interest in OTC due to his brilliant work on Ethanex, one of my favorite investment picks ever (read the story if you have not already). I believe he has the potential to achieve a similar outcome with FNDM and collect enough assets to present current shareholders with an upside. At least he is certainly incentivized to do so.

P.P.S I would like to thank SA user #Cruncher for the discussion regarding this stock!

Note: Subscribers of Microcap Review had an early look at the article. The stock is up 14.7% since then. If you enjoyed the research consider joining the marketplace service which you can check out here!

Editor's Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.

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.