Quarterly Performance Review Ending February 2018

Summary

• I believe in transparency when doing equity research. Therefore, I regularly publish performance of every ticker that I wrote an article on alongside the initial thesis.
• Through this, I want to build a strong habit of looking back at my own reasoning. The review will be heavily skewed to stocks where my thesis is not working.
• The past three months have seen both several positive developments (largely on the long side) and negative ones (largely on the short side).
• Due to my OTC newsletter, I am going to discontinue most of the coverage.

Dear Followers/Readers,

First of all, I would like to thank you for your continued interest in my work, and I hope you are getting value of out my research!

Before delving into the review, I wanted to provide an update. As you might know, I started my own OTC newsletter which should alleviate one of the main issues for investors, and that is idea sourcing. You can learn more about the newsletter in this SA blog post. Due to this, I have no longer the time to maintain meaningful coverage of the listed stocks.

In August of 2016, I introduced a monthly review of all of the tickers that I am actively covering alongside my initial thoughts about the stocks. I think this can be beneficial for the following reasons:

• Learning exercise - I will primarily focus on stocks where my initial thesis was wrong. I will try to understand why, how to prevent this from happening in the future, and what should one do about this fact.
• Increased frequency of thesis updates - This will be beneficial for people that are following specific tickers and might be interested in the latest developments that are not necessarily asking for a full-blown update.
• Creating a database - It is always fun to look back and either laugh about failures or cheer about winners.

I am doing so through the following simple tables.

OTC-Only Long Ideas

Note: This does not include any of the new ideas tied to my newsletter.

Discontinued Coverage

Notes: The price at the origin is the opening price on the date of the first publication, and the current price is the closing price on last trading day of the month. The original thesis that is labeled Neutral (Long) is a thesis where I have a positive view on the stock, but for whatever reason, I do not believe it is the right time to buy. The same goes for Neutral (Short). I do not judge neutral ratings unless the share price movement is significant, and I missed an opportunity to be on the right side of the trade. This is slightly subjective. Feel free to address any neutral rating that you believe I got wrong.

I also add two indices that can be used to "benchmark" the performance of the covered stocks. I chose Russell 2000 due to its small-cap bias and Russell 3000 in order to track the overall market.

During the reviews, I will not be talking about every stock, but rather ones that I am wrong about, or that are undergoing significant developments.

OTC Long Ideas

I believe that the performance of my OTC picks neatly point out the opportunity that lies in this peculiar market. All stocks are up apart from Detroit Legal News (OTCPK:DTRL) which however continues to trade at a dubious valuation. Thus, the stock has a lot of margin of safety built in and will likely continue to pay out material dividends. If you count these dividends, the stock would be in positive territory. Specifically, it would be up roughly 10% as the company paid out $75 per share in the past year (includes the most recent dividend of $22 per share paid out in January).

One should remember that Mills Music Trust (OTCPK:MMTRS) also pays out significant dividends. Thus, the appreciation including these would be 39% or 10% higher than just the stock price performance.

Fund.com (OTC:FNDM) has been up in the past but is now waiting for the ruling on the URL litigation which should hopefully come this year. The cash proceeds from the AdvisorShares litigation put a strong downside protection in the stock.

Since my last quarterly update, the most significant development in this group was probably connected to Paradise (OTCPK:PARF). This candied fruit producer announced that it is contemplating strategic alternatives. These might deliver the needed catalyst I talked about in my initial article.

I would also note that Macro Enterprises (OTCPK:MCESF) was also up much more than now in the past, the same goes for Mikros Systems (OTCQB:MKRS).

The thesis in these stocks is now a bit more reliant on the long-term future. MCESF was originally a relatively short-term idea as the company traded way below liquidation value backed by its property while it had solid projects in the pipeline. Now that this played out, the company might need to secure further projects for the market to reprice the stock higher. However, even now it still trades below what could be the liquidation value. Thus, there is still potential for upside.

MKRS now needs to consistently increase its cash flow from operations as it is starting to deliver on the significant projects that it has won in 2016 and early 2017. The valuation might still be relatively unreasonable, but I believe that further upside is likely dependant on new contract wins or a proper start of its commercial business. Due to the nature of the products and its track record, this is certainly likely. I would also point out that Zeff Capital, frequent micro-cap investors, recently got into the stock.

To conclude, overall the performance of the OTC stocks can also be supported by my recent public review of the database that I am working on. The analysis suggests that my thesis holds and that the OTC market is a space with valid and actionable investment opportunities.

Listed Short Ideas

As per usual where I learned the most was the short research that I conducted roughly a year ago. Three of my short picks went sharply against my thesis.

The biggest failure was World Acceptance (WRLD). However, I at least understood the potential of this happening when I was writing the research as this was really a binary thesis (either it is going to have problems with the watchdog or not). My main issue was likely underappreciation of this fact.

The second biggest was Trupanion (TRUP), a pet insurance company whose valuation continues to amaze me. While the long-term story behind the stock might make sense from a business perspective, the stock is now trading as if that long-term future already happened. It continues to trade at an insane price to tangible book ratio of 20x, or $850 million.

Sure, the cash flow from operations has doubled in 2017 compared to 2016, but it was still only $10 million. The company will have to continue to grow at a breakneck speed for at least the next few years to at least justify the current premium. The learning point here is that if I am looking at a growth stock, I better see a clear catalyst that would break the underlying story.

The last short target that went against my thesis was PROS (PRO) which was actually trading at around the initial price for the most part of late 2017. It started to surge in late November of last year.

I am not sure what is behind the appreciation when it reported relatively bad cash flow picture at the end of the year. It burned through $25 million just from its ops. This was an increase compared to 2016. However, I just skimmed the results. Thus, there might be something obvious that I am missing.

Two short targets worked out okay. However, Vuzix (VUZI) which was significantly below my initiating price for a while, is now back up for some unknown reason. The fundamentals continue to be dubious. It also continues to dilute current shareholders. I would also recommend reading this article that pointed to shady activity regarding promotion of VUZI stock. Spark Energy (SPKE) is finally down, but it took the company a ride up before plummeting. There was a good update article in November of last year.

I would conclude that while this is largely a negative performance, I believe that it provided me with great experience in terms of research. I recommend any investor or an analyst to try to pick a short target. Learn about it, try to fact check the research, follow the stock and see whether you have learned anything new. I would also recommend reading Mr. Tilson's recent article about shorting. As for my short focus, I can't wait to have more time to hop back in. As Arnold Schwarzenegger would say "I will be back".

Listed Long Ideas

My longs on the listed side worked out okay apart from ADDvantage Technologies (AEY) and P&F Industries (PFIN). Note that I am accounting for the $5 special dividend of PICO which was paid out last year and "decreased" the share price.

AEY was the biggest disappointment so far. The share price was probably pressured by the operating results which saw Nave Communications, one of the earlier acquisitions, turn negative and weigh down on the fundamentals. The company also failed to show anything that would radically alter the business picture.

While Triton, later acquisition from 2016, has been offsetting the underlying results of Nave, it has yet to do so on a material level. However, hints of this might already be there as EBITDA in the last quarter was $0.3 million from this segment.

The Cable segment on the other hand was holding up pretty well until the last quarter which saw a decline in revenues and profitability. This segment might be "hit and miss" going further as the company said that it closed two facilities connected to the business due to a loss of a customer. This could be a symptom of the long-term challenge as this segment could be slowly "dying".

All this being said the valuation continues to heavily discount the balance sheet. This might not be reasonable given the fact that despite the mixed results, it was able to generate cash from operations. One has to also remember that the assets are likely over depreciated. Therefore, even if the inventories are not reflecting true value, the company could still trade below what would be a "conservative" liquidation value. Its debt load is minimal now.

The main question is what is going to unlock this value, and as of now, I do not see a clear short-term catalyst (apart from bumper quarters). If that does not change, the share price might continue to trade within the price range of last year.

PFIN also did not yet appreciate and lost some value since I wrote my initial article (although it was trading above my initial price before the end of 2017). However, I cautioned investors that the investment thesis is long-term (2-3 years) because the value is being squeezed by the management.

The margin of safety though is still present. The valuation discounts the relatively stable cash flow stream as tangible book is $32 million while the market cap only $27 million. That cash flow, FCF was roughly $2.6 million for the past nine months, might even grow after the recent acquisition.

The potential share price appreciation is likely to be driven by positive earnings results as the management is nowhere near unlocking the full value of the company (paring back its salaries).

Other Coverage

Perhaps the most peculiar story from my other coverage is Technical Communications (OTC:TCCO). This company has continued to trade at a significant premium to tangible book while it is not clear whether the company is able to achieve sustainable profitability. It is also not clear that it is going to benefit from new contracts. The management has mentioned that it is likely going to receive further orders from Afghanistan, but that the timing is unpredictable. This could be crucial due to its relatively high-cost basis.

The company is guiding to become profitable in 2018 and have a backlog of $0.9 million. In my mind, this does not justify the almost $10 million premium to tangible book. While its product offering might be valuable, I do not believe this constitutes sufficient margin of safety.

I also added two OTC stocks to this list. JLM Couture (OTC:JLMC) has finally moved up. This bridal wear designer was previously trading at clear undervaluation (significant discount to NCAV), but a catalyst was not obvious when I wrote about the company for the first time. Especially due to the management which might not be completely aligned with minority shareholders (might be trying to low-ball the company or extract cash through salaries).

However, it registered great operating results last year, and when the company showcased the annual report just a few days ago, the stock spiked. It continues to trade below NCAV. Thus, if it is going to sustain the operations further upside might be warranted. I would though probably take most of the gains now as the next catalyst (apart from operating results) would likely have to be a sale of the company. This might take some time to occur.

UPG (OTCPK:UPGI) is up 20% since my initial report, but I would recommend investors to look at the management before plunging into the stock. I pointed towards the stock issuance plan which significantly diluted minority shareholders as a clear red flag.

AG&E (AGNU) is now traded OTC as well, but it has yet to show results that would warrant further research as the operations are struggling.

I would point out Schmitt Industries (OTC:SMIT) as well. I was rather neutral in the beginning, but it might be worth looking at the stock again as its business might be turning. The valuation is still backstopped by the real estate (which it has yet to sell however). You can read recent takes on the stock here or here.

WSI Industries (WSCI) likely underwent a turnaround after challenging 2016 and early 2017. The last quarter's revenue and profitability certainly looked like it. I was negative on the company during the troubles and have not followed it since. I believe that one can do well tracking these small manufacturers and seeing in which business cycle they currently are.

The same goes for SigmaTron (SGMA).

Great Ajax (AJX) is one stock that I might be interested in looking into as the company does not seem to be completely out of its negative cash cycle.

As per the introduction, I am not going to actively cover any of the listed companies, be it long or short. I am going to be hunting the OTC world for another hidden gem. I will continue to be active on SA as I will be posting some of my ideas from the OTC world from time to time.

I might revisit the performance of the coverage in one year's time.

If you ever have a question about any of the covered companies, feel free to message me, maybe my past research can still be of help to some.

Once again, thank you for reading my research!

Best,

Jan

P.S. Please do let me know if you think that the way I present the review is missing something.

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

Analyst’s 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.