Surge Holdings has reported a couple of exciting new developments since I last wrote about it on Seeking Alpha two months ago. I feel that the upside potential for Surge Holdings is more than 50x the current price over the next few years. To read a detailed discussion of my bullish thesis of Surge Holdings, please see the article, Surge Holdings The Unknown Story of High Potential Growth.
For a very quick recap, this is what Surge Holdings is doing today:
- Launched a nationwide cellular service which includes a free monthly plan that is paid for through advertisements. Surgephone.com
- Ready to launch (any day now) a pre-paid Visa debit card that can upload checks with a click of a camera. It acts as a checking account for anyone having difficulty accessing the banking system such as foreign workers.
- Surge has their own budget smartphone called the Volt 5XL.
And here are two exciting new updates for Surge Holdings since my last article:
- February 28th, 2019 - Signed and inked a definitive agreement with AATAC for a potential roll-out to 40,000 stores in 2019. AATAC is a buying group with reach into 80,000+ stores such as 7-11 (OTCPK:SVNDF), Circle K, Shell, Chevron (CVX), Gulf, Texaco and more.
- March 6th, 2019 – Surge Holdings filed an application to upgrade to the NASDAQ Capital Market.
It seems almost preposterous that I would be writing about a company which could be worth 50 - 100x more than today's price and especially so since I do not own shares as of today. As for having 'skin in the game', I am trying to gain exposure to Surge in other ways such my involvement in researching the company for those interested in a private placement. I will disclose that when it is finalized. As for the former point on why I value the company so high - below is a review of how I came up with those big numbers.
Quick Recap on Future Valuation
Interestingly enough, I don’t believe that the cellular service, pre-paid Visa cards and smartphones are the big play here. If received well, these products and services are highly profitable and could provide the impetus for the share price to move rapidly upwards. Yet the big play relates to the SurgePays Portal network which I will discuss in just a minute. Below is a quick calculation of how profitable I estimate Surge to be with just their pre-paid Visa cards and free cellular plan.
Pre-paid debit cards – These cards will assist foreign workers to access bank-like functionality similar to a checking account. If used like an alternative checking account by just 1 million out of the 14 million foreign workers estimated in the USA, the profit could look like this:
- Estimated 1% gross profit margin.
- 1 million workers using the cards with an average of $2,000 per month.
- $2 billion per month in throughput and $20 million in gross profit for Surge every month or $240 million per year.
- A 10x multiplier on gross profit is a reasonable valuation for this industry and sector.
- That values the Visa card opportunity at $2.4 billion dollars of market capitalization for Surge stock.
- Over 40x the current share price when assuming 1 million users of the pre-paid Visa debit cards.
Cellular plans – I will assume that 1 million people use the free cellular service.
- Surge anticipates $10 in ad revenue per month for the free phone plan.
- I estimate their costs to be around $6-7 per month. Let’s just assume $3 per month in gross profit.
- That translates into $3 million per month or $36 million per year.
- With a 10x multiplier that adds $360 million to the market cap.
- Over 6x the share price on 1 million free cellular users.
And that is just 1 million free users, not to mention the paid plans. Personally, I feel that adding 10 million free users over the next 2 or 3 years is not a stretch. In that scenario that would add $3.6 billion to the company’s valuation which is more than 60x the current price.
I will stop there and not place any value on the cellphones or the paid cellular plans. I think you get the point that the upside could be 50 – 100x the current price based on these 2 products. But that isn’t even the big play.
The Big Play is the SurgePays Portal
The big play relates to the e-commerce portal that is being placed in up to 40,000 corner stores in 2019. Any corner market that accepts even one Surge product, such as the free SIM card or smartphone, is automatically given the SurgePays Portal. The portal allows store owners to order Surge products. Surge already has agreements in place to offer 3rd party products including frozen food, CBD and other items. Surge is designing is an Amazon-like network for corner and convenience stores across the USA. And store owners have financial incentive to use the network as they become revenue partners when items are sold. They also receive recurring monthly revenue when signing up customers to Surge cellular plans.
Initially, using the SurgePays Portal will not result in big profit.
- The latest update by Surge indicates that they hope to be in 40,000 retail locations by the end of 2019 and that they hope to achieve $1,500 to $2,500 of top line sales per store.
- If we assume $2,000 per store multiplied by 40,000 stores, that results in $80 million per month.
- It sounds like a lot but if I assume a gross profit margin of 2% (which is an estimate derived from Paypal), that is $1.6 million per month for Surge or $19.2 million per year.
This is small compared to the potential of the pre-paid debit card and the monthly cellular plans. The potential of the other products could add hundreds of millions in gross profit to Surge Holdings annually and this looks like less than $20 million. So why do I claim this to be the ‘big play’?
Because once you control the supply and distribution network, you can acquire companies at will and give them instant nationwide distribution. Surge Holdings will be able to buy-out a gum company and give it distribution into 40,000 stores in 2020. Surge could acquire a frozen food company and place it in corner store freezers nationwide. Or new fin-tech products. Basically, whatever is relevant that people are buying is what Surge can acquire and give distribution to. Products and services come and go but the supply and distribution chain is the most relevant and valuable piece of the investment puzzle in my opinion. And if Surge grows that network beyond the 40,000 projected stores for 2019...
The big question is this: If Surge Holdings is such a great company with such high growth potential, why is it being valued at a mere $55 million market-cap today?
What Investors Might Be Missing
I believe that there are some red herrings which are diverting investor’s attention away from the big opportunity. I believe that once investors wrap their minds around what Surge is building, the price will quickly follow. Let’s consider some of these red herrings.
Surge Holdings is a reverse merger between KSIX and True Wireless. KSIX was an online advertising company. True Wireless is a company that provides subsidized wireless services in a few states under a government sponsored program. You can analyse these two companies all day long and get nowhere since both companies are not directly related to what Surge Holdings is building and rolling out today. Red herring.
Too Many Subsidiaries?
When you go to the Surge Holdings website you see a lot of products and services. Again, this can be very confusing and may muddle investors. You see the products and services that I mentioned previously in addition to such things as True Wireless, SafeHomePhone, Surge Money Order, the Surge Utility Token, a token spinner and Surge Logics. How do all of the pieces work together? Or maybe they don't and this is just a mish-mash of random ideas?
Keep in mind that some of these subsidaries are based on the pre-merger companies. I imagine that their role going forward will be diminished and are currently used to fund the 2019 roll-out. As well, some of the subsidiaries relate to potential future growth. They will all work together in a synergistic manner eventually but it may not be obvious what their role is today.
Consider how just a few of the subsidiaries might work together later on. You have a free cellular plan on your phone. You can also earn tokens that can be spent for actual goods in the corner market. This is your rewards system. You sign up for your pre-paid debit card and earn tokens. Want to gain extra tokens that you can redeem for actual goods at the corner store? Then spin a wheel or watch some ads and gain real buying power in the form of Surge Tokens. Next, you go to the corner market and buy products using your Surge Tokens – milk, automotive parts, CBD oil or even a smartphone. The problem with so many cryptocurrencies today is that they are not widely adopted. But Surge Utility Tokens solves this problem by allowing their tokens to be used nationwide at corner markets and convenience stores. At least that is my take on it.
At the same time, I understand how this can confuse investors. It is likely too much – too soon - for the small retail investor to absorb. What should you focus on today?
- Home in on the e-commerce network rolling out to 40,000 stores in 2019 and possibly twice that number later on.
- Focus on the initial offerings of smartphones, pre-paid Visa cards and ad-subsidized cellular plans.
- Forget about all the other subsidiaries for now which are either remnants of older businesses or growth strategies which will have increased importance later on.
What About Financial Statements?
The typical way to value a company is to pour over the financial statements. You look at revenue, earnings growth, value, profitability and make forward-looking projections. Again, what you are looking at today is the profitability of KSIX and True Wireless. What Surge Holdings is rolling out now is so new that it is not reflected in the financials. Trying to make any projection based on KSIX's digital advertising or True Wireless's government subsidized internet plans will result in futility. I think the market may be looking at the past financials in the wrong way when projecting the future opportunity which can be a red herring.
Surge Holdings made a massive pivot about a year ago. They quietly put together their new business plan in 2018 and then 2019 is the big roll-out. Think about other companies that made massive pivots and try to imagine projecting future growth based on past financials.
- Youtube was supposed to be a video dating service
- Paypal was supposed to transfer IOU's between Palm Pilots
- Twitter was a podcasting platform
- Slack started as a video-game venture
- Nintendo was a playing card company in the late 1800's
That’s not to say you can’t learn anything from looking at the financials. But you won’t be able to project sales, growth or future profit from it.
What meaningful insights can we gain by looking at the financials? The following figures are based on the Surge Holdings 2018 annual report.
Revenue increased by 14% between 2017 and 2018 while gross profit increased 25%. This is due to the merger and re-negotiated supply contracts in True Wireless. Neither of these figures relate to the new direction Surge is taking. This is a red herring.
Next, we will look at their assets.
Here we can see a pretty substantial drawdown in cash and cash equivalents. Much of the reason for this is that Surge spent time and money during 2018, not maximizing revenues for True Wireless, but for the big pivot of 2019. Funds were spent on the new SurgePays Portal, cellphones, SurgePhone Wireless and SurgePays Debit card.
Enough Reserves for the Rollout?
Will the cash balance of $444K plus $206K of accounts receivable be enough for the 40,000 store roll-out? Consider how this process works. If Surge places $200 of product per store and enter 4,000 stores per month, that works out to $800,000 per month. As these are purchase orders, they should get the capital back from the store in the following month. Yet, to roll-out to 4,000 stores each month, Surge needs to have $800,000 on hand. We have a problem.
Note that they already have $836,536 in phone inventory based on the cash flow statement for 2018. I assume that this represents the current inventory of Volt 5XL smartphones. I further estimate an inventory of roughly 20,000 phones based on the cash spent.
- The inventory of Volt 5XL phones should be the most expensive part of the product roll-out.
- Sim cards should be cheap and pre-paid Visa debit cards are not expensive to produce.
- Cashflows will start to come in from the cellular plans and phone sales in 2019.
- Not every store location will be suitable for a budget $80 smartphone.
- If half of the stores start with 1 or 2 phones, they should have enough phone inventory to cover at least 6 months.
The point is that Surge should be able to manage this on their own if the are very careful. $200 of product per store might only represent 1/3 to 1/2 of that amount in cost to Surge. And Surge already has inventory. That being said, Surge could definitely benefit from a cash injection which shouldn’t be too difficult based on the upside potential.
Cash Flow Statement - Surge Holdings 2018
Net income is negative $1.54 million. If revenue and gross profit rose in 2018, why the loss? The main reason is that Surge was focused, not on tightening the belt and optimizing True Wireless, but on positioning themselves for the big pivot and launch of 2019. Negative income and cash flows are pretty standard with technology companies in the early years.
The biggest reason for the loss of net income is the nearly $3 million increase in Selling, General and Administrative expenses. You can read the various increases below. They are mostly related to the merger and positioning for future growth.
Another major hit to the cash flows was buying over $836K of phone inventory.
Previously, Surge had hoped to be cash positive by the end of 2018, but they now project that to be the case by the end of 2019. Being cash flow positive is a key metric that I look for as regards sustainability of a small firm. Yet it is understandable that being cash flow positive is difficult at this early stage.
What About Risks?
All investments come with risk. But the opportunity with Surge is so new that investors may have a hard time pinning down the risk. Perhaps they feel that it is better to wait for a NASDAQ listing and more analyst coverage. While you can do so, I feel that the big opportunity is because investors do not yet fully realize what Surge is doing today. If they did, I imagine that the price would be around $3 – 4 per share instead of 64 cents. But let’s talk about some of the risks.
Investment capital. Surge Holdings has $444,612 in cash and $206,679 in accounts receivables. As stated earlier, I believe that Surge is able to take the slower route to growth, but I would prefer that they have access to $10 - $20 million in credit to really blow this out. My personal feeling is that getting access to capital will not be an issue. But it is still a risk worth considering.
Cellular service. There is the risk that their cellular service will not gain traction. Perhaps one of the big telecom giants will offer their own free ad-subsidized service. I don’t see that happening as the big telecoms have larger overhead and it would be a race to the bottom which kills profit margins. Better for them to allow Surge to be the 'discount provider'. But there is always the risk of getting stomped on by the big telecom giants such as Verizon (VZ), AT&T (T), T-Mobile (TMUS) or Sprint (S). There is also a risk that Surge Wireless users won’t accept the ads flashing and would rather pay a $10 premium to have the ads removed. This is fine provided they go ad-less with Surge, but less so if they switch providers.
Pre-paid Visa cards. There is risk that these cards will never be adopted as anything more than gift cards. Maybe the unbankable prefer dealing in cash. And if the pre-paid Visa cards start to be used like alternative checking accounts, you can expect there to be competition. My retort to this last point would be that Surge should have an advantage by being placed in 40,000 stores by the end of 2019. These locations are placed right in the center of their target demographic. How likely are the unbankable to go into a bank asking for these products? More likely that they will pick them up at the corner market.
Resistance to change. There is also the risk that store owners will resist change. Store owners may not use SurgePays Portal to its full potential. Maybe they prefer sourcing their own goods. Or maybe store owners will be reluctant to switch over from their existing supply and distribution channel - whatever that may be.
Growing Pains. Then there is the risk of rapidly scaling. What works with 10,000 customers might not easily scale to 1 million customers or 10 million. What if the e-commerce platform breaks down? What if customer service lags? What if there are glitches in the ad-serving network? All companies must go through growing pains. Success when scaling largely depends on the team executing the plan.
Ad-serving risk. Another risk comes from the ad-serving network. What if advertising companies do not want to be on the network? For instance, some products and services target the affluent while Surge products target a low income demographic. If advertisers see little return on their advertising dollars, they may restrict ads being shown. On the other hand, the real solution is to match advertisers with the target audience. Ads for fast food, thrift clothing, Walmart and an endless list budget products and services will be more widely embraced with a high rate of return on advertising.
Surge Holdings is a small company rolling out a titan-sized plan in 2019. The upside potential is massive and I feel that the majority of investors do not yet understand what the opportunity is. Some see the phone plans, others see the debit cards while many are confused by the large amount of subsidiaries. Still others are examining the financials of the pre-merger companies even though Surge Holdings made a massive pivot away from those businesses.
The big play is the nationwide supply and distribution network they are rolling out to in 2019. It could potentially be a massive disruption to how corner markets across America do business. I am also anticipating the uplisting of Surge Holdings to the NASDAQ for additional analyst coverage, higher liquidity and potential institutional investment dollars.
But one of the most important factors for me is that Surge Holdings is focused on helping the underserved, ignored and forgotten segment of our society. It just feels right.
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in SURG over 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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