"If we want to be valued like a larger cap company, we have to behave like one"
This quote above is paraphrasing Johnson Joseph, CEO of Peak Positioning Technologies Inc. (OTCPK:PKKFF) (PKK.C), after our last conversation about the details of the company's strategic investment partnership with Banlan Industrial Company Limited, a large Chinese petrochemical products distribution company. Banlan will invest $4 million into Peak for a controlling interest in the company - 199 million shares and warrants with a strike price of 5 cents - and the deal is expected to close at the end of January.
Investors who have followed myself or Peak are likely aware of my posts on the company over the last year and a half. My interest with Peak started with the acquisition of Quickable, but after speaking with management I realized that the primary goal was much bigger. It has taken a lot of patience but Peak has evolved into a company that stakes claim to two businesses in China that will produce tens or hundreds of millions of dollars in annual revenue a year by the end of 2017.
Despite the hard work that the Peak team has put into getting these deals towards the final stages of completion, PKK is still trading as a penny stock. The conversation I had with Mr. Joseph after details of the Banlan deal were announced had him enthusiastically stating that discussions between his team and Banlan led to the conclusion that Peak shares will eventually trade on the NASDAQ at $3.00 or greater, increasing from two Canadian pennies either with or possibly even without a reverse split in the not-too-distant future. However, I felt I had to temper his expectations a bit. As a small cap investor I have heard it all before as plenty of CEOs of microcap companies have made outstanding claims. They either outright lied in an effort to pump the stock price or they really did believe their own hype at the time but far overestimated the virility of their business and just failed to deliver.
Peak trades at a market cap of less than $10 million dollars because of the poor history of operating performance for speculative penny stocks and the fact that it has some of the most egregiously insane projections I have ever seen for such a small company. Peak shareholders are familiar with the LongKey business, which Peak management projects to grow from about $3-4M in revenue from 2014 to nearly $100 million by 2017. If that wasn't enough of a pill for the market to swallow, the company is now claiming that the agreement with Banlan will result in a $100M annual revenue run rate in 2016 for a new 100% Peak-owned subsidiary that is just being created in Q1 2016.
PKK has been stuck at a few pennies for a very simple reason - the market simply doesn't believe it yet. While Mr. Joseph was so excited to tell me about this deal, I had to be straight with him - it just sounds too good to be true. This is where we came to the conclusion that led to the quote at the start of this article. He understands that the penny stock world is a dangerous one filled with scam artists and failed businesses. He is so confident in these outstanding growth claims made by Peak that he is willing to undertake the steps necessary for Peak to be seen as a serious company in very short order, over the span of a few months.
This is part of the reason why I am writing this article. It has been reviewed by Peak management before publishing and every promise or projection I have attributed to Peak has been vetted by management (anything prefaced with the terms "I believe", "I assume" and the like are my own projections or opinions not attributed to Peak). The purpose of this article is not to pump for short-term price gains. As a shareholder in PKK for 20 months and a participant in the recent private placement (with a four-month lockup period), I am willing to wait at least another 12 months to see clear evidence that Peak is making good on its huge promises. I don't care if PKK is trading at 2 or 10 cents come January 1st. The purpose of this article is to lay out in detail Peak's plans over the next year. Investors can choose to buy in at 2 or 3 cents now and accept added speculative risk, or they can wait 6 or 12 months to see Peak make good on its promises and pay a higher price later but assume less risk.
Banlan and the "Plastic Bank"
As we all know, China is a major producer of export goods. There are millions of manufacturers that use plastic for their goods and packaging, so China's import demand for the raw materials that go into plastic is huge. There are only a few dozen large companies around the world like Exxon Mobile and Dow Chemicals that make the petrochemicals that go into the plastics and most of these small manufacturers in China don't have the buying power to deal directly with them. Banlan acts as a middleman as it aggregates all the orders from its thousands of clients then bulk imports the raw materials from one or more of these large suppliers and distributes them to the manufacturers. Banlan' revenue was 3 billion RMB in 2014 and projects to be 4 billion RMB in 2015, approximately $850 million CAD and $620 million USD.
Through its relationship with LongKey, Peak was introduced to Banlan's Chairman Jiatao Luo. Banlan had two specific goals in mind. First, it wanted to digitize and use the internet to revolutionize the plastics trade industry in China, and to provide trade-related financial services to the industry. Second, it wanted to be part of, or become a public company whose share price would reflect the value of its existing business and the potential behind its vision for the plastic industry in China. Peak so happened to be the right place in the right time with the right management team and a public listing so that Banlan decided to form a strategic partnership with it. The two companies will team up to develop a subsidiary that will be 100% owned by PKK, which will be referred to as "Peak China" for now, as the official name of the subsidiary has not yet been released.
Peak China will be responsible for developing the "Plastic Bank", a web-based Fintech (short for "Financial Technology") platform that will facilitate the transactions between Banlan and the Chinese manufacturers. It will handle everything from order entry to the financial settlement of the transactions. By having manufacturing clients use the platform, Peak China will gather data that it will then use and analyze to provide additional services to these clients. These services will include warehousing, logistics, purchase order financing and loans. Purchase order financing and loans have been identified as major needs for these manufacturers, so Banlan plans to use the Fintech platform to eventually become a "Bank" that caters to the specific needs of the plastic industry in China, hence the name "Plastic Bank".
In addition to the Fintech platform, Peak China will take over about 10-15% of Banlan's existing business, which will initially account for 80% to 90% of Peak China's revenues in 2016. This is why Peak management is so confident that this newly formed subsidiary will approach $100 million CAD in revenue next year. The subsidiary may be new, but the bulk of the revenue will come from existing business, not from speculative revenues of the Plastic Bank startup. However, Banlan projects revenues generated by the Plastic Bank to surpass those generated by Peak China's other activities within the first 2 to 3 years of operations of the Plastic Bank.
Why do Banlan and Peak want to do this deal?
While the development of the subsidiary for the Plastic Bank makes sense, one might wonder why Banlan would be so willing to give away 10-15% of its existing business to the Peak subsidiary where non-Banlan PKK shareholders will now have access to half of this revenue. The answer is pretty straightforward. If Peak management reaches its goal of eventually leading PKK to a $1 share price, Banlan investors would see their original $4 million investment for the 199 million shares and warrants exercised at 5 cents turn into $388 million. So from Banlan's perspective it's worth it to toss about $100 million in revenue of its existing business into a subsidiary which they only own half of in an attempt to speed up growth of Peak China and see potential gains into the $100's of millions on their investment in PKK. This deal is essentially half way to a reverse takeover.
From Peak's perspective this deal makes a ton of sense as a "get out of jail" card, with jail being defined as the TSX Venture Exchange. PKK, like many other small cap Canadian technology companies, has floundered on the exchange as it has looked to consolidate LongKey under its corporate structure for years but struggled to get needed capital. In this one agreement with Banlan, Peak gains immediate access to a $100 million business and receives the needed upfront $4 million in capital to develop the online platform for the Peak China subsidiary and achieve other corporate goals such as closing the LongKey deal, ridding itself of debt and having the resources to make good on the promises listed below.
While PKK has temporarily moved onto the Canadian Securities Exchange, a seemingly (for now) junior exchange to the TSXV, it now has a way to get on to the NASDAQ or TSX big board and be seen as a serious business instead of a penny stock in a fairly short time frame, possibly within two years. Peak management has given up a controlling stake in the company to Banlan, but will be working with Banlan to achieve their common goal of taking Peak from a $0.02 CSE listed company, to a $1.00+ NASDAQ listed company. While Banlan uses the Plastic Bank to deliver revenues and exceptional growth by revolutionizing trading in the plastics industry in China, Peak's management will offer technical expertise as needed while also managing the public vehicle, continuing to promote the company and ensuring it meets listing requirements in preparation for an eventual NASDAQ listing application. The strategic partnership between Banlan and Peak differs from a typical reverse takeover because Banlan wants Peak for much more than just the stock listing. Peak management had a choice between owning a large share of something small, or a smaller share of something much bigger and wisely chose the latter.
Why doesn't Banlan have a website? Is this another Chinese fraud?
Ever since the Sino-Forest debacle which caused the once $6 billion TSX-listed company to fall to zero on claims of fraud in a matter of a few months, Canadians and Americans have been very suspicious of Chinese investments listed in North America. One question that arose from shareholders upon first announcement of this deal is who is Banlan and why can't anything be found online about this company? It makes sense to assume that a company nearing $1 billion in annual revenue would have some sort of online footprint. With the company half way across the world, browsing the internet is pretty much the only way for investors in North America to confirm that Banlan is a real business without the costly expense of flying to China to see it for themselves.
Banlan is a large company, but it is B2B. It has only a handful of international suppliers and while its customers are numerous, they are for the most part obscure Chinese manufacturers which are even more anonymous than Banlan when it comes to online activity. The majority of Banlan's business transactions take place over the phone or in person. As a fully private company until now, it has had no need to appeal to investors and thus no business nor financial need to have a website (which is forthcoming) or online footprint of any sort up to this point. The fact that the Chinese plastics industry has not yet fully embraced the power of e-commerce and the Internet is a major reason why Peak has this unique opportunity with Banlan in the first place.
As an investor who is very familiar with short seller tactics, I have and will continue to give (unpaid) advice to Peak on what to have handy in case of a short seller attack. I don't need to get into any details here, but this includes gathering evidence of the business' legitimacy and size, evidence that revenues are real and are as filed with Chinese authorities and evidence proving no appearance of any conflicts of interest or at least those that can be easily explained or immaterial to the overall business. Peak has done a lot of due diligence on Banlan's operations. The company may share these findings if it feels it is necessary to do so in the future.
Given the significant financial reward Banlan investors will see if PKK hits $1 as hoped, I can see short sellers using that as a potential motive for wanting to pump up the stock price. I have warned them about the chance of unsubstantiated claims of fraud should the company be successful enough that its market cap increases to a level to become of interest to short sellers. The company will grow this business with that in the back of its mind and will be well-prepared to counteract any short attack it may receive simply because it grew "too fast, too soon", and things appear to be "too good to be true", two staples of lazy and generic short attack theses.
Nothing is for free. This outstanding deal with Banlan obviously comes with a heavy price - 51% of the company so that Banlan owns a controlling stake. Most shareholders would find this to be a reasonable price to pay given what Banlan has brought to the table. But between this, the recently-closed private placements to extinguish Peak's debt and the LongKey deal, the number of shares and warrants outstanding will balloon.
After closing the most recent private placement, Peak currently has 192.6 million shares outstanding and 67.9 million warrants outstanding at an average strike of about 3.5 cents. The good news is all debentures and convertible debt has been or will soon be wiped off the balance sheet. In addition to the issued and outstanding securities mentioned above, the following two transactions have the potential to see more securities issued in the very near future:
- The $4M strategic partnership with Banlan that includes 199 million shares and the same amount of warrants at a 5 cent strike price.
- LongKey stands to receive a yet-to-be-determined number of shares once the acquisition whereby it will become a wholly-owned subsidiary of Peak closes.
The Banlan strategic partnership brings the total share count up to 392 million and warrants to 267 million. When I asked about the dilutive impact of finalizing the LongKey deal, Mr. Joseph did not express much concern in terms of urgency or impact. It appears to be on the backburner until PKK and Banlan get Peak China up and running. Because of PKK's low stock price at this moment, he told me that they are waiting until the stock price rises a bit before negotiating a transfer price for the shares owed to LongKey so that Peak is in a stronger position.
I tend to believe Peak management on this as the deal with Banlan limits how many shares LongKey can receive as Banlan will own a controlling stake of 51% in PKK and will retain a right of first refusal on all future financings. Since LongKey management introduced Peak to Banlan, I can't imagine that they weren't included in the discussions between the two and I assume they are on board with Banlan's interests. After pressing for a bit, I asked if 50 million shares seemed like a reasonable guess of the number of shares it would take to settle the LongKey Transaction. Although Mr. Joseph was non-committal, I could sense that I was in the right ballpark, though I stress that this number came from a casual conversation so it is hardly written in stone.
Given the low strike price of the warrants, I assume that they will be all be exercised at some point in time upon any successful execution of Peak's business plan. Inclusive of the estimated 50 million shares for LongKey, PKK would have a fully diluted share count of 709 million.
Investors may be spooked by the share count. Given the trend of dilute, reverse split and dilute some more in the Canadian small cap world, they would be right to be worried at first instinct. But recall that PKK is getting a lot back for this dilution - in terms of existing revenue that will belong to Peak China in 2016, not some pie-in-the-sky speculative asset - so the share count needs to be judged relative to revenue and profits.
Prospective investors may also be hesitant due to the amount of "cheap paper" recently put out to the market. Keep in mind that the closing of the private placement was oversubscribed to its maximum point allowed by Banlan. I assume that there were investors who were refused participation in the placement whose only recourse would be to buy shares on the open market. There has been evidence of that as the stock price has inched up to 3.5 cents from 2 since its closure. I was a large participant in the placement and I can tell you that I have no interest in selling for a half-penny or a penny or two in profits. Assuming all participants think like me, the market will not get flooded with cheap paper, but may be flooded with buyers who couldn't gain access to cheap paper and who want to buy up slightly less cheap paper on the open market before it becomes properly valued or expensive paper.
Viewing the Banlan investment at 2 cents as cheap is quite erroneous. Banlan didn't merely get half the shares in the company for 2 cents. It gave up half the revenues in the 10-15% of its business that it is transferring to Peak China to other PKK shareholders and paid $4 million in exchange for Peak's public markets management expertise along with the publicly traded listing on the junior market in Canada and nearly non-existent OTC symbol in the U.S. Banlan is the one that gave up a lot in order to expedite the process in making the Plastic Bank into a viable, publicly traded business. Based on this significant investment I can't imagine that Banlan investors would want to flood the market with PKK shares at less than 10 cents.
Peak's promises throughout 2016 as it transforms from a speculative penny stock into a blue chip through profitable operations and a change in behavior
One of the topics I spoke to Mr. Joseph about over the challenges of being on a junior exchange was the complete disregard for shareholders with respect to financial reporting that some listed companies try to get away with. Most companies take the full 60 day deadline to report quarterly results and 120 days to report annual results. Many of them file on SEDAR.com (the Canadian data bank for public company financial reporting, similar to SEC.gov) without any press release and certainly do not produce any guidance. Most of them aren't even in a position to provide guidance as revenue is inconsistent or non-existent. This lack of timely and transparent reporting greatly limits investor interest on junior exchange listed stocks.
During my phone conversation with Mr. Joseph, he mused about how PKK might be able to reach a $1 valuation, especially with so many shares and warrants outstanding. He noted that while talking with Banlan they thought that by the end of 2016, PKK might be able to achieve a 4 or 5 cent EPS thanks to Peak China. Stick a 20 to 25 P/E ratio on that and it would produce a $1 stock price. A 5 cent EPS on 700 million shares is $35 million in net profits. Not an impossible goal on $100 million in revenue, but certainly a heavy task given that the starting line is still 2-3 months away.
Rather than relying on casual conversation with a shareholder, Peak management pledges to provide actual guidance sometime starting in either Q1 or Q2 when the subsidiary is up and running. I assume this guidance will come in the form of revenue and EBITDA projections for the full year as well as upcoming quarters, at least for the Peak China subsidiary. Depending on what ends up happening with the transaction, Peak may also provide guidance for LongKey and the overall corporation, though I view that as less necessary. In addition to that, Peak management pledges to start doing quarterly earnings conference calls as early as Q1. Rather than reporting at the end of May per the normal process for Canadian penny stocks, PKK will look to report during the late April to early May time frame of blue chips. I expect to give the company some leniency in the timing for filing its financial results on SEDAR for the first year as reporting these subsidiaries under the consolidated corporate structure will be a fairly challenging and costly accounting task.
Future quarters will include discussion of performance relative to guidance and why PKK hit, missed or beat the guided numbers. The nature of this subsidiary (a constant stream of revenue from the already existing business) allows for a relatively smooth revenue growth profile that the company can reasonably forecast as opposed to the usual transition from a pre-revenue to revenue earning business which can be very inconsistent quarter-to-quarter as orders are few and far between upon startup.
Peak management pledges to do investment roadshows for the purpose of attracting large investor and analyst interest. Banlan management may accompany Peak on investment roadshows across Canada and the United States whenever possible. Banlan representatives will be unable to accompany Peak on all roadshows as that would be a time and cost burden that could be better spent on managing its operations. But the goal will be for them to get at least one face-to-face meeting with as many North American investors as possible.
Providing clear financial guidance and conference calls will work in conjunction with investor roadshows and other promotional tactics in an attempt to gain institutional support and analyst coverage. The company can't guarantee that analysts will start covering PKK as that is out of management's control, but these three pledges will set up the framework for analysts to take notice. Banlan is on board with this idea and part of the $4 million will be allocated for these purposes.
Peak management has pledged that any reverse split is off the table for the time being. In previous incarnations of Peak's financing, a 1-for-5 reverse split was proposed. Ever since Peak has moved to the CSE, that proposal has been dropped. With potentially up to 700 million shares outstanding and a 3 cent stock price where the longer-term goal is to hit $1+ and move onto the NASDAQ or big board of the TSX, it would make a lot of sense for the company to still do a reverse split. But Peak management is adamant that this is off the table for the foreseeable future and could only happen if a significant positive event prompted it. For instance, I believe that if Peak met all listing requirements for the NASDAQ in 2016 except share price, it would then make sense to roll up the shares rather than wait another year or two for the shares to hit $3 (the NASDAQ minimum share price required) and then apply for listing.
Conclusion and Valuation
While Peak has made some big promises, it has outlined a strategy to implement those promises in a relatively short time frame, rather than the traditional strategy of penny stock management teams which outline some goals for the future at unspecified times then go into hiding for months or years. I remain cautiously optimistic that Peak's lofty goals it has set for itself will be attained and shareholders could be seeing the fruits of management's labor as soon as late April with proof of Peak China's revenue laid out in the Q1 report.
PKK hopes to have a $100 million run rate by the end of 2016 through Peak China, or an average of $25 million per quarter. Given that it will go live at some point in March and it may take some time to ramp up, I assume that 2016 revenues will be around $70 million (all figures in Canadian dollars, and assuming no significant changes in the RMB to CAD exchange rate). If the business can achieve a 10% margin, that will lead to $7 million in net income and a fully diluted EPS of a penny per share. If the stock price is 20 cents at the end of 2016, that would result in a fairly conservative 20 P/E for a growth stock that is looking to disrupt the Chinese plastics industry with its new Fintech. A 20-cent target isn't nearly as high as management's lofty goal of $1, but it certainly trends in the right direction and I don't think any investor would complain about a 600% upside from 3 cents in a year.
PKK makes a compelling investment as its relationships in China and skill set in developing financial systems have enabled it to capture two major business deals under its corporate structure. Investors who balk at the high share count need to consider it from the perspective of Banlan and LongKey. Up until now Peak has been a corporate shell without much historical revenue. Both of these companies have decided to give PKK shareholders access to their businesses that have annual revenue potential in the hundreds of millions in exchange for PKK shares.
PKK has been one of many microcap tech companies in Canada that has been quiet for years with a share price that has gone nowhere. Now the company is starting to make noise with big promises in a short time frame of a few months up to a year. I believe that investors who start to listen may be rewarded handsomely by the end of 2016.
Disclosure: I am/we are long PKKFF.
Additional disclosure: I hold positions in securities as disclosed in this article. I have not received any compensation for this article and all opinions reflected herein are my own. The information provided herein is strictly for informational purposes only and should not be construed as a recommendation to buy or sell, or as a solicitation of an offer to buy or sell any securities. There is no guarantee that any estimate, forecast or forward looking statement presented herein will materialize and actual results may vary. Investors are encouraged to do their own research and due diligence before making any investment decision with respect to any securities discussed herein, including, but not limited to, the suitability of any transaction to their risk tolerance and investment objectives.