In the spirit of the discussion and unrest over the royalty, which is "additional consideration" to the specific note issued on February 26, 2015, I'll put forth my thoughts to at least establish some form of expectation on what 'could' occur in these negotiations, and why.
This is an opinion piece, it may hold little or no value or relevancy in that actual negotiations. I do not have relevant experience in such a boardroom negotiation.
The absolute most critical thing to keep in mind here is that it Intermap has communicated on numerous occasions that the royalty was designed to be a 'placeholder'. A placeholder may or may not be a function of the future. But it is most certainly a function of the past.
This post should help shed light on what the original intent of the royalty could have been; whose place it is intended to hold. This post is created simply as a means to create an expected range with multiple scenarios. By no means has any of this been communicated to me; it's simply how I have learned to find what has been left missing, literally.
Below are two separate concepts to of how to 'value' the royalty, in my mind.
1) Fair market value on future expectation of reasonably assured net revenues:
What will the royalty pay out if Vertex keeps it?
Easy calculation here:
Total revenue SDI 1 = $175 million, GUARANTEED, once funding is complete.
Other expected revenues, including that of SDI 2 = $100 million (Ball park estimate being tossed around)
Third party expenses (educated guess): Average over the lifetime: 25%
FV = (175+100)*(1-.25)
= $206,250,000 * 17.5%
= $36,093,750 (This number should be reasonably expected given the details we currently have. Royalty will grow in value as pipeline grows, play with the numbers as you wish.)
Why 17.5%? Perhaps they had already pre-determined a value for the royalty, which would revolve purely around market price of the shares. 17.5% is specific to me, so this could imply a fixed underlying value, agreed upon as an 'initial term', also predicated on closing of the SDI. In my opinion, if 17.5% was selected as a rough future estimate for a pre-determined value of equity/debt, they purposefully chose a % rather than a $ amount to intentionally be able to profit on future revenues; But let's face it, if there was no LOA, it would not matter if the royalty was in $ or % terms as the return would likely be the same, negligable. The very fact a % was selected on future revenues implies there is an intention to convert based on two things: future expected net revenues, and, future share price (at the time the royalty was agreed upon). The first method is the former. The below method is the latter.
(***For clarity, this is NOT the intended value of the royalty that would have been determined back in February 23, 2015. We have no idea what value they could have derived. I am simply pointing out that the value 17.5% is specific. However, I am not including in these calculations an intended value of the placeholder based on projected net revenues from the point back on Feb 23, 2015 as it simply cannot be done with any accuracy. Therefore, the above is the fair market value from today's point of view. And the below is the book value from up unttil the placeholder was created, adjusted for the share price today.)
2) Adding up the "inconsistencies" method:
Clearly I believe there is a link below that literally defines what the need of a placeholder would be, and a possible underlying 'book value' which it would be priced upon and intended to be a function of. There has been a well documented process of PP's, debt agreements, extensions, cancellations and roll forwards. I did a write up on the reddit board already about the history of these notes and correctly called the recent extensions and their subsequent decreases in interest, but, that was easy to do and others did the same with less words. However, this write up is focused on what was not discussed in those notes. If you follow the numbers, things don't add up. You'll see.
Below are the important notes of interest, with a description of what happened. Further, just to be clear, each convertible note should have at minimum two components, and in some cases, three. The first, interest (and prepayment right). The second, conversion into shares, which is a function of the present value of the principle + accrued interest. The third, warrants, which should typically only be used as a sweetener and not the actual primary conversion tool.
Feb 6, 2014: This was a $5,000,000 PP at 16% whereby 12,367,054 convertible shares were issued at .45/share, and 3,091,572 warrants were issued at 0.56 strike as a sweetener. Total interest received was $800k, plus, monetary value of $7,296,454.62 in total compensation via convertible common shares + warrants ($5,565,174.3 + $1,731,280.32). Side note: This is standard structure.
Dec 26, 2014(i): $500k convertible debt issued at 18%, whereby 8,333,333 convertible shares attached and 1,666,667 warrants added as a sweetener, both at 0.07. Interest of $90k + total market value of $700k for shares and warrants. Side note: This is standard structure.
Dec 26, 2014(ii): Further to the subsequent information from the Dec 26 PR, two additional amendments were filed on two prior notes. One from June 1, 2012 and the other from February 1, 2014. The first amendment was for 1,700,000 warrants @ .31 to be repriced at 0.08, and the second amendment was for the sweetener warrants from Feb 6, 2014 note above, to amend the 3,091,572 @ .56, giving a total amendment of 4,791,572 @ 0.08. This amendment was sent to the TSX for approval. ONLY 4,597,443 were approved, leaving 194,129 ($89,299.34) unapproved. Perhaps these are still left at original strikes? Side note: This is the first sign to us that restrictions are being imposed by the TSX.
January 14, 2015: $500k convertible debt issued at 18%. Notice a key change here. This $500k convertible was only due to be converted into warrants, 6,000,000 at 0.08 to be exact. This is an important distinction because clearly at this point, we see the inability to offer convertible common stock as part of the deal. Further, these 6,000,000 shares come with an outlay of only $480k, which is also inconsistent with previous pricing. Typically, they would have allowed for an exchange of shares equal to the full value of the note; Principle + PV of accrued interest over the period. This is where I believe there was a first placeholder, but, again, completely unsubstantiated. IF this were consistent, I would have expected there to be equal consideration as the Dec 26 note. So, that would leave $220k unaccounted for, or, 2,750,000 convertible shares. FURTHER, and this is where the next set of restrictions appear, the TSX only approved 1,469,834 of the 6 million warrants. Therefore, 4,530,166 warrants were left unapproved, at 0.08, that was the equivalent to not receiving book value $362,413.28. Total inconsistency in this note = $582,413.28 not received by Vertex, on a $500k financing to the company.
February 26, 2015: $7.3 million debt financing. Vertex/Intermap rolled forward the entire February 6, 2014 note and increased the interest rate on the $5,800,000 to 25% to reflect the current financial situation of the company. They subsequently added $1,500,000 to fund the all time low working capital, just to get through another couple months until hopefully the LOA would be awarded. Vertex agreed to retire the entire convertible share amount of 12,367,054 from that note one year prior. ABSOLUTELY ZERO CONVERTIBLE SHARES OR WARRANTS WERE ISSUED OR APPLIED FOR ON BEHALF OF THIS NOTE. But, in comes the royalty we are discussing today. And, if anyone bothered to ask about the royalty back then, this is when they said, which is still unchanged today, that the royalty was a placeholder. It should be obvious now as to what place is was holding. So, to keep things consistent, I would expect the 12,367,054 shares were not cancelled out of good nature. They carried a book value of $5,565,174.30, as previously explained. To reflect the change in interest, I would expect if the shares were intended to be re-priced, it would be 13,326,567 shares at original strike price, an additional 959,513 shares. IF, these shares were, or, are still intended to be repriced to 0.08 on that day, we would expect there to be a whopping 98,310,739 shares exchanged, but now we see this is completely out of the realm of the possible. This is where I believe a major function of the royalty is embedded. I believe there is a possibility that if these shares were intended to be repriced, it would be so on the market price of the conversion date. Let's try the price .257 when I am writing this. This implies a total of 23,334,455 equity and warrants. Still high, but in the realm of expectancy now. But, we aren't done. The expected share count on the additional $1.5 million @ 25% would have been 28,278,689 shares at 0.08. Clearly we see why they could not even apply for such grants from the TSX. My best case scenario is Vertex agrees to reprice these at market price on the conversion date as well, despite the fact this is unfair to them. This is where I break my scenarios apart. Either way, a placeholder is needed until they were able to apply for these large number of warrants and newly issued convertible shares. Now, as these rates have similarly dropped from 25% to 15%, I do see an argument for the 'shares on reserve' to drop partially with those rates to 21,562,500, final book value of $1,725,000.
April 3, 2015: Another $1.5 million convertible share note at new interest rate of 15%. In this note, Vertex/Intermap agreed to retire the 8,333,333 conversion shares at 0.07 from the first December 26, 2014 note, and, ROLL IT FORWARD, to adjust for the new terms. Now, what we know is that the TSX only granted 9,178,266 shares. First, if we rebook and roll fwd the 8,333,333 at 0.07, we would result with 6,481,481 shares at 0.09, the price this note is based on. 9,178,266 - 6,481,481 = 2,696,785 NEW convertible shares at 0.09, which equates to: $242,710.63; another partial grant from the TSX. This would imply that fair compensation would have been 12,777,778 shares at 0.09, but, 10,080,993 were over a limit, at 0.09. Market price plays a huge role in all of this, by the way. The monetary value of that equals $907,289.37, which never reached Vertex as agreed upon in the terms of the deal, which would have been invested, if not for restriction.
-The Dec 12, 2014 note has not been included because Vertex has already converted the 500k note into the shares via irrevocable notice of conversion dated June 12, 2015, for 5,741,187 shares, pushing them closer to the 19.99% level.
- To date, the royalty has already returned $626,000 to Vertex for the 9 months ended September 30, 2015. Although this may play a minor role in helping decrease the cost of conversion, for the sake of conservatism, I have excluded it from all calculations.
So here are the results:
1) 194,129 shares @ .45 left unapproved ($89,299.34)
2) 2,750,000 convertibles @ 0.08 inconsistency ($220,000)
3) 4,530,166 warrants @ 0.08 unapproved ($362,413.28)
4) 12,367,054 convertibles @ .45 inconsistency ($5,565,174.30); adjustment: 13,326,567 @ 0.45 ($5,996,955.06)
5) 28,278,689 convertibles @ 0.08 inconsistency ($1,875,000); adjustment: 21,562,500 @ 0.08 ($1,725,000)
5) 10,080,993 convertibles @ 0.09 inconsistency & unapproved ($907,289.37)
Total missing compensation:
USD: $9,300,957.05 (BOOK VALUE)
By not being granted these shares and warrants in due time, it can be argued that Vertex forwent a lot of potential capital gains or investment income. These adjustments can be made, but the number will grow pretty wild, but I am sure this will be a part of the negotiation, if it has not already been decided from the onset.
I have created multiple scenarios here, none of them are more likely than the other at this point:
1) Worst case scenario: All book values above will be repriced and granted at the market price on the effective date of the note.
2) Next case scenario: ONLY the Feb 26 notes are included in the placeholder for the royalty, all other notes are deemed complete and no additional compensation needed. However, Feb 26 note will be adjusted for pricing on effective date.
3) Next case scenario: All notes above are included in the placeholder for the royalty. However, the retired 12,367,054 warrants original priced at .45 per share will be repriced at market price on conversion date. All others at effective date.
4) Next case scenario: Same as above. Additionally, the $1.5 million plus accrued interest will also be repriced at conversion date instead of effective date.
5) Next case scenario: All notes are included in the royalty, and all re-pricings and new issues will be priced at conversion date instead of effective date. This is the book value of all equity + debt that they were supposed to receive in these notes. By accepting such a deal, they forgo that return from effective date until conversion date. BUT, they send a very powerful message to the market that they believe that sacrifice was worthy, and would cause a monumental upswing in prices to reflect this.
6) Best case scenario: Equally as realistic as the worst case scenario, this scenario only includes the Feb 26 debt, and considers all other notes completed. The Feb 26 note will be re-priced at market price of conversion date.
Now, the above calculations are purely ignorant of what the 17.5% will be worth if kept. I do believe that due to the fact they selected a % royalty over a $ royalty that they do tend to negotiate based on the expected value of the pipeline, but, it should be reasonable.
Both methods are valid. The first method only pays homage to the future. The second method completely ignores it. I believe it may be a combination of both. In saying this, two key principles remain:
1) If the royalty remains, price will not appreciate unless there is a severe upgrade in the expectation.
- I forecast that in the first 12 months of the first SDI, the royalty will eat $6.5 million from the bottom line. This equates to a final forecast of only 0.04 EPS on the year, therefore, proving we are in fair value territory. Removing the royalty equates to an easy $1 fair market valuation. This is a main reason why I believe price did not appreciate greatly after the definitive agreements were agreed upon.
2) If the royalty remains and the pipeline grows, the royalty will grow, and all other shareholders will be worse off.
- Anyone who follows this closely knows the communicated pipeline of $500-$600 million may actually be on the extreme low end of the range. In fact, when you look at where Intermap is mapping, how many developers they are hiring, and how large the need for their product around the globe is becoming, you can get many multiples of this number for an expected future pipeline, years down the road. This is a high margin business, and despite the fact we have enough TLA's to protect us for years, the royalty will again prevent most of the profits from hitting the bottom line. As Vertex is, and will continue to be the largest shareholder (Intermap will stand by this), it proves it too is in their best interest to remove the royalty sooner rather than later. Their poison pill doesn't need to be the royalty, as their expected equity and warrant position will be sufficeint enough on a fully diluted basis. Do we ever expect them to capture that pipeline, no. Intermap will be taken well before that window opens wide. Vertex is the reason the company has been allowed to turnaround and they had faith in the new management team and structure, as well as their proprietary technologies and established footprint within the industry. They will certainly have the final say at what price this company is purchased for in 1-2 years time, before expiry of their warrants.
Therefore, if the royalty is removed, it is a good situation for us, at any price. Based on the conversion price Vertex receives, we can reasonably calculate what they actually value the shares to be, based on the expected royalty income sacrificed in the process. If they do aim to receive anywhere close to the upper end of the range ($30-38 million), then I personally am quite unsure what the capital structure will look like after, considering that is equal to the current market cap. This, to me, seems unreasonable, but, it's only one opinion. Therefore, if we are to assume it is rational to think Vertex will not be unreasonable, then I may look to the dead middle of my range: $15.35 million, and expect that could be a good place to set the expectation from a retail perspective. Some will say this is too low, some will say this is too high, which is why I might say it's just right. We'll see.
P.S. as for the timing, this too is quite uncertain, as we do not know the specific regulations in place on the warrants. We also don't know if they intend to be selective on the selling price on their shares. As a fun side note, I performed my own volume analysis on their selling pattern vs. that of Invesco's, and they have sold approximately 72% at the ask, meaning they let the market come to them, where as Invesco hit the bid 52% of the time, without remorse, as they just sliced and sprayed giant parent orders through all the ATS's to retrieve 'best price available' during extreme periods of illiquidity. Vertex has been more patient, however, they may also be on the clock and may become more aggressive. This is only speculation, but this is also how I knew Invesco was likely finished selling weeks ago, and was replaced by a new seller. The good news is they have already quietly sold 25% of their equity position to begin the necessary steps of this process. We all know they can not own more than 20% of the equity without tendering an offer to buyout the company, and we are reasonably assured the placeholder is in fact for convertible common shares from the Feb 26 note, among others. We cannot guess as to how much. And Vertex is left selling through the public market because institutional buyers likely cannot accept the risk at this point until the down payment arrives and work commences. Therefore, as many others have suggested, don't panic sell, don't listen to fear mongering and don't create a negative scenario in your head that fits the price action, for that is true confirmation bias that in the world of high risk investing, sucks you out of your position and forces you to sell when you should have been buying.
Disclosure: I am/we are long ITMSF.
Additional disclosure: INDEPENDENT DD FROM RETAIL INVESTOR. DO NOT SUBSTITUTE FOR YOUR OWN DD.