About Me

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Avram Fisher, Founder & Portfolio Manager of Long Cast Advisers, is a former equity analyst at CSFB and BMO covering industrials and business services. He has prior experience in private equity; as a corporate governance analyst; as a writer; reporter and private investigator; and as a lifeguard and busboy (I still clear plates when my kids don't). This blog is an open book of ideas about patient investing and about starting up a small-cap focused RIA. It is part decision-diary, part investment observations and part general musings. Nothing on this blog is a solicitation for business nor a recommendation to buy or sell securities. It is simply a way to organize and share thoughts with an expanding audience of independent, patient and talented small cap investors. www.longcastadvisers.com

Sunday, March 26, 2017

the best investing advice I ever got

years ago, one of my oldest friends, let's call him "daniel" (himself incidentally the son of a legendary investor), was consoling me.

for what you may ask?

another friend had excluded me from some event. i was in my 20's and such things felt mortally significant.

with perspective, i now know that the negative feelings that arise from being excluded  is fairly universal among humans of any age and of most cultures. in the worst cases, it causes otherwise smart people to do horrific things. these days in the generally overvalued prvt tech markets its characterized by the acronym FOMO.

in any case, "daniel" said to me: "why do you give a shit what he thinks?"

that turns out to be the best investing advice i ever got.

the desire for acceptance is a wonderful human trait but it is one investors should reflect on. how long can we go without it and for what reasons would we pursue it?

a chip on the shoulder isn't a bad thing unless it weighs you and your portfolio down.

-- END --

Friday, March 24, 2017

compounding, after taxes and inflation, isn't as much a wonder

the 8th wonder of the world - "compounding" - is the magical return that grows on itself, over and over. it is a goal for investors, and a challenge.

yet different investors experience 15% annual returns differently and this is not well understood.


the consistent 15% return grows $100k to $1M in 17-years

the investor who experiences 3% inflation has a real 12% return and takes 20-years to achieve $1M in real terms.

the short term investor who sells their gains every year and has a marginal 28% tax rate receives a 9% after tax real compound return. 28-years later the portfolio is worth $1M.

were one to invest $100K in a store or business, how long should they expect to wait for it to return 10x capital? 28-years seems like a long time. there are many alternatives to equity in public companies that should be considered when allocating capital

the beauty of the stock market is the ease of investing in businesses. on any given day there are tens-of-thousands of businesses worldwide with public bids. wait for the right ones at the right price, buy a lot of it and expect to own it forever.

the wonder is who wouldn't want to buy businesses, that redeploy capital wisely and grow in real terms, with the eye of owning them for long periods? anything else short changes the return.

-- END --

ALL RIGHTS RESERVED. THIS IS NOT A SOLICITATION FOR BUSINESS NOR A RECOMMENDATION TO BUY OR SELL SECURITIES. I HAVE NO ASSURANCES THAT INFORMATION IS CORRECT NOR DO I HAVE ANY OBLIGATION TO UPDATE READERS ON ANY CHANGES.

Tuesday, March 21, 2017

Sometimes a Balance Sheet is the Simplest Idea



Since this is a company in transition, the business description ("We are a vertically integrated, advanced materials provider specializing in monocrystalline sapphire for applications in optical and industrial systems...") is meaningless.

the important disclosures are the Shareholder Letter dated 2/21/17 and the new CEO announcement dated 3/16/17

I summarize below the key points from the shareholder letter ...


  • decision was made to limit our focus to the smaller but growing optical and industrial segments of the sapphire market ... quickly exit the mainstream LED and mobile device segments of the sapphire market ... sell most of our plant capacity and generate cash to provide more opportunities to deliver stockholder value.
  • We are actively pursuing the sale of a 134,400 square foot manufacturing and office facility in Batavia, Illinois. Also, additional land in Batavia, Illinois we acquired in March 2012, Also the sale of  a 65,000 square foot facility in Penang, Malaysia. 
  • Our wafer patterning equipment in Penang was sold in the fourth quarter of 2016 for $4.5 million, and we are structuring an auction in the next 90 days to sell the polishing and fabrication equipment. Additionally, the real estate is currently on the market. 
  • We are in the process of consolidating operations into our leased space in Bensenville, Illinois and Franklin Park, Illinois and vacating our largest owned facility in Batavia, Illinois. 
  • planning a second auction for the excess equipment in the Batavia plant in the next 90 days ... also actively selling this property and our initial focus is to seek a buyer that is interested in both the building and infrastructure. 
  • reduce overall company headcount from 220 at the end of September to 40 today, significantly reducing current and go-forward cash-burn. We have been careful to maintain the employee knowledge base in our strategic markets built over the past 15 years.
  • we are actively evaluating the acquisition of profitable companies both in and outside of the sapphire market in order to accelerate growth and to utilize our substantial net loss carry-forwards. 
  • Because acquisitions are being given greater consideration, the Board of Directors [has a new CEO Tim Brog] with more extensive experience in mergers and acquisitions 
  • In addition to reducing costs, these changes will maximize accountability to stockholders and bring in a fresh perspective and new skill set to the executive team and the Board of Directors.
  • we are beginning to see a meaningful improvement in cash flow. 

The new CEO has had prior success unlocking value in turnarounds and in monetizing NOL's through acquisitions. It is impossible to say whether he can do that again but the cost of failure is somewhat limited by the valuation relative to the balance sheet and mgmt's efforts to stem the cash burn. 

-- END -- 

ALL RIGHTS RESERVED. THIS IS NOT A SOLICITATION FOR BUSINESS NOR A RECOMMENDATION TO BUY OR SELL SECURITIES. I HAVE NO ASSURANCES THAT INFORMATION IS CORRECT NOR DO I HAVE ANY OBLIGATION TO UPDATE READERS ON ANY CHANGES TO AN INVESTMENT THESIS. I MAY OWN POSITIONS IN THE COMPANIES MENTIONED HERE.

Thursday, February 16, 2017

Year End Client Letter + Website Launch

I finally - at long last - launched my firm's website ...

www.longcastadvisers.com

... we published our 2016 "year end letter" concurrent with the website launch and that can be found on the website under the "Links & Letters" section.

I expect that I'll continue to post here about ideas and such, though not entirely certain how I'll balance that approach. As always appreciate your input, interest and comments.

-- END --

ALL RIGHTS RESERVED. THIS IS NOT A SOLICITATION FOR BUSINESS NOR A RECOMMENDATION TO BUY OR SELL SECURITIES. I HAVE NO ASSURANCES THAT INFORMATION IS CORRECT NOR DO I HAVE ANY OBLIGATION TO UPDATE READERS ON ANY CHANGES TO AN INVESTMENT THESIS. I MAY OWN POSITIONS IN THE COMPANIES MENTIONED HERE.

Tuesday, January 31, 2017

... And out of the Blue, I was Quoted in the NYT

Maybe it's a slow news day and not much going on, but I was quoted in the NYT the other day about the Park Slope Food Coop and its recent controversy surrounding the pension for its employees.

What the NYT actually quoted was a line from one of three letters I'd written to the board and the coop newspaper. The letters were about the poor returns in the pension fund and the need for the fund to articulate and disclose its investment process and strategy, as well as concerns over management, transparency and governance.

The quote in the NYT was specifically about one of the two trustees of the pension, George Haywood, a former Lehman partner who'd started his own investment mgmt firm many years ago.

He was also a coop member who since the 1990's managed the pension as part of his workshift (all members of the coop have to work 2 hours, 45 minutes / month). Under his mgmt, returns were under whelming.

I thought it would be fun to include links to the full letters and where applicable call out portions that are relevant and important to investors in general.

I conclude as well with a personal letter I wrote to George Haywood's lawyer, Gary M., with the hope that he would forward it along.

So as to not bury the lede, not long after I wrote the private letter to George, and after years of questionable management of the coop pension with potential violations of ERISA laws, Haywood quit the coop and was named a director at Fannie Mae.

***

LETTER 1, from September 1, 2016, was written in reference to three things ...

1) erroneously reported information about the coop revenues and gross profit
2) a graphic about the pension performance that was wrong,
3) a graphic depicting the impact of a pension shortfall illustrated as cheese on a pizza and coffee beans

... at the time, the issues with poor returns on the pension were just coming to light. I'd hoped these paragraphs - the last three of the letter - would resonate most with readers:

"I get that many people have limited experience with financial presentations but everyone—from infants to addicts—knows how to make decisions about preferences. The business of investment management is quite simply a concentrated version of the types of decisions made by everyone, all the time, such as what fruit, shoes or glasses to buy, etc.

The point is, it’s far better to present such information fully and with appropriate context than to promote the continued infantilization of people’s attitudes about finance with pizza pies and coffee beans.

The idea that “it’s too complicated, leave it to us” is a part of the fabric of institutional finance that unnecessarily enriches a few at the expense of many, due simply to ignorance and complacency. Every opportunity to break that cycle should be taken."

***

LETTER 2, September 29, 2016. At this point, a small but loud faction is pushing the pension to go all passive. Obviously, that's viewed as "most prudent" these days. I was just asking for someone to please articulate investment strategy. This is the full letter.

"To the Editor: 

I have been following the debate regarding the pension plan and its investment performance with a little concern and a lot of bemusement.

My concern is primarily around the unnecessary risk created by the managers of the plan for maintaining a concentrated investment portfolio without disclosing an investment plan or strategy. If the pension trustees would articulate its process and how each investment fits into that process, it could better assess the reasons for its underperformance, i.e. whether it’s from a flawed process or a flawed execution, and adjust as necessary.

My bemusement is from learning that the co-trustee of the plan, George Haywood, is a high-profile beltway-insider, with close ties to President Obama. I am curious why and how we have a relationship with him? It certainly isn’t because there’s a dearth of financial acumen in New York City and it smells like the kind of relationship where the due diligence begins and ends with “you should invest with so and so, s/he’s very good.”

Giving money without proper oversight to someone held in high regard by others but who cannot articulate reasons for success or failure is a terrible way to do business. We wouldn’t buy cheese, produce, vegetables or proteins that way. Nobody should invest that way."

***

LETTER 3, November 10, 2016, was written after I attended a general meeting, where I learned two things ...

1) the short list of highly speculative companies the coop owned
2) how little most coop members understood about the pension in general

... it was one last plea for them to define the investment process and strategy (believing that they actually had one).

"To the Editor

The goal of managing a pension of any size is to match future cash needs with future cash flows.

Presently, more than 1/3 of the Coop’s assets are obligated against those future needs, which are funded by Coop sales and by the investment performance of the plan.

As detailed in last night’s meeting, the plan invests in companies that are not about future cash flows but about a bonanza or bust payoff; it buys speculative stocks at a low price and hopes the price will grow if a future event happens.

However, no one knows the future. If they did, and knew with certainty that the bonanza would happen, these stocks would already trade at higher prices. The uncertainty keeps VirnetX trading at a fraction of the value of its now six-year old patent infringement lawsuit against AAPL, etc. These unknowns exist for all companies.

Knowing how the trustees define a good company and what has been their “batting average” on selecting the right ones would be incredibly helpful in gauging their effectiveness, far better than simply quarterly or annual returns.

If the trustees have a good process for selecting the right companies, and a track record for doing it well, then it’s just a matter of following that process and practicing patience. But if they can’t define the process, then we have no information, just the emotional whipsaw of the stock market.

Joe, who is one trustee, is an incredible asset to the Coop and he does so much with his heart in the right place and concern for all the stakeholders but—I speak here as a professional investment manager—I fear he is at the edge of his competence when it comes to investing. (Search “krill oil boom” and you’ll know what I’m talking about). That is not a good place to be with other people’s money and a terrible place to be for someone acting as a fiduciary.

George, the other trustee, and supposedly a capable and experienced biotech investor, should be able to explain and articulate his stock selection methods, process and expectations. That he hasn’t is completely unfair to Joe, who is left to explain why he “believes” these companies “will be great”, absent any fact, like a politician in an election cycle. It is also unfair to the stakeholders in the plan, and the Coop itself, for whom he creates risk.

The alternative approach pitched by Hessney is the widely accepted process of the moment. I’ve never been one for widely accepted processes and I believe there are better solutions for investing capital. But without a well thought out and well articulated investment policy statement that defines the processes by which the trustees make their selections, they are creating risk to the Coop. 

Randomness is a most unjust way to treat our capital and our employees."

***

Then I gave up writing letters to the board.

But I wrote one last letter to George Haywood via his lawyer Gary M. whose name & address I found on his SEC filings. I was told it was forwarded along.

The letter had two purposes ...

1) I wanted to meet him. He's not the typical coop member.
2) I got a sense that George didn't really know what was going on, and that the other trustee stubbornly wasn't asking for his help.

... here's portions of that letter.

Dear Gary –

I write to you in your capacity as George Haywood’s attorney on SEC filings to request that you please facilitate an introduction between us and also to relay information that I believe is important so that he can help a mutual associate.

The genesis of this letter is that we are both members of the Park Slope Food Coop. I realize this is a tenuous – perhaps absurd - connection for an introduction but it also the basis for the more critical information described below.

About the introduction ... Last November I started my own investment management firm, Long Cast Advisers, which makes concentrated investments in well researched small / micro-cap securities. We apply the same fundamental analysis I used while working for 15 years as a sell side analyst. With just a year under our belt returns are +25%. We are off to a good start.

I would like an introduction to ask for his advice and counsel on building an investment management firm. I have always found it helpful - and an enormous privilege - talking with experts like him who have experience and success in areas that interest and engage me. I would be most grateful for that opportunity.

About the information to be relayed ... Mr Haywood is one of two trustees on the PSFC pension plan. The plan, which is invested in many of the same companies as Mr Haywood, has been underperforming the major indices for the last two years.

Some members of the coop have engaged in an organized effort to highlight the underperformance, increase the plan’s disclosure and consider a change in strategy. (I am not a member of this group, though I agree that more transparency is always a good thing).

...

The key factor here is managing the task of a fiduciary while limiting risk. Based on what little I know about the plan, it appears that there is insufficient oversight in its administration, in the management of its assets, in the nature of its investments, and in its underwhelming performance. With an organized group planning to highlight these risks in order to implement its agenda, I fear a negative impact on the coop and perhaps even the trustees of the plan.

I have suggested to Joe several times that the plan should have a detailed policy statement that explains why and how it makes investment decisions so that in the absence of returns, the stakeholders can at least be assured that it is following a proven strategy, is invested wisely and always with prudent due diligence.

I have also told Joe that the plan should have quarterly or semi-annual letters discussing the why’s and how’s of performance with a look towards future expectations, the kind of memo that every Hedge Fund or Investment Manager worth their salt shares with clients. I would imagine Mr. Haywood already makes these available to his clients.

I am certain others with more experience in this area could provide additional counsel on how to better manage these risks, both seen and unseen.

I’m not sure how much of this has gotten to Mr. Haywood. Perhaps I am speaking out of line but I would rather be wrong for the right reasons than allow incaution to prevail. Mr. Haywood should know what is going on and I urge him help Joe so he is not alone in dealing with this. It is sad and unfair for Joe to work so hard for the coop with his heart in the right place to be discredited on this account.

George never responded to my request for advice and counsel on starting an investment mgmt firm but as mentioned, he's left behind a mess at the coop pension to become a director at FNMA.

-- END --

ALL RIGHTS RESERVED

Thursday, January 5, 2017

$ARIS Proxy Battle Comes to Its Expected Conclusion

Park City Capital filed this proxy today, a "concession" speech of sorts at the $ARIS annual meeting. It reads like a "last say" on the (unnecessary) proxy battle they brought and thankfully lost.

A few comments about the letter worth pulling out:

They wrote: "... I haven’t spoken with any shareholder that would be disappointed with receiving $8 to $10 per share in the next six months."

Who did they speak to? I did not speak with them (if you have nothing nice to say ...). Other shareholders told me they reached out to Park City and the calls went unreturned.

They wrote: "... we believe that our efforts have helped raise the profile of ARI in the investment community and its stock price. If we go away and ARI’s stock no longer gets the benefit of this premium, we believe there would be significant downside in ARI’s stock price."

This proxy battle robbed investors of about $250k in the costs to fight it, yet they tout the benefits this battle? That's crazy talk. It's like a crime wave raising the profile of a neighborhood.

The stock price will go down if they dump 1M shares onto the market. If they sell as mindlessly as they ran this battle, it will be a tough few months for shareholders, but I don't see how that benefits anyone.

They wrote: "Despite Roy Olivier and Will Luden telling me on multiple occasions that they would immediately accept an $8 per share offer, they have communicated to shareholders and independent proxy advisory firms a plan that they believe could result in a $15 stock price over the next five years."

Did the CEO really say this? I don't know. In an ideal world, a CEO spends zero time talking about its stock price and even less time thinking about it. Why think about things you can't control? Nobody knows the future, but we know what drives future share value, which falls into two general buckets:

1. management's ability to deploy capital in a way that generates usefulness for its customers in order to grow cash flow and profitability

2. the multiple investors are willing to pay for that cash flow and profitability, which itself is a reflection of the trust and confidence in its sustainability and growth.

If the CEO focuses on maximizing usefulness to its customers, and that results in growing cash flow and profitability, then investors will have more confidence in the company's sustainability and growth, and the stock price will go higher. He should do that and not talk about the stock price five years out.

I did not attend the meeting b/c travelling to Milwaukee in January just feels wrong. I know its a beautiful city - perhaps even underrated - with a nice new museum and some interesting neighborhoods. I've been there in January, I've been there in late winter, I've been there in summer. I prefer the latter, but I'll take late winter, when it's cold, but bright and sunny and you could sense the coming thaw and hope in the air.

In January, it just doesn't seem there is much hope yet. Just. More. Winter.

Happily, the winter of this costly proxy battle is over. Now the  company can get back to launching its new platform and the CEO can focus on taking steps to lower churn, grow the number of subscribers, the EBITDA per subscriber and generally getting back to the business of making the customers fat and happy. That will resolve all issues with the stock price today and in five years.

-- END --

ALL RIGHTS RESERVED. THIS BLOG IS FOR ENTERTAINMENT ONLY. THIS IS NOT A SOLICITATION FOR BUSINESS NOR A RECOMMENDATION TO BUY OR SELL SECURITIES. I HAVE NO ASSURANCES THAT INFORMATION IS CORRECT NOR DO I HAVE ANY OBLIGATION TO UPDATE READERS ON ANY CHANGES TO AN INVESTMENT THESIS. I MAY OWN POSITIONS IN THE COMPANIES MENTIONED HERE.

Friday, December 30, 2016

A New Book and a New Idea ($IVTY, $MDT)

I recently received a gift in the mail, a copy of this out of print book by former CIA intelligence analyst, Richards Heuer. The book is influenced by Kahneman and Tversky but framed primarily around the decision making part of analysis and not just the analysis of decision making.

It is a dense read with fewer "cognitive party tricks" than the pages of so many other popular books on the subject, but it's fascinating, even as I'm only halfway through it.

Since I've recently sold some positions and also have some new clients, I have the "high class problem" of having capital to put to work. So the book arrived just as I'm searching for new ideas and as a result, the aspect of the book that's come into sharpest focus is the relative nature of observations and its relationship to decision making.

We all know that colors have a relative nature, changing depending on the background. And we all know there is a relative nature to sound, to speed, to taste, to time, etc.

Concurrently, the book also introduced to me the concept of "bounded rationality", which describes our tendency to frame things in a specific way, then solve for the problem within that arbitrary frame. For example, my wife often poses questions at me along the lines of  "would you rather do this or that?" as if those are the only two options available, and without articulating the problem she's trying to solve. (I'll acknowledge the difficulty of being married to an over-analytical spouse when all she wants to do is go out for dinner).

Reflecting on these aspects of decision making is critical for the obvious reason that ours is a decision making business and few people do it well consistently. Though the first year of my firm provides a good start, consistency is measured in years not months, and I still have a lot to prove.

Furthermore, the returns we put up isn't some theoretical experience; I have a fiduciary obligation and professional responsibility to grow my client's capital and avoid losses on their hard earned money. It's important to get it right and I better not screw it up!

So with these new insights into the relative nature of observations, it comes to mind that the search I've been conducting for new ideas may be rife with biases I'd never before considered. Here I am reading Q's and K's, learning about businesses, screening, modelling, reading, reviewing ... and saying "no" over and over ... and up percolates an emotional experience, let's call it "frustration", about not finding good ideas.

Frustration can lead to impatience ... and then perhaps the relative nature of observations takes over ... and I'm suddenly comparing the next idea to the last idea instead of to an objective benchmark. Each idea is independent of the other - and I should be more eager to preserve cash for the right idea than rush into the wrong one - but what if I'm suddenly framing them relative to each other and thus distorting the analysis?

The problem with all this is twofold: First, the potential lack of awareness that fatigue and relativity can drive decisions. Second, because most of the stocks I tend to buy are lonely trades where validation can be incredibly delayed, I might not know whether I'm "right or wrong" about a stock for months, if not years. I'd rather hold cash than be wrong ... but I'd like to not miss opportunities to be right.

All of a sudden the obvious and well discussed theories behind deep value investing are crystalized: If you buy companies for less than its asset value, you don't have to worry so much about the future. It's an easy philosophy on paper but less so in practice, because some "deep value" businesses absolutely suck and the good ones don't trade for below their asset values for long. Value, as we all know, is infrequently obvious.

This all calls to mind something Howard Marks wrote about "the future":

"It would be convenient to say that adherence to value investing permits investors to avoid conjecture about the future and that growth investing consists only of conjecture about the future, but that would be a considerable exaggeration. After all, establishing the current value of a business requires an opinion regarding its future, and that in turn must take into account the likely macro-economic environment, competitive developments and technological advances. Even a promising net- net investment can be doomed if the company’s assets are squandered on money- losing operations or unwise acquisitions.

There’s no bright-line distinction between value and growth; both require us to deal with the future. Value investors think about the company’s potential for growth, and the “growth at a reasonable price” school pays explicit homage to value. It’s all a matter of degree. However, I think it can fairly be said that growth investing is about the future, whereas value investing emphasizes current day considerations but can’t escape dealing with the future."

The future, the fact that nobody knows it, and the risks associated with its possible outcomes are important considerations in all investments. One I've been considering - Invuity - which makes lighted surgical equipment for the operating room, recently sold off b/c of weaker than expected guidance for 2017 (the near future), but I think it may represent a compelling long term opportunity.

At $6.00, Invuity (ticker: IVTY) has a $100M market cap and is trading at ~2.5x 2017 sales guidance of $40M-$42M, a future that implies 35% topline growth. This is - I believe - a “capitulation price” for a company innovating in an overlooked and undervalued area of the surgical equipment market and in an industry where stocks tend to trade in the range of 2x-10x sales.

The company’s core product is an engineered piece of plastic that delivers cool bright light with a wide field and few shadows directly into the cavity of a surgical "field". This piece of plastic – for simplicity sake let’s just call it a widget for now – either clips onto a reusable retractor that the company sells or is built into the company’s version of ubiquitous operating room tools like "yankauers" and "bovies".

The company has two types of sales; a "capital" sale - an expensive piece of reusable equipment - and a "disposable" sale (ie recurring) via the handheld equipment and clip on widget. These products together improve visualization - a surgeon’s ability to see - in non-laproscopic / non-robotic procedures.

The company currently markets these products into four narrow verticals: Breast oncology, orthopedic surgeries, thoracic and spine procedures. Some procedures like "nipple sparing masectomies" and "anterior hip arthroplasties" are particularly well suited for the device as they are fairly technical and involve smaller incisions for open surgery, making "visualization" difficult.

These procedures benefit the patients via less scarring and/or faster recovery times so the concurrence of the new procedure's acceptance and the improved equipment may help grow their use and thus demand for the equipment, etc. (Note that despite the negative bias towards the anterior approach in this link, it acknowledges speedier recovery for the anterior approach as well as the greater difficulty with visualization).

B/c of the NSM procedure the company has had the greatest traction with breast oncology - about 40% of sales - but has under-penetrated the more lucrative spine and orthopedic procedures.

This is still a small company - not just in market cap but in actual size - selling just a few products into a few narrow verticals. At 3Q16, the most recent quarter, the company had 65 salespeople, many of them with the company for less than a year, selling into 700 accounts. Small, yes, but on a relative basis, compared with last year, this reflects 25% growth in salespeople, 50% growth in accounts, and a 63% increase in procedures per quarter, to 26,000 from 16,000 in 3Q15.




In 1H17, the company will launch one new product - the “PhotonBlade” - a lighted version of Medtronic’s PEAK PlasmaBlade, which will have the "light widget" built in and a tip that causes less scarring. The company believes this product will allow the company to further penetrate breast oncology and spine market.

It is worth noting here that IVTY’s head of R&D, Paul Davison, was the head of R&D at PEAK Surgical, before it was acquired by Medtronic in 2011. At the time of the 2011 acquisition, PEAK had $20M in sales and was acquired for a 6x sales multiple.

So what don't we know?

I have talked to a number of doctor's about the product for qualitative background. One, whom I respect and admire greatly, insists on caution with the investment. "They're not the first to try to do this," he says. "There've been people trying to come up with better lights on surgical tools for more than 30-years."

My response: "That's proof it's a problem searching for a solution."

Several other doctors I talked with expressed enthusiasm for the product; "Tt would be awesome if it did what they say it does" but they all universally blanched at the price.

And price is an issue. The company charges a huge 10x premium for their lighted product. Their disposable yankauers and bovies as well as the clip on widgets (called “waveguides”) cost $250 to $300 compared to non-lighted versions of the same products, which cost under $25.

In a market with thin margins for hospitals and risk that ACA will disappear, it seems ridiculous to think hospitals will pay this much for disposable plastic. The product pricing is the first of many obvious reasons why this company fails.

Yet, despite the premium and all the other obvious reasons, the company is on track to sell $24M of these disposable plastic products in '16 (and $8M in reusable products that the widgets clip into), all at +70% gross profit margins. And these are pure cost to the hospital; there is no CPT code that allows the hospital to get reimbursed for its use.

The reasons for the company's potential success are less obvious. Again, this investment depends on a future. But experience indicates that it takes time – and costs money - to introduce a new premium product to the market and for the market to adopt it. It takes time for a salesperson to “mature” and an account to “mature”. It takes time for doctors to see the light and press a hospital Value Analysis Committee to buy for them a premium priced piece of equipment.

And yes, the costs of selling currently exceed the revenues, but perhaps there is overlooked promise in the early operating evidence, particularly with the recurring revenue disposable widgets and most particularly at 3Q16, where the ratio of incremental sales to incremental marketing spend reached an inflection point and increased to 48%.



Management expects to keep sales staff flat into 2017 and focus on going “deeper” into existing accounts and were this to happen, we would see continued revenue scaling and then perhaps we are just now seeing the inflection and impact of more salespeople and more accounts on revenues.

Yet, the market is most skeptical as signs of success are improving. That skepticism, which underlies the low multiple, is driven by a variety of issues I'll lay out below:

1. The proximate issue with the recent decline in the stock price was a guidance shortfall. On the 3Q16 earnings call, mgmt guided to 35% topline growth in 2017 down from expectations of 50% growth, and this led to the stock’s capitulation. The stock was trading towards $13 heading into the quarter and hit $4.50 on the earnings release.

The 3Q16 sell-off reflected the market’s focus on the weak guidance. Through the lens of a DCF model, such a response makes total sense: If T+1 income is lower, the whole valuation declines. But from a qualitative perspective, there should be no point in investing in this company at any price – regardless of what the DCF says - nor under any circumstance without the belief that IVTY’s usefulness to its customers will grow over time, along with its sales and eventually profits.

What drives long term growth of a company – qualitatively - is a problem identified and solved at a price the customer can afford. We see evidence in the operations that the company’s illumination products are indeed solving a problem and they are generating traction on the valuable recurring revenue side of the business. But ...

2. Price seems to be a major issue.

A former employee I talked with said cost is the single biggest obstacle with "going deeper". This person said as they "get deeper" into accounts and sell more into each hospital, eventually the invoices roll up to the CFO who pushes back.

In addition, every doctor I talked with - bar none - expressed shock at the cost.

The company says the better lighting enables doctors to perform surgeries faster and therefore do 1-2 more per day. A response I got from another doctor was polite laughter: "If I were to make a list of items that slows down my [thoracic] surgeries, lighting would be like item 1,700."

The company also said interestingly, "when we show up on the CFO's desk, it means we're doing something right." Reminds me of the old saying: "Salesmanship begins when the customer says no."

3. In addition to being high priced, there's no CPT code for the product, so hospitals don't get reimbursed for their use. And hospitals aren't rolling in cash to spend on expensive equipment.

4. And recently there seems to be a lot of salesperson turnover.

5. And surgical procedures are supposedly moving away from open towards laproscopic and robotic

My response on these four items is that these issues are not "new". 

A brief look at a scuttlebutt message board for pharma sales reps shows people talking about the high product pricing, employee turnover, competition, etc. since at least 2014. In the interim, sales have grown from $14M to $32M. 

Meanwhile, the cost / benefit analysis of robotic surgeries doesn't appear to be compelling (though as long as insurance covers it, hospitals will do it). 

More broadly, product price is a solvable problem. They can continue down the path of a $250-$300 ASP, scratching for sales within the four narrow verticals and with the new product expected to come out in 1H17, they can offer bundled pricing. 

Or, they can lower prices. These products are cheap to make and if the product is desired, the potential for ubiquitous access across all hospital channels at a lower price is an attractive investment option, though even more attractive at the higher price. 

6. Ultimately though, the skepticism is bound - like life itself - by the limits of time. The company is unprofitable, running at losses of $40M in 2016 on sales of $32M and gross profit margins +70%. It also has $14.5M of outstanding debt at 12.5% interest, held by Healthcare Royalty Partners, a medspace investment firm that also owns 5% of the stock. And although the company has $34M in net cash on the balance sheet, it is still cash flow negative so at some point, there will be a future dilution event.

This is no walk in the park, but startups with losses and debt are not unusual, and this isn't the first rodeo for the management team - lead by CEO Phil Sawyer and CFO Jim Mackaness - who have prior experience running growth distribution businesses.

Nobody knows the future, but at ~2x 2017 sales, the stock market appears skeptical about the prospects due to losses, debt, the recent guidance shortfall, and issues that are not new.

That skepticism overlooks what appears to be some traction in the recurring revenue business and the traction is new, the evidence of success is new, the favorable relationship between the sales and cost curves are new and trending in the right direction.

Sure, my biases and frustrations, hubris about my successes, shame about my losses, all may have contributed to this idea floating up to a level of thinking that ... maybe it's totally irrational. A yankauer for $250? A plastic widget with some special light? Hospitals spending money on stuff they don't get reimbursed for?

Maybe I've talked myself into a bad idea ... but when the market is already valuing this as a bad idea ... and the evidence suggests that its not failing ... it seems to offer a favorable possibility for those armed with information and an uncommon perspective.

 - END –

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