A Brief Response to $INS Short Report

When I was a kid, one of the dad-things my dad used to say was "consider the source." If I came to him upset b/c so-and-so said something nasty, he'd say "well consider, the source." It meant ... should I take them seriously? Are they a legitimate conveyor of information? Should I really care what they think?

I continue to spend a lot of time "considering the source" though we live in a day and age when it's meaning has been turned inside out. On the rare occasion that I'm on a long drive by myself, I listen to Investors Field Guide and recall one recent and recommended episode ... "I met our guest Michael Mayer because of twitter. I followed and enjoyed one of several pseudonymous accounts that he maintains to experiment with ideas. His various accounts have wide followings" ... which I've been struggling to reconcile with the lesson to "consider the source". How do you value a source if you don't know who it is?

There've always been authority shaping mechanisms of one kind or another (the emperor, the church, the university, the paper of record, a bigger gun, etc.), which would exclude scrappy folks like Mayer and me for no other reason than our lack of access or pedigree.

Now however, an anonymous twitter account with interesting content and a lot of followers can carry the same weight as the emperor or church or university or paper of record. It's cool b/c without gatekeepers anyone can put up a blog (yay me!) and in an ideal world it expands meritocracy. But our world is far from ideal. Do I really need vaccines? I'll go online and see what it says.

Just from an observation of human nature, which tends to not change and oft strays from ideal, I have this gnawing fear that once we've exhausted questioning the legitimacy of everything we'll revert to the authority shaping mechanism of the bigger bone, sword or gun until we re-recognize that having some kind of organized system that kind of works is less exhausting than fighting all the time.

If it's not obvious by now, I'm the pessimist in my family, which bugs the shit out of my wife but is helpful with investing. This work requires holding two opposing ideas in our heads at the same time - success AND failure - in order to weigh, consider, inspect and decide, from all different angles.

And there isn't a single investment I've made where I didn't think early on or even at times throughout that whatever it is, it could be a total fraud. Part of my checklist is to conduct due diligence seeking signs of fraud - balance sheet imbalances, board composition, etc. - but just b/c you don't see it, doesn't mean it ain't there. Schiller's "Financial Shenanigans" delves deep into these issues and is a must read for anyone putting money into any individual stock.

Which brings me to a recent short report on INS posted by ... I don't know who ... some man or woman operating under  a corporate name who seems to have posted a bunch of short pieces on various public companies.

The report had legitimate concerns for sure, but no news.  The red flags it raised are front and center to anyone who reads a proxy and 10k on day one of their due diligence and does a bit of digging on day two. INS has a large client that is the target of legitimate short sellers. Parker Petit is on its board. It uses a regional accounting firm with limited pubco experience.

Everyone has their own comfort threshold and for some investors, these issues might equal a "hard pass". We all have to find and trust our own filters. But causation and correlation are two different things and those issues don't make the company a fraud just as the road that goes from my door to John Gotti's doesn't make me a member of the mafia.

No doubt, the issues raised in that report should be on anyone's list of considerations when evaluating the stock. On balance I felt - and still feel - that this a wonderful business and a wonderful investment opportunity. Others may disagree.

But a legitimate short thesis identifies frauds, broken business models and industries in terminal decline and this report fell way short of that, likely b/c INS doesn't fall into any these categories. Ultimately, the report resolved to a valuation short, plain and simple and as Manny Gerard once cautioned me, valuation shorts are really just a form of technical analysis.

As the report concludes ...

"If INS were to revert to a valuation of around 2-5x trailing sales, a multiple typical of Indian outsourcing businesses such as Syntel and Wipro as well as larger processing companies such as First Data, the stock would be worth roughly $5 to $12 per share (70%+ downside)."

... which is just silly. Those companies aren't growing organically +30% / year. Those companies haven't self funded their own development with internally generated cash flow for 15 years. Those companies aren't as parsimonious with expenses as INS is (few are). Those companies have probably issued more shares in the last year than INS (which doesn't dilute shareholders) has in its float.

However, buried in the "pants on fire" effort to raise red flags, there is a legitimate and critically important comment that's essential for perspective ...

"... if Apple gathered a full 27 million accounts over the first 3 years, equal to the entire number of American Express basic consumer cards-in-force in the U.S. ... "

... boom. The rest of the comment made little sense to me, but just that data point alone is a 100% appropriate response to the momentum traders who've pumped this stock up its triple waterfall.

CEO Dr. Strange has long explained that licenses are paid at certain thresholds on the number of active accounts. How likely is it that INS' big new customer (rumored to be Goldman Sachs / Apple) will have more active accounts in year one, or year two, or year three, etc. than American fucking Express? Put me down for "zero probability".

It's too bad the author didn't focus on that point, b/c it's a legit and important perspective to keep in mind. That doesn't make this a $12 stock however. There's evidence to suggest that behind the current large customer are more large customers, and if you consider the pathway and the TAM and comparable valuations of say PAYS it's not hard to get excited.

As I've written, I think there's a wide pathway for this company to do $100M in annual revenues at some point over the next five years not b/c their rumored customer is going to issue X0M credit cards but b/c they have a good system and good experienced people and a good platform to challenge the 40% EBITDA margin oligarchy that hasn't substantially invested in this area of their business over the last X years. (In my experience, PE owned companies like FDC don't make long term investments).

Take this FWIW. I know this blog ain't Forbes or Fortune. I don't have a CFA or an MBA from a prestigious university. This blog doesn't have a douchy Greek name. I don't rub shoulders with the twitterati and I still cry at the end of Cars.

I realize my 10-years experience as a sell side analyst means little to most people and that anyone can open an investment mgmt business. I never got past the gatekeepers at a variety of hedge funds and in this world each of us is our own gatekeeper. The only authority shaping that goes on here is what's occasionally punched out at a keyboard, which I hope includes a little original research and an interesting idea or two.

The goal here has always simply been to be an open book of lucid thoughts on the world of small company investing, following in the footsteps of others' who've done the same.

I've been spending less time here b/c investing resolves to IP and I owe it to my growing base of paying clients to save it for them. But it frustrates me when someone smacks down a good idea for no good reasons just as much as it frustrates me that others light up good ideas with poor reasoning. I can only advise others to work hard, read deep, figure out your own filters and stay skeptical.

I'll close with a brief anecdote: My wife is the optimist in our family. Years ago when we were still dating she came home from deposing a genteel older man noteworthy for two things: He made her a perfect homemade cappuccino and he told her "every relationship needs someone chipper". It's her most of the time, though I step it up when she's feeling down. Still, as a couple of NL East fans who hate the Braves, telling that story is the only time in our house we say "chipper" without screwing up our faces.

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