Bristow Group (BRS): Near term catalyst for 45% drop

  • Bristow is down by 80% since mid 2015 as bankruptcy fears continue to slowly play out. The moderate recovery in oil prices has been unable to help Bristow recover.
  • Bristow has just suffered a massive impact due to excess unhedged currency exposure to the British Pound (quite bad) and the imploding Nigerian Naira (even worse).
  • Accelerating resignations from various management and board members. Key replacement director notably has highlighted specific expertise in bankruptcy.
  • In a best case, BRS delivers very outsized losses going forward. In a worst case, BRS violates debt covenants and faces default.
  • Recent statements by management are blatantly at odds with previous SEC disclosure. SEC inquiries into the use of offshore tax havens may have a separate impact on the stock.

This report is comprised of 3 sections.

SECTION I details a string of recent critical problems hitting Bristow just ahead of earnings. Numerous issues do not appear to have been disseminated to or digested by the investing public at all. The fact is that Bristow has massive unhedged currency exposures to both the British Pound (down by nearly 15% in 3 weeks) and the Nigerian Naira (down by 40% in 3 weeks). However, numerous other issues are detailed, including concerns over UK Search and Rescue. In just 9 trading days, Bristow is set to host its quarterly earnings call and will be forced to disclose these impacts. I expect a nearer term decline of 40-50% on the stock (share price down to around $6-8). However, as with its recently bankrupted competitors, the prospects for an actual default within 9-12 months remains moderate to high (share price to below $1). This is precisely what we have seen with Erickson Air Crane (NASDAQ:EAC), CHC (HELIQ) and other helicopter operators, which imploded by 99% as their credit situations unraveled.

SECTION II primarily focuses on a line of SEC inquiries into Bristow. In early 2015, (when Bristow was still profitable and supposed to pay taxes) the SEC began inquiring into certain offshore tax strategies being used by Bristow. Bristow first attempted to give limited, partial responses, but the SEC persisted with further inquires and demanded details of Cayman Islands and other offshore entities. It was eventually revealed that these entities accounted for nearly half of pre-tax net income. In the midst of the inquiry, Bristow’s then-CFO John Briscoe abruptly resigned prior to completing the response to the SEC. The company stated that he was looking to “pursue other business opportunities”, however he never ended up moving elsewhere. He simply quit. The CFO spot was then filled by an internal appointment, Don Miller, who had previously been in charge of Bristow’s M&A. Presumably Mr. Miller would have had little exposure to Bristow’s offshore tax operations. However, within just 9 business days, Miller then completed the final response to the SEC. Prior to running M&A at Bristow, Miller had spent 9 years with Enron North America. Prior to Enron, Miller had advised Enron from his prior position at Citigroup.

Shorting a stock based on expectations for an SEC action can take great patience. So instead, my focus of interest is how formerly utilized tax strategies may have allowed Bristow to underbid on projects such as the UK Search and Rescue operations. Even prior to any SEC action, to the extent that Bristow is unable to maintain such a competitive advantage, it would have a further negative impact on profitability for things such as UK Search and Rescue (among others). As of now, UK Search and Rescue, while only 11% of revenues, remains the one bright spot for Bristow, amidst sharply declining revenues elsewhere. Details of UK Search and Rescue are included in Section I. With nearly 50% of pre-tax income being parked in offshore tax havens, there is also the possibility that Bristow will have to repay substantial back tax liabilities at a time when it can no longer afford to do so. The actual prospect for an outright SEC action remains as a “put option” on the price of the stock.

SECTION III highlights the consistent failures of sell side research in covering Bristow. Recent reports by Cowen, Barclays and Credit Suisse have consistently downplayed or disregarded the recent negative developments and maintained lofty share price targets. In each instance, sell side analysts ignore obvious problems and simply echo the hyped up optimism of management. These reports have served to drive money into the stock, visibly propping up the share price. The sell side has consistently pumped the stock since it was trading at $60, and continues to pump it all the way down. Not surprisingly, these analysts generally come from the banks who have run Bristow’s past debt and occasional equity offerings over the years. Given Bristow’s constrained finances, the company is now a high priority investment banking client as it needs to raise money in the near term. More importantly, a number of the banks have served as lenders to Bristow. As a result, they are virtually certain to NOT issue anything that looks like concern over solvency.

In Section III below, I highlight the repeated examples from their research reports where they have ignored obvious problems which then quickly materialized and pummeled the share price. I also show how despite the ongoing implosion in the share price, these banks continued to pump the stock by simply quoting and echoing incorrect statements from Bristow management.

Section I – Bristow Group headed for a 45% decline

When I look for compelling shorts, I generally look for stocks which have at least 30-50% downside. And that is what I usually predict when I write about them in public.

But I have consistently found that these troubled stocks end up falling much more than 50% once their problems are exposed. Many of the stocks I have exposed quickly fell by 75-99%.

Examples include: Revance Therapeutics (NASDAQ:RVNC), SunCoke (NYSE:SXC), ForceField Energy (NASDAQ:FNRG), Regulus (NASDAQ:RGLS), Aemetis (NASDAQ:AMTX), Biolase (NASDAQ:BIOL), TearLab (NASDAQ:TEAR), CytRx (NASDAQ:CYTR),, Galena (NASDAQ:GALE), Northwest Bio (NASDAQ:NWBO), Ignite Restaurants (NASDAQ:IRG), among others.

The mot important factor with each of those stocks above was to identify a near term catalyst.

In particular, readers should refer to my article on helicopter operator Erickson Air Crane which subsequently declined by 98%, now trading at around 60 cents down from $25. According to the subsequent lawsuits, the concerns I highlighted were the precise primary cause for the collapse in the share price.

As with Erickson, Bristow Group (NYSE:BRS) is set for a very substantial decline and there is also a near term catalyst.

To paraphrase an old joke:

Q: What’s the best way to become a millionaire ?

A: Start with a BILLION and run helicopter company.

I can’t decide whether I think that management at Bristow are truly bad actors (dishonest) or whether they are just incompetent bunglers. In reality, it doesn’t much matter because the effect has been the same. Yes, I get it, times have been tough for anyone servicing the oil and gas industry. The offshore helicopter industry has been hit particularly hard, as evidenced by multiple recent bankruptcies.

But the point is that management has continuously and repeatedly given dramatically incorrect reassurances to shareholders about Bristow’s performance and prospects. These guys have repeatedly demonstrated that they will say ANYTHING in an attempt to keep the stock up.

With each quarter comes a new set of excuses for the past, as well as promises for the future. But in each case, when the actual results do come out, management is somehow “surprised” by new negative factors. I will demonstrate this in great detail below.

In each of the past 3 quarters, the share price quickly fell by at least 20-30%following management’s earnings call due to disappointing “surprises” from management.

The upcoming quarter, to be announced in 9 trading days is going to contain some shocking new disclosures for investors. The share price will once again take a significant dive.

As we have seen repeatedly in the past, currency “headwinds” (historically from less significant regions for Bristow such as Asia and Brazil) have been a consistent theme in Bristow’s large miscalculations, leading to significant losses and drops in the share price.

In fact, the impact of massive unhedged currency exposures is about to get much worse.

But doesn’t Bristow hedge its currency exposure ? (No, they don’t)

I find it downright bizarre that a company with such tremendous currency exposure around the world does not even bother to hedge its exposure with futures or other contracts.

But this is indeed the case. Bristow does not hedge its currency exposure.

On page 21 of the 10K, Bristow notes that:

Generally, we do not enter into hedging transactions to protect against foreign exchange risks related to our revenue or operating expense.

In a subsequent presentation, Bristow addressed the question by stating that they simply “naturally hedge our currency exposure through client contracts when possible“. But this has clearly and consistently not worked at all, as demonstrated in recent quarters.

In the previous year, currency moves were not nearly as extreme as recent moves, yet “surprise” currency moves saw Bristow operating revenue decline by $98.6 million year-over-year. The hit to net income was $30 million. And again, these were not drastic currency moves.

In order to avoid breaching loan covenants, Bristow has been forced to cut its dividend by 80%, slash cap ex and eliminate cash bonuses for employees. The loan covenants were renegotiated in May. But in fact, all of this was BEFORE the new and negative currency developments occurred.

As we will see, due to recent extreme currency moves, things are about to get quite substantially worse for Bristow and so far management has clearly failed to disclose the full impact to investors.

Currency impact mostly affects revenues and earnings (as opposed to balance sheet)

Over just the past few weeks, Bristow has clearly been heavily impacted by due to the 15% fall in the British Pound (approaching 20% decline since last year). European (primarily North Sea) revenues comprise fully 50% of Bristow’s total.

I am primarily focused on the significant revenue / net income impact of the currency plunge. But given that Bristow has historically kept nearly half of its earnings “indefinitely reinvested abroad”, there could also be a negative balance sheet impact it the tens of millions of dollars.

Nigerian revenues are around 15% of total, which doesn’t seem overly large. But in June, the Nigerian Naira dropped by a massive 40% when the government stopped defending its historical peg to the dollar. Bristow had previously disclosed the potential for very substantial exposure to moves in the Naira. But because the currency has historically been pegged, no one has paid much attention to this. Following the move in the Naira, Bristow has disclosed nothing to the general public.

Note that I expect very little near term impact on the balance sheet from the Naira. In fact, Bristow may even be slightly net short the Naira (with more Naira liabilities than assets), however this likely amounts to less than $1 million. So the balance sheet impact is likely immaterial in either direction. Instead, the main impact from the Naira will be a plunge in revenues and sharp increase in Bristow’s ongoing losses.

Disclosure shortcomings – past and present

Just prior to Brexit, management insisted in SEC filings that it had absolutely no material exposure to any fall in the Pound. This limited the damage to the share price during the Brexit days. But shortly after Brexit,management quietly admitted that the exposure could in fact equate to tens of millions vs. 2016 operating income. In fact, I now think it could be much more.

Following the collapse of the Naira, management has made no disclosure of the actual impact. On its Nigerian operations. But as we will see below, at a minimum it is likely to equate to 22% of Bristow’s entire 2016 global operating income. This will soon need to be disclosed in the upcoming earnings call. And, as with the Pound, I suspect that the actual number could be much greater.

Despite the enormity of its impact, the crashing Naira has not even been noticed by Bristow investors or reflected in the share price. The share price did dip briefly on Brexit, but has since recovered much of those losses.

As it has repeatedly done in the past, Bristow management has continued to publicly put on a positive spin to support the weak share price. As expected, sell side analysts simply echo the positive statements from management.

These statements will be dissected in detail below.

When times were good, Bristow refused to issue much stock at share prices over $60 and instead continued to lever up substantially with debt. The share price has since fallen to as low as $10.80. Debt load now exceeds $1.1 billion vs. a market cap of around $450 million. Multiple competitors have recently already gone bankrupt but are still operating. They are undercutting Bristow and price and flooding the market with used helicopters, eliminating Bristow’s ability to monetize their own.

Earlier in 2016, bottom feeding “value hunters” might have been tempted to think that Bristow trades at a discount to book value.

But in terms of “asset recovery” in a bankruptcy situation, Bristow’s helicopter assets are now worth far less than the book value stated on the balance sheet. Just in May2016, following the bankruptcy of competitor CHC, Oil and Gas People noted that:

With the market conditions for helicopters so poor there is a lot of idle aircraft around, if CHC have 100 or so that they want to get rid of, then how many do the other big players in the market have? The leasing companies of course won’t want these aircraft back but under Chapter 11, they have no choice. With regards to buy back, the market is flooded with unused helicopters with supply far outstripping demand. The leasing companies have a couple of choices, receive the airframes back under chapter 11 and receive no payment at all or sell the airframe at a discounted market value price and get shot of it?

search in the 10K for the word “impair” turns up 175 hits.

For 2016, Bristow already recorded a loss on impairment of $55 million and an additional loss on disposal of assets of $30 million.

Because the assets are so heavily impaired, and because of the heavy debt load, the downside in the share price remains quite large.

The point of this article will be that when details of massive exposures incurred in recent weeks becomes public, the stock will quickly fall by 40-50%. It may take more than one day, but I expect it to settle at around $6-8.

We have seen this repeatedly in the past. In each of the past 3 quarters, the share price quickly plunged by at least 20-30% due to new surprises disclosed at the last minute by management.

Anyone foolish enough to see this information and still hold through another disastrous upcoming earnings call certainly deserves the losses they have coming.

Yet despite an almost inevitable plunge in the Bristow share price going forward,short interestin Bristow Group remains below 10% of the float and the borrow is cheap at around 1%.

Company overview and investment summary

Headquartered in Houston Texas, Bristow Group is an operator of helicopter services in various locations around the world. The majority of its consolidated operating revenues (76% of total) come from providing flight services to oil the offshore oil and gas industry, with heavy exposure to the North Sea (Britain and Norway). Operating income is also heavily exposed to operations run in Nigeria. The firm also provides Search and Rescue services as an adjunct to various governments as well as running a helicopter training school in Florida. However, both of these segments account for much smaller portions of revenue.

Bristow has plunged by 80% since mid 2015, largely due to the plunging price of oil. The stock was hit again on the Brexit vote in June due to Bristow’s heavy exposure to the UK, but since the stock has regained much of the brief Brexit losses.

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Bristow Group has been around in one form or another for decades. Like other helicopter operators, the company has massive cap ex requirements and also needs to make use of massive leverage (debt).

Over the past 3-4 years, the company has been forced to spend $2.5 billionon cap ex. This was achievable when markets were strong. Now, it is not.

Bristow could have easily issued tremendous amounts of stock at prices in the $60’s in previous years (when its market cap was close to $3 billion), but instead the company largely chose to lever up and continue raising debt. It now sits under a pile of $1.1 billion in debt with a market cap of only $450 million.

Over the past year, operating cash flow was just $116 million, which was not nearly enough to support the $372 million in required cap ex. To investors, Bristow continues to state that it has “liquidity” of $360 million. But in fact it only has cash of $104 million, down from $130 million last quarter.

When times were good (think oil at $100), Bristow was actually able to turn a decent profit. But as the price of oil plunged, revenues have fallen. Margins have been hit hard. Multiple competitors have filed for bankruptcy such that they are flooding the market with their unused equipment and lower priced services.

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The effect on Bristow’s financials has been dire.

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Things did appear to have bottomed starting in May/early June when several things happened at once. These factors had tempted a number of investors back into the stock, preventing it from collapsing altogether.

First. The price of oil rebounded sharply from lows of around $25 per barrel in February to as high as $52 per barrel in June.

Second, management was able to renegotiate covenants on its debt agreements with banks, to avoid otherwise going into default.

Third, in June (when oil peaked at $52) several members of management made a few purchases of stock near its multi decade lows. However, total purchases amounted to just $464,000, the majority of which came from the CEO. But in general, it was starting to appear that things might get better for Bristow.

But late June was extremely unkind to Bristow.

The surprise Brexit vote caused the British Pound to plunge by nearly 15% from its recent levels. That takes the decline to well over 20% since mid 2015.

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Like many stocks, Bristow’s share price took a hit on Brexit. It fell to a new multi decade low of $10.80 (intraday). But then, along with the rest of the market, Bristow stock rebounded, returning to current levels.

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Contradictions vs. SEC disclosures – a quick “about face”

(Note: information in this section is separate from the information in Section II, which details the SEC’s inquiry into offshore tax havens.)

Part of the rebound in Bristow’s shares price was likely due to the fact that in original disclosures (from the 10K in May), Bristow has disclosed that its exposure to the Pound was “not meaningful”. At the time of the disclosure, the Pound was at $1.55-1.58.

Investors were clearly soothed by management’s existing disclosure.

Yet two weeks AFTER the Brexit vote and the Pound collapse to around $1.30, management gave a presentation in London (Evercore) where it quietlyestimated that each 10% drop in the Pound would end up equating to a $10-12 million drop in operating income. So we should likely expect the real impact to be at $20 million or more (up from a previous statement of zero in the 10K).

So within just a few weeks, their estimate of currency exposure went from zero to potentially over $20 million.

This alone equates to a 50% increase vs. the operating loss just reported. From this, it quickly becomes clear that management has zero clue what is going on with its currency exposures.

In fact, if past earnings calls are any guide, we should expect the impact to be even bigger.

The situation in Nigeria looks like it could ultimately have a far greater impact. Yet (true to historical form) management has so far publicly disclosed nothing about the impact of the Naira.

Nearly all of Bristow’s African revenues come from the oil producing country of Nigeria. For the past year these African revenues comprised fully $255 million of total revenues.

Little noticed disclosure previously noted that Bristow’s exposure to the Naira was significantly greater than exposure to the Pound. Based on their original forecasts, a 10% change in the Nigerian Naira would equate to a 5.6% drop in operating income. So the estimated impact was already for a 22% drop in operating income (or rather a further 22% increase in operating loss).

But again, given that management grossly underestimated its exposure to the Pound, I believe that Bristow could actually be far more exposed to the Nigerian Naira.

Because of the long standing fixed peg 200:1, most would have assumed that there would be no need (and no ability) to effectively hedge the Naira.

But in late June, the Naira was unexpectedly unpegged from the dollar and it immediatelyplunged by 40%. It has remained at these new levels.

On June 20, the Wall Street Journal noted that:

Nigeria’s currency plummeted more than 40% against the dollar on Monday, the latest sign that low crude-oil prices continue to disrupt the economies of some major oil-producing nations.

Anyone with exposure to Nigeria (ie. Bristow in particular) should have seen this coming for some time. Even back in February, US News reported that:

…Money changers sit idle, with no dollars or euros to sell.

“We’ve run out of foreign exchange,” says Shehu Mahmud, the acting chairman of an association of money changers in the capital Abuja…. Already, the currency [Naira] has lost more than 50 percent of its value on the black market.

As we have seen in Venezuela, the plunge in oil prices has led to dramatically lower production as well as increased political unrest. The 40% plunge in the Naira is certainly going to contribute to further instability in Nigeria.

There are two realities that need to be faced with respect to this $255 million in historical Nigerian revenues.

First, even if revenue were to remain unchanged in Africa, profitability on these revenues will now drop to near zero because much of the cost basis (including fuel, offshore pilot and mechanic costs etc.) will be in dollars while the revenues coming in will be denominated in now-devalued Naira.

But based on this, the second reality is that it will likely make very little business sense to continue operating in Nigeria with the now devalued currency. As a result, up to $255 million in historical revenues is now likely now in question.

You don’t need to take my word for it, just ask the Nigerians.

Just on July 12th, one Nigerian Naira news service noted that:

There is double-digit inflation, a lack of dollars (which prevents investors easily repatriating profits) and domestic terrorism, including bombing of oil pipelines, putting a further dent in government coffers.

“The naira is going to sink further, and it’s a formula for a disaster,” says Steve Hanke, professor of applied economics at The Johns Hopkins University. “Capital flight will accelerate so disrupting foreign direct investment.”

The weak currency, which looks set to get even weaker, will likely scare new investors away and current investors will be increasingly likely to pull their money out of the country. And the country’s growth will slow without the investment dollars.

As we will see below, losses from the Naira implosion could well have significant implications for Bristow’s massive debt situation and new covenants.

But what about UK Search and Rescue

While in London, and while ignoring the problems in Nigeria, management clearly attempted to over-emphasize its one bright spot: that UK Search and Rescue operations would see little impact from Brexit. Yes, this stability would be a mild positive. However, such revenues accounted for just 11% of revenues in 2016 vs. 76% for oil and gas operations.

To put this in perspective, revenues from Nigeria were 40% more than revenues from Search and Rescue.

In fact, Bristow won this contract way back in 2013 on a competitive bid vs. now bankrupted CHC Helicopter Group. At the time, Bristow was a $3.5 billion company with a $70 stock price and could afford to take chances on the bid. At the time, CHC was also very healthy and was preparing for a $530 million IPO which would value CHC at over $3 billion. Yet even then CHC refused to bid anywhere near as low as Bristow.

CHC’s COO Peter Barlotta leaked an email to the press about the low ball bidthat Bristow used to win the contract.

In the email, Bartolotta also reveals that one of the other bidders has tendered a bid some 20% lower than that of CHC’s, adding: “We don’t have insight to the financial or other motivations of competitors. But we know that the economics at a price 20 percent lower than our interim bid simply aren’t right for CHC.”

The winner of the contract in 2013 turned out to be Bristow.

Despite undercutting CHC by 20%, to a level which apparently makes no economic sense, Bristow still described its Search and Rescue operations as being among its most profitable. It is entirely unclear to me how this could be the case.

However, as mentioned above, in 2015, the SEC began inquiring about Bristow’s use of offshore tax havens to minimize taxes paid on overseas income. Specifically, the use of Cayman Islands entities was a point of focus.

The SEC and tax angles here are an entirely different component of the short thesis. As a result, I have included a detailed Section II which lays out this information. There are two key points: First, to the extent that Bristow was using an unsustainable tax advantage to compete on UK SAR, the end of this advantage will soon hit profits. Second, to the extent that Bristow improperly evaded US taxes, it would need to repay those taxes NOW – at a time when it certainly cannot afford to do so. The information is well worth reading and has likely not been read by most investors in Bristow, so I would strongly encourage readers to go through it.

The revenue value of the 10 year Search and Rescue contract , which began in 2015, was originally disclosed specifically as £1.6 billion (Pounds) when the exchange rate was close to 1.6 GBP/USD. That would have equated to around USD$2.5 billion, or roughly $250 million per year in revenues.

Yet despite the 20% drop in the British Pound since then, management continues to use the original translated value of the contract in presentations, including the presentation in London. As always, despite past experiences, Bristow describes the Search and Rescue revenues as being “naturally hedged“, rather than actually hedging the revenues financially. In other words, Bristow continues to not hedge currency exposure.

Management’s discrepancy here amounts to nearly $500 million over the life of the 10 year contract.

In any event, even assuming the highest possible estimated contract value over 10 years, Search and Rescue revenues remain small, amounting to less revenue than Africa (or even Asia for that matter).

And keep in mind that competitor CHC had its own Search and Rescueoperations, which also accounted for around 10% of revenues. Shortly before filing for bankruptcy, CHC’s CEO had a conference call with analysts and investors to stress the “stability” provided by these Search and Rescue revenues.

But again, somehow Search and Rescue is where management chooses to direct our attention ahead of the upcoming earnings call. It is really the only positive factor than can be discussed, amongst many larger negatives.

As an aside, little impact expected from Norwegian Krone

It should be noted that previous disclosures also indicated a heavy exposure to the Norwegian Krone. However, the Krone has not been particularly volatile. I expect little impact from anything relating to the Krone.

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Insiders are already fleeing the sinking ship, as management continues to publicly reassure

In a June 8K filing, Bristow announced that it was terminating cash bonuses for employees. It did note that it was handing out a few million shares in bonuses to top management, but these are most likely not highly prized by employees who have seen their existing equity awards plunge by 80% in the past year. The value of their past bonuses has quite literally evaporated, such that getting new shares of the rapidly plunging stock likely means little.

We are already seeing multiple recent management departures, including Chief Admin Officer Hillary Ware, as well as Jeremy Akel (Chief Operating Officer), Mike Imlach (VP of Global Ops), and Mike Sim (VP of Business Development)

On June 13th, two directors resigned after being with Bristow for over a decade. The director who replaced them is notably known to have specific expertise in bankruptcy.

On June 27th (just after the Brexit vote), Bristow appointed William Higgins as a new director. The Heli Hub industry journal was notably focused on Mr. Higgins past bankruptcy experience with Leslie controls in a headline:

Bristow Group adds new Board director with particular experience

Heli Hub noted that:

We are not clear on why Mr Higgins’ skills in bankruptcy protection have been noted, whether that is something Bristow feel they might need, or whether it is an SEC requirement to provide those details in this sort of statement.

Getting a clearer picture of default risk

I have previously expressed my concerns about helicopter operator Erickson Air Crane, which then declined from $25 to just 60 cents. But that company never formally filed for bankruptcy.

But anyone involved in the helicopter industry should be very familiar with bankruptcy.

In the 1980s and 1990’s, Bristow was fully owned by British and Commonwealth Holdings, which went bankrupt during that time.

Bristow was then acquired by Offshore Logistics, which itself had gone bustduring the prior oil price downturn.

When competitor CHC filed for bankruptcy in May of 2016, it seemed that the last straw was a fatal flight accident that grounded much of its fleet. Likewise, in June of 2016, Bristow announced that it was grounding most of its Airbus EC225 helicopters following that crash.

This follows two serious helicopter crashes by Bristow itself near Lagos, Nigeria. In the first crash, 6 of the 12 passengers were killed.

An article from Bloomberg is now raising the issue that the most recent crash in Norway “has sparked a debate over whether the industry’s deepest cost cuts in 15 years are imperiling safety.”

Bristow continues to struggle under over $1.1 billion in debt and must meet heavy cap ex requirements if it wishes to stay business. In London, Bristow now noted that it would be attempting to defer capex in order to preserve cash.

The effect of the currency implosions is that Bristow will now likely be running up against its loan covenants AGAIN, just a few weeks after revising them with banks.

Again, it is important to remember that the currency implosions above have occurred just within the past few weeks, and subsequent to the prior loan negotiations which just took place.

Making matters worse, Bristow’s ability to generate cash from asset sales and returns now appears to be under pressure as well.

In the 10K, Bristow had as a risk factor that:

In May 2015, a global competitor filed for Chapter 11 bankruptcy protection and announced its intention to reject leases resulting in the return of approximately 90 leased helicopters to lessors. This significant return of aircraft into an already oversupplied market could undermine our ability to dispose of our aircraft and could have a material adverse effect on our business, financial condition and results of operations.

Keep in mind that this was one year before the additional bankruptcy of Bristow’s largest competitor, CHC.

From bankruptcy, CHC had noted that:

The reorganization is expected to strengthen CHC’s financial position by reducing long-term debt and enhancing financial flexibility while allowing the Company to manage and operate its fleet of aircraft. CHC expects day-to-day operations to continue without interruption throughout the court-supervised restructuring process.

Under the bankruptcy, CHC is flooding the market with excess, unused helicopters as well as potentially undercutting Bristow on price. This should be obvious, CHC will now be free of much of its long term debt obligations, but will certainly need to cut price in order to attract customers during its bankruptcy.

Such cost cutting and emphasis on low pricing was significant enough to be disclosed as a separate risk factor in the recent 10K.

A focus by our clients on cost-saving measures rather than quality of service, which is how we differentiate ourselves from competition, could reduce the demand for our services.

The bankruptcy filing from CHC just happened in May, such that we have only begun to see the impact of the increased pressures on Bristow.

Yet, as described below, various sell side analysts seem to suggest that bankruptcy means that CHC will no longer even be in business or competing with Bristow. These sell side analysts are merely echoing inaccurate statements from Bristow management.

Are Bristow bankruptcy concerns overblown ?

When defaults happen, they often happen in a various abrupt stages.

CHC Group filed for bankruptcy in May, but it had “decided not to make” an interest payment as early as April 15th.

But keep in mind that just 3 weeks before the default, Moody’s had still been rating CHC Group as a B2 credit.

Just 3 weeks later, when the bond payment was missed, Moody’s suddenly downgraded CHC by 5 notches to “D” (for Default). It was very abrupt.

Bristow currently has over $1.1 billion of debt and just $104 million in cash. Cap ex requirements still greatly exceed operating cash flow. And Bristow’s market cap is down to less than $500 million.

As of its most recent review. Moody’s was rating Bristow as Ba3just 1 notch above where it was rating CHC immediately before its default. But this was well before the recent currency implosions.

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But wait, it gets better.

A few weeks before defaulting on its debt and filing for bankruptcy, CHC had put out a press release touting its Q1 financial results.

The results appear surprisingly similar to what we see from Bristow.

CHC noted the following:

· Improvements in cash flow

· decrease in aircraft related capital expenditures

· cost control initiatives progressing according to plan

But the biggest item was that CHC noted that

We exited the fiscal 2016 third quarter with liquidity of $377 million and we are focused on strengthening and increasing the quality of our liquidity.

Despite the assurances, within just a few weeks, CHC Group had defaulted on its debt payments and filed for bankruptcy.

We should remember that Bristow also boasts of having recent “liquidity” of $360 million. But also remember that only $104 million of this is cash. The remaining $256 is just more debt. Even though cash had actually fallen by $28 million, the company stated that “liquidity had increased by 20%”. And again, these figures are all prior to the recent currency implosions.

The relentless “optimism” of Bristow management

The point of this section is as follows:

As the share price was plunging to multi decade lows, management gave a presentation in London which then boosted the stock price by 10% that day. The presentation was typical for Bristow and outlined how everything was going great and that bankruptcy was not a risk. Yet statements in the presentation clearly contradict recent SEC disclosures.

Investors should note that management has been delivering the same optimistic pitch over and over again since mid 2015, during which time financial results have continuously plunged and the stock has dropped by 80%.

Management will (and does) say just about anything, even when it is downright silly.

Following the sequential resignations of multiple members of senior management in recent months, Bristow tried to spin these departures as a positive with a press release entitled.

Bristow Group Strengthens Operational and Leadership Structure

Prior to the release of earnings for the September quarter (released in November), Bristow’s share price sat at $37 (already cut nearly in half since January). Management’s positive spin on earnings consisted of its usual delusional optimism.

I am proud of our team’s progress during the quarter in implementing our economic restructuring initiatives designed to enhance Bristow’s leading competitive position and financial strength,” said Jonathan Baliff, President and Chief Executive Officer of Bristow Group. “We have been successful in reinforcing our financial flexibility through an expected deferral of approximately $100 million of capital expenditures out of fiscal 2016 with further deferrals expected over the next five years. We also are announcing a new two year $200 million term loan which will provide additional liquidity in light of this downturn.

In particular, management simply blamed the effect of a strong dollar for additional losses of $22 million. But if we could just ignore that….then things would look great.

Our results for the September 2015 quarter included a number of negative items, including the impact of the strong U.S. dollar, which detracted from our underlying performance where our regional operations delivered respectable results led by Europe Caspian and Asia Pacific. Excluding the impact of the foreign exchange losseswe would have reportedadjusted EBITDAR of $122.7 million, in line with the prior year quarter with an improved adjusted EBITDAR margin of 28.9%.

And with the stock in the $30’s management disclosed that it had even approved a $150 million stock buyback program. (With cash getting more and more scarce for Bristow, this ruse clearly has had little effect on the share price. )

Management noted that it was lowering guidance for the full fiscal year(ending March 2016) from $3.10 – $3.75 to an EPS of $1.80 to $2.40.

So management’s original estimate was initially wrong by around 40%. (Hint: it then gets worse).

THE POINT IS THIS:

INVESTORS HATE SURPRISES.

THE STOCK BRIEFLY ROSE BY 15% PRIOR TO THE EARNINGS RELEASE IN NOVEMBER.

FOLLOWING THE RELEASE OF EARNINGS AND THE CONFERENCE CALL IN NOVEMBER, BRISTOW’S STOCK QUICKLY DROPPED BY 20% (TO BELOW $30), HITTING NEW LOWS FOR THE YEAR.

(click to enlarge)

So then in February, Bristow released earnings for the December quarter. By this time the share price had now fallen to $20-25 (prior to earnings).

Not only did Bristow reaffirm guidance of positive EPS for the year of $1.80 to $2.40, but the press release was again filled with reassuring language:

Our third quarter results demonstrate the success of our diversified business development and economic restructuring efforts in the face of unprecedented challenges for our oil and gas clients. These initiatives demonstrably improved our third quarter margins while improving our competitive position and financial flexibility,” said Jonathan Baliff, President and Chief Executive Officer of Bristow Group

The company went on to tout:

  • Search and rescue strength
  • Cap ex cuts
  • “Improved liquidity”
  • More loans
  • Financial flexibility

Sound familiar ?

But the reality was that (surprise) revenues had declined by 21.2%. (Surprise) Currency exposure hit revenues by $14.9 million. (Surprise) Bristow’s dividend was cut by 80%. (Surprise) a steep drop in the Aussie Dollar caused additional losses.

THE POINT IS THIS (ONCE AGAIN):

INVESTORS HATE SURPRISES.

FOLLOWING THE RELEASE OF EARNINGS AND THE CONFERENCE CALL IN FEBRUARY THE STOCK IMMEDIATELY DROPPED BY 30%, HITTING NEW MULTI DECADE LOWS OF $11.90.

(click to enlarge)

That takes us to May.

By the time full year earnings were released in May, the stock had slowly recovered to around $15 again, supported largely by a 60% rise in oil prices off of the February lows.

Then, (surprise) rather than a $2.00 PROFIT (as announced in both November and February), management announced a LOSS of $2.12. So once again, even the revised-lower numbers were off by a very long shot.

In May, management’s new spin now turned to soothing investor fears over looming bankruptcy.

CEO Baliff highlighted “the success of our cost reduction and diversification efforts” and emphasized a “20% increase in liquidity“.

In fact, in reality, cash had DECLINED by $30 million since December. All Bristow had really done was increased its borrowing ability by altering loan covenants. Surprise !

Once again, Bristow was unpleasantly surprised by the impact of foreign exchange on its results and had not given investors any warning. Surprise !

Additionally, changes in foreign exchange rates during fiscal year 2016 decreased operating revenue by $14.7 million and $98.6 million quarter-over-quarter and year-over-year, respectively.

THE POINT IS THIS (FOR A THIRD TIME):

INVESTORS HATE SURPRISES.

FOLLOWING THE RELEASE OF EARNINGS AND THE CONFERENCE CALL IN MAY THE STOCK IMMEDIATELY DROPPED AGAIN BY 25%, FROM $15.50 to $11.50, AGAIN TESTING MULTI DECADE LOWS.

(click to enlarge)

As Bristow’s stock was fighting further declines, it was supported by a 20% spike in oil prices. Oil prices quickly jumped from $43 to almost $52.

(click to enlarge)

But in fact, this was all BEFORE the Brexit crash, the Pound slump and the surprise Naira implosion.

In May, the situation was looking grim for Bristow. Hence the new multi decade lows for the share price.

But since that time, things have actually gotten much, much worse.

The Pound has dropped 15%, exposing Bristow to tens of millions in further losses.

The Naira has imploded, affecting $255 million in African revenues, and (supposedly) equating to “only” a 22% further increase in net operating losses. (Again, given the sheer size of the devaluation, I suspect the impact could be much greater).

Likewise, the price of oil has now declined by 10-15% from June highs.

This has all happened in just a few weeks.

(click to enlarge)

(click to enlarge)

Yet rather than showing further decline, the share price has now stabilized at around $13.

Management’s Evercore presentation in London on July 12th caused the stock to rally 10% in a single day. However, it is notable that volume was light.

THE POINT is that we have seen repeatedly seen this game from Bristow management in the past.

Once again, Bristow management has failed to disclose the massive impact of recent currency swings and attempts to divert attention to things like the tiny Search and Rescue business and its bogus “increased liquidity” from simply adding more debt capacity in the face of dwindling cash.

All of this calamity has happened just a few weeks after Bristow renegotiated its loan covenants with lenders as part of its $1.1 billion in outstanding debt.

The near term catalyst will be the new disclosures (surprises) raised on the upcoming conference call. Bristow will then yet again set new multi decade lows, which I expect at around $6-8.

Helicopter operators – past experience

A while back, I highlighted my concerns about helicopter operator Erickson Air Crane , including the fact that insiders and board members were set to dump large amounts of stock. The stock immediately plunged by 30%. A number of analysts and bloggers were quick to defend the stock even in the face of the inevitable. Jim Cramer even touted the stock on Mad Money. But as investors looked more deeply into the equity and credit fundamentals, the ongoing deterioration became clear and the stock continued its descent.

Erickson had been trading at around $25 at the time I wrote about it. It now trades for 60 cents.

(click to enlarge)

My article was explicit and clear. There should have been little doubt about what to expect. Yet articles quickly surfaced from those determined to catch the falling knife.

Positive articles that came out AFTER my analysis included the following:

– Erickson Air-Crane Set Up Nicely For Short Squeeze

– Erickson Air-Crane: Big Risk, Big Reward

– Erickson Air-Crane: Acquisitions Will Reward Patient Shareholders

– Erickson Inc. – Contemporary Value Investing Valuation And Hidden Value Of Assets Point To 200%+ Upside

– Erickson Inc – The Fall And New Potential

A separate helicopter operator, CHC Group (OTCQX:HELIF), came public in 2014, only to go bankrupt in 2016. As before, we can see that “bargain hunters” failed to spot the obvious on the way down.

– CHC Group Is A Value Investment

– CHC Group: More Than Just A Contrarian Play On Oil

– CHC Group: Down But Not Out

– CHC now trades for just 40 cents (even adjusted for its reveres split) following bankruptcy.CHC had just field for bankruptcy earlier this year and the Wall Street Journal noted that:

CHC is now asking the U.S. Bankruptcy Court in Dallas, to let it drop at least 90 aircraft from its fleet of about 230 helicopters, most of which are leased, as part of a broader restructuring that will target more than $2 billion in debt. The Canadian company said it can “no longer bear the weight” of its burdensome debt structure and expensive fleet amid declining oil prices and the resulting drop in demand for its services…. CHC is one of two global companies alongside Houston-basedBristow GroupInc. that dominate the business of ferrying workers and cargo offshore for energy companies and have been forced to shrink and cut costs.

The hype on Bristow

As with Erickson and CHC, there has been no shortage of “value hunters” being burned on the way down during Bristow’s straight-line descent from $60 to as low as $10.80.

– Market’s Overreaction Has Undervalued Bristow

– Bristow Group Inc. – Strong Insider Action Lifts Helicopter Stock

– Bristow Group Has Become Too Cheap To Ignore

– Bristow Group’s Overlooked Strength

– Bristow Group Is Worth Accumulating

– Brisow Group: This Former Highflier Is Too Cheap To Ignore At Just $14

Section II – details of the 2015 SEC inquires into offshore tax jurisdictions

On March 2nd, 2015, when Bristow was still profitable and supposed to be paying taxes, the company received a letter from the SEC inquiring into “foreign jurisdictions, the effective tax rates in those jurisdictions, and the amount of pre- tax profit in those jurisdictions”. The SEC also wanted to know more about “Foreign earnings indefinitely reinvested abroad” – which is a corporate code name for earnings on which the company hopes it will never have to pay US taxes at all.

In the prior year, Bristow had reported paying a US effective corporate tax rateof 23.4%. However, this was actually the result of a number of special one time items. Without the benefit of those items, Bristow’s effective tax rate in the US was reported as just 13.7%.

Bristow’s CFO (at the time) John Briscoe, compiled the information and responded to the SEC on March 13th, 2015, including the following table:

(click to enlarge)

There are a few things to notice in Briscoe’s response:

1. In March, CFO Briscoe only responded to the SEC with 5 overseas jurisdictions: The UK, Nigeria, Norway, Australia and Trinidad.

2. The overwhelming amount of pre-tax net income comes from the UK, then Nigeria. The other areas showed net losses (not net income).

3. For the UK, Bristow reported a tax rate of just 10.9%.

4. For Nigeria, the tax rate was reported as 89.4%. But this was explained as follows: “For example, in Nigeria, we accrue and pay taxes based on our gross income by applying a deemed profit margin of 20%. Therefore, a year of poor financial performance resulting in low or negative pre-tax earnings does not translate to significant tax expense reduction in Nigeria.”

On May 4th, 2015, the SEC wrote another letter to Bristow in which it made clear that Bristow had not responded fully to the previous letter, and in fact had omittedoverseas jurisdictions amounting to 48% of its pre-tax income, which should amount to to $259 million.

Among other various items, the SEC stated that:

you have detailed the pre-tax income for your primary foreign jurisdictions, which represents 52% of total net pre-tax foreign income… Please explain to us the nature of the remaining amount of pre-tax income from foreign jurisdictionsthat are not included in your response to prior comment 2 of $259.3 million

The SEC also requested that Bristow identify the foreign subs whose earnings were indefinitely reinvested.

The SEC had instructed Bristow to respond to this request within 10 business days. However, Bristow responded back that it needed until June 1st to get the required information.

On June 1st, Bristow responded, including the two tables below.(click to enlarge)The key points to notice from the 1st table above are as follows:

1. In the new response, Bristow now included 11 jurisdictions rather than just 5. The newly included jurisdictions suddenly includes offshore tax havens such as Guernsey, Panama, Cayman Islands and the Netherlands, which Bristow had previously omitted.

2. Suddenly we see the Cayman Islands account for $112 million in Pre-tax incomesecond only to the UK.

3. Of course, the Cayman’s have a tax rate of just 0.7%. That is to be expected.

4. But we now see that US pre-tax income has been fixed at negative$14.5 million.

(click to enlarge)

The key points to notice from the 2nd table above are as follows:

1. The largest foreign sub is BL Holdings II CV, which is based in the Netherlandsand is responsible for just under $100 million in Pre-tax income (roughly 40% of pre-tax income for the year).

2. For the Netherlands, the tax rate is just 0.8%

3. Including the other foreign subsidiaries amounts to a total of $124 million in pre-tax income, nearly one half of total pre-tax income for the year being “indefinitely” re-invested abroad

4. Bristow did NOT disclose conducting substantial operations in the Netherlands

The SEC once again responded with further questions on July 31st, again asking for a response within 10 business days.

Once again, Bristow replied that it needed more time to address these issues, and stated that it would reply by August 28th 2015.

Just two weeks later, and prior to responding to the SECCFO John Briscoe abruptly resigned from Bristow at the age of 57.

In a press release put out by Bristow, the company noted that:

John Briscoe, who will be leaving his current position as Chief Financial Officer to pursue other business opportunities.

In fact, it is now almost 1 year later. According to Bloomberg, he former CFO has not been employed elsewhere. According to LinkedIn, the former CFO lists himself as being “retired” and offers his services as an energy consultant.

In other words, CFO Briscoe simply quit Bristow with no other job lined up and so far has not found any other employment. Contrary to the company press release, he was certainly not “pursuing other business opportunities”.

This seems quite unusual. Bristow’s choice of a replacement was equally unusual.

Bristow appointed Don Miller as the new CFO. It is noteworthy prior to his time at Bristow, Miller had spent 9 years at Enron North America. Prior to his time at Enron, Miller was one of Enron’s bankers. Miller had spent 12 years as a an energy corporate banker at Citicorp. Most will remember that Citigroup had a very intimate relationship with Enron during its spectacular rise, and ultimately paid over $1.6 billion to settled claims that Citi helped Enron defraud investors. The New York Times reported that:

Citigroup Resolves Claims That It Helped Enron Deceive Investors

Within just 9 business days, new CFO Miller was up to speed and had a complete response to the SEC.

The SEC responded with its standard boilerplate letter stating that it had no more questions.

Here is a screenshot of the final letter.

(click to enlarge)

I understand that many (perhaps most) investors do not read SEC correspondence at all. As a result, many investors may interpret the letter above to be an “all clear” from the SEC. This is clearly not the case.

Just to demonstrate this, I am including an identical boilerplate letter received by MDC Partners (NASDAQ:MDCA) following its own correspondence with the SEC.

The SEC had been inquiring into a wide variety of accounting issues at MDC for a number of months. As with Bristow, there were multiple rounds of correspondence back and forth. The correspondence ended with the following letter, which is (quite obviously) identical, verbatim to the one received by Bristow.

(click to enlarge)

After receiving the above letter from the SEC, MDC subsequently disclosed that it had then received a subpoena from the SEC regarding the exact issues which had been addressed in the correspondence. The share price immediately plunged by 33% and the CEO was forced to resign.

At the time, I had been preparing a lengthy bearish article on MDC, but the subpoena came out first and the share price tanked before I could publish.

THE POINT:

My point is that investors simply don’t read SEC correspondence. And even when they do, they seldom understand what they are reading.

How are the SEC inquiries related to the current situation at Bristow ?

When oil prices were higher and Bristow was reporting profits, it was doing so while reporting a very low corporate tax rate. During the SEC inquiries, Bristow previously reported a rate which appeared to be 23%. But excluding special items, this rate was just 13.7%.

However, it remains the case that various divisions within Bristow are taxed independently of the corporate parent due to use of offshore jurisdictions. So even when the parent appears to be losing money, various divisions SHOULD likely be subject to taxes. The most obvious candidate for this would be the UK Search and Rescue operations. Although UK Search and Rescue comprises just 11% of revenues and is relatively fixed (not growing), Bristow management continues to highlight them due to their supposed stability and profitability.

Yet we saw above that somehow Bristow was able to undercut competitor CHC by at least 20% on this contract, to a point where CHC said it did not make sense financially.

We have also seen from SEC disclosure that Bristow’s UK’s corporate tax rate is less than half of the listed corporate tax rate for that year.

We also saw from the SEC disclosure that nearly half of Bristow’s pre-tax net income was being posted in offshore tax jurisdictions, mostly in domiciles where it conducted no operations, and mostly in jurisdictions where it paid virtually no taxes.

There are two potential scenarios here. We could end up seeing one, both or neither of them, depending on how the SEC shakes out.

First, as it applies to current financials, to the extent that Bristow is found to be inappropriately evading taxes via offshore entities, it could still have a financial impact on current financials – even when the corporate parent appears to be losing money and not liable for taxes. This would presumably happen at the division level.

Second, to the extent that there have been taxes avoiding in past years, when Bristow was profitable, it would create a large tax liability payable now – when Bristow can least afford it.

Section III – Sell side coverage of Bristow has been consistently misleading and flawed

As my regular readers know, I frequently watch for sell side BUY recommendations and take the opposite side of the trade when such recommendations are deeply flawed. A few weeks ago, several sell side shops were busy hyping shares of OraSure Technologies (NASDAQ:OSUR). The hype was that OraSure was set to continue with a lucrative contract with drug giant AbbVie (NYSE:ABBV). The result of the sell side hype was that OraSure was rising sharply on strong volume.

When I wrote about OraSure, I performed far deeper research than the shallow analysis of the sell side. I demonstrated that (contrary to sell side research) OraSure was “virtually guaranteed” to lose this contract, which would cost the company $40 million straight to the bottom line. OraSure shares quickly tanked by as much as 20%.

Within 24 hours, OraSure announced that it had indeed lost the lucrative AbbVie contract.

With Bristow, the key movers of the stock include Cowen & Co, Barclays and Credit Suisse, as shown below. A closer look reveals that all of them have touted or supported the stock, and all of them have been 100% wrong in every instance going back well into 2015. Yet they persist in touting and supporting the stock even now. (Hint: Bristow is in deep need of raising money and is therefore a high priority investment banking client).

The graphic below shows the dismal ratings history for each of these three investment banks.

(click to enlarge)

Cowen & Co. Research

One of my favorite sell side shops to get short on is Cowen & Co. It seems that whenever a company is in obvious need of raising large amounts of money, investment banker Cowen is there with an “Outperform” rating and a lofty share price target. As a result, I have often gotten short Cowen research names.

Most recently, when I wrote about Revance Therapeutics (RVNC) the stock had just soared 50% to over $40 based on hype from Cowen that the company was likely to be a “buyout target”. Cowen placed a $55 target on Revance. The evidence was transparently obvious that Revance’s data was deeply flawed. Not only would there be no buyout, but I predicted that Revance’s share price would be cut in half. Revance’s data was indeed highly problematic and the stock has since plunged to just $13. Despite the obvious problems, Cowen simply maintains a $55 target on the stock.

With Bristow, Cowen’s July 18th outperform rating saw the shares climb by nearly 7% on substantial volume for the day. Within 2 days, nearly all of those gains had already faded.

Be it equity or debt, Bristow is an obvious investment banking client because the company is in dire need of money to offset falling revenues and service its $1.1 billion in debt. Cowen has a far weaker investment baking franchise than some of the “bigger boys” on Wall Street. As a result, the firm appears to have consistently higher share price targets which curries favor with investment banking clients. This is why I end up doing so well shorting Cowen research names.

Just as Bristow’s earnings were announced in November (as highlighted in Section I above), Cowen came out with a research note in which it made a number of supportive statements, all of which echoed the statements of Bristow management. Despite the obvious disappointments and the plunge in the share price, Cowen noted:

We believe Bristow’s business diversification (UK SAR, fixed wing, leverage to offshore production) translates to relative earnings stability during the downturn.

Clearly this was preposterous. Cowen went on to parrot management’sassertions on CapEx deferrals, cost savings and the strength of UK SAR.

The firm maintained a huge $41 target on the stock even when the share price plunged to $30 and below.

Then, as we saw above, earnings in February were a disaster that should have been easily predictable. Even as the business environment deteriorated substantially, Cowen maintained its Outperform rating and $41 target into February even as oil was approaching new lows of $25.

In fact, Cowen even reiterated this rating immediately before earnings were announced on February 8th. As we saw, results were an absolute disaster and the share price plunged to new multi decade lows of around $11.

So the next week, Cowen did cut its target from $41 all the way down to $16. But it has continued to maintain its “Outperform” rating ever since.

As part of its report, Cowen described an “attractive risk / reward” and noted that “we see concerns over covenants in the credit facility to be overdone”. As we know, the stock continued to decline and Bristow was forced to renegotiatecovenants – just a few weeks later.

Back in June, Cowen actually re-upped its target price to $18 based on rising oil prices and the newly revised covenants. But since that time, oil prices have resumed their decline, currency “headwinds” have created very obvious near term problems and the CHC bankruptcy is flooding the market with cheap helicopters and underpriced competition.

Barclays Research

Barclays has been covering Bristow since the middle of 2015. Barclays has consistently rated the stock an “Equal Weight” (NYSEARCA:HOLD), and simply lowers its target price each time the stock plunges.

When the stock was in the $50s, Barclays told us it was worth $58.

When the stock was in the $30s, Barclays told us it was worth $40.

When the stock was in the $20s, Barclays told us it was worth $38.

And now that the stock is in the teens, Barclays tells us it is worth $20-22.

When the stock (soon) gets into the single digits, I expect that Barclays will once again downgrade the stock to around $10.

Barclays has been a member of Bristow’s banking syndicate, such that despite the continuously falling share price, Barclays has consistently told investors to continue holding the stock. And in June, they even upgraded the stock to an “Overweight”.

Most recently, Barclay’s noted:

We believe BRS’s first order of business, before any need to tap the capital markets, is to pursue sale leasebacks of up to $340 million of UK SAR aircraft, which may prove attractive sale leaseback candidates despite our cautious view of the leasing market, as well as asset-based financingfor up to $125 million of UK SAR bases and infrastructure,

Quite obviously this simply ignores the impact of the CHC bankruptcy under which we are now seeing the market floodedwith unused helicopters. It is an obvious point that no serious analyst should miss.

The recent reports from Barclays seem to quote management almost verbatim in touting the importance of UK Search and Rescue, Capex deferrals and the “advantages” of the CHC bankruptcy for Bristow. (See above on the impact on pricing).

Credit Suisse Research

Like Barclays, Credit Suisse has continuously told investors to keep holding Bristow (a “Neutral’ rating), despite a relentless 80% decline in the share price. And just like Barclays, each time the share price plunges, Credit Suisse waits until AFTER the fact to lower its share price targets.

As the share price declined since last year, Credit Suisse went from a target of $65 to $50 to $35 to $20 and now most recently to just $15. At no time has Credit Suisse ever called Bristow a sell. Like Barclays, Credit Suisse is also one of Bristow’s lenders, so this should be expected.

So Credit Suisse has been telling us to hold the stock all throughout this 80% decline. But lately, this recommendation gets even harder to understand.

The most recent report from CS describes the “industry in a tail spin” as customers are doing more with less. CS then lowered its estimates, forecasting ongoing losses into FY17/18, with below consensus estimates. CS describes the market as being “oversupplied”. Regarding the recently grounded H225’s, CS notes that “we could see a scenario where demand from the O&G business for the H225 never returns to its previous level”.

But in order to justify not moving to a sell recommendation, CS describes Bristow as being “net short” the Naira but sees virtually no impact on the income statement. The implosion of the British Pound was not even addressed.

In the same report, CS discloses that 90% of its recommendations are for Buy or Hold, while only 10% of its global ratings are listed as “Sell”.

From current prices, CS sees just 12% upside in the share price.

Conclusion

There are so many problems with Bristow that it is difficult to know where to start. However, I can safely say that I expect a steep plunge to $6-8 following new “surprise” disclosures on the upcoming conference call.

Further declines and ultimate bankruptcy risk are harder to handicap. But as with Erickson and CHC, there could be significantly greater downside over the next 9-12 months.

What investors DO KNOW is this:

Bristow’s shares have already declined by 80% over the past year, as its financial condition has deteriorated drastically. Cash balance has fallen. The dividend has been cut by 80% (so far). Revenues continue to drop and losses continue to mount. Multiple competitors have recently gone bankrupt and are now flooding the market with unused helicopters and underpriced competition. This heavily affects Bristow’s asset values as well as its revenue and income (losses).

Management and board members are resigning, and management specifically recruited a replacement board member with notable experience in bankruptcy

Bristow is sitting on over $1.1 billion in debt, and was forced to renegotiate debt covenants in May. At the time, the banks were most likely encouraged by a recent doubling of the price of oil off of its February lows, from $25 to over $50. However, its credit rating has already been downgraded to Ba3.

But with subsequent developments the banks are now likely sweating bullets.

What investors DO NOT KNOW is this:

There have been major negative developments for Bristow, many occurring in jut the past few weeks. Investors are totally in the dark.

Very shortly AFTER the new covenants were agreed, Bristow was hit hard by the 15% fall in the pound and the massive 40% drop in the Nigerian Naira. (At the same time, oil fell by 10-15% from its February highs.)

These huge impacts are the result of huge massive unhedged currency exposures.

Despite having tremendous exposures to various global currencies, Bristow does NOT engage in financial hedging.

As recently as May, management was saying that it had zero exposure to any move in the British Pound. Yet we are now finding out (just a few weeks later, post Brexit) that its real exposure could be in the tens of millions of dollars.

But the bigger surprise will be Nigeria. So far management has said nothing about the 40% drop in the Nigerian Naira, even though previous disclosures would indicate that operating income should plunge by 22% on this alone. African (mostly Nigerian) revenues amounted to $255 million in 2016. However, due to the plunge in the Naira, these revenues are most likely going to disappear due to the simple economics of the depreciated Naira.

(It should be noted that the soon-to-disappear Nigerian revenues are actually larger than all Search and Rescue revenues.)

In addition, we are also likely to hear about significant pressure being placed on asset values, revenues, profits (losses) and margins as a result of CHC filing for bankruptcy in May. CHC is now operating at a distinct advantage to Bristow. It can undercut Bristow on price and is flooding the market with unused helicopters.

The SEC inquiry

The full impact of the past SEC inquiries has yet to be determined. But there is no good outcome that can be expected from it. The SEC was specifically asking about Bristow’s use of offshore tax havens to protect nearly 50% of its pre-tax income from US taxes. Prior to completing a response to the SEC, the then-CFO resigned despite having no new employment lined up. Bristow then oddly replaced him with an M&A executive whose past experience was in working for and advising Enron for decades.

The impact of an SEC action (if any) could affect both current and future financials by eliminating offshore tax advantages for Bristow. This problem could arise at the division level, even when the parent is losing money for the time being. This would simply make ongoing losses even larger. Even worse, an SEC action (if any) could potentially result in the payment of back taxes owed, at a time when Bristow can least afford it.

As we clearly saw with MDC Partners, the conclusion of a detailed dialogue with the SEC is by no means an “all clear”. Following the similar conclusion of its dialogue, MDC disclosed an SEC subpoena. Its stock fell 33% and the CEO was forced to resign.

The catalyst for a 40-50% drop in the share price is the upcoming earnings call, with a number of new “surprise” disclosures.

Management has made its predicament far worse by repeatedly hitting investors with unexpected surprises, resulting in much larger losses than were originally expected.

Management repeatedly tries to focus investors attention on any minor positive development, while attempting to downplay major negative events. But in each case, the truth comes out at the end of each quarter.

In each of the past 3 earnings calls, we have seen the share price quickly drop by at least 20-30%.

We have seen nearly identical situations before with helicopter operator Erickson Air Crane, and we saw it before with direct competitor CHC Helicopter. Both of these companies were originally trading in the $20’s.

As they declined by more than 50% to the single digits, “value hunters” thought they could time the bottom in the stock. In each case they appeared to be “too cheap to ignore”. But with declining fundamentals and a heavy debt load, there simply was not bottom to be found. Both Erickson and CHC now trade for just pennies on the dollar.

The sell side research on Bristow is in fact worse than most. The various analysts have continually told investors to Hold or Buy the stock even as it plunges with each and every new earnings report or corporate development. It appears that the majority of the content from these reports consists of near-verbatim quotes from management, expressing their usual relentless optimism, while largely ignoring points of obvious concern. As is often the case, the majority of sell side analysts happen to have been involved as Bristow’s investment bankers and lenders.

Disclosure: The author was previously an investment banker for a major global investment bank and was engaged in investment banking transactions with a wide range of companies. The author has not been engaged in any investment banking transactions with US listed companies during the past 5 years. The author is not a registered financial advisor and does not purport to provide investment advice regarding decisions to buy, sell or hold any security. The author currently holds a short interest in BRS and during the past 12 months has shared his fundamental and/or technical research with investors who hold a short position in the stock. The author may choose to transact in securities of one or more companies mentioned within this article within the next 72 hours. Before making any decision to buy, sell or hold any security mentioned in this article, investors should consult with their financial adviser. The author has relied upon publicly available information gathered from sources, which are believed to be reliable and has included links to various sources of information within this article. However, while the author believes these sources to be reliable, the author provides no guarantee either expressly or implied

Expect OraSure To Drop 35% (Or More) Next Week

Summary

  • OraSure dipped just slightly from its 2016 highs on a recent report from Raymond James downgrading OraSure to a “Market Perform”.
  • The report completely dismissed significant near-term problems for OraSure. Another BTIG analyst has been quick to defend the stock.
  • As shown below, OraSure is virtually guaranteed to lose a very lucrative deal with AbbVie next week, costing it over $40 million.
  • As shown, OraSure will lose more than 100% of its annual profits and 90% of cash flow, revenue growth will be eliminated.
  • With OraSure trading at 3.5x sales, the stock will quickly lose around 35% as soon as an 8-K is released next week.

The perils of sell side research

Over the past year or so, I have written a number of articles highlighting short selling opportunities on overvalued healthcare stocks, which had near-term problems.

It is worth noting that in every single case, we saw uber bullish sell side analysts predicting that these troubled stocks would RISE, often by 50-100% (or even much more).

So how have our analysts done for us?

When I highlighted Revance Therapeutics as a short, the stock had recently surged from $26 to $40 with Cowen calling the stock a takeover target. Cowen pushed a $55 target price. Revance has since collapsed to $13 – down more than 60% and 75% below Cowen’s target.

When I highlighted Osiris Therapeutics (NASDAQ:OSIR), the stock was at around $9. Despite obvious signs of malfeasance, Piper Jaffrey was supporting the stock with a $28 target. It has since collapsed to $5 – down more than 40% – amid an SEC investigation (precisely in line with my warning to readers).

Keryx Biopharm (NASDAQ:KERX) is down by around 40% since I highlighted its obvious problems. The stock had been trading at around $10, but various analysts had just upgraded the stock with multiple targets as high as $32.

Omeros Corp. (NASDAQ:OMER) is down by 45% (and was previously down by almost 50%). The stock had been trading at around $18 before I had written on it, even as analysts were telling us that the stock was worth $30-38. It now trades for just $10.

Tokai Pharma (NASDAQ:TKAI) is down 40%, from $10 to around $6. But analysts had been telling us that the stock was going to as high as $38-44.

Likewise, both BTIG and Raymond James have supported OraSure with targets of $8-9. Today, I will show here that OraSure (NASDAQ:OSUR) is now headed for a very sharp decline of at least 35% (or more), driven by a catalyst which I expect in the next few days.

Sell side analysts have now steered investors wrong once again. We only need to wait a few more days for this to be proven out.

Note: OraSure is also a very attractive short because there are no visible catalysts on the horizon, which could cause any meaningful appreciation in the stock price.

Investment summary

On June 6th, shares of OraSure briefly hit a new intraday high for the year at $7.99. Shortly thereafter, a downgrade from Raymond James caused the stock to drop to below $7.00, a modest decline.

The cited reasons for the Raymond James downgrade were a) the stock had reached its target of $8.00, meaning that there was little additional upside and b) OraSure faced the simple possibility of losing a lucrative co-promotion deal with AbbVie (NYSE:ABBV).

However, Raymond James has substantially dismissed the real likelihood of losing the co-promotion deal. It has also dramatically downplayed the full impact to be felt on OraSure’s stock price.

As the stock price became even weaker in recent days, breaking below $6.50, sell side firm BTIG came out defending it with a $9.00 target.

(click to enlarge)

For the AbbVie deal, Raymond James noted that:

To be clear, our working thesis is that this relationship is sustained through 2019

The firm then notes that in the event OraSure does lose the relationship, then the stock probably goes to “near $6.00.” So they are suggesting downside of a mere 10-12%.

The report from BTIG was downright bizarre. The firm states that it “does not have a strong opinion” about the termination of the contract, but reiterates a $9.00 target.

The actual realities with OraSure are far more severe:

– OraSure is now virtually guaranteed to lose the AbbVie deal (as shown below)

– The six-month notice date is June 30, 2016 (i.e. today). The announcement could take place at any time on or after that date. OraSure will have 4 days to file an 8-K.

– The impact on OraSure will be very significant, and the stock should trade back to $4.50 or below (at least 35% downside)

– At current prices, OraSure is definitely a Strong Sell

Below, I will show where the analysts have it completely wrong.

Company overview

OraSure Technologies is a medical device company, which primarily makes a variety of healthcare diagnostic tests. The company is best known for its rapid point of care (“POC”) tests for HIV and Hep C. These are known as OraQuicktests and they provide test results within about 20 minutes. For 2015, sales of these two types of tests accounted for around 40% of revenues at OraSure.

The idea of a rapid oral HIV test was initially very promising. However, OraSure suffered from an unfavorable update to the CDC’s (Center for Disease Control) guidelines which recommend that laboratories conduct initial testing for HIV with an FDA approved antigen/antibody combination (4th generation) immunoassay that detects HIV-1 and HIV-2 antibodies and HIV-1 p24 antigen to screen for established infection with HIV-1 or HIV-2 and for acute HIV-1 infection and that none of the assays in the currently recommended algorithm are FDA-approved for use with oral fluid or dried blood spot specimens.

(click to enlarge)

As a result, the CDC update cramped much of the upside from OraSure’s HIV test. This greatly increases the reliance on its Hep C test.

OraSure also provides diagnostic tests for other infectious diseases (including flu, H1N1 and Ebola), but these account for less than 5% of revenue. Other products include substance abuse testing kits (9% of revenues) and cryosurgical systems (10%) of revenues.

The company also has a subsidiary, which sells genetic testing kits, which is responsible for around 20% of revenues.

Net revenues increased by 11% from 2014 to 2015, reaching $119 million. However, this growth was entirely due to the revenue boost from the co-promotion deal with AbbVie. Without that deal, OraSure is not really growing revenues at all.

Prior to the AbbVie deal, OraSure had lost money every single yearsince 2007.

In 2015, as a direct result of the AbbVie co-promotion deal, OraSure then reported its first profitable year, with a net income of just $8.1 million.

Profitability has continued into Q1, with net income of $2.5 million for the quarter.

But again, as we will see below, more than 100% of net income in each quarter is derived from the relationship with AbbVie. Without it, OraSure returns deep into continuous loss making territory.

(This is in stark contrast to the views expressed by the BTIG analyst).

The co-promotion deal with AbbVie

In June 2014, OraSure signed a co-promotion deal with AbbVie, which was reported to be worth up to $350 million if all milestones were met. AbbVie was to market its VieKira Hep C drug along with OraSure’s rapid point-of-care Hep C test and AbbVie was to have exclusive co-marketing rights.

The deal has two parts, both of which were enormous for OraSure.

The first part is up to $75 million exclusivity payments. These exclusivity payments will continue on for the life of the deal (5.5 years), or until it is terminated, regardless of performance. That equates to $13.6 million per year in guaranteed revenue for OraSure.

The second part is up to $55.5 million in milestone payments per year if certain annual targets are met. The actual payments are determined according to how many new patients are enrolled in the patient database above a certain threshold.

The enthusiasm for the deal was quickly reflected in the stock price, and OraSure soared from $6 in June to $10 by year-end 2014, An increase of around 65%.

It is now 2 years later and we are approaching AbbVie’s first “right to terminate” date. AbbVie has the right to cancel the deal as of December 31, 2016. But it is important to note that AbbVie must give 6 months notice in order to terminate.

That means that the termination can be announced at any time on or after June 30th. Given the huge impact on revenues and net income, this is most certainly a material event, requiring an 8-K to be put out. OraSure will have 4 days from the notice of termination to put out the 8-K.

The negative effect on the stock should be immediate and substantial as soon as the 8-K from OraSure is released.

There are three points to take away from this article.

The first point is that the termination of the deal by AbbVie is virtually certain (in contrast to the statements from analysts). And AbbVie is highly incentivized to make the termination happen at the earliest possible date.

The second point is that the effect on OraSure, both the company and the share price, will be very significant (again in contrast to the analyst assurances). I currently expect a share price decline of at least 35%.

The third point is that following its appreciation from $4.50 to current levels, OraSure is already dramatically overvalued vs. its med device peers.

Each of these points is detailed below.

POINT #1 – Termination of the deal is virtually certain

The problem here is that the entire deal has been an abject failure for both parties. Neither AbbVie nor OraSure are making any significant product sales off of the deal. Yet under the terms, if the deal is not terminated, AbbVie is still obligated to pay over $40 million in additional exclusivity payments. As we will see, AbbVie’s sales of its Hep C drug have been deeply below expectations for almost 2 years now. We will also see that performance (OraSure leads and sales) under the co-promotion deal has been dismal. As a result, AbbVie is virtually guaranteed to terminate the deal. To continue such a deal simply makes zero sense whatsoever for AbbVie.

AbbVie’s VieKira (Hep C) sales have been a massive disappointment

Back in 2014, AbbVie knew that it was a latecomer to the Hep C market. Gilead’s (NASDAQ:GILD) Sovaldi had already been approved in December 2013 and immediately began racking up blockbuster sales. Sales of Sovaldi in Gilead’s first quarter alone amounted to over $2 billion. Gilead’s second Hep C drug, Harvoni, launched not long thereafter and also hit immediate blockbuster status. The price tag on these drugs from Gilead is up to $120,000 for a 12-week treatment.

AbbVie’s Viekira Pak wasn’t approved until December 2014.

Clearly, AbbVie was looking for ways to compete with Gilead’s drug.

One tactic was to simply cut price. Another tactic was to cut a co-promotion deal with OraSure, which gave AbbVie exclusive rights to co-promote a Hep C drug with a rapid point-of-care diagnostic test.

As shown early on by Gilead, the international Hep C market is worth tens of billions of dollars. As a result, AbbVie was willing to spend big. The co-promotion deal with OraSure was reportedly worth up to $350 million to OraSure. Even with the price cuts on VieKira, AbbVie initially noted that it expected $3 billion in Hep C drug sales in its first year. In contrast to Gilead, AbbVie sells VieKira for around $80,000.

Following an initial expected launch with $3 billion in sales, there was expected to be a significant ramp up in subsequent periods as well.

Yet despite the discounts and the co-promotion deal, sales of AbbVie’s VieKira have been a deep disappointment. In its first full year, 2015, AbbVie pulled in sales of around $1.6 billion – about half of what it had expected. This is when the OraSure co-promotion deal would have been in full swing.

The weak sales then continued into 2016, with Q1 sales coming in at $414 million. So 2016 is on track to be in line with the dismal 2015.

Not only have absolute revenues been a deep disappointment, but there has been absolutely no ramp up in sales even after 6 quarters.

The first major problem was that not long after it was launched, VieKira was facing serious heat from the FDA.

The warning was described as follows:

The hepatitis C infection treatments Viekira Pak (AbbVie) and Technivie (AbbVie) may increase the risk for serious liver injury, particularly in those with underlying advanced liver disease …. The FDA will now require the company to add information about serious liver injury adverse events to the Contraindications, Warnings and Precautions, Postmarketing Experience, and Hepatic Impairment sections of the Viekira Pak and Technivie drug labels.

AbbVie’s stock quickly dove by around 15% on this news.

The second big problem for AbbVie and VieKira was the launch of a competing drug by Merck (NYSE:MRK) and the unexpectedly aggressive price-cutting by Merck. For example, as a result of the price cuts, AbbVie soon lost much of its business with Veteran’s Affairs.

But overall, it continues to be the case that Merck and AbbVie have failed to steal significant market share from Gilead, despite their price cuts and heavy marketing spend. Gilead has managed to hold on to a market share of about 85%, while Merck and AbbVie fight over the remaining 15%.

In fact, for AbbVie, the struggles appear to be getting worse. In January, AbbVie gave guidance of $2 billion in VieKira sales for all of 2016. But by April, that guidance had been slashed by 25% to $1.6 billion.

In short, even this long after launch, sales are low and stagnant. AbbVie’s VieKira has failed to become a successful drug, which largely eliminates the company’s motivation to spend big on the co-promotion agreement.

But more importantly…

How do we KNOW that AbbVie will cancel this contract ?

Against that backdrop of dismal sales with zero growth, AbbVie continues to make large guaranteed payments each year to OraSure. The total of these payments is up to $75 million, in increments of $13.6 million per year.

By canceling the deal, AbbVie can therefore save itself just over $40 million from a deal that clearly isn’t working. Given the ongoing weak sales of VieKira and the lack of performance from the co-promotion deal, continuing to pay over $40 million makes absolutely zero sense for AbbVie.

The other component of compensation under the deal takes the form of “milestone payments,” which are awarded if new patients enrolled in the patient database exceed certain thresholds. The other evidence of the failure of this deal is that nearly 2 years after the deal was signed, OraSure has not even received any milestone payments whatsoever.

The failure of the deal is equally visible from the OraSure side of the equation. By looking through the financials, we can see that there is virtually no activity being performed. OraSure discloses that it pays a fee to AbbVie for detailing the OraQuick test. This fee is classified under Sales and Marketing.

Under an agreement with AbbVie, we are co-promoting our OraQuick® HCV test in certain U.S. markets, including general practitioners and certain specialty physicians. Under this arrangement, AbbVie has agreed to detail our OraQuick® HCV test in the physician markets and we pay AbbVie a fee for these detailing services.

The way that this works is that each time AbbVie details the product to a physician, the physician is then provided as a “qualified lead” to OraSure and OraSure then pays a fee to AbbVie.

But despite a slight increase in HCV test sales, OraSure’s Sales and Marketing expense actually fell by 15% in 2015.

What this means is that AbbVie is not even bothering to detail the product to physicians under the co-promotion agreement. And as a result, OraSure is not paying them any meaningful fees.

There is quite literally no activity ongoing under the co-promotion agreement.

Yet we can see that BTIG takes a very contrived “glass is half full” view of this problem. BTIG notes that if OraSure loses the deal, then it would not be required to pay detailing fees. But with TOTAL Q1 Sales and Marketing Expense (across all products) of just $8.7 million, there is very little to be saved.

In reality, common sense (and the benefit of hindsight) now tells us that this was clearly a bad idea and a bad deal for AbbVie from the get go.

Co-promoting VieKira with an exclusive diagnostic device does nothing to ensure that doctors will actually end up using VieKira. They can just as easily start using the OraSure test while prescribing Gilead’s drugs. In addition, the revenue (and commissions) to be gained by the AbbVie sales rep for selling additional OraSure tests are so low by comparison that the AbbVie sales reps have zero incentive to even bother pushing the low-priced OraQuick devices. While a single course of AbbVie’s VieKira can run around $80,000 per patient, the OraQuick device costs just around $20. There is simply no upside for the sales reps to promote it in practice.

In other words, the co-promotion deal has failed and it was destined to fail from the very beginning. Combined with the ongoing dismal sales of VieKira, AbbVie is now virtually 100% certain to cancel its exclusive arrangement with OraSure, which would otherwise cost it over $40 million over the next few years.

As for timing, AbbVie will almost certainly cancel as soon as the notice date (June 30) arrives. OraSure will be required to release an 8-K announcing the termination within 4 days of receiving notice from AbbVie, which means the announcement can be expected as soon as next week.

POINT #2 – The effect on OraSure’s share price will be very significant

Despite its downgrade of the stock, Raymond James had expressed optimism that the relationship with AbbVie would remain intact. Clearly, we can see from the above that this is highly, highly unlikely.

Raymond James had also suggested that even if the deal was terminated, the stock price might trade to around $6.00 and not much lower. Again, this is far too optimistic.

OraSure has only recently swung to profitability, following 7 years of continuous losses. The deal with AbbVie accounts for more than 100% of all of OraSure’s profit in each of the past 5 quarters.

The boost from this deal is hard to overstate. The exclusivity payments to OraSure are just free money with a 100% gross margin. The payments therefore flow straight to the bottom line.

For full year 2015, OraSure earned $8.2 million. But the payments from AbbVie amounted to $13.5 million.

For 1Q 2016, OraSure earned $2.5 million. But the payments from AbbVieamounted to $3.4 million.

Here is where the BTIG report is the most flawed. BTIG attempts to state that these payments do not have a 100% margin impact because OraSure would have had to spend money in the past on customer training, etc.

The real fact is: once OraSure loses the co-promotion deal with AbbVie, it will need to BEGIN spending heavily on Sales and Marketing for the first time.

As a result, even though the loss of AbbVie will result in $13.6 million, the real effect on the bottom line will be noticeably GREATER than $13.6 million. So the net margin effect is, in fact, greater than 100%.

But to keep the analysis simple, I am just assuming that the impact on the bottom line is the full $13.6 million.

(click to enlarge)

Without the payments from AbbVie, OraSure immediately returns to a loss making status for the foreseeable future. As noted before, prior to the AbbVie deal, the last time OraSure turned any kind of a profit was in 2007.

(click to enlarge)

Not only are the payments from AbbVie 100% profit, but they are also 100% cash. For full year 2015, OraSure generated $15.8 million in operating cash flow. But $13.6 of this came from the AbbVie exclusivity payments. In Q1, OraSure reported $4.7 million in operating cash flow, but again, $3.4 million but straight from the AbbVie exclusivity payments.

The point is that roughly 90% of cash flow and more than 100% of net income are the direct result of the AbbVie deal. Without that deal, OraSure transforms into a money losing company, which generates virtually no cash.

So now, let’s look at the sky-high valuation of OraSure. The key problem is that in addition to losing money and not generating much cash, OraSure will be showing little to no growth.

POINT #3 – Even prior to the pending loss of AbbVie, OraSure was already dramatically overvalued vs. its peers.

When Raymond James downgraded OraSure from Overweight to Market Perform, its first reason was simply that the stock had reached its full value at $8.00 and there was no further upside to be had.

But we can also see that OraSure has dramatically outperformed all of its peers over the past 12 months.

(click to enlarge)

As shown above, Meridian Bio (NASDAQ:VIVO) and Alere (NYSE:ALR) are both down slightly and have never really been up over the past year. Trinity Biotech (NASDAQ:TRIB) is down by more than 40%.

Trinity is quite similar in size and business to OraSure. The company makes point-of-care diagnostic tests used to detect autoimmune, infectious and sexually transmitted diseases, diabetes, and disorders of the liver and intestine. Like OraSure, the company does around $100 million per year in revenue. It is also substantially more profitable than OraSure. Again, that stock is now down by 40% since last year. Trinity made a profit of around $20 million last year, putting it on a P/E ratio of about 10x and a Price to Sales ratio of around 2x.

The next best comp is Meridian, which is also very similar. The company sells clinical diagnostic test kits, for certain gastrointestinal, viral, respiratory and parasitic infectious diseases as well as bulk antigens and reagents. Last year, the company did $194 million in revenues and was more profitable than OraSure. Meridian is also down by around 30% from last year. Like Trinity, Meridian is profitable and trades on a P/E of around 20x.

The point to be made is that OraSure has continued to stay noticeably elevated simply as a result of the benefits it has enjoyed from the AbbVie deal.

So the question then becomes: without AbbVie, what are we left with at OraSure ?

We can now see that without AbbVie, OraSure is a money-losing business across the board. It is also one that generates virtually no cash.

The problem gets worse as we look for growth.

OraSure’s largest business segment is Infectious Disease Testing, responsible for around 40% of revenues. However, that segment (even with the AbbVie promotion going on) grew just 3% last year. OraSure is a no growth business.

Cryosurgical systems, the 2nd largest segment actually shrunk by 23%.

In fact, the only segment to show any appreciable growth was Substance Abuse Testing. However, that accounted for just 10% of total revenues.

(Note that “Other” revenues of $15.2 million included $13.6 million from AbbVie)

(click to enlarge)

The above numbers are for OraSure’s main business segment. OraSure has a second business segment, the DNAG segment, which sells genetic testing kits. Sales here increased from $23.8 million to $29.9 million.

Overall revenues at OraSure increased from $106.5 to $119.7, an increase of $13.2 millon. However, $13.6 million of revenues came from AbbVie. OraSure is therefore shrinking, not growing.

The valuation crisis at OraSure

Despite the fact that OraSure will be losing money every quarter, and despite the fact that OraSure will be generating virtually no cash, and despite the fact that the business is slightly shrinking (not growing), OraSure continues to be valued at more than 3.5x sales

Conclusion

Back in 2014, AbbVie was willing to do whatever it took to crack the Hep C market from first mover Gilead. It was willing to discount prices and spend big on a co-promotion deal with OraSure. That deal was potentially worth up to $350 million, showing just how ambitious and optimistic AbbVie was at the time.

Two years later, the deal has revealed itself to have been poorly thought out and a complete failure.

Sales of AbbVie’s VieKira have been dismal and continue to disappoint. Sales are low and there is no growth.

Nearly two years after the deal was signed, OraSure has received no milestone payments whatsoever. But more importantly, we can tell by looking at OraSure’s financial statements (in particular Sales and Marketing expense) that activity under the co-promotion agreement appears to be truly nil. There is quite literally nothing going on under the co-promotion agreement at all.

And yet AbbVie continues to pay $13.6 million per year in guaranteed exclusivity payments to OraSure for doing absolutely nothing. These remaining payments would total over $40 million if the deal were not cancelled.

As a result of these factors, AbbVie is now virtually guaranteed to cancel this failed deal as soon as the termination date allows on December 31, 2016. AbbVie is required to give 6 months’ notice, meaning that OraSure should be notified right around June 30th. OraSure will be required to put out an 8-K announcing the termination within 4 days.

Without the $13.6 million per year in easy revenues from AbbVie, OraSure is in big trouble. Very big trouble.

The revenues from AbbVie are 100% margin, such that they flow straight to the bottom line. They are also 100% cash. This comprises more than 100% of OraSure’s annual profit and around 90% of OraSure’s cash flow. It also made up all of the “growth” that OraSure saw in 2015.

Without these payments, OraSure is a money losing company, which generates virtually no cash and which is not growing. Yet it is currently trading at 3.5x Sales. OraSure is therefore grossly overvalued on an absolute basis, as well as vs. its med device/diagnostic peers.

As soon as the 8-K is released, most likely within the next few trading days, OraSure should be expected to fall by at least 35% to around $4.50 or below. Note that in late 2015, OraSure had been trading as low as $4.50, even with the AbbVie deal in place. So there may be substantially more downside below that level.

Disclosure: I am/we are short OSUR.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: The author was previously an investment banker for a major global investment bank and was engaged in investment banking transactions with a wide range of healthcare companies including medical device, pharmaceutical, genomics and biotech companies. The author has not been engaged in any investment banking transactions with US listed companies during the past 5 years. The author is not a registered financial advisor and does not purport to provide investment advice regarding decisions to buy, sell or hold any security. The author currently holds a short interest in OSUR and during the past 12 months has shared his fundamental and/or technical research with investors who hold a short position in the stock. The author may choose to transact in securities of one or more companies mentioned within this article within the next 72 hours. Before making any decision to buy, sell or hold any security mentioned in this article, investors should consult with their financial adviser. The author has relied upon publicly available information gathered from sources, which are believed to be reliable and has included links to various sources of information within this article. However, while the author believes these sources to be reliable, the author provides no guarantee either expressly or implied

Behind the Scenes with Proactive, Inovio and Unilife

Note #1: Prior to publishing this article, the author filed detailed complaints with the US Securities and Exchange Commission regarding the parties and activities described herein.

Note #2: Due to the large volume of documentation obtained by the author, only a small portion is included in this article. However, the author has made efforts to ensure that the SEC and Seeking Alpha are aware of all findings, including those not detailed in this article.

Note #3: Many of the suspect articles referred to below have already been removed by Seeking Alpha. This can be seen by scrolling through Yahoo Finance, where the headlines still remain. However, the author had previously preserved electronic copies wherever possible in order facilitate ongoing investigation of the authors involved.

Investment overview

Following my recent article describing undisclosed stock promotions at CytRx Corp (CYTR) and Galena (GALE), using controversial IR firm The Dream Team Group.

These stocks have quickly fallen by 20-30%. Shares of InterCloud (ICLD) next fell by 30% on Friday following class action lawsuits and from concerns regarding paid promotions there by Dream Team writers Tom Meyer and John Mylant. The issues at InterCloud were also uncovered in the wake of my last article. All of these stocks are now down by at least 50% from their recent promotional highs.

Continue reading…

Behind the scenes with Dream Team, CytRx and Galena

Note: At least 13 recent articles covering CytRx have been removed from circulation at Seeking Alpha, the Wall Street Cheat Sheet, Motley Fool and Forbes. Many were removed in just the past two days. A list of these removed articles is shown at the bottom of this article. The author has preserved PDF copies of these articles at MoxReports.com.

In total, more than 100 articles tied to The Dream Team have now been removed from circulation in just the past two days.

Overview

A few weeks ago I received a surprising email asking me to be a paid stock tout for IR firm “The Dream Team Group”. I was asked to write paid promotional articles on Galena Biopharma (GALE) and CytRx Corp (CYTR), without disclosing payment. Rather than refuse outright, I decided to investigate. I began submitting dummy articles to the Dream Team rep (with no intention of ever publishing them). My goal was to determine how involved management from these two companies were in this undisclosed paid promotion scheme. Below I will provide detailed documentation (emails and attachments) which indicate that management from both Galena and CytRx were intimately involved in reviewing and editing the paid articles on their own stock at precisely the time they were looking to sell / issue shares.

Continue reading…

Links to pulled articles on CYTR

The following is a partial list of archived articles on CytRx which have been removed from circulation.  I expect to continue uploading additional articles on CytRx and other Dream Team clients going forward.

sa_cytr_2013_12_12_JohnMylant

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Sungy Mobile Set To Burn US Investors

Company overview

Sungy Mobile (GOMO) is a US listed Chinese ADR. The company’s main product is a downloadable “app” for Android phones which allows users to customize their icons and wallpaper. The company currently has a market cap of approximately $900 million and trades on a PE ratio of over 100x. The stock is very liquid and trades $10-15 million (over 400,000 shares) per day. Short interest in the stock is negligible at just 282,483 shares (less than 1% of outstanding).

Investment summary

Sungy represents a compelling short sale opportunity in the near term. At prices above $24, the stock has near term downside of at least 50%, which would still leave it trading above its recent IPO price of $11.22.

Continue reading…

MiMedx set to fall further

My last short article discussed Farmer Brothers Coffee (FARM) and since that time, the stock has come off by nearly 20% without much of a bounce. Prior to that, I discussed Unilife (UNIS), which is now down by 15-20% for largely the reasons I predicted. Before that, I highlighted unacknowledged and low-priced product competition for Organovo Holdings (ONVO). At the time, the stock had been trading around $13.00, and now it has fallen to $9.00. Prior to that, my earnings call on Ignite Restaurant Group (IRG) correctly predicted a fall of around 30% in that stock.

But for today, I am focused on an even better near-term short opportunity in MiMedx Group (MDXG).

Continue reading…

Trouble Brewing at Farmer Bros Coffee (FARM)

Background

Farmer Brothers coffee (FARM) was founded in 1912 by Roy E Farmer. The company is headquartered in Torrance, CA, which location also serves as a manufacturing and distribution hub.

The company became publicly traded in 1951 and for a while was profitable and paid a dividend. Yet the company has now failed to generate any annual profit since 2007. In 2011, the company cancelled its dividend, citing ongoing financial circumstances.

The company is not widely covered on the research side, while much of the institutional holdings consist of passive index funds. As a result, the share price has gradually crept up from a low of around $7 in 2012 to over $24 by late 2013. Much is this has been due to strong performance by other stocks in the coffee space such as Starbucks (SBUX) and Green Mountain Coffee (GMCR).

Continue reading…

The big picture at Unilife (UNIS)

Investment considerations

As bulls and bears debate their longer term expectations for revenues at Unilife, many have missed the fact that there are near term catalysts which can be expected to have a very certain impact on the share price well before these longer term forecasts have a chance to play out.

Investors should also pay close attention to the stock promotion efforts which have accompanied the recent press releases and they should be aware of some nearly identical promotions in the past. As shown below, these types of stock promotions can often create more bounce in the share price than the actual news released by the company itself.

Separately, investors who wish to assess the longer term revenue prospects should make themselves aware of the current competitive environment. Many investors appear to have missed the existence of numerous competitors with similar product offerings who already have substantial cooperation from big pharma players.

As a final consideration, many investors have engaged in substantial debate over two negative articles which were published in Forbes in September. These articles contributed to significant volatility in the share price when they discussed a whistle blower lawsuit brought against Unilife by a former employee. Many investors appear to have never read the actual lawsuit and instead have simply relied upon the interpretation as represented by Forbes. Anyone with a longer term interest in Unilife should certainly read the suit themselves and come to their own interpretation. I have included as an Appendix a link to the full lawsuit text filing along with several text excerpts.

Section 1: Long term theses vs. near term catalysts

Last week was a volatile one for shareholders in Unilife (UNIS).

On Monday, the shares had traded as low as $4.03, closing at $4.15. But after the market closed, Unilife announced “an agreement with Novartis to supply clinical products from one of its platforms of injectable drug delivery systems for use with one of Novartis’ targeted early-stage pipeline drugs”.

The mere mention of “an agreement with Novarits” had a predictable effect on the share price, and Unilife quickly traded as high as $5.25 in extended hours trading – an immediate gain of more than 25%.

These gains followed similar gains the previous week, following theannouncement of a long term supply agreement with Hikma Pharmaceuticals on November 20th. Just prior to this announcement, the stock had closed at $2.80.

After trading to as high as $5.25 in extended hours, the shares ended the week at $4.31, but had traded as low as $4.16 again on Friday. In other words, by the end of the week, Unilife had already given up almost all of its sharp gains following the Novartis release. The stock has already received price target upgrades from its three investment banks last week, but this appears to have provided very little support for the share price.

An outpouring of analysis on Wednesday added to the volatility in the share price, but appears to have not given much direction to the share price. In that one day, there were three large short articles and two large long articles published. These authors took turns repeating one another, contradicting one another and ignoring one another. All of this also happened to occur on the same exact day that CEO Alan Shortall was presenting at a conference in New York. Not surprisingly, the share price was very volatile that day, at times being down by 10% or up by 5%. It was equally unsurprising that the share price finally ended the volatile day almost entirely unchanged (up by just 2 cents).

The bull thesis is based on the opinion that this recent series of supply agreements will ultimately produce perhaps hundreds of millions in revenue from big pharma partners. However, even the bulls acknowledge that meaningful revenues are not expected to materialize until after several ramp up periods of as long as four years.

The bear thesis was fully detailed by Kerrisdale Capital which notes that recent announcements from Unilife are nearly identical to numerous announcements stretching back 10 years, each of which suggested that the onset of massive revenues was imminent. Such announcements had consistently caused the share price to soar dramatically, just as they have again done in the past two weeks. As they have been recently, analysts were then quick to upgrade the stock. Yet revenues for Unilife have continued to dwindle while Unilife has steadily issued nearly 40 million new shares in just the past few years.

For those looking to trade the stock, the inherent problem with both of these bull and bear theses is that both are predicated on how potential contracts and revenues will play out over a period of several years. Given the tremendous volatility in the stock recently, long term views may not be of ideal use.

Both sides are free to speculate on the longer term future of Unilife. However in the near term, one thing is quite certain: By the end of December, Unilife will likely be out of cash and the company is almost certain to issue a substantial amount of equity before the Christmas holiday. This is the near term catalyst.

Author Dr. Hugh Akston illustrated this catalyst quite clearly in a recent article. As of September 30th (i.e. two months ago, its last reported quarter), Unilife was down to just $7 million in cash. The company steadily burns around $3 million every month. The company did receive $5 million as an upfront payment from Sanofi in October, but Unilife has already disclosed that it plans on paying down a loan to Varilease for roughly that amount. As of right now, Unilife is therefore down to around $1 million in available cash vs. its consistent cash burn of around $3 million per month.

The incentive to conduct a very large equity offering is clearly substantial. Last week (following the sharp spike), Unilife had quickly risen by nearly 90% and was trading at its highest levels since 2011. But this is simply on a “nominal” share price level. In reality, the large number of shares which have been issued every year means that last week Unilife was closing in on its highest evervaluation (market cap) since coming public in the US. Some investors may not realize this given that the share price has fallen from above $10.00 to around $4.00 at present. Yet it remains the case that the market cap for Unilife had just hit within around 10% of its highest ever valuation since trading in the US.

The recent upgrades by Unilife’s investment banks were all based upon enthusiasm for the Novartis announcement. Yet these banks are not privy to any additional information beyond the press release, which we can all read equally well. The banks simply relied upon this simple press release to provide generous upgrades to their share price targets. Such jockeying for position ahead of a near term equity financing suggests that these banks are looking for an equity offering that will be bigger rather than smaller and which will provide millions of dollars in investment banking fees to whoever is selected by Unilife. Currying favor with the company by upgrading the stock should therefore have been fully expected. These upgrades have failed to support the stock, so it appears that the market has already come to this realization on its own.

Section 2: Evaluating the stock promotion efforts

When looking at the “big picture” at Unilife, investors need to understand that there is an active effort at stock promotion which has been going on for quite some time. The details from this particular effort are virtually identical to other stock promotions, some of which I have highlighted in past articles.

Here is how it typically works. (And readers should keep in mind that I am not specifically referring to Unilife in this description. I am referring to a cookie cutter process that can be seen very frequently across numerous micro cap reverse merger stock promotions)

In each case, the promotion involves a small, money losing reverse merger which supposedly has the potential for massive near term transformation along with billions in revenue potential. At some point, the company issues one or more press releases which happen to mention global mega giants within its industry. Specific terms which would allow for proper revenue forecasting are typically not disclosed for competitive reasons or due to “confidentiality”. The share price often moves to some extent based on these press releases. But much sharper gains appear when certain third party authors interpret these press releases for us and then issue massive multi bagger share price forecasts. Share prices can then often show additional gains of more than 50% in a very short period. But the gains are typically very short lived. Over time most of these promotion efforts end up giving up all of their gains, and in many cases they end of falling even further, for reasons that will be shown below.

On Friday, author Tech Guru weighed in once again to help us “parse” the debate on Unilife. He notes that he expects $50 million in revenue in 2014. By way of comparison, over the past 5 years, Unilife has generated a cumulative total of only around $25 million in revenues. But most of this came in 2010. More recently, revenues have dwindled to around $0.6 million per quarter. During this time span of several years, Unilife has repeatedly issued similar bullish forecasts which made statements such as:

we have been swamped with demand from a lot of other pharma companies who also have unmet needs.”

“We expect to be supplying this to many pharma companies in the near future,”Allan said.”

Past press releases dating back as far as 4 years include the following. (Note these are all PRIOR TO 2013, and as such should have already had an impact on revenues).

2010 – Unilife and sanofi-aventis Agree to Exclusivity List for Unifill(TM) Ready-to-Fill Syringe

2010 – Unilife and Stason Pharmaceuticals Sign Asian Distribution Agreement for the Unitract(TM) 1mL Safety Syringe

2011 – Unilife Signs Clinical Development and Supply Agreement with Global Pharmaceutical Company

2011 – Unilife Wins Supply Contract with Nation’s Largest Healthcare Alliance

2011 – Unilife Starts Unifill Syringe Sales to Another Pharmaceutical Customer

2011 – Unilife Commences Initial Supply of the Unifill® Syringe to Sanofi

2011 – Unilife on Schedule to Fill Initial Orders for Unifill Syringe

2012 – Unilife’s Bolus Injector Platform Targeted by Global Pharmaceutical Company for Use in Multi-Drug Program

2012 – Unilife Signs Long-Term Supply Contract for the Unifill Prefilled Syringe

In many cases, these press releases were just as exciting as the recent ones in 2013. They also consistently provided (very brief) boosts to the share price of Unilife as expected.

But the results have varied dramatically vs. expectations.

The points from these graphs demonstrate the following: the share price has been steadily declining for the past several years, even as Unilife has consistently issued millions of new shares. Likewise, revenues have dwindled by more than 70% while losses have grown substantially. All of this has occurred despite the consistent release of “news” from Unilife which has been largely similar to that which was released in the past few weeks.

It is therefore unclear how Tech Guru could be so optimistic regarding a tremedous surge in revenue next year.

A few months ago, I highlighted a different campaign by Tech Guru with Neonode Inc. (NEON), which appears to be nearly identical to the promotion of Unilife in virtually all respects. The similarities and parallels here should be patently obvious to anyone who has followed Unilife.

Tech Guru began writing on Neonode earlier in 2013. Between March and September, he wrote bullish articles on the company on average every 2-3 weeks. Neonode is engaged in licensing touch sensor technology, mostly to electronics OEMs.

Just like Unilife, money-losing microcap Neonode had put out several very promising press releases this year which could be linked to global giants within its industry. Over a period of months these included such heavy weights as Samsung and LG, along with automotive contracts with Volvo. Clearly this was going to be huge and transformational.

Just like Unilife, Neonode had been putting out nearly identical press releasesfor years, but consistently failed to generate meaningful revenues – despite the global giant partners. Just like Unilife, Neonode has never earned a profit in its numerous years in business. And just like Unilife, the press releases from Neonode were always kept vague and omitted the most relevant details, typically due to competitive or confidentiality reasons.

Given that multiple years of nearly identical press releases from Neonode failed to produce large scale revenues or any profits at all, it is unclear why Tech Guru would project that more identical press releases in 2013 would somehow lead to near term windfall profits and a skyrocketing share price. But by trumpeting names like LG and Samsung and predicting returns of more than 400%, his articles did cause the share price to briefly rise by around 60% to as high as $8.84 up from around $5.00 in March.

Just like with Unilife, the investment bankers were quick to upgrade Neonode based on nothing more than the very vague press releases. Investment bank Craig Hallum initiated coverage on Neonode when the stock price was just $3-4, and put a target of $7.50 on the stock, implying that they expected Neonode to double. The timing of this coverage was downright bizarre given that Neonode had just lost its largest customer, Amazon (AMZN), which had been responsible for 40% of its revenues at the time. But the upgrade worked and Neonode rose. By August, Neonode had still failed to replace its lost revenues and reported a notably large earnings miss which sent the stock plunging by more than 20%. What did Craig Hallum do ? They upgraded the stock again – now with a $10.00 target. This upgrade, along with more bullish articles by Tech Guru (predicting a $27 share price) sent the stock to just under $9.00. This sequence of events is all detailed clearly in my September article.

By now, this sequence of events should all feel very familiar to those who follow Unilife. So far they have been largely identical.

What happened next with Neonode was quite predictable. Neonode and its management sold $19 million in equity. Craig Hallum ran the deal (as expected) and made millions in fees. Meaningful revenues from the mega announcements may still be years away (if ever) and the stock price quickly fell by around 30% back to around $5.00 – right where it began. Prior to the offering, Tech Guru had been writing bullish articles on Neonode every 2-3 weeks for a 5 month period. This was a dedicated and persistent effort. But following the offering, the articles suddenly ceased for several months.

Many investors may wonder if such promotions can actually have a meaningful impact on the share price. The answer is a categorical “yes, they can”, especially if executed by a professional. This point can be made clear with a separate example.

Lately the Novartis news has taken center stage to the point where many investors have stopped focusing on the recent Hikma news from November 20th. The Hikma announcement caused Unilife to soar by more than 30% to $4.03. But after the initial surge, investors began a meaningful sell-off as they fully evaluated the news. It was only a double promotion from a paid subscription service called “The Focused Stock Trader” that sent Unilife soaring.

The graph below illustrates the sequence of events.

– Nov19 / 20 – Unilife announces Novartis news – stock rises to $4.03

– Nov21 – UNIS stock immediately trades down as low as $3.63 (down 9.9%) closes at $3.73

– Nov22 – 25 – UNIS struggles to hold above $4.00

– Nov26 – TFST promo article to paid subscribers only – UNIS immediately jumps from $3.85 to as high as $4.38 (13% jump and a new 52 week high).

– Nov27th – TFST article released on SA at 2:35 pm – stock jumps again from below $4.20 to as high as $4.50 (breaking yet another 52 week high)

– Nov28th – Thanksgiving – market closed

– Nov29th – Friday – stock closes at $4.40

– Dec 2nd – Stock closes at $4.15 (down 6%) hitting a low of $4.03 again (right where it began)

– Dec 2nd (after market close) – Novartis news released

The conclusion from this is that the stock had been quickly falling below $4.00 until it was pumped up by TFST and his distribution to his subscriber and then the follow through on Seeking Alpha. The stock was quickly losing momentum again, and the only thing the resurrected it was a new press release regarding Novartis.

TFST is a paid stock promotion letter. According to its results page, TFST is among the best investors in the entire stock market throughout the history of time eternal. Better than Buffet, Ichan or Soros by a long stretch. It notes that:

As our results show, The Focused Stock Trader recommendations were correct 52 out of 55 trades for an average return of 29.69% per trade with 2 trades generating returns in excess of 200%. The average holding period for our recommended trades, not including open trades, is 24 days. THE FOCUS STOCK TRADER HAS BEEN CORRECT 95% OF THE TIME GENERATING 30% EVERY 24 DAYS.

Apparently by following TFST, one can quickly become immensely wealthy. Fortunately, TFST makes its expertise available to the public, for anyone willing to pay $400 per quarter ($133 per month) or $1,200 per year ($100 per month). Based on this, it is very easy for TFST to pull in a 6 figure income from subscription revenue irrespective of the performance of any trades it recommends.

closer look at TFST reveals that many of these stock picks end up being for very speculative reverse mergers which demonstrate great volatility. The research underlying them is often questionable, yet TFST has apparently generated significant returns on the upside, quickly selling before these stocks fall back to Earth.

For example, back in August, TFST highlighted Organovo Holdings (ONVO). Histrack record notes that he had sold the stock for prices as high as $11.20. But when the stock was trading at over $12.00, I highlighted the fact that much of its gains were due to misinformation and inaccurate comparisons to 3D printing stocks such as 3D Systems (DDD) and Stratysys (SSYS). The article from TFST contains the exact type of misinformation that I had referred to. He noted that

Needless to say, Organovo can do for 3-D printing what Microsoft (MSFT) did for PCs and Ford (F) did for the automobile; make a long-sought after dream a reality.

Shortly after TFST was selling at $11.20, the stock quickly ended up falling below $8.00. The stock has recently jumped due to the CEO’s presentation at retailinvestorconference.com. But even on that conference, the CEO went out of his way to make clear that Organovo is NOT a 3D printing stock.

TFST clearly benefited from the rise in the Organovo even though its research was largely unfounded. So, what’s the harm ?

The harm is that when stock promoters put out unfounded research on tiny, speculative reverse mergers, investors end up buying into these stocks without understanding that there are very substantial risks. TFST’s next pick was Fab Universal (FU), which he ended up making a whopping 99% on, selling it at $10.75. Congratulations to TFST, however that stock has since been halted after a fraud expose by GeoInvesting. Prior to the halt, this stock had last traded at $3.07. Trading has not yet resumed. Anyone who has been stuck holding a Chinese microcap which has been halted due to fraud allegations would likely not hold much optimism for the future of Fab. TFST was smart enough to get out at $10.75, but its subscribers may not have been so lucky. On its website TFST notes that:

In our reporting, we will suggest the purchase point; however, it is up to you to decide when to close out the position.

Likewise, on Unilife, we will have no idea how quickly TFST will end up running for the exits. In fact, it may well be the case that TFST will have the benefit of selling to individuals who are still buying based on research provided by TFST. That advantage, along with over $100,000 per year in subscriber income, makes for a great business model for TFST.

A longer look at the TFST track record shows a predisposition towards speculative and volatile reverse merger stocks which often end up in the cross hairs of short sellers. Revolution Lighting (RVLT) which TFST was selling as high as $5.00 was later exposed by a short selling and fraud focused site the StreetSweeper. The stock subsequently fell by as much as 50% from where TFST was selling, and it now sits at around $2.80. But it appears to have been another great trade for TFST who got out early. Likewise, it is very difficult to understand how anyone could have ever recommended beleaguered OCZ Technology (OCZ) which has been on terminal status for over a year.

TFST had noted that :

Short sellers are still holding on, but perhaps not for long. OCZ’s short position is at an unsustainable 79.3%.

Within a month, the shares had already plunged by around 80%. Since that time the shares have fallen by more than 95% and now trade for around 10 cents. It looks like there was a reason why the short interest was so monumental.

Yet OCZ has continued to be a promo pump target even now. Ashraf Eassa recently warned that there is still a pump campaign trying to spread rumor of a buyout on this now dead stock.

In separate disclosure on November 29th, TFST noted that his holding periodwas as short as just 14 days. The point is that small reverse mergers can often pop due to the sensation which surrounds vague press releases. This is especially true when the press releases include the names of major, global industry players. As players such as TFST have demonstrated, the best way to profit from such hype is to buy the rumor and (very quickly) sell the news.

The promoters behind Unilife have demonstrated a consistent tendency to back speculative, money losing reverse merger stocks. As with TFST, other backers have found themselves on the opposite side from short sellers.

Tech Guru had previously penned an article to rebut the short thesis on Coronado Biosciences (CNDO). Coronado had the implausible idea of making medical treatments out worm eggs which grow on pig feces. Tech Guru sought to debunk the short thesis which had been highlighted again by such skeptics as the StreetSweeper.

In its “public oath” the StreetSweeper states that:

We aim to partner with the public in exposing corporate fraud and bringing its engineers to justice. To that end, we pledge to investigate credible allegations of misconduct and – if the evidence supports those accusations – report the truth about our findings. At the same time, we agree to disclose any conflicts that could potentially color our judgment. By embracing these core principles, we hope to protect ordinary Americans and deliver them news that they can trust.

Readers can take that “public oath” with whatever grain of salt that they like. The point from it is that sites such as the StreetSweeper do not focus on stocks which are merely overvalued by 10-20% or which might have a bad earnigs quarter. They are focused on catalysts which are far more dramatic and which imply far larger share price moves.

As with Unilife, the shorts made their case by saying citing a horrible track record by management, including huge share sales despite no revenues. In backing this company, Tech Guru was defending the indefensible. As should have been expected, the use of worm eggs from pig feces failed in clinical trials and the share price plunged from over $8.00 to as low as $1.25. Yet the elevated share price before the failure allowed management to raise over $200 million from stock sales over the past few years. The shorts were particularly focused on the fact that a small group of insiders had been repeatedly involved in similar speculative ventures which soared on the hype but which imploded following large share sales. Since the implosion of Coronado, Tech Guru has ceased providing further updates on the company.

The point from these examples is that generating excitement around tiny reverse mergers which generate little to no revenue is far easier than generating excitement around larger companies which are profitable and stable. This is precisely why promoters choose such companies. Yet by ignoring or denying the warning signs highlighted by the skeptics, these promoters can often encourage other investors to invest in stocks which have very significant (and unknown) downside potential.

Other Unilife bulls appear to be engaged in a different strategy when writing about Unilife.

In the past year, Fusion Research has gone from zero articles on Seeking Alpha to almost 400. A new article appears from them on almost every trading day, with the result that Fusion is now #1 on long ideas, #1 on services stocks and #1 on industrial goods. These rankings are based purely on number of hits.

Fusion describes itself saying:

Fusion Research is managed by a team that has been actively involved in the financial research industry for over 5 years. Our business is rooted in principles of trust, integrity and fundamentals-driven markets.

But it also notes that

We create strategic partnerships with companies and firms to gain unprecedented domestic and international following of our coverage.

In fact, a closer look at Fusion’s own website reveals that Fusion is actually an IT outsourcing firm which focuses on simple web development and HTML. There is a link where once can “learn more” about its investment research activities. But that link is broken and leads to nowhere.

In its almost 400 articles, Fusion has consistently written about mega cap stocks which have a huge built in following of thousands of readers. But it has also made it a point to write about smaller stocks which have recently shown dramatic price moves and which will also automatically generate a large number of hits.

The key point is as follows: During a two week period, shares of Unilife soared by as much as 88% on the back of two press releases which are encouraging but still far too vague for planning or forecasting purposes. Prior to this, the shares closed at $2.80 and the shares have already begun a substantial retreat.

The attention of promotional authors can often have an even larger impact than the news from the company itself. While this can often create great short term trading opportunities for those who are nimble, holding these stocks after they peak can end up producing substantial losses on the way down. Investors should be aware that those who promote such stocks often have zero intention of holding the shares and often intend to play it as a quick “buy on the rumor trade”. Other authors are simply attracted to the most volatile stocks which tend to generate the largest number of page views and typically do not even buy the stocks they are writing about.

Section 3: Competitive considerations for Unilife

Many of the recent articles have been overwhelmingly focused on highlighting the dramatic upside associated with Unilife, while downplaying the substantial risks of buying on this spike. They have also ignored the competition.

There is a reason why promotional authors tend to ignore the risks and competition: it works.

We can very easily see what happens when an author pays even moderate attention to risk elements after a stock has already spiked. Once the stock has spiked, any attention to risk can send it sharply lower.

On December 2nd, Dr. Thomas Carr wrote a very bullish article on Unilife entitled “Unilife: Set To Double In 2014?“. In his opening pitch, he notes that he is long the stock and that:

As it turns out, demand for Unilife’s unique medical dispensing technology is so strong and growing so fast that shares of the company may well be one of 2014’s best investments in the healthcare sector.

What was the result of this strong enthusiasm from one who identifies himself as a “doctor” ? The stock actually fell 7% that day. There are two reasons for this.

Despite his own personal bullishness and disclosing a long position in the stock, Dr. Carr was forthright enough to at least mention the substantial downside that comes along with Unilife. He noted that:

New and current investors should keep in mind the risks outlined above. The company may well be covering up past fraudulent activity. The Biodel deal may well fall through. Management may continue its unfortunate streak of over-selling its EPS potential.

But of much greater importance was the fact that Dr. Carr was among the first to pay more than passive lip service to the existence of substantial competition within this market.

Even Unilife itself discloses that there is meaningful competition in this space. But the mostly retail investor base in Unilife often seems to feel that Unilife is inventing a new product and will quickly command a monopoly in the space.

In its most recent 10K filing, Unilife discloses its view on the competition which already consists of some of the largest and best financed giants in the healthcare industry, saying:

We are aware of five companies which specialize in the production and supply of glass ready-to-fill syringes. These companies are BD, Gerresheimer, MGlas AG, Schott and Nuova Ompi. We estimate the market concentration rate for these five companies to be approximately 95%. We believe BD’s market share to be in excess of 50%, as it has supply relationships with most pharmaceutical companies and contract manufacturing organizations.

The point that investors need to realize is that this is not a soon-to-be-created new market which will be dominated by Unilife. It is already an established and highly competitive market.

In September, the big news for Unilife was the Sanofi contract which may eventually lead to meaningful sales of Lovenox in prefilled syringes. But in its September conference call, Unilife noted that

the IMS data for Lovenox for 2012 shows the sale of over 450 million prefilled syringes with Lovenox in it.

The point is that there are already hundreds of millions of units of being provided by competitors on the market two years before Unilife even plans on entering the picture in 2014. Many investors have been entirely unaware of this competitive reality and have assumed that Unilife is about to create a multi billion dollar monopoly.

Dr. Carr briefly listed a number of Unilife’s competitors within the space who have existing or pending product offerings which will largely compete within the same space.

In addition to Beckton Dickinson (BD), Gerresheimer, MGlas AG, Schott and Nuova Ompi (which were mentioned by Unilife), Dr. Carr also mentions such giants as Amgen (AMGN), Pfizer (PFE) and West Pharmaceuticals (WST). Medical giant Baxter International (BAX) is also active in prefilled syrniges. Baxter is valued at $37 billion based on annual sales of over $14 billion.

The point is that breaking in to this space will be difficult, even despite several encouraging potential supply contracts. The competition in this space is well established and extremely well financed and will have the ability to compete aggressively on volume, quality and price.

Conclusion

The market has now had the opportunity to digest in full the recent news from Unilife along with the ample analysis from third party authors. CEO Alan Shortall has had the opportunity to speak to investors in New York and the sell side analysts have already had their chance to upgrade the stock.

With all of these events now being mostly digested, the stock appears to be once again giving up its recent gains rather than continuing to surge higher.

The market may well be already pricing in an equity offering due to the realization that Unilife will likely be out of cash before Christmas.

Much of the sharp rises in the stock can be tied to recent promotional articles by authors who tend to focus on short term trades in speculative reverse merger stocks. In the past, some of these efforts have sensationalized press releases from other micro cap reverse mergers and have predicted a surge in near term revenues and multi bagger share price returns. This is an easy task when the press release includes the names of global giant heavy weights.

But when similar such press releases have been consistently issued for years without meaningful resulting revenues, investors should likely ask themselves how the latest series of press releases will create a result that is in any way different.

There is already existing competition in the specialty syringe space, with hundreds of millions of units being delivered even just for individual drugs such as Lovenox. Those who have been under the impression that Unilife has created a novel product and will soon be commanding a monopoly would do well to expand their research into the substantial competition in the specialty syringe space.

Appendix I – details of Unilife lawsuit

For those who wish to read the details of the Unilife lawsuit in their entirety, updating filings from August can be found at the following link at my website atmoxreports.com. Readers can also sign up for email alerts. There is no charge for this and email addresses are not shared with anyone. Ever.

Readers should also be aware that Unilife has already responded to the article on Forbes. A link to that response can be found here. However, readers should also note that there are a number of items in the actual whistle blower lawsuit which do not yet appear to have been responded to by management.

The lawsuit was brought by Talbot Smith, formerly an executive at Unilife who was hired in 2011. The suit notes that Smith was a Stanford graduate with a BS in Industrial Engineering and an MS in Operations Research. His starting salary was $230,000 plus various incentives including bonuses and stock options.

The gist of this lawsuit can be seen on the first page of the filing. The cited “causes of action” are a) violations of Sarbanes Oxley and b) violations of the Dodd-Frank Act.

Sarbanes Oxley (or “SOX”) was passed in 2002 in direct response to various accounting scandals including Enron, Tyco and Worldcom. SOX requires that top management certify the accuracy of SEC filings and dramatically increased the penalties for fraudulent activity.

Dodd Frank was passed into Federal Law in 2010 in response to the financial crisis which began in 2008 and also was designed to incorporate enhanced protections for investors.

As noted, the lawsuit was originally filed and received by the US Department of Labor/OSHA. The lawsuit notes that the Secretary of Labor did not make a final determination within the 180 day deadline, but that “sufficient prima facie evidence was found to begin an investigation” (page 2). As a result, the case was moved to Federal Court.

This filing is very long because it also incorporates original copies of the press releases and the 10K filing which are said to contain the inaccurate statements.

Some of the claims by Smith state that products being supplied by Unilife were not “validated” (as had been claimed by Unilife) because the FDA required activities had not been completed at the time that these statements were made to investors. Unilife subsequently brought in FDA auditors who stated that by the time of the audit, the validation could be considered complete.

These FDA claims will therefore be very difficult for either side to verify. The argument Talbot would make is that compliance would have been achieved well after he reported his observations to the FDA, but prior to the audit. The argument from Unilife is simply that this is not true.

Other claims should be less ambiguous. For example, on page 7, we can see Smith’s claim that the previous 10K filing made inaccurate statements to investors regarding shipments of “commercial” product by Unilife. Talbot backs this statement by noting that “no revenue had been collected from commercial sales of the Unifill product”. Ultimately, an audit by the SEC will be able to trace documentation of this claim and make a determination. This should be black and white.

Likewise, Talbot claims Unilife made false statements about its production lines. Talbot claims that at the time of the statements, two of the production lines were actually still in Denver, Colorado, and certainly not installed. Again, this should be a very black and white matter to resolve in an investigation.

In general, I am far less focused on the FDA issues because I believe that they will be far more difficult for either side to resolve. But on Page 11, the lawsuit describes additional product quality failures which had supposedly been reported by Smith via email. The lawsuit then notes that

The following day, Mojdeh told Smith to come into his office. Mojdeh instructed Smith that he should not put any concerns into emails because they could be used against the company in future legal action

Once again, an investigation will certainly dig up any emails prior to this conversation. Either the emails referred to by Smith exist or they do not, so there should be a conclusive result to an investigation by the SEC.

Other claims may be easy to document, even though actual “intent” may be hard to prove. On page 11, the lawsuit notes that:

Unilife also took actions to mislead investors about its customer demand and manufacturing capacity. To this end, Mojdeh directed Smith to have his team purchase 1,000,000 units of Unifill components per month in spite of the fact that there was no customer demand or manufacturing capacity to justify this level of purchasing. Mojdeh told Smith that the objective of the purchases was to make suppliers believe that Unilife was manufacturing at this volume, with the hope that the information would leak to the financial markets.

The point here is that proving that Unilife made unnecessary purchases at huge volume should be relatively straight forward. And this could easily be explained by the ballooning losses and dwindling revenues seen over the past 3 years. Yet actually proving the intent of Mr. Mojdeh will likely be a more difficult endeavor in an investigation or a courtroom.

On page 12, the lawsuit states that:

Another action that Unilife took to mislead investors was to run fake production when investors or customers were visiting the facility. On more than one occasion, scrap was run through the machines to make it appear that Unilife was making product when it was not. Product was placed on skids by the warehouse doors to give the false appearance that product was being packaged and send to customers when it was not.

Presumably the only way to get much resolution will be when the SEC subpoenas the warehouse workers who either did or did not perform these activities. The truth should be easy to get at because warehouse workers typically do not have a large financial inventive to bend the truth when faced with the potential for perjury charges. In addition, there are likely a large number of warehouse workers. Keeping a secret gets harder as the number of individuals increases.

On Page 13, the lawsuit notes that

Shortall made comments that were posted on the Yahoo! Finance message board on July 10th, 2012, indicating that Unitract was profitable with a 20% gross margin, when Unilife was in fact losing $1.00 per unit.

Again, this will be an easy one to either prove or disprove.

Conclusions regarding Unilife lawsuit

The details spelled out in the lawsuit vary between crystal clear and verifiable to murky and difficult-to-prove. Some investors may be inclined to wonder why we have not already seen some resolution to these matters given that they relate to issues dating back to 2011. Other investors may be inclined to feel that if we haven’t seen consequences yet, then there may simply be nothing to worry about.

In general, SEC investigations take considerable time and there are no “hints” along the way which would given guidance as to the eventual conclusion. For example, in October 2013 the SEC was just providing final resolution to the fraud case at YuHe International, which has been ongoing since 2011. China frauds were a big focus in 2011, and in October 2013 the SEC finally got around to issuing final judgment against China Media Express (“CCME”), also following fraud that was uncovered in 2011. The point is that these things can often take a few years before visible results are uncovered. No one should expect that there would have already been an immediate result just because these findings were made public over a year ago.

Disclosure: I am short UNISONVO. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Organovo set to fall by 50%

Investment overview

Shares of Organovo Holdings (ONVO) have recently skyrocketed due to widespread media coverage and an equally widespread misunderstanding of the company’s near term revenue potential. The stock has risen from $2.00 to over $13.00 in the past 12 months and is now valued at over $1 billion. To date Organovo has generated no real commercial revenues, but has brought in small amounts of money from grants and collaborations. The company hopes to launch its first commercial product, a 3D liver assay, in December of 2014, 13 months from now. A launch of any possible next products has not been announced or discussed, but would likely take several more years for any visibility. So for now, this one product is all that there is to hope for for the next few years.

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