GreenPower Motor – the wheels on the bus are slowing down

Portfolio manager summary

GreenPower Motor (TSX: GPV, NASDAQ: GP) is an EV bus company that we believe has significant misunderstood risks:

  • Unlike certain EV plays (cough, cough, NKLA), GreenPower actually has revenues! The problem is that those revenues are entirely from California, and have been dependent on a subsidy program that we estimate accounted for ~74% of calendar year 2019 and 2020 YTD revenues
  • As a result of state budget constraints, the subsidy program itself is expected to keep shrinking – we believe this dynamic has already started to affect GreenPower’s revenues, which are down 41% compared to the same period in the prior year
  • We believe that GreenPower has prioritized G&A over R&D, having spent ~$2MM on R&D over the last five fiscal years while spending close to $8MM on “Administrative Fees”; this is perhaps the reason why GreenPower has no patents and licenses, and could explain the inconsistencies we found in how the company has marketed its products in press releases compared to how it discloses the specs on its vehicles
  • We believe that CEO Fraser Atkinson has kept some questionable people in his orbit of colleagues – his prior endeavors have seen SEC subpoenas, a delisting by the BC Securities Commission, and collapsing stock prices
  • One of GreenPower’s major shareholders is a BC bus entrepreneur who owned a company implicated in deaths of two teenagers in a crash that was determined to be due to a “flagrant disregard for safety provisions”
  • Another (former) major holder of GreenPower is reputed by penny stock investors as having a history of “toxic financings”. They were also a holder of SCWorx, a company recently halted by the SEC
  • The PCAOB imposed sanctions on GreenPower’s auditor, Crowe MacKay, related to a 2014/2015 audit, and the PCAOB noted deficiencies related to a 2017 audit that included “the inappropriate issuance of an audit report without having planned and performed an audit under PCAOB standards”
  • We believe that GreenPower’s revenue growth is likely to be significantly hampered due to the shrinking California subsidy program – this, compounded with the governance risks outlined above, leads us to assign a $2 price target to GreenPower’s stock, down 84% from the last close

Despite having real revenues, GreenPower has major risks misunderstood by retail investors

GreenPower Motor Company (TSX: GPV, NASDAQ: GP) is a British Columbia-based designer, builder, and distributor of all-electric buses used in various applications. It is the product of a 2014 reverse merger into Oakmont Minerals, which at the time was being run by current GreenPower CEO Fraser Atkinson.

GreenPower’s product offering is comprised of:

GreenPower EV Star Min-E – Which is an electric mini-bus available in four configurations and with a “life expectancy of ten years

The Beast– A Type-D School Bus which is offered in two different lengths and configurations

EV Transit Bus Line– GreenPower’s low-floor transit line that features multiple models: 30-ft EV250, 40-EV350 and the double decker EV550

With all the hype about EVs out there, and a great many charlatans pumping their technologies, the combination of EV and reverse merger might leave a skeptical investor questioning this company.

Much to our surprise, and, we would imagine, to yours, GreenPower has achieved the first step to establishing a real business and has booked approximately $25.3MM in revenue since March 2018, which on the surface, seems impressive, but we believe is unlikely to be sustainable.

GreenPower’s stock is up ~767% this year and up ~300% since July – before we delve into why we believe this is unjustified, let’s recap the long case:

  • GreenPower has revenue! More than what NKLA can claim – which gives GreenPower real legitimacy as an EV business
  • A hype-driven exponential increase in investor interest in the EV space and trade opportunities created because of the rise of EV stocks such as TSLA (up ~410% YTD) and NKLA (up ~167% YTD)
  • Electric buses are a unique segment of the EV market, not pursued by many public companies (perhaps the closest public competitor is Ballard Power)
  • Increased government investment in the EV infrastructure, especially electric buses

Mariner Reality Check: The wheels on the bus are slowing down

We believe GreenPower’s revenue is about to fall off a cliff as a result of its exposure to California’s subsidy program. GreenPower is only registered as a motor vehicle manufacturer and dealer in California, and the company has “not yet sought formal clarification of our ability to manufacture or sell our vehicles in any other states.”  In our view, this effectively makes GreenPower a “one-state” wonder. 

We believe that revenues to date have been supported significantly by one government program (we estimate that 74% of GreenPower’s total revenue in calendar years 2019 and 2020 YTD is from the program): California’s Hybrid and Zero-Emission Truck and Bus Voucher Inventive Project (HVIP).

Funds allocated to HVIP were fully claimed by November 2019, no new funds have been allocated, and HVIP expects the next allocation to be lower – thus far, we have seen GreenPower’s YTD 2020 revenues fall 41% from the same period in 2019 – we expect them to fall further given shrinking HVIP program funding.

Like the bus in Speed, we believe the shrinking HVIP program is the proverbial bomb in the bus, as EV truck/bus producers fight for a piece of a smaller pie – except Sandra Bullock isn’t there to steer the bus to safety and Keanu Reeves isn’t there to defuse the bomb.

In this report, we explore the risk of falling HVIP credits, GreenPower’s claims about its products and autonomous driving, the CEO’s history with seemingly questionable characters (hint: SEC allegations) and an auditor with PCAOB deficiencies.

The combination of all these factors leads us to believe that GreenPower’s stock, trading at 16x 2021 revenues, is inappropriately valued, and assign a price target of $2, down 84% from the last close.

We believe that a shrinking HVIP credit program poses the number one risk to GreenPower’s topline and its future growth

At first blush, electric vehicles are extremely expensive compared to their ICE counterparts. An average diesel transit bus costs $500,000, compared to an EV bus at $750,000, while a diesel school bus costs around $110,000 compared to an EV school bus at $230,000.

Because of this pricing differential, governments have long offered subsidies to bring the cost of the vehicles close to their cheaper, gas-powered peers and induce usage of cleaner technologies to mitigate harm to the environment.

Since GreenPower is only registered as a motor vehicle dealer in California, the ONLY truly relevant subsidy program in our view is California’s Hybrid and Zero-Emission Truck and Bus Voucher Inventive Project (HVIP). The HVIP program was established in California following the passage of the California Alternative and Renewable Fuel Carbon Reduction Act and to date, HVIP has deployed more than 4,000 medium-to-heavy duty vehicles across 1,100 participating fleets. 

The California HVIP works as follows:

  • Every budget year, the California Air Resources Board (CARB) sets a budget that will be allocated to the HVIP program
  • Vehicle buyers submit purchase orders to dealers, and the dealer uses that order to apply for the HVIP voucher
  • The purchaser will receive the vehicle at a discounted price at point of sale, while the dealer will receive the incentive payment from HVIP as well

In the case of GreenPower, HVIP provides the following incentives for its products:

These incentives allow for an effective reduction in the price of the vehicle for the end user, and have been a meaningful source of revenues for GreenPower. The Voucher Funding Map allows users to download a CSV file to show how much funding GreenPower has gotten from the HVIP program:

The data set shows GreenPower received approximately $13.5MM in funding from HVIP for what we believe to be calendar 2019 and YTD 2020 (since GreenPower only began mentioning the program starting in 2019). Over this same period, GreenPower has reported $18.3MM in revenues – this implies that HVIP has been responsible for 74% of GreenPower’s revenue for calendar years 2019 and YTD 2020, making it a very important source of revenue.

Why does this matter? If ~3/4ths of GreenPower’s revenues are associated with one state subsidy program and the budgetary authority is reducing their funding, that creates quite the pickle for GreenPower; not to mention that demand for these vouchers has been increasing.

  • We called HVIP, and learned that by May 2019, funds allocated for the HVIP voucher program for the July 1, 2018 to June 30, 2019 fiscal year had already been claimed, so a waitlist for the next fiscal year’s allocation was started
  • According to GreenPower, on October 24, 2019, CARB approved funding of $142MM for the fiscal year starting July 1, 2019 until June 30, 2020 – because there was a $125MM waitlist already extant, the entire $142MM was spoken for by November 2019 – it follows, in our view, that funds for any GreenPower order that arrived after November 2019 are simply not available
  • The implication, in our view, is that new HVIP subsidy funding for GreenPower has been effectively unavailable since November 2019, and will, best case, be available in early 2021 – this represents over a year without incremental subsidy funding to help drive demand for GreenPower’s orders

This dynamic seems to be hitting GreenPower already, as June 2020 YTD revenues are down 41% versus the same period in 2019.

Based off the press releases from the company, above are the orders/deployments announced by GreenPower since the beginning of the year. On top of most of these orders being announced since June (after the stock caught fire and almost 8 months since funding closed), the startling fact is that all these orders are from California based customers, suggesting their dependence on HVIP funds.

We view HVIP as a key demand driver for buyers of EV buses – without subsidization, we believe that few municipalities or customers have the wherewithal to purchase premium priced EV vehicles. This, combined with the fact that HVIP has been such a meaningful contributor to GreenPower’s revenues and concentration of orders in California, leads us to believe that GreenPower’s revenue growth is about to be seriously hampered as the HVIP program shrinks. If these customers do not receive HVIP funding, will they really follow through with these orders? 

The Company has shied away from talking much about subsidies and their significance as a potential headwind; however buried in its filings, GreenPower itself has also mentioned the negative impact of HVIP funding:

In the 2020 20-F:

“On November 1, 2019, CARB announced that it had received voucher requests for the entire $142 million budget allocated to the HVIP program for the current fiscal year and was no longer accepting new voucher requests until new funding for the program is identified. This announcement has negatively impacted new sales prospects for GreenPower buses in the state of California and any further reduction or elimination of the grants or incentives in the state of California would have a material negative impact on our business, financial condition, operating results and prospects.

For the quarter ending December 2019:

“by November 1, 2019, CARB announced that it had received voucher requests for the entire budget allocated to the HVIP program for the current fiscal year and was no longer accepting new voucher requests until new funding for the program is identified. This announcement has negatively impacted new sales prospects for GreenPower buses in the state of California.

We believe the market underappreciates the risk that is posed by the HVIP program:

  • While the program has led to revenues for GreenPower in the past, it has made the company almost entirely dependent on the HVIP and California ecosystem
  • Given our estimate that ~3/4 of the company’s revenues are from the HVIP program and all the announced orders since January originating in California, we believe that the shrinkage of the HVIP and its increased competitiveness poses a huge risk to the company’s topline
  • This has already started to impact the company in our opinion, with YTD revenues down 41% compared to the same period last year, but we fear the worst is yet to come

Not only are the state subsidies trouble for GreenPower, we believe that the company’s R&D and product marketing are a cause for concern.

Product marketing and R&D concern us…a lot

The EV industry is still very much at a nascent stage and companies within the industry need to be constantly innovative to stay on the forefront. Some of the most adopted EV products available today, i.e Tesla products, are the product of billions in R&D and product development costs.

Over the past five fiscal years, GreenPower has spent just $2.2MM on product development – a relatively small dollar expenditure when you consider that TSLA, in 2006, before it had ANY revenue to speak of, spent $25MM on R&D:

To put this in context, TSLA, in a year when it had zero revenues and was still very much a nascent business, spent over 10x what GreenPower has spent in the last five fiscal years.

What GreenPower has spent on is “Administrative Fees”, a cumulative ~$8MM over the same period, or almost 3.6x its product development spend. In our view, we do not believe that companies that claim to be innovative yet spend minimally on said innovations are good investments.

Why spend so much on “Administrative Fees” rather than pursue innovation, as Greenpower lacks substantive IP? “We do not currently have patents and licenses, but may choose to obtain patents and licenses on our designs, processes or inventions in the future.”

Why allocate funds to “Administrative Fees” when those funds could be used to legally protect its own designs and inventions?

We wonder if this lack of spend on product development is the reason for the inconsistencies we’ve discovered in some of GreenPower’s marketing and specifications. GreenPower’s media outreach appears to present outcomes that are much higher than the specifications outlined on its website.

Instance 1: EV550’s range

  • In 2016, GreenPower delivered an EV550 bus to the Greater Victoria Harbour Authority – the article covering the delivery noted that the “Last October, GreenPower supplied the Greater Victoria Harbour Authority with North America’s first fully electric double-decker bus. It was also the company’s first delivery, an ‘EV550’ that can travel up to 300 miles on a single charge (MPC)
  • But on GreenPower’s own product site, the EV550 today is characterized by a minimum range of 175 miles

Instance 2: A wide range of seating capacity on the Synapse Shuttle

  • But when it delivered the Synapse Shuttle to a client in 2019, the vehicle capacity appears to have shrunk – “The Synapse Shuttle is a thirty-six foot purpose built all-electric bus with seating for over 40 passengers and a range of up to 150 miles on a single charge. The Synapse Shuttle can be configured with multiple charging options including Level 2 on-board charging or Level 3 DC fast charging”

Instance 3: Range estimates for the EV 350

  • In April 2018, GreenPower announced that “its EV350 40-Foot All-Electric Transit Bus has outperformed its original range expectations. The zero-emission vehicle recently traveled 205 miles with 50% SOC (state of charge) remaining battery power after the trip” (this implies a 410 mile range in our view)

These inconsistencies make us question the credibility of GreenPower’s management team – our questions only increase with the announcement that it was developing a fully autonomous vehicle.

Autonomous driving, like EVs, has been used by to excite and entice investors curious about the future of transportation. During the quarter ending March 2020, GreenPower announced that it had entered into an agreement with Perrone Robotics (“Perrone”) to build a fully autonomous EV Star for the transit market. We are very skeptical that this is anything but hype – fully autonomous driving is notoriously hard and we believe it is unrealistic that this milestone will be achieved in the near future (from Business Insider):

What GreenPower seems to propose is Level 5 automation, which is “decades away”:

GreenPower ’s partner in this effort, Perrone – did a Series A with Intel in 2016 – by the time Perrone received this funding, Google had already spent $1.1B on its autonomous driving project. In 2019, Uber raised $1B JUST for its driverless cars business. We cannot comprehend how GreenPower and Perrone will be able to compete or innovate in this market given the level of capitalization required to invest and subsequently commercialize the technology.

Recall that GreenPower, in the last five fiscal years, has spent just ~$2.2MM in product development while it has spent $8MM on “Administrative Fees”. The company does not have patents or licenses – this causes us to question the company’s autonomous driving claims and goals. How is GreenPower supposed to compete or innovate without protected IP?

We believe that GreenPower should focus on aligning its specifications with its marketing, rather than marketing optimistic cases and instead presenting “minimum” specs. To us, this is not the sign of growing, innovative company.

We believe that the people in the GreenPower ecosystem have serious credibility issues

We are big believers that the people behind a company – the executives, directors, and major shareholders – are critical to the success or failure of the company and its strategy. Their prior business performance, personal conduct, and relationships should be an indicator of the likelihood of success of their current venture, especially in light of the nascent nature of the EV space.

When we evaluated GreenPower’s key personnel, we found what can best be described as a series of red flags – collapsing stock prices, an SEC subpoena, and major shareholders with issues that made us uncomfortable.

Enter Management: Not so “Versatile” after all

In February 2003, GreenPower’s current CEO, Fraser Atkinson, after leaving his position at KPMG, was appointed CFO of a Canadian company known as Versatile Mobile Systems, which traded on the TSX Venture Exchange under the ticker VV. Notably, another Versatile AND GreenPower board member, Malcolm Clay, was also a KPMG alum. At the time, VV was “primarily engaged in software development and sales of computer software, hardware and systems integration services related to wired and wireless mobile business solutions.”

In 2008, VV appointed one Alessandro Benedetti to its board – an Italian gentleman who had, in the early 1990s, been arrested “on charges which included false accounting”, and “entered into a plea bargain with the prosecuting authorities under which he entered a guilty plea and accepted a sentence of imprisonment.”

This doesn’t seem like someone you’d want on your board, right? It seems that Mr. Benedetti has continued to court controversy, having recently been identified by the WSJ as having worked in concert with Softbank’s Rajeev Misra to strike “at two of [Rajeev’s] main rivals inside SoftBank with a dark-arts campaign of personal sabotage”.

In 2009, shortly after Benedetti’s appointment, VV started a private equity subsidiary, Mobiquity Investments Limited, on the fact that the “core strength of our Board of Directors, in particular Alessandro Benedetti and Bertrand Des Pallieres, is in banking and private equity activities.”

Come October 2009, and we find that VV has taken an 8.3% in the Equus Total Return Fund (NYSE: EQS), a Houston-based business development company (BDC) making investments in the debt and equity securities of companies with an enterprise value of between $5MM and $75MM.

By January 2010, EQS’s stock price had fallen approximately 55%, and the VV players (CEO John Hardy, CFO Fraser Atkinson, and the aforementioned Des Pallieres and Benedetti) approached EQS’s existing board asking for board representation. On April 13, 2010, EQS filed a definitive proxy with the SEC to, among other things, consider the election the VV directors.

Just 13 days later, on April 26, 2010, the SEC “subpoenaed records of the Fund in connection with certain trades in the Fund’s shares by SPQR Capital LLP, SAE Capital Ltd., Versatile Systems Inc., Mobiquity Investments Limited, and anyone associated with those entities.”

These entities were all related to one another:

  • Mobiquity was a subsidiary of Versatility

We cannot speculate as to what this was related to or amounted to, but we believe it’s fair to say that drawing the attention of the SEC is never a good sign. A letter sent to EQS shareholders on May 3, 2010, characterized the SEC matter as follows: “the Securities and Exchange Commission issued a subpoena and notice that it was conducting an investigation into possible violations of federal securities laws in connection with trading in Equus stock.”

By June 2010, the VV group had been elected to the board on their promises to change the poor governance of EQS, with Hardy winning the Executive Chairman seat and Fraser becoming the Chairman of the Audit Committee. But it seems like they did not live up to their promises, being called to task by a shareholder for:

  • “Accounting inconsistencies” – remember that Fraser was Chairman of the Audit Committee!
  • “Ridiculous” board salaries, with John Hardy earning “2% of the fund’s current market cap annually”
  • “Within 6 months they announced plans for a massively dilutive rights offering”

Sure enough, it doesn’t look like Fraser and his crew generated much value at EQS – since being appointed to the board, EQS is down 50%.Versatile itself has suffered a similar fate – by March 2016, it had accumulated a working capital deficit of CAD $3.3MM, accumulated losses of CAD $63.7MM, and “material uncertainty that may cast significant doubt as to the ability of the Company to continue operating as a going concern”.

By January 2017, Versatile received a cease trade order from the British Columbia Securities Commission for failing to file its financials, and was subsequently delisted. Shareholders were caught unaware:

From its peak in 2011 until it was delisted, Versatile fell 14c to 3c, approximately 79%:

From 2009 to 2013, Fraser was also the Chairman at Rara Terra Minerals, a Canadian mining outfit that trumpeted developments at one of its rare earth properties in November 2012: they believe that they had found “numerous geophysical anomalies on the Xeno property meritorious of geochemical followup next summer.” Barely two months later in January, Fraser resigned from the board and the Company announced a private placement.

In May 2013, Rara Terra later abandoned rare earth mining, and rebranded itself Echelon Petroleum – in 2017, Echelon became Trenchant Capital Corp (TCC CN).

More importantly, Fraser presided over an 82% plunge in Rara Terra’s stock in 2011:

We believe that Fraser Atkinson’s track record speaks for itself – he has aligned himself with seemingly questionable individuals and several listed entities which he was associated with have virtually collapsed in price. Below, we show that his association with potentially dubious individuals continues today.

The RedDiamond connection conundrum

In May 2020, GreenPower released a prospectus to outline the sale of approximately 11.5MM shares by a group of shareholders who obtained their shares through private placements. The selling shareholder table reveals that one of these holders, RedDiamond Partners LLC, was selling all of its 737k shares in the company:

In the footnotes we learn that:

  • RedDiamond’s address is 156 West Saddle River Road, Saddle River, NJ 0745
  • John DeNobile exercises control over the shares RedDiamond owned

A quick look at RedDiamond’s SEC filings shows that in 2019, RedDiamond held shares in a company called SCWorx, a “provider of data content and services related to the repair, normalization and interoperability of information for healthcare providers and big data analytics for the healthcare industry.”

Yes, that SCWorx (WORX), which was halted for three months by the SEC in April 2020:

SCWorx’s CEO pled guilty to felony tax evasion charges and the Covid-19 test supplier they used had a CEO who was a convicted rapist – huge hat tip to Hindenburg Research for a job well done on this one.

Curiously, while RedDiamond is the DeNobile entity that reported its WORX holding to the SEC, another DeNobile entity, RDW Capital LLC, actually shows up as a stockholder in a share exchange agreement:

DeNobile and his business partners, through RDW and other entities they control, have been criticized by microcap investors as providers of “toxic financing” – a form of discounted financing where the convertible note holder is allowed to convert to equity at a price below market. These shares, since they are issued below market, provide an immediate return to the holder, who can then dump them in the open market, causing the stock price to collapse.

The prior presence of RedDiamond’s shareholder list is yet another apparent indication of the types of people Fraser Atkinson associates himself with, which we believe calls into question his credibility as CEO of GreenPower.

A principal shareholder and a potential “flagrant disregard for safety provisions”

In GreenPower’s US IPO filing, we learn that another principal shareholder of the company is Gerald Conrod:

Imagine if you owned shares in an EV bus company and one of the company’s principal shareholders used to run a bus company that had operations that resulted in death? In our view, this would cause us to be highly skeptical of said EV bus company. This is exactly the situation here.

In 1979, Gerald, along with a partner, started Conmac Stage Lines, after the BC government-owned operator ended tour and charter service. On January 30, 1984, one of Conmac’s buses lost its brakes and crashed, killing two high school students and injuring more than 50 others. A BC coroner’s jury cited a “flagrant disregard for safety provisions” as the primary cause of the crash. “During the 17-day inquest, the jury heard ConMac Stages Ltd. continued to use the 20-year-old bus for high-school trips despite inspections that revealed a cracked frame, poorly anchored seats, a broken speedometer and defects in the braking system.” The jury also heard a former driver say that the “company routinely swapped parts on its buses to meet the standards of motor vehicle branch inspectors.”

Gerald has in fact been involved with Fraser since Oakmont bought Greenpower in 2013, when he held approximately 15% of Greenpower’s shares. We find it hard to imagine why a bus company would want to partner with Gerald.

To recap, GreenPower’s CEO and principal shareholders have seen SEC investigations, significant price declines in the companies they were involved in, and a delisting – we view these are major red flags in the ability of management to execute on the stated vision of the company. We believe this complicates the already precarious situation that we believe exists as a result of the declining HVIP credits.

Given all this, one might hope that GreenPower’s auditors are the adults in the room, but we believe that this is NOT the case. Our findings below, regarding GreenPower’s auditors, further compound our concerns that GreenPower presents unquantifiable risk to investors.

Is GreenPower’s auditor credible?

Crowe MacKay, GreenPower’s auditor, has had its own issues that call into question the reliability and credibility of the company’s financials. In Dec 2018, the PCAOB imposed sanctions and fined Crowe MacKay $25,000:

These sanctions related to Crowe MacKay’s audit of Canadian mining company Hunt Mining Corp.’s 2014 and 2015 financial statements, where Crowe MacKay, among other issues:

  • [F]ailed to exercise due care and professional skepticism, and failed to plan audit procedures to obtain sufficient appropriate audit evidence to provide a reasonable basis for the Firm’s audit report”
  • “[F]ailed to consider information in the prior year’s audit working papers obtained from a predecessor auditor”
  • Conducted Hunt’s audits under Canadian GAAS instead of PCAOB standards, which was required due to Hunt’s status as a “foreign private issuer for the purposes of United States federal securities laws”

Insanely, Crowe MacKay, a Canadian accounting firm, failed to “evaluate relevant public information” to recognize that its audit client needed to be audited under PCAOB audit standards.

In 2019, the PCAOB released the results of a 2017 inspection which found deficiencies in both the audits that PCAOB inspected:

  • For one issuer, the PCAOB found “the inappropriate issuance of an audit report without having planned and performed an audit under PCAOB standards”
  • For the other issuer, the PCAOB found a failure to “perform sufficient procedures to test the valuation of a liability”

Let’s review that first one – basically, Crowe MacKay issued an audit report without conducting the audit using PCAOB standards – some of the standards that the PCAOB referred to are as follows:

It appears that Crowe MacKay’s shortcomings in its audit practices could be a significant risk to GreenPower shareholders, compounding what we view as management’s checkered history. How can GreenPower’s shareholder believe the company’s financials when the very firm in charge of vetting those financials appears to lack the policies and processes to do so?

Conclusion & valuation

The Mariner Instant Replay on GreenPower is as follows:

  • We believe that GreenPower’s revenue growth will collapse as the business is materially exposed to California’s shrinking HVIP subsidy program
  • We believe that GreenPower lack of R&D spend calls into questions its competitiveness. We believe that GreenPower’s autonomous driving partnership is unlikely to get off the ground given the difficulty and investment requirements to achieve fully autonomous driving
  • We believe that the people in the GreenPower ecosystem have past histories that call into question their credibility, including SEC subpoenas and delistings
  • We believe that auditor Crowe MacKay’s history suggests that GreenPower has little in the way of substantial auditor oversight, calling into question the reliability of reported numbers

Let’s be generous and assume a 25% reduction to the next HVIP budget – based on this, we model that GreenPower’s revenues could fall another 25% from the $6MM calendar year run rate implied by the first two calendar quarters of 2020, resulting in forward revenues of approximately $4.5MM.

Being generous (again) and applying TSLA’s FY21 price/sales multiple of 8.1x to GreenPower’s revenues, we arrive at a price target of $2, down ~84% from the most recent close and inline with the stock price before its massive run up. Given the hype and volatility typically associated with EV stocks, we believe the path to our target could be volatile.

Mariner’s Final Word: Remember Your ABCs (Always Be Cautious)

NOTE: Aside from confirming that GreenPower holder Gerald Conrod was in fact the bus entrepreneur that owned Conmac, Greenpower did not respond to our other questions.

More than meets the AudioEye – we see ~50% downside

Portfolio Manager Summary

AudioEye (AEYE) is a software-as-a-service (SaaS) company that provides website accessibility compliance – in plain English, it claims to use machine learning/AI to ensure that clients’ websites comply with web content accessibility guidelines (WCAG), specifically as they pertain to individuals with disabilities. 

From the lows in March, AEYE’s stock is up ~585% – key highlights of the bull thesis include AEYE’s recent performance in certain financial metrics and expected potential catalysts for the stock – for both 1Q and 2Q 2020 the company beat analyst revenue and EBITDA expectations. The company’s monthly recurring revenue (MRR) also increased 104% in Q1 and 105% in Q2 compared to the same period last year. Since the end of 2019, the company’s customer count has gone from 6,800 customers to over 20,000.  B. Riley recently upgraded its price target to $25 from $21 citing what has been a common theme among retail investors which is: “the pandemic-driven shift toward digital channels that could serve as a medium-term tailwind for web accessibility adoption”.

While these factors have pushed the stock price up, we believe, at its core, the business remains unchanged.  To capitalize on such momentum and be successful, a company needs good management, strong investment in innovation, a strong product and various other factors. In this article we delve into what we believe are serious issues with AudioEye, and why we think it lacks in all these areas, posing a great risk to shareholders.

AEYE has the following:

  • Founding team has experience starting businesses that seemingly go nowhere. Many of these businesses have engaged in related party deals and have been alleged pump and dumps, one of which was halted by the SEC and down 82%
  • Founder Nathaniel Bradley’s latest venture is Parallax (OTC: PRLX) which was recently halted by the SEC because of the accuracy of the claims made by the company regarding its COVID-19 test
  • At one point, “Pharma Bro” Martin Shkreli was a significant shareholder in AEYE. The connection to Shkreli continues to this day, as the current CEO was previously involved with Shkreli’s effort to revive KaloBios 
  • We believe AEYE already has weak governance – but further questions are raised when we investigate the background of another board member who sat on the board of another company with big promises that ended in bankruptcy  
  • The product category has been looked upon skeptically as automated accessibility remediation might not be the best solution 
  • For a company that claims to be innovative within their field, AEYE has spent minimally on R&D. Their R&D spend as a percent of revenue is well below the SaaS company median and nominally does not justify its valuation or claims of valuable IP 
  • Our research suggests that AudioEye’s financials should be looked at with the highest amount of skepticism. Their auditor appears to have a pattern of serious PCAOB deficiencies and was charged by the SEC for improper professional conduct
  • The company has amended and reclassified historical financials (and at one point restated 97% of its revenue) likely enabled or caused by material weaknesses in internal controls 

Because of these considerations, we believe that AEYE’s prospects are no better than they were before the stock started running in April, and assign an $8 price target to the stock, down ~50% from the last close.

Founders’ unusual entrepreneurial histories

AudioEye was allegedly founded in 2005 as “an R&D company” by a group including the company’s current SVP of Customer Advocacy and former President, Sean Bradley. Sean and his brother, Nathaniel (the former AEYE CEO through 2015), are prolific entrepreneurs, having started or run several entities alongside James Crawford and David IdeKino Digital, Kino Communications, Kino Interactive, Modavox, Augme, and Hipcricket.

Rather than run these companies privately, it appears that Nathaniel Bradley and his crew enjoyed listing them on the OTC markets – both Modavox and Augme were pink sheet companies, as is his current venture, Parallax (OTC: PRLX).

Curiously, the Kino/Modavox/Augme ecosystem not only had this group of people in common, but it also culminated in series of related party acquisitions, as helpfully explained by James Crawford:

So Modavox bought Kino and Augme, and Augme purchased Hipcricket in 2011 for an eye popping $45MM, and rebranded the entire company Hipcricket. Unfortunately for all parties involved, Hipcricket filed for bankruptcy in 2015, and its assets were acquired by SITO Mobile for just $5MM, just over 10% of what Augme paid back in 2011.  

Perhaps it is reasonable to say that the Bradley brothers are better at starting companies than running them, and we view Sean in a leadership seat at AEYE as a significant red flag.

If that weren’t enough, the SEC recently halted trading of Nathaniel Bradley’s Parallax Health Sciences, “because of questions regarding the accuracy and adequacy of information in the marketplace. Those questions relate to statements Parallax made about its purported development of a rapid screening test for COVID-19 and its purported access to large quantities of COVID-19 diagnostic testing kits and  personal protective equipment” Since the beginning of 2019, Parallax’s stock is down 82% – not a rousing endorsement for companies in Bradley’s world. 

One of AEYE’s other founders, David Ide, is worth a deeper look – in addition to founding AEYE, Ide claims to have founded Spindle Mobile, Spindle, Inc and sits on the board of SEFE and GlyEco:

  • In 2012, SEFE spiked from approximately 80c to $2.20, before utterly collapsing 98% to close the year at just 5c
  • Between September 2013 and March 2014, Spindle Inc. rallied approximately 368%, only to collapse 93% to just 24c by September 2014 – the stock was recently halted at $0.003
  • GlyEco appears to have suffered the same fate as SEFE and Spindle – it has gone from mid-teens in 2017 to just 3c today

Now if this has you thinking, “are these pump and dumps?” – maybe you’re on to something. We’ve seen several posts critical of SEFE and the people involved, Ide included, but this Seeking Alpha comment really caught our eye:

While we readily admit that neither Nathaniel Bradley and David Ide are involved in AEYE today, their troubling past activities cause us to cast a skeptical eye on anything AEYE does.  And that is just the beginning of this story.  Later we’ll dig into the auditor, product and investment in the company’s future.

A troubled ‘Toosie Slide’: we believe that repeated reshuffling at the executive level is concerning

In April 2015, Nathaniel Bradley resigned as CEO and President of AEYE, coinciding with the company’s announcement that it needed to restate certain financials (more on that later).  His brother, Sean, was moved to the President role, and Nathaniel was inexplicably kept on as Chief Innovation Officer and Treasurer.  James Crawford also resigned as COO and Treasurer.

In November that year, Todd Bankofier was named CEO, remaining there until he was apparently demoted to Chief Revenue Officer in September 2019, when executive chairman Carr Bettis stepped in as interim CEO.  Then, in January 2020, what we would assume to be an unhappy Bankofier notified the company of his resignation.

Just two short months later, AEYE announced the appointment of Heath Thompson as CEO, with Bettis quoted: “Heath has a decorated past in leading technology and specifically SaaS business model transformations.  In Heath, we found a leader who possesses the skills that we were looking for to execute on AudioEye’s long-term growth plans.  We are looking forward to leveraging Heath’s track record and unique skill set to take advantage of the rapidly growing market opportunity for our products and technology.”

And then, barely five months later, we learn that Heath Thompson has moved away from the CEO role into a “strategic advisor” positionDoes this mean Heath is even employed at AEYE? What could he have experienced that would make him step down as CEO in such short order? 

A “Pharma Bro” Shkreli associate takes over as CEO

Upon Heath Thompson’s departure, David Moradi, who joined the board in 2019, took over as CEO.  Moradi is the Founder and Manager of Sero Capital, LLC, a Miami Beach-based entity that owns approximately 28% of AEYE.  Moradi, like the Bradley brothers before him, has an “interesting” background.  

In November 2015, “Pharma Bro” Martin Shkreli and other investors took a majority stake in OTC-listed KaloBios, a CA-based biopharmaceutical company, in an effort to revive the company’s leukemia drug.  The other investors here included one David Moradi, who was elected to the board of KaloBios.  KaloBios eventually filed for bankruptcy in December 2015 and terminated Shkreli as its CEO when he was arrested, and has since been restructured as Humanigen (OTC: HGEN).

Moradi and Shkreli do appear to work together in more ways than one, since Shkreli himself owned 7.7% of AEYE at the end of 2016:

On top of being connected through Moradi, one of the Directors who resigned very recently was also involved in KaloBios.  Alexandre Zyngier (LinkedIn), lists himself as the Founder of Batuta Capital Advisors. This same firm is named in a bankruptcy document as the financial advisor to KaloBios. He served on the board of Audio Eye from October 2015 to July 2020.

We view these relationships as significant red flags, as Martin Shkreli was convicted of securities fraud charges in 2017.  

And if this were not enough, AEYE has Marc Lehmann on its board – for those of you not familiar with Marc, he has a sterling resume with degrees from NYU and Wharton, and stints at Appaloosa, SAC, and JANA Partners.  

This would be well and good for AEYE, but unfortunately Marc was also a director at Green Growth Brands (GGB), a Canadian cannabis company.  GGB was critically evaluated as a hostile suitor for Aphria by Hindenburg Research, who characterized GGB as follows:

Hindenburg’s commentary was prescient, as GGB filed for bankruptcy protection in May 2020, after it faced a “severe liquidity crisis”.  We tip our hat to Hindenburg Research for their work here.

We would question the judgment and intentions of anyone who would sit on a board of a company like GGB, and view Marc’s presence on the AEYE as a red flag.  

This, combined with Moradi and Zyngier’s apparent Shkreli affiliation, Heath Thompson’s surprisingly short tenure, and the Bradley brothers’ track record, causes us to question management’s claims and credibility.  These are by no means dispositive of untoward activity, but we view them as significant red flags and risks to shareholders.

We believe the questionable business practices of management have planted their seeds within the company. A pattern of product and technology reshuffles combined with negative industry commentary about the product category suggests that investors may be expecting too much from too little. 

AEYE’s evolving product suite

AEYE, despite being incorporated in Delaware in 2005, actually goes back a bit further – it was started in 2001 as a product which allowed “site owners convert any text-based web site into an intuitive, mirrored audio format” so that users could “navigate the internet solely by listening to Streaming Audio prompts and performing simple keystroke commands from any internet-enabled device”.

By 2005, AEYE was marketing itself as a social entrepreneurship venture:

“The development of AudioEye reflects our core values of social entrepreneurship. The company was founded as a private market solution to an important public policy problem. Many learning-disabled, visually impaired, elderly, young children, non-English speakers, and sighted individuals are faced with a low quality Internet experience. It is improving everyday, but we believe AudioEye can open many doors for those left behind by the first Internet revolution”

By 2011, AEYE had decided it had been founded in 2003 and billed itself as a developer of “Internet content publication and distribution software that enables conversion of any media into accessible formats and allows for real time distribution to end users on any Internet connected device”, adding several new products to its existing audio platform:

  • An emergency alert system that claimed to deploy instant alerts to a community of subscribers
  • “E-Learning” systems “accessibility at the forefront”
  • The IF Factory – “Internet Factum (Factum: do everything) offers a specific accessible product line including internet pay-per-view, mobile, enterprise broadcasting, accounting venue and event based technology products”

By 2013, AEYE had added new lines of business – licensing and patent enforcement:

None of these alterations and products seems to create a sustainable revenue stream, with revenues peaking in 2013 and falling 78% to a nadir of $339k in 2015:

Then, after spending an average of just $443k per year in R&D in 2014, 2015, and 2016, we have essentially what AEYE pitches as its product set today – an “always-on, proprietary machine-learning/AI-driven technology automatically identifying and resolving the most common WCAG accessibility errors (approximately 35-percent) coupled with AudioEye’s team of digital accessibility subject matter experts monitoring, manually testing and resolving the remaining errors.”

But, according to our research, it doesn’t seem like website accessibility software packages are as easy to deploy or as effective as the players in the industry would like you to believe. 

The first product review that shows up on Google for AEYE is from Kris Rivenburgh, the Chief Legal Officer and Chief Accessibility officer of Essential Accessibility and an expert on website accessibility compliance, who reviewed AEYE’s products and came to following conclusions:

“AI hasn’t come very far with accessibility”

The best automated scans only flag ¼ of accessibility issues (AEYE claims 35%!)

What Kris implies is that true website compliance only happens with manual reviews and testing of the code, as confirmed by his conversation with an AEYE salesperson:

The second review, from whoisaccessible.com, ranks AEYE at the top of their product reviews with a score of 4.7 out of 5, with an overwhelmingly positive assessment:

Even this review, however, cites the difficultly of automated compliance:

Whoisaccessible.com provides links to receive quotes from the accessibility providers that it reviews, and in its fine print discloses that it may receive compensation through affiliate program for the products reviews on its site:

Searches on Reddit found conclusions similar to Rivenburgh’s:

A Reddit thread titled “Questions for AudioEye buyers and users” asks about the reasons behind using AEYE as well as perceived user experience:

Some of the responses are insightful as to the difficulty successfully achieving website compliance as well as the decision to market the products as mitigating legal risk vs actually helping disabled users:

100% compliance is only achieved by changing code

Why do people sign up for WCAG compliance?

Significant skepticism from a reviewer

“Technical individuals in all sectors that understand that these solutions are nonsense”

“We’re simply not there yet”

Another thread, about competitor AccessiBe, has similar commentary about the product category:

“…I found their claims to be ridiculous. The same is true for AudioEye, UsableNet, and more.”

A June 2020 piece critical of AccessiBe’s product goes further, saying:

R&D spend appears to lag industry median, nominal spend doesn’t appear to get it done

For a company that claims its roots as an “an R&D company”, AEYE appears to spend much less on R&D than the average SaaS company.  A 2018 review of public SaaS company R&D spend by Sammy Abdullah of Blossom Street Ventures found that “SaaS companies spent on median 23% of revenue on R&D”, with “the 10 smallest companies by revenue spent 41% of revenue on R&D”.  

AEYE, on the other hand, has spent just $3MM in R&D from 2011 to 2Q20 on $32.5MM in revenue, or just 9.4%.  While R&D as a % of revenue exceeded 100% in 2014 and 2015, from 2017 onwards it has averaged just 5.7%:

Curiously, what AEYE does spends on is G&A – since 2017, AEYE has spent 81% of its revenues on G&A:

To put this in context, a study of SaaS operating expenses shows that the average SaaS company (the 50th percentile) with AEYE’s approximate revenues, spends a little less than 20% of its revenues on G&A:

Where is all this G&A going? Well, a quick look at the proxies and 10-Ks shows that the named executives, including board chairs, have received total compensation equal to 48% of AEYE’s revenues from 2012 to 2019Sean Bradley, the only remaining member of the founding team left at AEYE, has emerged the winner – from 2012-2019, Sean received $2.2MM in total compensation, or an eye-popping 9.8% of AEYE’s revenues during the same period.

This rather stark difference between AEYE’s R&D and G&A spend as a percentage of revenue compared to SaaS peers is troubling, in our opinion, as it suggests that management has been and continues to enrich itself at the expense of developing cutting-edge products.

From this, Mariner gathers that:

  • Accessibility compliance is hard to achieve with an automated solution
  • Current providers of the solutions are focused on mitigating legal risk rather than enhancing usability
  • These providers are likely overstating their claims and value add, given the difficulties outlined above

Despite these product and category concerns, AEYE has seen its operating metrics and revenue improve.  In the next section, we raise issues that should cause investors to stop and question AEYE’s impressive results – we found an alarming and material restatement, weak internal controls, and a questionable auditor. 

Is AEYE’s 2015 restatement the tip of the iceberg?

In 2015, AEYE announced a restatement for:

“…its quarters ended March 31, June 30 and September 30, 2014.  The Audit Committee also authorized an internal review of controls and policies.  Accordingly, investors should no longer rely upon the Company’s previously released financial statements or other financial data for these periods, including any interim period financial statements, and any earnings releases relating to these periods.  In addition, investors should no longer rely on the preliminary earnings release issued by the Company on January 12, 2015 relating to the quarter and year ended December 31, 2014.

Based on the review to date, the Company anticipates removing all revenue derived from non-cash exchanges of a license of the Company for the license of the Company’s customer and all revenue from non-cash exchanges of a license of the Company for services of the Company’s customer, and reducing by a material amount previously reported license cash revenue.  The aggregate amount of revenue reported for the first nine months of 2014 for non-cash transactions was approximately $8,100,000.  The reversal of revenue on the non-cash exchange transactions will also impact additional accounts including reductions in Prepaid Assets, Intangible Assets and Amortization Expense. The Company also expects that certain expenses will be reclassified.  Additional adjustments may be identified pursuant to the ongoing review and analysis.  The Company has also begun a review of calendar year 2013 activity to determine whether there are any adjustment that may impact previously issued financial statements.  There are no known adjustments to 2013 financials at this time.  The cash balance is not impacted by these changes.”

One would think that after such a major restatement – the restatement reduced $8.8MM in revenues reported for the first 9 months of 2014 by 97% – that AEYE would fire its auditors, MaloneBailey. But it didn’t, and MaloneBailey continues as AEYE’s auditor – and, we believe, that this is a red flag which may cast doubt on AEYE’s financials.  If MaloneBailey can’t get revenue right – quite literally the top of the P&L and the driver of the business – why was it allowed to remain as the company’s auditor? Worse yet, does their continued presence mean that this previous level of inattention persist today? We are befuddled. 

We believe AEYE’s auditor lacks credibility and presents meaningful risk to investors

MaloneBailey, it turns out, seems to have a pattern of audit issues – from 2009 to 2017, the PCAOB inspected a total of 97 of MaloneBailey’s audits, and found 33 audits with deficiencies, 34% of the sample.  We present findings from the last four inspections below – we believe that this commentary shows a pattern of simply accepting whatever company management teams present MaloneBailey as their financials:

Sources: 2017, 2016, 2015, 2014 PCAOB inspections

The 2014 inspection commentary is particularly striking:

It should perhaps come as no surprise that the SEC charged MaloneBailey’s and one of its audit partners with improper professional conduct in connection with its audit of Left Behind Games. Just the year before, the audit client referred to in the charges, Left Behind Games, had its executive Ronald Zaucha fined $2.6M by the SEC and was permanently banned from trading stocks. The charges imply that Zaucha and Lydon altered language proposed by MaloneBailey.

This is made worse by the fact that AEYE continues to have a material weakness in internal controls over financial reporting:

Changes to historical accounts

We believe that AEYE’s combination of a material weakness in internal controls over financial reporting and its auditor’s numerous negative regulatory comments and SEC charges should not inspire confidence in investors.  In fact, we found changes their most recent quarterly results that should be cause for concern – it appears that AEYE’s management has reallocated costs (“reclassified” and “amended the categorization of”, in their words) in its historical financials in a manner that could make them look “better” in the eyes of investors.  

In both the June 2020 and March 2020 10-Qs, the prior period (June 2019 and March 2019) quarterly income statements have had costs reallocated:

While there has been no change in operating income:

  • It appears that costs of revenue were shifted (and moved from opex) from June 2019 to March 2019, making the sequential gross margin transition from March to June go up 30bps versus going down 160bps, creating a more stable gross margin trend
  • Operating expenses also changed, with dollars being reallocated from G&A to sales & marketing – this, in our view, also “dresses up” the financials – investors are much more likely to look favorably on a business that is spending more on sales & marketing than G&A

Deferred revenue growth is nonexistent in 2020

In the face of improving metrics and revenue growth, one would expect to see growth in key SaaS metrics.  Typically, for SaaS businesses, growing deferred revenues and bookings are a sign of continued customer adoption and future revenue growth, which is why SaaS businesses command high valuation multiples.  After a large one-time customer win in 2Q19, which was reflected in AEYE’s bookings (and the reason why 2Q20 bookings were down 41%), bookings have steadily fallen, and deferred revenue is down 5% from YE19:

Contrast this to MSFT, for example, which is a giant company whose growth should be constrained by its size – MSFT’s June deferred revenue balance is up 26% in the first six months of 2020. One would think a smaller, more nimble company like AEYE in an allegedly attractive space would be able to beat that.

The Mariner Instant Replay:

  • AEYE has previously had to restate its financials due to issues related to revenue recognition 
  • AEYE’s auditors, MaloneBailey, displays a pattern of failing to obtain sufficient evidence for its audit opinions and has been charged by the SEC
  • AEYE currently has a material weakness in its internal controls over financial reporting
  • AEYE has recast its historical expenses
  • AEYE’s stalled out deferred revenues may be a signal that growth is not as sustainable as reported

All this begs the questions: 

  • Can shareholders really trust AEYE financial statements or auditors after such material restatements and questionable activity in its accounting practices? 
  • If the company’s financial metrics improve over the next few quarters, is such an improvement believable? In our opinion, AEYE’s accounting practices and auditors create an unquantifiable risk for shareholders

Even if we were to believe the company can fix its management and accounting slip-ups, the company’s core product is at best uncompetitive, in our view.  

  • Finally, can shareholders trust management (and a board) with questionable histories who decide to double down on auditors who can’t catch basic restatements?
  • If they keep them around, are they hiding something we are missing?

Conclusion & valuation: reasons to steer clear

Given our concerns about management credibility, a seemingly undecided product strategy, low relative R&D spend, what appears to be a weak, if not captured, auditor, a material weakness in internal controls, and historical accounting changes, we believe AEYE presents significant risks to investors.

We believe that the stock’s ~585% move from March to now is largely unjustified, and has to with investor perception about AEYE’s growth.  

After scoring a large one-time deal in 2Q19 that grew bookings 140% year over year, bookings in 2Q20 have normalized down 41% to approximately $4.3MM a year.  This places the company at a bookings run rate of just 25% above where it was running in 1Q19, making the 38% revenue growth estimates for 2021 likely unattainable. 

We believe that, assuming the numbers reported by the company are true, that this performance does not justify an 8.6x FY20 price/sales multiple.  MSFT, by contrast, trades at 10.2x FY20 sales. We think that AEYE, given our management concerns and stalling deferred revenue growth should trade at no more than 4x forward sales of $20MM, implying a price target of $8.24, down approximately 50% from the last close.

Mariner’s Final Word: Remember Your ABCs (Always Be Cautious)

Don’t get charged up on BLNK – questionable origin story, management history and product issues portend potential 90%+ downside

PM Summary – 90% downside in the BLNK of an eye

  • Blink Charging (BLNK) is an owner and operator of electric vehicle charging infrastructure whose stock has appreciated 505% since June on TSLA’s meteoric rise, increased Robinhood attention and potential that we will show is likely unrealistic
  • BLNK’s origins trace back to a 2009 reverse merger with ties to Barry Honig whom settled with the SEC for $27MM for “classic pump-and-dump schemes”. In addition to the potential Honig connection, CEO Michael Farkas’s ties to other alleged pump and dump artists and SEC charges of its 2nd largest shareholder lead us to believe that the people behind BLNK could present serious risks
  • BLNK’s core assets come from the 2013 asset acquisition of bankrupt EV charging company ECOtality – it has no technological IP; as such, BLNK’s revenue growth has significantly seriously lagged the EV industry –  yet CEO Farkas made >$7m in compensation during this period
  • We believe that this is due to persistent issues around product quality, customer churn, and user experience, and believe that these issues will continue to hamper BLNK’s growth
  • We believe BLNK’s management team and underlying products do not justify its 46x FY20 revenue, and assign a ~$1 base case price target to the stock, down 91% from here

Executive Summary – BLNK’s origins as a reverse merger in the orbit of SEC-charged pump-and-dumpers combined with its acquisition of inferior assets out of bankruptcy are a significant risk to investors 

Blink Charging (BLNK) is an owner and operator of electric vehicle (EV) charging equipment and networked EV charging services proclaiming to capitalize on the ever-growing EV industry.  However, this report aims to prove otherwise and bring question into the people and underlying business.  BLNK’s performance in the EV market has been tepid and is obscured by consistent promotion and retail mania over the EV space. 

BLNK began as Car Charging Group, a 2009 reverse merger starring SEC-charged Barry Honig (more on him later) that in 2013 acquired the Blink assets from ECOtality, a charging station business that went bankrupt despite being the beneficiary of over $100MM in government grants.   That same year, BLNK also acquired Beam LLC and 350Green, both subscale companies where the CEO of the latter company was charged with fraudulently obtaining federal grants.  We believe that the management team and underlying asset base are a significant cause for concern.

To begin with, CEO Michael Farkas appears to step in as a controlling shareholder when Honig and company sold out of the stock in the 2010-2011 timeframe as it skyrocketed up and subsequently collapsed.  Farkas was previously the principal shareholder of an entity whose executives were charged with a pump-and-dump scheme, and whose assets were caught smuggling cocaine.  Despite this questionable background, he collected over $7MM in compensation from Blink through 2015-2019 for near no growth, which has broadly lagged the broader EV space.  Management concerns extend to the fact that the company is on its third CFO since 2015, and it has disclosed a material weakness in internal controls over financing reporting.  It seems like this lack of oversight and controls could allow an unscrupulous management team to present dubious figured or pay itself excessive compensation (which they did, over $27m of compensation since inception). 

For a “technology” company, BLNK doesn’t even have a P&L line item for R&D spend, and has what appears to be minimal technology related IP – it has just 4 active US patents, all of which came from the ECOtality deal.  The patents (USD626063S1, USD674334S1, USD626065S1, USD626064S1) solely pertain to the visual design of their stations, not the underlying technology (note to reader: unless you are Apple and we’re talking about the iPhone design, visual design patents don’t have much value).  This stands in stark contrast to competitor ChargePoint, who has about 59 patents assigned, several of which are related to their technology.  User reviews of the chargers suggest poor maintenance, low functionality, and high fees – a major hindrance when TSLA, has a network of free (in some cases) rapid chargers for its fleet of cars, which lead EV sales in the US.  Our proprietary research shows that charger counts have FALLEN at two key customers since the ECOtality deal, making us question the level of effort BLNK’s management has taken to grow the business.  Not to mention at least one client BLNK claims that doesn’t appear to have BLNK chargers…

All this makes us question the ability of this business to be competitive and causes us to question the legitimacy of the price move from approximately $2 to over $10 over two months.  Combined with revenue growth well behind that of the EV industry and the proximity of alleged pump and dump artists to the company lead us to believe that the stock is unsupported by fundamentals and the price move is entirely unjustified.  We assign a price target of approximately $1 to BLNK, representing downside of 91%, and caution shareholders against chasing this stock.

Company ties to alleged pump and dumpers starring the infamous Barry Honig

BLNK has its origins in Car Charging Group (CGGI), which itself is the product of a 2009 reverse merger with a Nevada shell known as New Image Concepts. In its 2009 10-K ownership table, we find that 33% of the company is owned by none other than Barry Honig (yes, that Barry Honig), his son Jonathan Honig, and father-in-law Herb Hersey:

Recently, and unrelated to BLNK, the SEC alleged that Barry Honig and other codefendants, “amassed a controlling interest in the issuer, concealed their control, drove up the price and trading volume of the stock through manipulative trading and/or paid promotional activity, and then dumped their shares into the artificially inflated market on unsuspecting retail investors…Across all three schemes, Honig was the primary strategist, calling upon other Defendants to, among other things, acquire or sell stock, arrange for the issuance of shares, negotiate transactions, and/or engage in promotional activity.”

Barry has a certain way with companies, and that way is usually down a lot, by near 90%:

In fact, in the 2009 filing, we learn that CGGI hit a low of just $0.002 that year, climbing to $1.01, thereafter rocketing to $75 sometime in 2010, only to collapse to $1.00 low in 2011 – a 97% drop in split-adjusted price from $2250 on 12/31/09 to $68 at 12/31/11:

Not only was the origin of the company related to a pump and dump artist, current management also has ties to similarly accused individuals.

CEO Michael Farkas’s ties to alleged pump and dumpers and penny stock dealers

In 2011, and unsurprisingly in the context of the Honig SEC complaint, we see that Honig and his associates disappear from CGGI’s ownership:

Two new names emerge, Ze’evi Group and Michael Farkas – Farkas, it turns out, “has served as our Chief Executive Officer and as a member of our board of directors since 2009” (but is not shown as a beneficial owner and not mentioned once in the 2009 10-K, which cites Belen Flores as CEO).  In fact, Farkas appears to have been named CEO in an April 30, 2010 filingIf BLNK’s own filings can’t accurately represent when Farkas became CEO, should they be relied upon for other information?

But the story gets stranger – in the 2013 10-K, we learn that Farkas in fact, controlled Ze’evi Group, controlling just over 44% of CGGI in at the end of 2013Corporate records show that Farkas was actually an officer of Ze’evi Group going back to 2009, which would imply that he controlled approximately 60% of CGGI once Honig and co blew out of the name.  We can only speculate as to what relationship Farkas has or had with Honig, but we can say that based on the stock performance of other Honig names, stepping into a post-Honig situation could lead to tears.

Farkas appears to have hidden his initial control over the entity as its stock price cratered in 2011, which makes us wonder what role, if any, he had in helping the Honig crew exit their holdings.

Why is this important now?  Farkas, as we will show later, as current CEO since 2018 and prior CEO from 2010 to 2015, has presided over growth far behind that of BLNK’s industry and made acquisitions which appear to have created little, if no, value for BLNK shareholders.  But before that, we show that Farkas has been in proximity of some questionable, if not outright illegal, activities.

In 2009, the SEC accused Brent Kovar and Glenn Kovar, among others, principals in a company known as Sky Way Global, LLC, of defrauding investors through multiple so-called ‘pump-and-dump’ schemes”, “timing stock sales from at least 2002 until 2005 to news releases that claimed President George W. Bush and others had endorsed company technology that would protect airplanes from terrorism.  In 2003, Sky Way Global itself was merged into a public shell to become known as SkyWay Communications Holding Corp.  Michael Farkas, it turns out, was characterized as SkyWay’s “principal shareholder”, owning almost 10% of the company:

And if the Kovar pump-and-dump was not enough, Skyway was involved with potential drug trafficking:

“In 2006 an airplane Skyway said it had acquired in exchange for stock was caught in Mexico with 5 1/2 tons of cocaine on board.

In an email Friday, Farkas said, “Skyway was thoroughly investigated by several government agencies although there were indictments given to others, I was never accused or charged with any wrong doing.”

We are certainly not alleging that Farkas had anything to do with smuggling cocaine, but the actions of a company that he was principal shareholder of dictate the level of skepticism with which investors should view his ventures.

Farkas reminds us of Pigpen from Peanuts, with a cloud of “something” just following him around – BLNK’s second largest shareholder Justin Keener (9.9% ownership), was recently charged by the SEC for “failing to register as a securities dealer with the SEC. Keener allegedly bought and sold billions of newly issued shares of penny stock, generating millions of dollars in profits.”

Management quality can present risk to investors

To recap, BLNK and Farkas have been in some proximity to:

  • Barry Honig, who was accused of and settled pump-and-dump charges
  • Brent Kovar and Glenn Kovar, who were accused of “defrauding investors through multiple so-called ‘pump-and-dump’ schemes” – Farkas was involved as a key investor in the entity
  • Justin Keener, BLNK’s #2 shareholder, who was charged by the SEC for being an “Unregistered Penny Stock Dealer” 

And let’s not forget Balance Labs (not to be confused with BLNK), which Farkas owns 88% of, has collapsed from over $3 in 2016 to just $0.75 at the end of 2019 (it barely trades now, calling into question whether it has any value):

With so many EV companies out there, why invest in a company with questionable individuals with less than stellar track records? We continue to dive deeper in the story and find even more issues internally with the company…particularly with governance and management turnover.

Executive turnover and a material weakness leaves investors exposed

It should perhaps come as no surprise that over the last four years, BLNK has gone through 3 principal financial officers/chief financial officers and has seen several board members resign, including Kevin Evans, who resigned under the following circumstances: “To the knowledge of the Company’s executives and Board members, Mr. Evans resigned due to a failure to find common ground with the Executive Chairman [Michael Farkas]

And if all this were not sufficiently concerning, BLNK has a material weakness in its internal controls over financial reporting, specifically “related to lack of (i) formalized controls and procedures required to ensure that information necessary to properly record transactions is adequately communicated on a timely basis from non-financial personnel to those responsible for financial reporting, (ii) segregation of duties in our accounting function, and (iii) monitoring of our internal controls.”

This, to us, suggests that not only do the players in the BLNK ecosystem present outsized risk to investors, but the ability of the company to accurately report its performance is insufficient to offset the risk of potentially risky conduct by those same players. 

We believe that on this basis alone, BLNK presents significant downside risk to investors at these levels. In addition to the concerning origin of the company, we find that the current business has been struggling dramatically as well and yet management continues to receive hefty compensation.

Little growth in a growth industry, while Michael Farkas makes millions

In its 10-K, BLNK characterizes itself as a “leading owner, operator, and provider of electric vehicle (“EV”) charging equipment and networked EV charging services.” We question the basis of this claim. 

To begin with, BLNK appears to significantly lag its competitors in market share – for Level 2 EVSE stations (commercial chargers), BLNK’s market share is just 8% compared to competitors: ChargePoint’s 37%, TSLA’s 13%, and just 4% in DC Fast Chargers:

This market share differential appears to reflect BLNK’s inability to keep up with the growth of the overall EV and EV charging markets. According to the IEA, electric vehicle and charging station growth since 2014 has greatly exceeded BLNK’s revenue growth – BLNK’s revenues from 2014 to 2018 were down 3.8%, while the total of public and private chargers grew 277% in the same period:

In fact, the number of BLNK charging stations have barely grown over the last two years, going from 14,165 at May 2018 to 15,151 at June 2020, a growth of just 6.9% – BLNK actually LOST about 135 charges in 1Q20 (and note the 269 drop in the charger count over 6 days in 2019):

In the context of its most recent results, BLNK’s TTM 2Q20 revenues of $4.34MM is just 10% greater than its 2015 revenues of $3.96MM. Despite this growth, operating income has remained persistently negative at -$11.8MM:

For this performance, CEO Michael Farkas has made approximately $15MM since 2009, and in the period from 2015 to 2019, he has made close to $7.2MM.

Source: BLNK 10-Ks

In 2018 alone, Farkas made 17.9x and 21.7x what BLNK’s CFO and COO, made, respectively:

In light of this misaligned compensation versus company growth dynamic, we sought to understand the reason why BLNK’s growth lagged its industry.  We believe that this is due to acquisition of subscale assets from failing companies whose management teams either couldn’t successfully execute or simply attempted to defraud the government.

BLNK’s underperformance is rooted in acquisitions of sub-scale and bankrupt competitors 

The question remains – why is BLNK’s growth underperforming its industry? 
In 2013, BLNK embarked on an acquisition spree of four companies – Beam LLC, Synapse/EV Pass LLC, 350Green LLC, and ECOtality’s Blink assets – the Beam and Synapse deals were small, we believe, with Beam ($2.1MM in consideration) having just 40 chargers and Synapse ($892k in consideration) just 68. 350Green, at $1.2MM in consideration, came with its own management baggage:

It would follow that the substance of 350Green’s business may not have been very significant, if at all existent.

BLNK’s core assets come from the purchase of assets from bankrupt ECOtality

We believe that the answer to BLNK’s underperformance lies in the 2013 ECOtality acquisition that turned CGGI into Blink.  In 2013, CGGI acquired ECOtality’s Blink-related assets (and subsequently changed its name in 2017) out of bankruptcy, picking up more than 12,450 Level 2 commercial charging stations, 110 fast-charging stations, and a network supporting them.

By that time, ECOtality had received over $100MM in Department of Energy grants, but its SEC filings suggested serious underlying business issues, the most critical being a “failure to attain sales volumes of its commercial Electric Vehicle Service Equipment (“EVSE”) sufficient to support the Company’s operations in the second half of 2013.”:

This lack of sales is likely tied to bad user experiences and low user reliability ratings dating back to 2013 related to the Blink brand:

Our research on Blink today suggests that these issues persist and are the most likely driver of BLNK’s lagging results – users complain about broken chargers, long charge times, and high fees:

Slow charging complaints

Reliability and functionality issues

Stations in terrible shape?

Expensive and poorly maintained

The complaints and poor reviews are not limited to Reddit, however – people have reviewed individual stations in a similar manner:

A San Diego station reviewed on Yelp

Plugshare reviews on a Walgreens station in Elk Grove, IL

Plugshare review at Whole Foods

Even the BLNK app has bad reviews on the Google Play App store, with barely 2.5 stars

One of the biggest headwinds to BLNK’s growth is related to TSLA – in 2019, TSLA accounted for 78% of all US EV sales, making it the #1 seller of EVs domestically.  TSLA drivers can access one of its 16,103 Supercharger fast charging stations and one of 23,963 regular TSLA chargers to charge their vehicles (both free to use for certain drivers).  Said another way, the leading vendor of EVs already has a charging infrastructure tailor-made for its cars, significantly lowering the likelihood that TSLA drivers would choose a BLNK charger over a TSLA one.

The case of the missing chargers

We spent quite a bit of time scouring BLNK’s charger map and its client highlights (in BLNK’s investor deck) to understand its infrastructure.  What we found suggests that little effort has been made to grow the business.  In using the charger map to count chargers at BLNK’s “select clients” (pasted below), we found several interesting data points that suggest BLNK has not expanded its network beyond what it acquired from ECOtality:

  • Kroger – according to the charger map, BLNK has 52 chargers at Kroger locations.  In this article, we learn that back in 2013, Kroger was planning to invest $1.5MM to expand its charger base from 74 to 225 through its partnership with ECOtality.  Even though ECOtality went bankrupt in the same year, BLNK doesn’t appear to have pursued the partnership, and even saw total Kroger chargers fall from 74 to 52, a 30% reduction
  • Fred Meyer – according to the charger map, BLNK has 63 chargers at Fred Meyer locations.  Here, we learn that by 2015, Fred Meyer had installed 68 chargers across 33 stores.  Even though the article quotes a Fred Meyer spokesperson saying it plans on adding another 18 chargers, we wonder if this ever happened – it is 2020, five years later, and the charger count at Fred Meyer locations has FALLEN from 68 to 63, about 7%.   

This makes us wonder why BLNK management didn’t capitalize on these opportunities that it inherited from the ECOtality deal.  But we found something even more unusual at St. Joseph, a healthcare organization based in California which BLNK claims as a client:

St. Joseph has just two hospital locations, one on Dolbeer Street in Eureka, CA 95501, and another on Renner Drive in Fortuna, CA 95540 – but neither location has a BLNK charger, according to BLNK’s own site:

Plugshare actually just shows competitor ChargePoint’s stations at the Eureka and Fortuna locations:

The Redwood Coast Energy Authority, which “is a local government Joint Powers Agency whose members include the County of Humboldt; the Cities of Arcata, Blue Lake, Eureka, Ferndale, Fortuna, Rio Dell, and Trinidad; and the Humboldt Bay Municipal Water District,” would be the governing organization for charging infrastructure in this geography – IT DOES NOT MENTION BLINK CHARGERS IN ITS DESCRIPTION OF LOCAL CHARGING INFRASTRUCTURE.

We wonder why BLNK would show St. Joseph as a client when it doesn’t appear to be – more importantly, what does this say about the rest of the client list? We believe that this could indicate that the number of BLNK chargers is potentially overstated.

This, in our view, combined with poor user reviews about charger reliability, maintenance, and price does not bode well for the future prospects of the company – we believe that BLNK will continue to underperform the rapid growth in the EV industry at the ultimate cost to the shareholder.

Conclusion & valuation

In this note, we laid out several key findings that we believe makes BLNK a seriously risky investment that is likely to disappoint investors:

  • CEO Michael Farkas’s seeming proximity to individuals charged by the SEC with pump and dump schemes
  • A richly compensated CEO despite revenue significantly lagging industry growth and persistently negative profitability 
  • Asset base (chargers) appears to be the legacy assets of failed or bankrupt companies 
  • Ongoing user complaints about BLNK’s product stretching as far back as 2013
  • Churn at key customers, and a potentially overstated charger base
  • No intellectual property related to the underlying charger technology

We believe that the underlying business here is not positioned to compete with its peers and thus will not “catch up” to industry growth.  We believe that the stock price run from approximately $2 in June to approximately $10 today should be considered skeptically given the history of the individuals involved here.  

At 46x FY20 revenues, its valuation strains credulity.  The business is significantly unprofitable with what we believe are limited prospects to catching up to the EV industry broadly and has hemorrhaged an estimated $115MM in FCF since 2010.  

Given this, we believe the business should be valued at its liquidation, or book value, of just 17c in a downside scenario and at $2 a share in a bull case scenario (basically where it was before this non-fundamental move).  The average of our price targets produces a base case target of $1.09, a drop of 91% from the 8/18/20 close.

Timbercreek Financial (TF) – a tenuous business model with hidden balance sheet risks (50% base case downside)

Portfolio Manager Summary (all amounts in CAD$)

  • We believe that the COVID-19 pandemic will accelerate the stresses already hidden in TF’s portfolio and expose TF’s underwriting and financing strategy
  • We believe that Timbercreek is grossly underprovisioned compared to its small-cap MIC peers – its current loan provision is 73% below the peer average – unusual to say the least. While its peers have taken actions to protect their balance sheets, TF has not, and we believe the dividend is at risk
  • In this report, we unveil two large exposures that collectively account for 14% of book value today – we believe they were significantly underprovisioned and that investors were inadequately informed about the issues at these properties – these assets were “sold” in a manner that, in our opinion, allowed TF to avoid taking appropriate provisions (our diligence, presented below, shows these “sales”)
  • These issues are critical in light of what we believe to be TF’s inability to sustain itself and its growth through internal cashflow generation. This calls into question the stability and security of the dividend given limited disclosure about the inherent risk embedded in their mortgage portfolio, as evidenced by the Sunrise portfolio and the Northumberland mall
  • We believe that this limited disclosure about underlying risks allows the company to retain the ability to obtain critical capital markets funding to support the dividend and support the stock in order to raise equity to (again) fund the dividend
  • Consider that old habits die hard – if TF is underprovisioned on two significant loans as our diligence suggests, we believe that is reflective of the tone at the top and likely throughout the organization. We infer that they must be materially underprovisioned elsewhere – COVID is likely to put TF’s book and provisions to the ultimate test and we believe the dividend is at riskin light of this, we assign a $4 price target to TF
  • Our summarized loan findings follow:
    • The Sunrise Properties’ loan appears to have been impaired since 2016 based on appraisals and bids received during the CCAA bankruptcy process that would imply material asset impairment
      • While TF no longer has a mortgage investment in Sunrise, it now owns the assets outright. After various attempts to sell the assets, TF had to abandon the sale process in late 2019 – these assets were likely impaired before COVID, thereby harming TF shareholders (the assets could only be worse after)
      • While Sunrise was initially a $28MM exposure to TF, management has since added almost $20MM to the investment as part of the credit bid and subsequent capital investment, avoiding a write down to their initial exposure
      • Since abandoning the sale process, management has been curiously quiet about the state of Sunset
    • The Northumberland Mall loan has been in the TF book since 2012 – the borrower went bankrupt in 2018. Despite 35% vacancy at Northumberland at foreclosure and plunging comparable mall valuations in the US, TF barely provisioned the exposure
      • We visited the mall in March, prior to COVID closures – it is despairingly vacant and stressed, as you can see in the photos below
      • TF appears to have used financial engineering to avoiding provisioning the mall – it “sold” the mall in 4Q19 by providing the “buyer” with over 100% financing – which brought the loan back into the “performing” category
      • With COVID further disrupting mall traffic, Northumberland is unlikely to be servicing its debt – we believe TF has limited tools left to avoid these losses
      • While initially a ~$35MM exposure, TF provided the mall “buyer” with a $55MM mortgage to potentially facilitate redevelopment and, we believe, to avoid a write-down

Executive Summary: Why COVID will expose TF’s hidden risks

Before the market sell-off, Timbercreek Financial (“TF”) appreciated over 37% in the last 5 years due to continue access to the capital markets and investor appetite for yield.  Unlike its Canadian counterparts who are down ~40% since COVID started, TF is down a mere 16% – we believe that this dislocation is unlikely to last (EQB – down ~37%, HCG – down ~41%, LB – down ~34%). Our diligence suggests that the impact of COVID will lay bare TF’s underwriting and put its dividend in jeopardy. We believe that TF is worth 53% below its current trading price, as we will detail what we believe are significant risks with filings and photographic evidence of their assets and loan portfolio.

In this article, we share with you our bespoke diligence which highlights two examples of significant loans made by Timbercreek (that reflect 14% of TF’s equity today) – we show how TF took what appear to be minimal provisions against clearly distressed loans and painted what we believe to be a rosy picture for investors. We believe that any provision taken on either asset would materially increase provisions while also constraining the company’s ability to fund its dividend through external financing. For example, we visited a mall 70 miles from Toronto that represents over 7% of TF’s book value – its vacancy is at least 25% and the property is in disrepair; we believe that COVID makes recovery here near impossible, yet TF provided over 100% financing to a buyer to move the loan into the “performing category” from the “impaired” category, likely making it wildly underprovisioned given the considerable risk. If we were able to find evidence for this for just two large loans, what does it say about the rest of the portfolio?

We believe that this, combined with a levered balance sheet and COVID-driven industry stresses, calls into question the stability of the dividend going forward, and we assign a $4 price target to TF’s stock.

Timbercreek Financial seems too good to be true

To begin, it’s important to understand why we started researching TF in the first place. TF’s February 2018 equity offering caught our eye – we noticed that TF was operating at 46.4% leverage, by their own definition, at 4Q17, implying that this equity offering was necessary to provide the funds required to continue growing the loan book (i.e., TF was unable to take on more debt). This led us to examine TF’s 4Q17 provision for mortgage losses, which we found to be just 9.7bps of the total $1.1B in mortgages, net of syndications, dramatically lower than its peers by a minimum of 82%. Put simply, the red flag investors should see here is that a company that is paying a healthy dividend should not be raising capital to fund that dividend over time.

A further examination of other small-cap Canadian mortgage investment corporations that lend into the residential, multi-residential, and commercial construction spaces shows that TF carries the lowest provision of the entire group, approximately 73% below the peer average of 87.9bps in 1Q20:

Worse, this seems to indicate that either TF is a superb underwriter of credit risk, or that it is not adequately provisioning for credit losses – the fact that the provision keeps rising would suggest the latter, and so does our deep diligence into two of TF’s large exposures. This is deeply concerning to us as most Canadian financial institutions are increasing loan-loss provisions. Despite indications of loan impairment and asset distress, we believe that the provisioning is inadequate and investors are unaware of the significant risks embedded in these exposures.

The Sunrise Portfolio – not as sunny as hoped

On TF’s 4Q16 conference call, then-CEO Andrew Jones mentioned a Saskatchewan investment that had sought protection from creditors through the Companies’ Creditors Arrangement Act (CCAA), Canada’s equivalent of the Chapter 11, restructuring process. 

A search of CCAA records revealed that this investment was most likely the Sunrise/Saskatoon Apartments partnership.

In late 2015, one of TF’s predecessor companies, along with other lenders, agreed to finance the acquisition and redevelopment by New Summit Partners of a set of apartment properties in Saskatchewan – of the 15 properties New Summit acquired, TF was the senior lender on 11 properties, which were known as the Sunrise properties. TF agreed to commit $115MM in funds for the transaction, and we believe they syndicated most of this amount, leaving it with ~$28MM of on-balance sheet exposure to the Sunrise properties, or approximately 4.3% of 4Q16 book value.

In June 2016, the Timbercreek entity associated with this loan became part of TF as we know it, through an amalgamation under the Business Corporations Act (Ontario).

Just six short months later, in December 2016, the Sunrise properties borrower applied for CCAA protection, citing “insufficient cash flow to complete development on the Properties in the face of demands for payment by their secured creditors and trades.” (unfortunately, the PWC CCAA page for the Sunrise properties was taken down sometime in the last few months, but the Government of Canada confirms PWC as the monitor and provides the same web address (now dead) where the documents we mention were sourced). You can try to obtain the records using the contact information found in the above link, which includes Michael Vermette at PWC, or by reaching out directly to the Vancouver Registry.

The CCAA process, which we show in the appendix to this article, resulted in appraisals and bids that showed that TF’s position as senior lender was in fact impaired, which we believe was not communicated to equity investors.

In the end, there was no market price for the Sunrise properties that would NOT impair TF and the other senior lenders’ positions in Sunrise, so TF ponied up additional capital to participate in the credit bid to acquire a 20% interest in 14 of the New Summit properties (including Sunrise), which increased their on-balance sheet exposure to $41MM (now $47MM).

In the 4Q16, 1Q17, and 2Q17 financial statements, TF repeatedly indicated that “there is no objective evidence of impairment”, which we believe contradicts evidence from the CCAA process – the following clippings are from the PWC monitor reports and/or affidavits taken during the CCAA process:

  • While appraisals were ongoing in 1Q17 and bids showed significant impairment in 2Q17:

While we believe that TF’s lack of provisioning (which it could have eventually reversed) in the face of numerous market indications of impairment was imprudent, and TF’s communications about this situation to its investors appear to contradict what was disclosed during the CCAA process.

Below we contrast comments made by TF’s founder and then CEO, Andrew Jones, to TF’s equity investors with statements found in the CCAA documentation: 

  • On TF’s 4Q16 earnings call, Jones said the properties had “…a sizeable amount of cash flow coming off…” them – but Tim Clark, New Summit’s GP, had the following to say in an affidavit dated 12/16/16
  • On TF’s 1Q17 earnings call, Jones said that the “renovation and lease up of those assets by the receiver or monitor is going very well” – but Jamie Dysart, Executive Director, Mortgage Investments, at fellow senior lender Kingsett stated the following in a May 2017 affidavit:
  • Lastly, on TF’s 2Q17 earnings call on 8/11/17, Jones said that TF was “controlling the asset and we have lots of equity” – but on 8/8/17, the lender group’s credit bid had been approved; by definition, a credit bid is equal to the value of the loan outstanding, implying that no equity existed. 

We believe that TF had to credit bid for these assets to avoid a significant impairment to their position as lender.

So what’s become of this portfolio? For several quarters after the credit bid, TF’s CEO Cameron Goodnough talked about selling the asset, as recently as the 2Q19 conference call:

But during the 3Q19 call, it looks like management abandoned the process:

This example is significant – at 4Q16, TF’s average loan size was just $8.2MM – the Sunrise exposure at this date was $27.6MM, or over 3x the company average. We believe that investors were largely unaware of the events and evidence we present here – evidence that could have significantly affected the company’s P&L to the detriment of its shareholders.

Our next example is similarly large but is a current loan exposure that materially deteriorated and could seriously affect TF’s financials.

The Northumberland Mall – can financial engineering hide bankruptcy forever?

In TF’s 2Q18 filings, a $36.9MM exposure move from Stage 2 (performing but increased credit risk) to Stage 3 (impaired) but with only a 1.2% provision:

1Q18

2Q18

On the 2Q18 earnings call in August, management reported to investors that the asset in question was current and in Toronto, per Director Ugo Bizzarri (but “near” Toronto, according to CFO Gigi Wong):

According to Teranet, on May 8, 2018 (in 2Q18), the mortgage for the Northumberland Shopping Centre, Inc., a mall in Cobourg, Ontario (population ~20k), was transferred to 2292912 Ontario, Inc, a subsidiary of TF, per TF’s 2017 Annual Information Form:

Not quite two weeks after the 2Q18 call, the Cobourg News Blog published an item saying Timbercreek had, in fact, taken over as owner of the mall:

And in fact, a Notice to Creditors filed on September 26, 2018 shows that the Northumberland Shopping Centre Inc, the borrower and owner of the Northumberland Mall, filed for bankruptcy, making TF the effective lender in possession of the Northumberland Mall:

Now why does this matter? Well, around the time that TF took possession of the asset, it was seriously distressed. Sandalwood, the property manager at the time, showed vacancy of approximately 130,973 square feet against leasable area of 370,769 square feet of leasable area, or occupancy of just 64.7%!

Even TripAdvisor visitors noted the level of disrepair the property was in:

We believe that given the high vacancy alone, TF should have provisioned more than just $463k on the property at the time. However, as the situation has become worse over time given the secular trend affecting malls and the ongoing despair at the Northumberland property, the provision needs to be materially higher, which will likely hurt earnings when this provision is appropriately taken.

In fact, a 2019 TripAdvisor post echoes the sentiment of the prior posts:

A new property manager, Trinity Group, was engaged last year to attempt to lease up the property, and has made progress – on January 17, 2020 the Cobourg News Blog posted an item outlining 95,966 square feet of vacancy against 375,000 square feet of leasable area (per Trinity Group), or an occupancy rate of 74.4%. It is also notable that as of February 3, 2020, Trinity Group removed the site plan shortly after the January 17th blog post.

If the stores looked like this before COVID, what might they look like after?

We visited the mall between the hours of 10am and 1:30pm on March 12, before the COVID closures.  This visit supports the conclusion that it still remains in distress and in need of capital – there is significant vacancy and lack of traffic:

Ocean Jewellers looks like it might just be opening late, but the mall directory shows it is no longer a tenant:

Even the existing stores are limited in staff, customers and size:

Metro:

Dollarama – a couple long empty aisles:

HR Fashion Plus

Hart

Sportcheck

Photos above indicate the emptiness and lack of staff this mall has in its stores. The outdated “entertainment” storefronts such as the cinema and bowling alley shows a low level of quality and care given to this piece of property.

The cinema has just three movies playing:

Mall employees said that 8 stores closed in the second half of 2019, and that every tenant in the mall is on month-to-month leases – which could heavily affect occupancy rate during COVID.

Given the level of vacancy and appearance of the property, we believe that investors may overestimate TF’s ability to “resolve” the asset:

2Q18, when the loan first moved into the Stage 3 category – this call occurred about 6 weeks before the borrower filed bankruptcy:

3Q18, after the bankruptcy filing, with guidance that the loan would be resolved by year end:

4Q18, guiding that the property will get “resolved” in the second quarter of 2019

On the 1Q19 call, no one mentioned the mall, but it was still on the books, and on the 2Q19 call, management claimed there were no questions AT ALL:

These clippings show that TF was telling investors it would resolve the asset, but nothing happened until over a year after foreclosing on the asset.

Well, so what’s happened to the Northumberland mall? According to Teranet filings, the mall was “sold” to Trinity Northumberland, Inc (presumably the same Trinity who was initially appointed as property manager) on 12/19/19 for $35MM, which happens to be pretty close to the carrying value of the outstanding loan on the balance sheet. At the same time, the purchaser took out a $55MM mortgage on the property, essentially financing 100% of the purchase and getting some more cash in the door for redevelopment purposes:

Now before we give you more details here, let’s talk about malls as an asset class. Much has been said about the demise of malls, most of it valid and relevant to this property. The Teranet data shows the initial mortgage being created in 2012, a time when lenders didn’t anticipate the kind of carnage that has ripped through B and C mall land (see NYSE:CBL and NYSE:WPG, for example) as a result of falling foot traffic and ecommerce. Today, lenders are underwriting B and C mall assets at upwards of 15% cap rates – but for a mall with a 25% vacancy rate and in sore need of capital investment, there is no telling what kind of valuation it could fetch.

In fact, similarly situated properties in the US have seen their loans massively impaired at maturity:

  • Fashion Outlets of Las Vegas, a now REO asset in Primm, NV, defaulted on its mortgage in 2017 with a year end occupancy of approximately 75%. It appraised for $125MM in June of 2012, when a $73MM mortgage was put in place, but the value of the property has since fallen to $28.8MM as of June 2019. The current appraisal value implies a 60% loan loss to the mortgage
  • Salem Center, a Salem, OR mall also defaulted on its mortgage in 2017 with a year end occupancy of approximately 79%. It appraised for $18.5MM in June of 2019, compared to $44MM when its $33.3MM mortgage was originated in 2012. The current appraisal value implies a 44% loan loss to the mortgage

Knowing this, how could TF justify financing 100% of the purchase price of a mall asset, and then throw another 57% of the purchase in as additional cash?

When asked about amount of the new mortgage on the 4Q19 call, Managing Director Scott Rowland simply didn’t answer the question:

So, dear shareholder, TF has “sold” an asset (and moved the loan backing it back from Stage 3 impaired to Stage 1 performing) by providing the lucky buyer with 100% financing (and then some)! We believe that TF likely rolled their loan outstanding into a new mortgage and threw in another $20MM in for the borrower to redevelop the asset, allowing the buyer to take ZERO equity risk in the transaction. Who wouldn’t want to buy an asset with no skin in the game?

Balance sheet risks are compounded by TF’s financing strategy

So why do Sunrise and Northumberland even matter?

  • They are/were disproportionately large exposures–the Sunrise properties’ loan balance of $28MM (4.3% of book value at 4Q16 and 6.6% of BV at 1Q20) was almost 3x TF’s average mortgage investment size, and Northumberland’s new loan balance of $55MM (7.6% of book value at 1Q20) is 5.8x the size of the average TF mortgage investment size
  • It was clear from appraisals and bids that TF’s position as senior lender to Sunrise was impaired, but investors were unaware of this
  • Given the state of the Northumberland asset and comparable transactions, TF’s position as a lender is likely materially impaired, but management provided a buyer with over 100% financing to take the asset out of an impaired category
  • What does this say about other loans that might face the same issues or fate at Timbercreek?

We believe that TF has been, and continues to be, dangerously under-provisioned and that as a result investors have been/are unaware of the underlying risks on the balance sheet. This reminds us of Home Capital (TSX: HCG) in 2017, which had a perceived high quality loan book but was subsequently exposed as hosting dubious mortgages with increased risk that were never disclosed to the market, reflecting >10% of their book value; the stock then fell over 90% reflecting these undisclosed issues. We are concerned that similar patterns could be taking place at Timbercreek Financial, and that TF is behind its peers in preserving capital flexibility:

These issues we’ve highlighted here are critical, as the TF bull case is largely based on Timbercreek’s perceived expertise and continued dividend payments. In addition to issues with individual loans, TF’s financing strategy poses significant risk to the dividend. We believe that TF doesn’t generate enough cash to service its dividend and grow the loan book, and that it is essentially borrowing money to pay the dividend. This represents an outsized and underestimated risks to shareholders, especially in light of TF’s already high payout ratio and tendency to roll a significant amount of maturities every year, coupled with the fact that, according to Trepp, CMBS mortgage delinquency rates are approaching all-time highs.

With the exception of 2019, in the fourth quarter of the prior three fiscal years, TF’s borrowers have missed over 40% of the scheduled maturities for that quarter, implying that TF had been regularly extending loan maturities at year end:

Practically, this dynamic means that TF is not receiving enough capital back at the end of each year to grow the loan book and service the dividend without external financing. In fact, over the last 21 quarters (1Q15 to 1Q20), TF’s operating and investing outflows have exceeded its operating and investing inflows by $71MM: 

The obvious implication here is that since operating and investing inflows are less than outflows, TF is actually unable to service the dividend without external financing – in fact, in order to plug the operating and investing deficit and address the buyback, interest payments, and service the dividend, TF has had to find over $403MM in external financing over the last 21 quarters:

Sure enough, over the same period, TF has drawn $409MM from the capital markets:

In addition to the dividend risk embedded in this sort of unsustainable model, we believe that an appropriate level of provisioning would result in a much lower stock price. In a normal scenario, we’d expect TF to appropriately provision for the Northumberland mall based on a combination of its peers’ provisioning and a loan loss severity for Northumberland consistent with the previously mentioned Fashion Outlets and Salem Center.

Things are hardly normal now though – Northumberland is a distressed asset whose traffic is now likely near zero, in a city whose population overindexes to older people, the demographic most seriously affected by COVID. We believe that the likelihood that the property ever really recovers is low, and that TF’s debt is materially impaired, if not entirely so. The ability of the mall to service the new $55MM note has likely evaporated, as news of malls tenants in other properties choosing not to pay rent abounds. We believe that a more reasonable loss severity for the Northumberland Mall is closer to 70% vs. the average 52% from Fashion Outlets and Salem Center, given that the asset and loan are now likely teetering on non-performance and the likelihood of turnaround is low. Assuming a 70% loss to Northumberland, we get to an average price target near $4, down 53% from the 7/28 close:

We believe that given the reliance on external funding, TF has to choose between growing the loan book or maintaining the dividend – unfortunately, given what we believe to be less than ideal capital recycling, TF cannot do the latter without the former. The Northumberland exposure, in addition to broad portfolio distress due to COVID, makes a dividend cut over the next 4 quarters a frighteningly likely outcome.

Wrapping it all up

In addition to what appears to be a risky financing strategy, we believe that the shareholder base is unaware of the risks we’ve outlined here. In fact, we are willing to bet that shareholders aren’t aware that TF provided a $100MM mortgage to Cresford Developments, a real estate developer who is subject of a lawsuit alleging a “cash crisis”and the misrepresentation of financial condition (Anthanasoulis v. Cresford; CV-20-00634836-0000; Ontario Superior Court of Justice):

Sure enough, in late March 2020, three of Cresford’s projects entered receivership – while the property for which TF provided capital was NOT impaired and included in receivership, the receiver’s findings included “evidence of a number of questionable accounting and management practices by the Cresford Group that had the effect of hiding substantial cost overruns on all the Cresford Projects [the projects in receivership]”.

These findings related to a TF loan recipient call into question the level of diligence and prudence with which TF underwrites its investments:

With one significant finding that could eventually affect TF’s own position:

In the end, we expect shareholders may be hurt by these dynamics and we hope that this article helps to illuminate the apparent risks hidden in this business.

Appendix – Excerpts from the Sunrise CCAA process

At 12/31/16, we see that TF is the largest creditor to the properties with $104MM of exposure, of which we estimate $28MM was on TF’s balance sheet, while the remainder was syndicated:

Thus begins a process by which TF received numerous market-based indications that its loan was impaired, but did not take a provision to reflect this impairment:

  • On April 4, 2017, TF and Kingsett (another senior lender) received property appraisals from Altus, which revealed that at current market values, the First Secured Lenders would be in a shortfall position:
  • In fact, the appraisals show the current market value of the Sunrise properties at $101.6MM against first lien debt of $103.3MM, an approximate 2% impairment to TF’s position, but no provision was taken to anticipate this loss in value
  • As the CCAA process continued, the lenders sought to sell the properties in groups – in May of 2017, a discussion was held concerning offers received for 5 properties known as the Group 1 Lands, showing that the properties with TF mortgages were significantly impaired

In June 2017, senior lender Kingsett sought the approval of a credit bid for the Group 1 properties and indicated it would also seek approval of a credit bid for the remaining nine Group 2 Sunrise properties. On June 16, 2017, the Court approved the sale of the Group 1 and Group 3 properties to various entities controlled by Timbercreek and Kingsett and ordered that the Group 2 properties (the remaining 9 Sunrise properties) be listed with Kingsett’s credit bid serving as the floor price for the process.

  • Unfortunately for the lenders:
  • But on 7/26, Bondstreet, who had only conducted limited due diligence, approached with a $131.5MM bid for these 9 properties, which it subsequently reduced to $115MM, below the value of Kingsett credit bid, thus implying an impairment to the creditor’s outstanding loans

Can’t FIXX this – We believe Homology’s HMI-102 is in trouble

Portfolio manager summary (Idea originally posted May 4, 2020)

  • Homology (FIXX) is a gene therapy company whose technology has been criticized by scientists as “untrue to the scientific community”
  • On April 15th, 2020, a key patient in FIXX’s only Phase 1/2 clinical trial shared test results on Facebook that suggest FIXX’s HMI-102 gene therapy is unlikely to be efficacious
  • In response, FIXX stock fell almost 25%, and instead of providing all investors with an update, management quietly updated the sellside, stressing product safety but not efficacy
  • In light of this result, we believe that the HMI-102 trial will not reach its primary endpoint, and that the stock should trade to cash value, or $5.80 per share
  • Social media is important – early stage drug company Allakos also had trial revelations posted to FB – the exposure of these led the stock to fall over 50%

Executive summary

It’s an understatement to say that Facebook has changed the world – it’s created an ability for people to be transparent about their experiences, lives, and opinions, for better or worse. In the case of Homology, it’s for the latter. Homology, a gene therapy company whose technology has already been scrutinized by scientists as “untrue,” has just one product in clinical trials, HMI-102, for the rare disease phenylketonuria (“PKU”). As Med Genie reported back in January, FIXX’s trial update showed interim phenylalanine (Phe) results that suggested HMI-102 was not efficacious for low and mid-dose patients.

Our note highlights a data point the company would very much like you not to know – the only patient in FIXX’s high dose cohort posted her results on Facebook, and they show that HMI-102 is unlikely to reach trial endpoints even at a high dose. We believe this patient was forced to take her posts down as a result, and management selectively disclosed the issue to the sell side, providing comments about the drug’s safety, and conveniently ignoring the implications to efficacy and the business. Maybe they were hoping to raise capital before officially announcing trial results. Who knows? We believe that the HMI-102 program is dead in the water, and since its progress is the major driver of FIXX’s value, we believe that the stock should trade to cash value, or $5.80, down 56% from the April 27th close.

Background

The best shorts are often one-trick ponies, but rarely do we find one where a single data point completely upends the long investment case. Homology Medicines, FIXX, is one of those rare finds.

Homology is a gene therapy company which has their first and lead product candidate, HMI-102, in a dose-escalation Phase 1/2 trial (pheNIX) for phenylketonuria. FIXX also has 2 IND-enabling programs and some discovery stage programs, but the HMI-102 trial is the company’s main shot at viability.

PKU is a relatively rare disease, with a U.S. incidence of approximately 350 cases per year and a prevalence of just 16,500, per FIXX’s 10-k. PKU is tied to mutations in the gene that control PAH, an enzyme that metabolizes phenylalanine, or Phe. The condition results in a deficiency in the enzymatic activity of PAH, causing an excess in Phe in the bloodstream that can result in intellectual disability. PKU patients are identified soon after birth, and are primarily treated with a Phe-restricted diet. FIXX’s HMI-102 seeks to modify the underlying genetic cause of PKU, effectively curing the disease and allowing patients to eat normally and not experience the cognitive and metabolic issues from higher than normal Phe.

FIXX’s technology, which does not use the CRISPR approach to gene therapy, has already been subject to scrutiny, with David Russell, a researcher at the University of Washington, saying, “What’s surprising is this company raised so much money on something thought to be untrue in the scientific community,” in a piece in MIT Technology Review.

We believe that recent revelations about the efficacy of HMI-102 support this skepticism and show that the drug is not efficacious, kicking out the one leg holding up FIXX’s business, and that FIXX should trade to cash value, or $5.80 per share, down 56% from the April 27th closing price.

The pheNIX trial

The pheNIX trial for HMI-102 launched in June 2019, and its primary efficacy endpoint is two plasma Phe measurements below 360 umol/L (or 6 mg/dL) between 16 and 24 weeks after dosing. Following evaluation of the first two patients in a cohort, “a decision can be made to either escalate to the next dose level, add a third patient or expand the cohort at the selected dose level”.

Now before we review what’s new, it’s helpful to note that a mouse study presented at the 21st Annual Meeting of the American Society of Gene & Cell Therapy titled “Sustained Correction of Phenylketonuria by a Single Dose of AAVHSC Packaging a Human Phenylalanine Hydroxylase Transgene” showed that HMI-102 showed an effect to mouse Phe levels just one week after dosing – in fact, mouse Phe levels remained relatively flat after that first drop.

This would imply that the therapy shows its effect soon after dosing and the longer timelines contemplated in the study endpoints are to indicate that the effect is long lasting. Sure enough, we see a similar dynamic in the pheNIX trial data released by FIXX in December 2019. There were 3 patients examined here – from the 10-k: “(n=2 patients in the low-dose Cohort 1 and n=1 patient in the mid-dose Cohort 2) as of the data cutoff of December 2, 2019. A fourth patient was dosed in Cohort 2 subsequent to the data cutoff date and was therefore not included in the analysis.”

In this release, we see the two patients in the low-dose cohort experienced no improvement in fasting Phe after dosing or even 12 weeks later. The cohort 2 patient, getting a mid-dose, showed an improvement in Phe level immediately after dosing, but their Phe level did not fall below the 360 umol/L threshold defined as the primary endpoint (it stayed around 500) calling into question the efficacy of the treatment, which Med Genie mentions in their piece (from the 10-k):

Damning revelations

On March 5, 2020, a woman we will call Miss A started a Facebook group (since made private or taken down on April 15, 2020) to discuss her experience getting gene therapy for PKU:

On March 9, 2020, Miss A, who lives in Normal, IL tells us she’s going to Chicago, which happens to be one of the pheNIX trial sites:

The next day, Miss A provides us with enough to data to know that she is Patient 5, part of the high dose cohort 3 in FIXX’s HMI-102 trial (cohort 3, mentioned by Miss A, would be the next dose up from the cohort 2, the mid-dose cohort):

Dr. Burton appears to be Dr. Barbara K. Burton, a physician focused on PKU at the Ann & Robert H. Lurie Children’s Hospital of Chicago, a trial site mentioned in the pheNIX trial description on clinicaltrials.gov:

This, taken together with the fact that Biomarin’s own PKU trial was in too early a stage to enroll a Cohort 3 patient in March 2020, it’s probably safe to say that Miss A is taking part in FIXX’s pheNIX trial.

On March 11, Miss A receives her infusion:

Miss A then shares a series of updates on how she is feeling and the progress of her weekly visits post-infusion. Six days post infusion, she says she hasn’t gotten any test results back, but that it may take 2 or 3 weeks to get a Phe level:

27 days post-infusion, Miss A tells a FB commenter that she won’t get Phe levels till six weeks post-infusion:

And then 35 days post-infusion, on April 15, 2020, a bombshell – Miss A gets her Phe levels, and at 25 mg/dL or 1497uMol/L, they are well above the 360 uMol/L endpoint threshold after 5 weeks (and after the drug typically takes effect), suggesting that HMI-102 is not efficacious even for a high dose patient:

Just a few hours after her post, Miss A’s entire group is either taken down or made private, perhaps at the demands of FIXX itself.

Management’s disclosure problem

We believe that management was aware of this post and tried to manage the perception of it by talking to the sell side and to select investors. In fact, Oppenheimer’s equity sales desk was sharing the below email conversation between their analyst Matt Biegler and FIXX’s Theresa McNeely to explain the price action on April 15th:

Who was Theresa planning to speak to? We know that Baird’s Madhu Kumar got a call:

But when we asked Theresa ourselves, she was much less forthcoming:

It appears to us that FIXX chose to inform the sell side and potential larger investors, who appear to be selling the stock (it has dramatically underperformed biotech broadly), but not the average investor. This is a significant red flag that investors should be aware of.

Why all this matters

Because the mouse study and the Cohort 2 data showed an effect to Phe levels one week after dosing rather than a gradual reduction, we can conclude that Miss A’s level, at 1497 uMol/L, is probably not going to get better, unfortunately. Further, her levels several weeks into the trial are still much higher than the threshold level specified in the primary endpoint of 360 uMol/L. This means that the therapy is showing zero efficacy even for a high dose patient. This data point is damning given the size of the trial and importance of the high dose patient in light of the lack of efficacy in the low and mid-dose cohorts.

Now the sell side may parrot management and say that there is no way to know whether Miss A is who she says she is, but the evidence is certainly strong supporting her case. They may say that there was no way for her to know her Phe level, but her posts show that she expected to receive them. They may also say that the drug is safe, and that liver enzyme elevation should be expected in a therapy like HMI-102, but that’s all beside the point. The point is that the Phe level Miss A received 5 weeks after infusion show that HMI-102 is not efficacious.

These results support the skepticism around FIXX’s use of the AAVHSC vector in liver directed gene therapy, which, based on the results thus far, and in particular Miss A’s results, appear to show zero efficacy and thus makes it inferior to Biomarin’s AAV5 vector.

Furthermore, if management thought this information was material enough to talk to the sell side analysts covering the stock, why not put it in an 8-k or even a press release for the benefit of their entire shareholder base? Given the materiality of the information, wouldn’t all shareholders have benefited from the same level of disclosure rather than be kept in the dark? This is behavior consistent with that of MDXG and ALLK, both companies with executives formerly from reputed companies who have seen their stock prices demolished.

For FIXX, we believe that this is a huge problem – the HMI-102 pheNIX trial is the ONLY program in their portfolio that is in the Phase 1/2 stage, and thus the primary path to viability for the company. With this piece of data showing that HMI-102 is not efficacious, we believe that the program is likely worthless and unlikely to proceed to commercialization. While FIXX may try to apply HMI-102 to other indications, we believe that doing so would essentially restart the trial and approval clock without making up for the lost time to market from a failed PKU trial.

Furthermore, social media matters. While FIXX management may be dismissive of people posting on Facebook, these posts have value. In the case of Allakos (ALLK), Seligman Research put together a barn burner of a report which included numerous Facebook posts questioning the efficacy, safety, and trial design of ALLK’s drug candidate. Since that report, ALLK stock is down approximately 51%, and ALLK actually has several later stage trials.

In the case of FIXX, we believe that HMI-102 in PKU is the ONLY path to viability – given the lack of efficacy of HMI-102 at high dose, we believe that the HMI-102 program is dead, and that the stock should trade to its cash value per share, or $5.80 per share, down 56% from the April 27th close price.