PYR: A family affair rife with conflicts, roundtrip revenues, and plenty of unfulfilled promises – PT $0.74

Portfolio manager summary

  • Pyrogenesis (PYR) stock has rallied over 1300% (since Jan 2020) on the back of a series of aspirational press releases and inclusion in ARK’s PRNT 3D printing ETF 
  • Our research reveals that PYR has obfuscated disclosure about related parties, has significant conflicts of interest, recognized revenue from a company it partially owned and financed, and has repeatedly overpromised and underdelivered
  • Since 2014, PYR boasted about hundreds of millions of dollars in potential revenue from various businesses like 3D printing and waste to energy systems, among other things – in reality, PYR generated $7MM in average annual revenue while burning a cumulative ~$23MM in FCF
  • PYR’s 3D printing segment gained little traction despite half a decade of press releases; its initial $12.5MM contract produced limited revenue and recent Aubert contract win generated no sales; PYR seems poorly positioned to compete against 3D heavyweights DDD and SSYS
  • “Family Matters” 1: PYR touted Drosrite International (DI) as a “client”, and waited over a year from the initial release to disclose in filings that DI was actually owned/controlled by the CEO’s son (we estimate that DI represented between 30% and 56% of 2020 revenue)
  • We question the substance of DI – it failed to reach PYR’s revenue expectations and our diligence found that while DI lists a Mahwah, New Jersey Regus office as its headquarters, DI DOES NOT have a lease for private space there
  • We believe that management formed DI to skirt Saudi/Canada trade restrictions in place at the time
  • In 2020, PYR invested a sum in HPQ (another listed Canadian small cap) and proceeded to book an identical amount in revenue from HPQ! An unlikely coincidence we’d characterize as roundtripping of financing dollars into revenue (we estimate HPQ represented 23% of 2020 revenue)
  • 2020 reported revenues could be over 100% overstated as we believe that a portion, if not all, of the revenues from DI & HPQ are conflicted and unsustainable as a result of the above relationships
  • “Family Matters” 2: PYR’s CEO was handpicked by its allegedly “independent” board to negotiate on behalf of PYR with a counterparty run by the CEO’s father (for whom the CEO himself held a power of attorney).  This ended with a settlement of $3.7MM in favor of the father.  In our view, this reflects a clear conflict of interest and is what led to the concurrent resignation of the audit committee chair 
  • We believe the pattern of exaggeration and unusual dealings makes PYR’s claims about its plasma torch business flimsy – our research corroborates the view that this technology will not be a revenue panacea
  • Amidst all of this, PYR has significant internal control issues, something we view as alarming given PYR does business with related entities perceived to be unrelated; in our view, this makes the financials hard to believe
  • We believe that 40% to 80% of PYR’s revenues are suspect (or non-arm’s length) and we assign a $0.74 price target to the stock, down ~88% from current levels

PYR: Press releasing a stock to a $1B+ market cap

(all amounts in CAD unless otherwise noted)

Pyrogenesis (PYR) is a Montreal-based company that offers various metals related product lines including aluminum waste recovery systems, plasma torch and plasma waste destruction systems, metal powders for additive manufacturing, and a process to produce high quality silicon from quartz, among others. We believe that PYR has repeatedly failed to bring any of these businesses to scale, as evidenced by its revenue development.

Since the beginning of 2020, after peaking at a $1.9B market cap, PYR’s stock is still up over 1300% on a flurry of press releases and inclusion in ARK’s PRNT 3D printing ETF (even though PYR is hardly a 3D printing company, in our view).  In this note, we address why 1) this move is unjustified and 2) our views that PYR’s 3D printing effort is unlikely to succeed.  We wonder whether ARK is aware that PYR’s efforts into 3D printing have yielded minimal results – a $12.5MM contract win never full materialized and the current named 3D printing client has yet to buy anything from PYR.  Not to mention PYR’s main focus is NOT on 3D printing.

Unlike other names we’ve written on, PYR has real products and some real customers.  That said, our quarrel with PYR lies in its disclosure issues, interactions with family members, conflicts of interest, potentially financing its own revenues, what we believe to be exaggerating potential business, and internal control issues.  We believe the relationships and transactions found in PYR’s history should cause investors to question the veracity and potential of the company and its fundamentals.

As a teaser – PYR waited over a year before disclosing in a filing that its “client” (as per press releases), Drosrite International, was actually an accounting subsidiary of the company controlled by CEO Peter Pascali’s son.  We believe that PYR aided in the formation of this entity to skirt trade restrictions in place at the time.  

Investors were also excited about PYR’s involvement with HPQ Silicon, a Canadian company “that focuses on becoming a producer of nano silicon materials”.  What investors missed was that PYR invested $2.4MM in HPQ, and then recognized $2.4MM in revenue from HPQ for the sale of intellectual property – what we’d term a round trip between equity financing and revenue.  

These examples, plus a 4x increase in DSO, other exaggerations and unusual transactions call into question the company’s credibility and reported numbers.  We assign a target price of $0.74 to PYR, down ~88% from current levels and to where it was around May 2020.

Not quite hundreds of millions in revenue

To give our readers an idea of what PYR is about, we highlight a series of claims and show you what actually happened:

  • February 2014 – “PyroGenesis is confident that the results from this fourth contract, expected within the next 3 months, will lead to a full scale industrial plasma installation worth in excess of $10 million dollars”
  • October 2014 – “Once this process is fully commercialized, potential revenues are in the hundreds of millions of dollars.”
  • March 2015 – “PyroGenesis Announces Signing of an Exclusive Marketing License Agreement for $500,000 Plus Commitment for Six (6) 50 TPD Waste Treatment Systems Totaling Over $120 million”
  • September 2019 – “We fully expect that this will be the first of many systems ordered by the Client who will benefit, upon reaching a certain milestone, from a limited territorial exclusivity. This contract, together with signed backlog, recently announced contract award, and the imminent US Navy contract for $13.5M, portends to a backlog of over $40M, which must be addressed within the next 18 months, come September. This does not include the $35M of backlog in subsequent years. It is a very exciting time for the Company.”

What we have here are claims that imply tens of millions, if not hundreds of millions, in revenue from 2014 onward, and a 2019 claim that would imply revenue in excess of $40MM through 2020.

Here’s what PYR’s revenues ACTUALLY looked like – not tens of millions, let alone hundreds of millions in revenues post 2014/2015, and less than half of the alleged $40MM backlog is represented in 2020 revenue.  Not to mention that a meaningful amount came from DI, a newly-disclosed accounting subsidiary of the company and HPQ, which is approximately 12% owned by PYR.  Note here that 80% of 2020’s revenue was, in our view, not arm’s length, as we discuss later.

Source: Company filings

We believe that this shows that the company has engaged in serially overpromising revenue opportunities that just didn’t seem to materialize.  In our view, this is either indicative of poor execution, simple overoptimism, or willful exaggeration designed to move the stock price.

We don’t believe PYR can compete in 3D printing

Despite a flurry of press releases about 3D printing capabilities, including PYR’s inexplicable inclusion into ARK’s PRNT ETF, we don’t believe PYR will gain any traction in the space.

In July of 2014, PYR announced that it had signed a $12.5MM contract “the Sale of Powder Production Systems for 3D Printing with International Large Scale Manufacturer”, sharing that its backlog exceeded $20MM.  In the release, PYR announced that they would supply the customer with its “unique metal powder production platforms” over an 18-month period for $12.5MM.  In October 2015, or 15 months later, CEO Pascali indicated that they expected “the downpayment for the next nine (9) systems in Q4 2015/Q1 2016 with all nine (9) systems expected to be delivered by Q4 2016.

The filings tell a different story – the FY15 filings note that PYR and the customer had unresolved differences:

Source: FY15 MD&A

In fact, in 2016, PYR completely abandoned the project:

Source: 2Q16 MD&A

So, no $12.5MM 3D printing revenues materialized despite the company’s guidance.

It’s also useful to note that while PYR signed a “mutually exclusive partnership agreement” with Aubert & Duval, a “subsidiary of the ERAMET Group” to supply powder to the “European Union Additive Manufacturing/3D Printing Market” in 2019, this has produced NO REVENUE TO DATE:

Source: 2020 AIF

From a fundamental standpoint, PYR seems to be poorly positioned.  A Google Patents search through Pyrogenesis’s patents for “powder” or “plasma atomization”, PYR’s methodology, reveals fewer than 20 patents in the US & Canada – but this is not the only metric by which PYR lags 3D heavyweights like DDD and SSYS:

Sources: PYR 2020 40-F, DDD 10k, SSYS 20-F

DDD and SSYS each spend over 100 times what PYR spends on R&D, have over 25 times the staff, and much more intellectual property.  PYR, with just a powder offering, has to compete with DDD and SSYS’s turnkey printer and materials offerings.  Given the lack of historical traction and limited resources versus major competitors, we just don’t think PYR can compete.

The pattern continues with Drosrite International

On April 29, 2019, PYR announced “that a potential contract (“Contract”) of over $20M in first year revenues, together with significant subsequent years revenues, is imminent.”  The company followed this press release with another in June 2019 that it was, in fact, awarded the contract, but that the “client and the business line cannot be disclosed at this time” until the contract was signed:

Source: Press release

On October 9, 2019, PYR revealed that the contract was with a “US based private company duly constituted and existing under the laws of the State of Delaware”, Drosrite International (DI), that was licensed by PYR to “manufacture, market, sell and distribute DROSRITE™ systems and technology to the Kingdom of Saudi Arabia, and certain other countries in the Middle East, on an exclusive basis”.

PYR was due some pretty impressive revenue from this deal – $20MM within 12 months, with $6.4MM coming within 2-4 weeks of the announcement:  

Source: Press release

This was followed by:

  • A March 2020 press release announcing that the receipt of $1.44MM under the DI contract, and that “DI will pay PyroGenesis approximately, based on current exchange rates, $25M over the next 12 months”

In our view, none of this is credible, or true, for that matter – the first claim, from October 2019, that DI would pay $20MM to PYR within 12 months did not materialize – PYR’s Drosrite segment did approximately $10MM in revenue in 2020, or 50% less than what PYR guided from DI alone in October 2019.  

It is our view that PYR is also nowhere close to receiving $25MM from DI by March 2021, as guided in March 2020.  We believe this is yet another data point in the pattern of PYR overpromising and underdelivering.

We believe Drosrite International’s relationship to PYR was, for a time, likely purposefully obfuscated

Included in the October 2019 PYR release was a link to DI’s press release, where we learn that DI’s CEO is named Alex Pascali:

Source: Press release

Could this be the same Alex Pascali that was a PYR employee?

Source: LinkedIn

It took over a year, about six press releases, until November 3 2020, and an amendment to PYR’s Annual Information Form (AIF), before PYR finally disclosed to investors that DI, was, in fact, a subsidiary for accounting purposes and controlled by PYR CEO Peter Pascali’s son, Alex (note to our readers: these are not our words – they are written by the company – another reason to read the fine print):

Source: AIF

From the original October 2019 contract signing through the November 2020 disclosure that DI was “on an accounting basis, a subsidiary of the Company, and not a client”, PYR press released twice explicitly calling DI a client:

Source: Press release

Source: Press release

PYR also issued another four subsequent releases where it provided updates on the DI payments without disclosing the fact that DI was controlled by Alex Pascali.  Was the investing public to assume and know that Alex was Peter’s son?  As you can see below, the original 2019 AIF made no mention of Alex Pascali:

Source: 2019 AIF

We believe that PYR management actively sought to hide this from investors, which, in the grand scheme of what we talk about in this report, is another indictment of management’s credibility.  Aside from what we believe to be a serious misrepresentation that lasted over a year, we believe there are major issues with this relationship, specifically that its delayed disclosure speaks to internal control and compliance issues at the company

The first is with the economic substance of DI – in the 2020 filing, we learn that PYR does not have any subsidiaries.  This means that while DI is a subsidiary for accounting purposes (primarily because it is controlled by a relative of PYR’s CEO who is an employee of PYR and is, quite literally, a “related” party), it is, from a corporate structure and legal standpoint, an independent entity.  

Generally, one would expect a legally separate entity that holds itself out as a business would have some economic substance, but our view is that it doesn’t.  DI is required to pay PYR amounts “equal to the payments received by Drosrite International under its Dross Processing Service Agreement with Radian Oil & Gas”:

Source: AIF

This would suggest that DI has to move all of its Radian client revenues up to PYR, making it a pass-through vehicle for the benefit of PYR. DI, under its agreement with its client Radian, has to “manufacture and deliver” DROSRITE systems, which should entail some level of expenses.  

This, to us, appears to cause a problem – DI received payments from Radian but needs to transfer those payments to PYR, all while incurring costs to “manufacture and deliver” systems, which would imply that DI is all costs, making it lossmaking.  How does DI finance itself since it is allegedly independent of PYR?

We also have concerns about the general substance of DI.  The address listed on DI’s website directs users to Regus office space:

Source: DI website

We tried calling DI multiple times, but were never able to reach anyone.  More interestingly, we reached out to Regus to confirm whether DI is a tenant.  

The answer shocked us – Regus told us that while DI has a membership to use the lounge in the Mahwah Regus space, and can rent offices on a day-to-day basis, it DOES NOT have a lease for private space at the Mahwah site.  

We struggle with the substance of a business that 1) does not answer its phone and 2) does not have even semi-permanent space.  It’s almost like DI doesn’t want to be found.

Inquiries to PYR about DI’s manufacturing were not answered.

We believe DI was formed to skirt trade restrictions

This then begs the question, why does DI exist in the first place? Why couldn’t PYR simply sell its products directly to Radian Oil & Gas, a Saudi Arabia-based company? It is our view that DI was formed to skirt trade restrictions between Canada and Saudi Arabia in place at the time.

According to Delaware corporate filings, DI was formed on December 18, 2018:

Source: Delaware Division of Corporations

This date is significant – in August 2018, Saudi Arabia suspended new trade with Canada after Canada’s foreign ministry “urged Riyadh to release arrested civil rights activists”:

Source: CNBC

Shortly thereafter, Export Development Canada, Canada’s export financing agency, suspended Saudi-related activity.  Practically speaking, this meant that PYR could not have started trading directly with Radian, which is Saudi-based.  

So, through DI, a US-based, legally independent vehicle, PYR could perhaps skirt the trade restriction.  The reality is that while DI is legally a separate entity from PYR, and thus not legally owned by a Canadian parent, it is still controlled by Alex Pascali, as an employee of PYR, as eventually disclosed by PYR.  We would characterize this as the creation of a US entity to adhere to the letter of the law, but certainly not the spirit of the law given the control by a PYR employee who is the child of PYR’s CEO.

It took ten months, until July 2019, for Export Development Canada to change its position on Saudi Arabia from “off cover” to “open on restricted basis”, but by then PYR had already pot committed itself by making both the April and June 2019 announcements we mentioned above, and kept the DI narrative going.

We believe that PYR actively sought to skirt export restrictions – PYR also waited over a year to formally disclose to investors the nature of its relationship with DI.  Furthermore, we believe it shows investors to what lengths PYR will go to create the illusion of growth. 

In our next sections, we show another significant conflict of interest (this time with an entity from the Offshore Leaks database), revenues that aren’t quite arm’s length (in our view), and internal control issues that should cause great concern to investors.

We believe PUREVAP revenues are the result of providing financing to HPQ

PYR has made much about its PUREVAP technology, a family of silicon processes which it is exclusively developing for HPQ Silicon Resources.  HPQ’s origins are as a mining company whose “activities are centred on becoming vertically integrated using it’s [sic] proprietary PUREVAPTM “Quartz Reduction Reactors” (QRR) (patent pending) process”.  

Despite a $260MM market cap, HPQ has never generated any revenues (through 3Q20) and has a $28MM retained deficit.  HPQ has just two employees on LinkedIn!  From 2011 until September 2020, HPQ has burned $11.1MM in cash flow from operations and relied on cumulative financing of $23.4MM to keep going.  PYR, on the other hand, reported $4.1MM in PUREVAP sales to HPQ in 2020, of which $3.6MM was the sale of intellectual properties – more on this shortly.  

Source: HPQ filings

PYR’s relationship with HPQ began in 2016, when it sold IP to HPQ – as part of the purchase price, $300k was paid through the issuance of 1,363,636 shares of HPQ to PYR, making PYR roughly a 1% owner in HPQ at the time.  The terms of this 2016 contract are that PYR will received a royalty equal to 10% of HPQ’s net sales with minimum payments – PYR waived the 2018 and 2019 minimum payments, and collected $150k in 2020 in what appear to be minimum payments.

In August 2018, PYR increased its ownership in HPQ to 9.6% by acquiring 16MM shares of HPQ at $0.12 for a total investment of $1.95MM in HPQ.  Note that over the period ending December 2020 where PYR took its ownership of HPQ to 11.55%, it has never filed an early warning report as required by Canadian regulators.

PYR also granted HPQ a $1.5MM credit line to “cover unexpected project cost over runs that could potentially occur after then end of planned test period in 2019 until December 31, 2020.”  Note that HPQ disclosed the credit line from PYR – but PYR has not mentioned in its filings that it extended a line of credit to HPQ, yet another disclosure issue at PYR in our view.

Now here is where it gets strange – on September 1, 2020, PYR announced that it had purchased 4MM units out of a 4.5MM unit HPQ private placement for a total investment in HPQ of $2.4MMIn August, PYR signed a “development agreement” with a subsidiary of HPQ, HPQ Nano Silicon Powders  where PYR would receive royalties at 10% of the subsidiary’s net sales:

Source: 2020 AIF

In the 2020 annual filing, we learn that PYR sold IP to HPQ Nano Silicon Powders in 2020, for….you guessed it…$2.4MM:

Source: 2020 AIF

What a coincidence – PYR invested $2.4MM in HPQ, and also booked $2.4MM in revenue from HPQ! That looks an awful lot like manufacturing revenues from providing financing to HPQ. 

The other curious aspect of this relationship is PYR’s booking of royalties – HPQ, quite literally, has no revenue, even through the first nine months of 2020.  Despite this, PYR has booked a royalty receivable from HPQ and its subsidiary totaling $1.6MM:

Source: 2020 AIF

How could PYR possibly recognize a royalty receivable (and book it into revenue) with HPQ not generating any revenue? A 10% royalty on zero should be zero. There is no revenue, and no receivable.

What’s even stranger is that HPQ’s 20-year estimate of royalties payable to PYR are just $815k, almost 50% less than what PYR carries the receivable at:

Source: HPQ 3Q20 financials

So unless HPQ had a dramatic upswing in revenue in 4Q20, we cannot make sense of the discrepancy in royalties between PYR and HPQ.

Phoenix, an offshore conflict of interest

There have been many mentions of in PYR’s filings of a settlement between Phoenix, a company controlled by Peter Photis Pascali, father of PYR’s CEO Photis Peter Pascali.  In prior filings, we learn that PYR had issued shares to settle amounts owed to Phoenix, a “related party creditor” and that effective September 2018, “Peter Photis Pascali and Phoenix Haute Technology Inc are no longer related to the Company.”

Whew. Or so you’d think. What this statement doesn’t capture is the drama that led to that conclusion and the conflict of interest it entailed.

The Revised 2019 AIF we mentioned earlier – you know, the one that FINALLY disclosed to investors the relationship between PYR and DI, also provides disclosure regarding the Phoenix settlement that until then had been kept from investors. Essentially, Phoenix disagreed with PYR on what it was owed related to a 2011 sale of intellectual property to PYR.  The Revised 2019 AIF reveals the following:

  • Following Phoenix’s claim about what it was owed, “One member of the Board expressed the view that the claim of Phoenix was not a valid claim and the board process lacked independence”.  
  • The next day, April 27, 2018, that board member RESIGNED from the board.  Our research would suggest that this was Angelos Vlasopoulous, who was Chair of the Audit Committee.  This would leave four directors, one of which was PYR’s CEO, the son of the controlling shareholder of Phoenix
  • The remaining three directors “agreed that P. Peter Pascali [PYR’s CEO] was in the best position to negotiate a settlement with Phoenix”

We have to question the independence of a board who appoints the son of an opposing party to negotiate with that party in the best interest of the PYR.  This is an even greater issue, in our minds, because Peter Pascali, the CEO of PYR and son of the controlling shareholder of Phoenix, had a power of attorney to take actions on his father’s behalf, and Phoenix was considered “ ‘under common control’ of the Father and P. Peter Pascali from an accounting perspective when the settlement agreement was entered into”:

Source: 2019 Revised AIF

Peter Pascali was not only CEO of PYR, but was also considered a control person of Phoenix – despite this, he was sent to negotiate on behalf of PYR against an entity that was considered under his “common control”.  This, in our view, is a massive conflict of interest that should cause investors great concern as it exposes the company to situations where its interests may be deprioritized.

Phoenix itself deserves a look – the full name of the entity is Phoenix Haute Technology Inc, and, to our great surprise, turned up in the Offshore Leaks database as a British Virgin Islands corporation:

Source: Offshore Leaks

The Offshore Leaks database is a report disclosing the details of over 100,000 offshore companies and their beneficial owners – while there are many legitimate uses of offshore entities, and Phoenix may be such a use case, offshore entities have been used to mask ownership and avoid taxes, according to ICIJ.

Let us be clear – we are not suggesting the Pascalis are engaging in any untoward behavior using this entity, but its offshore domicile is a cause for concern, in our view, given the DI dealings and Phoenix conflict of interest.

And speaking of conflicts of interest, we couldn’t end this section without mentioning that PYR leases its corporate headquarters from….you guessed it…a related party of the CEO, the Pascali Trust, which owns the building:

Source: 2019 Revised AIF

We believe that PYR is misrepresenting its relationship with the US Navy

PYR dedicates an entire slide of its investor deck to its “relationship” with the US Navy, claiming it was “engaged” by the Navy:

Source: PYR investor deck

PYR also press released the same $11.5MM deal announcement:

Source: Press release

But searching through the Department of Defense’s contracts database, which posts contracts in excess of $7.5MM reveals NOTHING about PYR:

Source: Department of Defense

This leads us to one of two conclusions:

  • The CAD $11.5MM contract is actually not guaranteed at that amount or is in reality less than USD $7.5MM 
  • PYR does not have a direct contract with the Department of Defense

We cannot prove or refute the first one, but we do have a view on the second one.  PYR had previously announced Navy deals, and in a 2011 announcement, actually disclosed that the Navy design, construction, and testing was “done on behalf of Newport News Shipbuilding, a division of Huntington Ingalls Industries (NYSE: HII)”, suggesting that PYR’s contract was, in fact, not with the Navy, but with Newport News Shipbuilding:

Source: PYR press release

In fact, in 1Q15 MD&A, PYR confirms the delivery of a system to Newport News Shipbuilding:

Source: 1Q15 MD&A

And in a 2019 press release, PYR announced that the US Navy was “moving forward with a two-ship buy” and that the Navy had “reached an agreement with the shipbuilder, Huntington Ingalls Industries (HII) [parent of Newport News Shipbuilding]”.  

It’s pretty clear to us that the relationship is between the Navy and Newport News Shipbuilding, and not between PYR and the Navy, yet PYR’s management neglected to include Newport News Shipbuilding in the investor deck and the September 2020 press release announcing the $11.5MM contract.

It’s almost as if the company wants investors to think it has a direct relationship with the US Navy, a much more impressive and newsworthy organization than a shipbuilder.  It is our belief that PYR’s relationship is not directly with the Navy, and we believe that PYR chose to exaggerate the nature of the relationship in order to foment investor interest.

Until now, we’ve shared our view that PYR has engaged in several transactions that appear conflicted, mispresent the company, or seem to be obfuscating the business:

  • It took over a year for PYR to disclose that DI was run by CEO Peter Pascali’s son; we believe that DI was formed to skirt trade restrictions in effect at the time
  • We do not believe the full ~$10MM of Drosrite and $4.2MM of HPQ revenues are truly arm’s length given the family relationship in DI and ownership stake in HPQ – these collectively account for 80% of 2020 revenue
  • PYR appears to have manufactured $2.4MM of 2020 revenue, or approximately 13% of 2020 revenue, by investing the same amount into HPQ (of which PYR owned > 10%)
  • Peter Pascali’s negotiations against an entity he was deemed to be under common control is an apparently massive conflict of interest
  • We believe that PYR is misrepresenting that it has a contract with the US Navy – its own prior disclosures show that products were designed on behalf of a shipbuilder
  • PYR failed to disclose its over-10% ownership in HPQ (on a partially diluted basis) as required by Canadian filing rules

We believe that these are events that seriously undermine management’s credibility and suggest a pattern of exaggeration and self-dealing.  We believe that these issues could portend a poor future for investors in PYR.

We believe the plasma torch opportunity is much smaller than investors think

We believe that in light of the unusual transactions and pattern of apparent exaggeration that investors should look at PYR’s plasma torch announcements with a jaundiced eye.  In 2020, PYR made three announcements regarding inroads to proving our selling plasma torches for iron ore pelletization:

  • April 2020 – successfully completed the first phase of a modeling contract with the goal of replacing all existing fossil fuel burners at a “multi-billion-dollar international producer of iron ore pellets” implying a revenue opportunity nearing $1.5B to replace 500 burners
  • June 2020 – a second similar contract with another “multi-billion-dollar producer of iron ore pellets” with over 100 burners
  • July 2020 – a Client C has “entered into active equipment purchase discussions with the Company”
  • September 2020 – announced receipt of a “Draft Contract” related to the April 2020 release which appears to have resulted in the sale of ONE torch at $1.8MM, almost 50% below the “up to $3M” per torch revenue outlined in the April release

Doesn’t this look awfully like the 2014/2015 announcements promoting hundreds of millions of dollars of revenue? Only in this case, it’s billions.  We’re skeptical here, not just because of the history of bold claims PYR has made, but also because of our research into plasma torch technology.

Simply speaking, plasma torches can be used to generate the heat required in the steelmaking process through electricity rather than fossil fuels.  This, in theory, makes a lot of sense and would be an environmentally friendly solution.  

Feedback from an industry expert (obtained on condition of anonymity through an expert network) corroborates the environmental argument, but suggests that plasma torch technology still has a long way to go:

  • He stated that no company he has seen could conceivably make 100 or 200 torches in a two-year window, given the current manufacturing infrastructure.  This is critical in light of PYR’s “over 10 plants each requiring approx. 50 plasma torches” commentary and is further supported by the fact that PYR’s leased manufacturing facilities total just 6739 square meters, or 72,537 square feet
  • Power supplies for plasma torches are hard to get – it takes six months to get one or two power supplies for the torch due to the difficulty of obtaining the rare earth magnets needed
  • His clients don’t believe fossil fuels will be replaced for another 20 years – it would be a gargantuan effort over the next three or four years to build out the electricity infrastructure necessary to support the power requirements to replace furnace burners with plasma torches

This feedback supports the idea that plasma torches, while an interesting and useful technology, are unlikely to be gamechanging in the near term.  In our view, PYR has, consistent with its prior communications, exaggerated the near term opportunity for plasma torches.

PYR appears to lack substantial internal controls

The above sections, in our view, show significant issues with PYR’s credibility.  Management appears to have serially promised things it didn’t deliver, and engaged in a number of transactions that we view to be conflicted or downright unethical.  These shortcomings matter all the more since management identified “material weaknesses in internal control over financial reporting” at the end of 2020.

We highlight several of the deficiencies here:

  • Deficiencies relating to the board and audit committee’s oversight and governance of external financial reporting and related party transactions
  • A lack of senior financial reporting resources
  • “[C]ontrol activities related to documentation and consistency in accounting for intangible assets internally generated and revenue recognition were deficient”
  • PYR “did not design and maintain appropriate segregation of duties and controls over the effective preparation, review and approval, and associated documentation of journal entries and did not have adequate review procedures for the recording of manual entries”
  • PYR “did not implement and maintain effective controls surrounding certain complex spreadsheets, including addressing all identified risks associated with manual data entry, completeness of data entry, and the accuracy of mathematical formulas”
  • PYR “did not maintain effective user access controls to adequately restrict user access to financial applications and related data commensurate with job responsibilities”

The practical implications of these deficiencies, in our view, is that investors cannot rely on PYR’s reporting, because there are no processes in place to ensure that that this reporting is, in fact, correct.  PYR, in fact, appears to agree with this conclusion:

“These control deficiencies create a reasonable possibility that a material misstatement to the consolidated financial statements will not be prevented or detected on a timely basis. Therefore, the Company’s principal executive officer and principal financial officer concluded that the design and operation of the Company’s disclosure controls and procedures are not effective as of December 31, 2020.”

Source: 2020 40-F

We believe that the combination of what we view as misrepresentations, exaggerations, conflicted parties, and these internal control weaknesses mean that PYR is a risky investment that should be avoided.  We believe that investors should not believe PYR’s reporting or multiple press releases.

For additional detail, here are the internal control weaknesses as outlined in the 2020 40-F:

Source: 2020 40-F

Valuation and conclusion

The Mariner Instant Replay:

  • PYR has promised hundreds of millions of dollars in revenues and failed to deliver on those promises
  • We don’t believe PYR can be competitive in 3D printing
  • DI has missed the goals set by management in multiple press releases
  • It appears that PYR delayed disclosure of the control and related party dynamics of both DI and Phoenix
  • We believe DI was formed to skirt Canadian/Saudi trade restrictions, which we believe presents a credibility issue for management
  • PYR appears to have financed a portion of its own revenues from HPQ, and does not appear to have filed its ownership in HPQ with regulators
  • We believe that PYR demonstrated a serious lack of independence in having its CEO negotiate against an entity for which he had power of attorney
  • PYR does not appear to have a direct contract with the Navy
  • We believe PYR has overstated the plasma torch opportunity
  • PYR appears to lack substantial internal controls

The overall summary here is that it appears that PYR engaged in a number of transactions that, when combined with poor internal controls, could be misrepresented in the financial statements.  In addition to this, we believe that PYR’s comments about its business wins are either willful exaggerations or that management are serial optimists unable to appropriately manage expectations.  In our view, either conclusion calls into question management’s credibility with its current claims and the real potential of the business going forward.

The practical implication, in our view, is twofold:

  • We are unable to assess whether the reported Drosrite revenue of $9.9MM in 2020 was accounted for properly given the unusual relationship with DI (an accounting subsidiary but not a corporate subsidiary)
  • We believe PYR’s ownership in HPQ, as well as the fact that it appears to have financed a portion of its PUREVAP revenues by investing in HPQ, makes it hard to believe the $4.2MM in PUREVAP revenues in 2020

This skepticism is supported by the over 4x increase in DSO, suggesting PYR is booking revenue without collecting the cash:

Source: PYR filings

Which brings us to valuation – PYR’s EV is 51.5x 2020 sales, an eye-popping valuation for an industrial business. We believe that Drosrite revenues in excess of the $5.5MM received by DI from Radian are suspect, as are the $2.4MM in revenues recognized from HPQ (equivalent to the $2.4MM investment PYR made in HPQ).  This reduces revenue to our “credible” estimate of $10.9MM, down 39% from what was reported in 2020.  

Applying a 100% premium to the highest EV/sales multiple in the comp set, 4.9x, which is DDD’s valuation, we arrive at a price target of $0.74, down ~88% from current levels and near where the stock was in May of 2020:

Source: Bloomberg

NOTE: PYR did not respond to our questions, which we submitted through their IR form.

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.

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