The market has been a little sketchy lately as earnings season winds down and everybody pauses to catch their breath after what’s been a flurry of earnings-induced stock moves. The pause might be short-lived, as it looks like the House passed a tax reform bill that will, among other things, slash the corporate tax rate to 20%, reduce the number of tax brackets, boost the child tax credit, and do away with the estate tax by 2025.
In other words, the best thing you can do to save money on taxes now is procreate, and do whatever you can to extend the life of those holding your inheritance for another eight years! I’m joking, of course. But in all seriousness, one thing you can do is hold onto a bunch of small-cap stocks, since they have a far higher average tax rate than large caps, and stand to benefit more from a corporate tax cut.
That latter point probably accounts for the S&P 600’s rally yesterday, which lifted the index above its 50-day line and stopped the bleeding that had been accelerating in the month of November.
As I’ve said before, given the intensity of the September rally, it’s not surprising that small caps are giving a little back. But it doesn’t feel great when your new purchases are down. And that’s the case in our portfolio right now—our two most recent additions are in the red and, other than BioTelemetry (BEAT), those are the ONLY stocks in our portfolio underperforming the small-cap index over the same holding period. On average, our current stocks are beating their benchmark by 23%.
So, what do we do now? Stick with the plan. Keep averaging into positions you want to own, and reduce exposure to those that you don’t. It really is that simple. We’re not going to make all the right calls, but we don’t have to. We just need to be right more often than we’re wrong, cut our wrong calls loose before they become crippling losses, and give our right calls room to run so they pull our average return up.
Updates
AppFolio (APPF) dropped after a reporting a beat-and-raise Q3 last week, but shares have firmed up this week and appear ready to mount a recovery. The stock is now 17% below the 52-week high it hit in early October. I suspected Morgan Stanley might reconsider their longstanding “hold” rating on the stock, and in fact, this week the analyst covering the stock boosted his price target from 38 to 46, justifying the increase by highlighting AppFolio’s profit growth (which is far ahead of expectations from a year ago). On the flip side, the firm notes that when AppFolio is ready to grow outside of Property Management (which represents over 90% of revenue) and Legal, it will likely incur significant startup and/or acquisition-related costs. This is true, but not enough of a concern to keep me from changing my Buy recommendation, especially given the recent dip in the stock. BUY.
Asure Software (ASUR) reported early last week and the stock has jumped back above 13 with relatively high trading volume. This week, the company announced a partnership with Atmospheric Commercial Interiors, a large office furniture dealer, to have the company sell Asure’s SmartView Occupancy Sensors and Resource Scheduler software solution. This deal appears to have meaningful potential, though of course, we’ll have to get some follow-up results as the quarters tick by. The bottom line is that Asure’s quarterly report and CFO hire appear to have given investors the confidence to start buying the stock again. It’s trading around 14 now, which is 40% higher than it was in late October, and 19% below its 52-week high from early June. Keeping at Buy. BUY.
AxoGen (AXGN) has been a standout performer in our portfolio lately; the nerve repair specialist has enjoyed a roughly 20% rally after reporting a terrific Q3 on November 1. We’ve been watching the stock closely since finding out in early October that an early investor, EW Healthcare Partners, filed to sell out of its position. The position is sizeable, consisting of up to 4.86 million shares (roughly 14.5% of total shares outstanding), which it purchased for 3.6 each. Yesterday morning, AxoGen announced that EW Healthcare Partners will sell one million of the shares at an offering price of 21, roughly a 16% discount to Wednesday’s closing price, but still above the price the stock traded at prior to reporting Q3 results. These shares already exist, so there is no dilution! However, AxoGen also announced it will sell 700,000 shares at 21, and this offering is dilutive by roughly 2% (33.4 million shares were outstanding at the end of the quarter). At the offering price, AxoGen will raise roughly $14 million. The company has $22 million in cash, and $20.3 million in debt on a 4.5-year loan (interest only through October 2018, then 30 monthly payments of principal plus interest, at 8.5%). It is not cash-flow positive, so I expect this money will go to shore up the balance sheet and pay for general purposes, including some debt principal repayment. We should expect additional secondary offerings in the future. The stock traded on huge volume of over 1.5 million shares yesterday (average daily volume is 220,000), so it looks to me like most, if not all, of this offering is now out there. While it’s tough to predict, I don’t think this capital raise will hurt the stock’s performance over the coming months. It was opportunistic, wasn’t excessive (in my opinion), and gives the company a little breathing room. The stock was down around 9% yesterday, which I believe is more reflective of the number of shares available from the two offerings than an excess of shares being sold by other investors. I think you can buy this dip. BUY.
BioTelemetry (BEAT) has been anything but dependable (other than dependably going down) for the past two months, but appears to be searching for stable ground right now as shares have traded in the 24 to 26 range this week. Continue to hold. HOLD.
Earnings: Done
Datawatch (DWCH) is still not performing well after reporting earnings a couple of weeks ago. The big data specialist has seen shares pull back to around the 10 level, which is less than 10% above its 200-day line and roughly 5% above a possible support zone that held up after the company reported Q3 results in mid-July. Nothing has changed with our investment thesis over the past week. This remains an under-followed microcap stock that needs to show several quarters of accelerating growth through new product introductions and a measured transition to the cloud. Keeping at Buy. BUY.
Earnings: Done
Everbridge (EVBG) rallied as high as 30 in the days after reporting a knockout Q3, and management jumped on the opportunity to raise capital. It’s almost certain they had the game plan in their back pocket all along since the method is somewhat complicated. The short version is that Everbridge will issue convertible debt to raise around $100 million. At the same time, Jaime Ellertson, the CEO, is selling $17.2 million of stock, consisting of a block of 650,000 shares at 26.97 (to close on November 20). The convertible debt is, in my opinion, a good option for raising cash since it’s far less dilutive than a straight-up equity offering. The CEO’s sale doesn’t look good on the surface since the implication, as is the case whenever an insider sells, is that he thinks the price of the stock now is good enough and there’s not much upside. That, however, is failed thinking. Insiders sell all the time. Any of us that received a salary plus had the vast majority of our stock holdings all tied up in one, single company, would want to diversify too! I’m seeing that Jaime Ellertson owns 1.74 million shares (he sold roughly the same number of shares in April), so he’ll hold just over one million shares after this transaction.
The convertible notes offering is a little complex, but if you like finance you’ll probably find it interesting. The reason for doing a convertible debt offering is that you typically get a lower interest rate than you’d otherwise get because you’re allowing some of the debt to be converted into stock at a later date. In this case, Everbridge is offering $100 million of five-year notes at an interest rate of just 1.5%. Each $1,000 of the debt carries 29.7 shares of stock with an initial conversion price of 33.71 (27% higher than yesterday’s close). Debt holders must wait at least three years before they can convert any of their notes into stock (and if they do, it will be at Everbridge’s option), and only if the stock is trading above 43.8 (130% of the conversion price).
If you do the math, you find that if all the notes are converted, Everbridge will end up issuing around 30,000 new shares. That’s a drop in the bucket (literally, it’s 0.1%) considering there are over 28 million shares outstanding. If Everbridge was to raise $100 million today through a stock offering at the same price the CEO is selling his 650,000 shares at (26.97), it would have to issue roughly 3.7 million shares, which works out to over 13% dilution. What would you rather: 13% dilution or 0.1% dilution, with a commitment to pay back $100 million in 1.5% notes in five years? I’d opt for the latter, especially since, one would hope, the company could always issue stock five years from now (theoretically at a much higher price) to finance the debt repayment.
So that’s how the numbers work. And we haven’t even asked the question yet: Why does Everbridge need $100 million?
The company ended last quarter with $23.6 million in cash, it generated $4.3 million in cash from operations, and, over the last nine months, were it not for $21 million paid for acquisitions, it would only have burned around $15 million in cash. The obvious answer is that it wants to pad its balance sheet so it can make some acquisitions. That’s a discussion for next week, after I have a few minutes to think about where Everbridge is most likely to add technology and talent. In the meantime, I’m keeping the stock at Buy, on the premise that the stock will recover following any weakness related to this debt and non-dilutive stock offering from the CEO. BUY.
Earnings: Done
LogMeIn (LOGM) is back near its 50-day line, and at the price (117) where shares of the collaboration software company traded heading into earnings. It announced an update to its LastPass password security product which features new partner integrations and should make the solution even more attractive to enterprise customers. Keep holding on. HOLD HALF.
Earnings: Done
Materialise (MTLS) announced two new partnerships this week. The first is an OEM license agreement with Simufact Engineering, a provider of metal additive manufacturing (AM) process simulation software, to incorporate Simufact’s simulation and support structures software tools into Materialise’s Magics software. The second is an agreement with SYNNEX, the exclusive distributor for HP Jet Fusion 3D printers in the U.S. and Canada, to allow SYNNEX to sell Materialise software bundled with HP Multi Jet Fusion printers. My understanding is that this is in addition to the software that already comes with HP’s printers, which Materialise developed specifically for HP (called Materialise HP Build Processor). You might recall from the recent Q3 earnings call that OEM software sales were soft in the quarter, reflecting fewer 3D printer sales from existing partners. I believe HP’s new printer is disrupting the industry, and it’s a great thing that Materialise is partnering with HP, since it gives the company a piece of sales that HP might be grabbing from other 3D printer manufacturers. I’m keeping at Buy. BUY.
Earnings: Done
Primo Water (PRMW) was moved back to Buy after the drinking water company reported a quarter that was good enough to get analysts to boost their price targets, and get the stock back above its 50-day line. It crossed back above its 200-day line this week and is now making a run at 13 (it traded at 10 a month ago). I have to admit, I’m breathing a little sigh of relief given that I elected to hold this stock through a 50% decline. Obviously, I have conviction in its ability to make us more money, and we’re certainly not in full-on rally mode here (the 52-week high of 15.39 is 20% above where we are now). But we’re back to moving in the right direction. There’s going to be some resistance near 14, so don’t be surprised if shares move sideways for a bit. BUY.
Earnings: Done
Q2 Holdings (QTWO) was moved back to buy after the company, which sells software to banks and credit unions, saw shares maintain their upward trajectory following the release of Q3 results. As I said last week, I thought there was some potential for the stock to dip given management’s commentary about banking/credit union consolidation at the small end of the size curve leading to modest customer count contraction. But that hasn’t happened, most likely because big investors understand that the long-term benefits of bigger client wins mean more users (i.e., banking clients, like you and me) on the platform. And that pushes revenue, EPS and cash flow higher over time. Keeping at Buy. BUY.
Earning: Done
Tactile Systems (TCMD) was moved to Sell after shares fell after quarterly results. No meaningful updates from the past week. SOLD.
Earnings: Done
U.S. Concrete (USCR) announced this morning that it closed the Canadian-listed Polaris Materials acquisition for roughly C$300 million. The purchase will help U.S. Concrete expand in the Pacific Northwest and West Coast, including supplying aggregate to Northern California. The stock is trading sideways. Keeping at Buy. BUY.
Earnings: Done
