At yesterday’s close we published our “aggressive buy” upgrade to get our high level thoughts into the hands of our investment community while the stock was still trading at levels that do not reflect the transformative impact of yesterday’s news. There has clearly been a great deal of tax loss selling (note that the stock is still trading just marginally above the 52 week lows set a few weeks ago) and it could continue into today’s final trading day of the year and we see this as an opportunity for many to establish new positions and/or for those still holding from our original buy rec several years ago to start to add shares again.
For those new to the Remark story, we “discovered” Remark Media about four years ago and published research pointing out the ridiculous value it represented at $1.65 per share. The stock subsequently ran to $10+ and we recommended that investors take their gains off the table at $8+. We have published mostly neutral or bearish reports since that time, as we could not wrap our head around the Kan Kan investment. Remark was essentially incubating a social media data start up over the last two years with capital investment of upwards of $15m and it was difficult to quantify what value (if any) the platform would create for shareholders. Like many start ups, Kan Kan was a big capital drain that produced little to no revenue. But that has all changed in the last 60 days, as the company has signed multiple agreements with various entities to provide services related to its Kan Kan Data Intelligence Platform. Deals with Tencent and other companies to use Kan Kan’s social media credit scoring platform and the new deal with Alibaba that we believe will lead to many new deals with other entities will further monetize the Kan Kan platform and may push the revenue generated by Kan Kan in 2017 well ahead of our $6m estimate. We note that there is very little incremental expense associated with each new company that partners with Kan Kan and the boost in revenue that we expect to see as a result of the new deal with Alibaba could have a dramatic impact on the company’s margins going forward.
We believe that the value of Remark’s 5% stake in Sharecare is +/- $80 million if an arms length transaction occurred today, but we would expect any liquidity event with Sharecare itself (IPO, acquisition, etc.) to result in a substantially higher valuation. Some have pointed to an $800,000 equity investment in Sharecare that Remark made in 2015 to argue for a very low valuation of Sharecare, but they are apparently unaware that Remark’s original agreement in the development of Sharecare included anti-dilutive provisions that allow Remark to maintain its ownership stake on a percentage basis when certain dilutive corporate events occur. Remark has an option to invest cash based on the much lower valuation specified at the outset of that agreement and the recent $800k purchase is another example of the benefit the company continues to reap from what it sowed a half decade ago.
The bottom line here is that the stock price essentially gives the operating businesses of Remark Media to investors for free, as the Sharecare stake will prove to be worth $80m or more and that represents the current market cap it its entirety. We believe Remark’s three operating businesses (content/commerce, online travel/ticketing, Kan Kan) will prove to be worth substantially more than the $80m Sharecare stake and the current valuation now represents a disconnect on par with that we discovered when Remark was at $1.65 four years ago and we see any chance to build a position in Remark Media shares below $4.50 as a tremendous opportunity.
We have encouraged investors to be cautious with Remark over the last 12 months, as the acquisitions (of Vegas.com and China Branding Group) transformed the company’s financial statements and outlook, while the company continued to pour significant resources into the development of its Kan Kan Data Intelligence Platform. While the acquisitions had very clear and compelling top and bottom line implications and potential for growth, we were concerned about the runway for the Kan Kan project and found it’s potential difficult to quantify. For this reason, we encouraged investors to take a “wait and see” approach until there is tangible evidence of value creation and the potential for Kan Kan to produce revenue.
The announcement today of Kan Kan’s selection by the AliBaba Cloud Group to provide its advanced facial recognition and image classification services to Alibaba cloud’s Robotic Vision Ecosystem Union represents a huge step forward in the company’s growing relationship with Alibaba and (according to Remark CFO Doug Osrow) a very significant revenue opportunity that will impact the financials in the first half of 2017. This is the traction we have been waiting to see and we believe it is now time for investors to aggressively accumulate Remark Media shares again. With the stock up only 1.3% since the news was released this morning, we believe the lack of investor recognition of the implications of this deal plus what is likely end of year tax loss selling presents a tremendous opportunity for adding shares.
After the close yesterday RAVE Restaurant Group announced a $3 million shareholder rights offering that will allow each shareholder to purchase convertible notes redeemable for Rave stock at an exercise price of $2 per share. These non-transferable rights are being granted to all shareholders as of December 21, 2016, so it appears that the offering and conversion price were set based on a 10% premium to the closing price of Rave ($1.82) on Dec. 20. Shareholders can purchase one $100 note paying 4% interest for every 355 shares that they own. Newcastle, the company’s largest shareholder whose principals include Rave CEO Clinton Coleman and Rave BOD chairman Mark Schwarz announced that they will participate and have essentially already paid in the full amount ($1 million) that they can invest under the deals terms based on their holding of approximately 1/3 of the company’s outstanding shares.
It is important to note that there is also an over-subscription right that will allow holders who exercise their rights to the full extent of their holdings (which Newcastle already did) buy any remaining rights not exercised by existing shareholders. Thus, if existing shareholders do not exercise their right to purchase these notes, Newcastle can exercise its over-subscription rights and essentially buy approximately 15% of the company for $3 million.
This presents an interesting situation, as shorts have sold hundreds of thousands of shares in a bet against Rave. These shares have been borrowed from shareholders who have made their shares available for hypothecation and sold, but the shareholders have just been awarded the right to purchase these convertible notes, be paid the 4% coupon and ultimately convert the notes into 50 additional shares when they choose to do so. Those who were short Rave stock as of December 21 will have to provide those rights or buy shares to replace the ones that they borrow and sold.
It also bears consideration that many short sellers made the bet in anticipation of a capital shortfall for Rave. With the company receiving a capital infusion of $3m as part of this offering, any pressure due to capital concerns will no longer be a factor at least for the next year or so.
The bottom line here is that this offering is giving shareholders an opportunity participate in Rave’s capital raise in proportion to their existing stake in the company. To the extent that some choose not to do so, the largest shareholder of Rave (Newcastle) will be able to increase their percentage stake. And the entirety of the situation will provide some very interesting and not too appealing options for the short sellers who have bet against Rave.
A quick update on the Groove VC watchlist. Last week’s LD Micro conference was fantastic and the Groove community was well represented by investors as well as portfolio companies as both Inuvo and Remark Media made impressive presentations.
Inuvo – Inuvo’s stock notched a major uptick in price and volume over the course of the week following the release of news regarding the company’s record Cyber Monday results and this move was likely extended by the bullish presentation by CEO Rich Howe at the conference. Inuvo seems to have regained much of its operational momentum with recent revenue trends indicating significant sequential improvement and we believe this could be an inflection point for Inuvo stock. Comments during the presentation indicated a positive shift in the revenue picture over the last few weeks generally and management bullishness was at a level we have not seen in a while. Additionally, we believe that Inuvo will increasingly be viewed as a prime acquisition candidate, as investors scour the landscape for the next ad tech company to be targeted by Chinese firms flush with cash and highly valued stock deal currency. The recent acquisition of Inuvo comparable Media.net for an eye-popping $900 million itself requires that investors take a closer look at Inuvo’s operations and relative valuation. Inuvo’s stock is quite cheap versus the value its operations and revenue stream could bring to many companies who appear to be shopping in the ad tech space.
Remark Media – Remark CFO Doug Osrow presented at the LD Micro convention this week and gave a very favorable update, highlighting the recent deals that will for the first time begin to monetize the KanKan data mining operations. He also indicated that they see such deals as just the tip of the iceberg, with many more similar deals in the works that will drive additional revenue over the next year. We were also interested to learn of Remark’s increasingly close ties with Alibaba, as we were previously unaware that many of the engineers working on the KanKan project are working at an Alibaba facility in China. This was one of several indications that we see indicating that the company’s operations are getting more and more intertwined with both Alibaba and TenCent, which we perceive as very favorable for the long term potential of the KanKan project.
Other key takeaways:
– Remark continues to improve conversion metrics for ticket and hotel room sales at Vegas.com and they gave examples of changes that will be made over the next couple of quarters that they think will result in continued improvements in the rate of conversions.
-Sharecare – Remark’s 5% stake in health care portal Sharecare contiues to grow in value and recent disclosures related to an acquisition have indicated a $500m revenue run rate for Sharecare. Comparable valuations in the space put its likely valuation at a levels that could make Remark’s Sharecare stake worth $50 to $100m when it comes to market, which could mean that the Sharecare could prove to be worth the company’s current valuation by itself.
Rave Restaurant Group – RAVE’s Pie Five subsidiary is accelerating the roll-out of new restaurants in new markets, with 3 new Pie Five restaurants opening in three new cities in the 7 days ended last Friday. On a recent conference call management indicated that this “acceleration” of new Pie Five openings will continue over the next six months and we note the positive revenue impact ($50k+ per year) of these openings versus the negligible capital required with new franchisee owned restaurants.
Pie Five continues to be a trailblazer among the bigger players in the fast casual pizza space, beating competitors Blaze, MOD, Pieology and Uncle Maddios to the punch with the first drive through location (one opened last week and another will be opening soon) and the launch last week of its new app that connects with third party delivery services in select markets. Both the drive through and the app that allows orders to be delivered are industry firsts though several of the other players have indicated that they expect to experiment with third party delivery as well. We continue to see Pie Five as an innovator in the fast casual pizza space even though its parent company Rave Restaurant Group’s stock continues to be overlooked. We believe that RAVE stock trading at 1/10th the valuation of MOD Pizza’s equity raise last month suggests a tremendous opportunity to buy shares at prices that are still heavily discounted.
After yesterday’s close it was reported that MOD Pizza, one of the other largest players in the fast casual pizza space has raised another $42 million to continue expanding its rapidly growing base of stores. While MOD Pizza has grown to almost twice the size of the Pie Five chain, this funding round brings the total raised to approximately $150 million which means that MOD’s valuation may be approaching $200 million, but it is definitively between 8-10X the current Pie Five valuation. This announcement from MOD highlights an eye-popping valuation disparity that has emerged between the two companies with nearly identical concepts/products – MOD received enough cash yesterday to pay 2x the current price for all RAVE shares outstanding and still have $4 million in cash leftover because RAVE Restaurant Group’s stock market valuation was only $19 million as of the opening this morning ($1.92).
While MOD could clearly pay cash to acquire RAVE and more than double its store count in one fell swoop, we do not think that will occur. However, we do believe there are other players who are in the fast casual space who do have the appetite for such a deal and we believe that the ridiculous disconnect that has emerged between RAVE’s enterprise value (no debt so literally $19 million based on current market price) and the value that could be created for shareholders with a rapidly growing 100 unit fast casual pizza chain + a 225 unit pizza buffet chain in the hands of a larger chain or private equity group will increase the pressure on the RAVE Board of Directors to open up the bidding. The RAVE Board of Directors has taken steps to increase communication with shareholders by holding its first quarterly conference call last week, but the company’s largest individual shareholders have asked for more – specifically the formation of a committee and/or the hiring of a firm to solicit offers for Pie Five and Pizza Inn individually and/or for an acquisition of RAVE in its entirety. With its closest comparable now valued north of $150 million, it will be increasingly difficult for RAVE to remain independent unless the stock trades significantly higher.
Rave Restaurant Group reported a mixed picture Wednesday morning with revenue up 6.3% in line with our expectations for $15.5m, but a marginally larger bottom line loss than expected due to approximately $400k in costs related to two store closings. Year over year revenue gains were largely driven by a Pie Five system wide sale increase of 35.7% that resulted from its rapidly growing store base, which was slightly offset by a 1.6% decline in revenue reported by Pizza Inn. RAVE reported continuing challenges for Pie Five with the same store sales falling 14.7% as new stores experiencing lower sales trends entered the base, while Pizza Inn bucked a challenging trend among sit down restaurants with a slight increase in same store sales.
RAVE’s stock traded much lower following the report, continuing a trend that started the afternoon before earnings were released. RAVE’s stock declined 15% in Tuesday’s trading session and this was followed by another 20% decline at the open on Wednesday morning, but the shares recovered much of that fairly quickly and ended up down only 7% for the day. We were surprised by the 15% decline the day before earnings were released and astounded by the trading following the report, as the numbers and commentary released with the quarterly earnings did not appear to justify a sell off at all.
Following Wednesday’s trading session, RAVE management held the first investor conference call in the history of the company. Management communicated many details regarding the company’s operations that helped investors to understand the story behind the numbers and we believe this will go a long way in helping bring more investors into the stock as operational results improve. Key takeaways from the call –
1) Pie Five Store Openings Will Accelerate – only six new Pie Fives opened in the reported quarter, but there are 8 scheduled to open in the current quarter and the scheduled openings will result in an accelerated pace of openings in 2017. No new corp. owned store openings unless fill in locations in DFW market.
2) Capital Needs – questioned about this, management indicated that the company has no long term debt and they do not intend to take on debt. Also, in being pressed on shareholder concerns about dilution if there are additional stock sales, management made it clear that there will be significantly lower capital needs going forward as the corporate owned store opening expenses, the costs associated with lease termination and other store closing expenses will not be a factor the remainder of the year which should the company to operate with much lower capital needs than what we saw in the current quarter.
3) Pizza Inn – continues to perform well in a difficult market. New stores opening are producing at much higher volume than the older locations, closings have all been the lowest revenue producers and this revenue impact has largely been offset by the new store openings. CEO Coleman indicated that the company would not lose sight of the potential and value of the Pizza Inn chain and they would continue to focus on maximizing that value while they work to fix the issues with Pie Five.
4) Online Ordering for Pie Five – management believes that online ordering fits well with the Pie Five approach and that it will eventually drive increased sales due to the convenience factor. This was introduced during the quarter at most of the corp. locations, it went live with the first franchisee group in Kansas City last week and it will be rolled out in stages over the next 3-4 months systemwide. We see this as a very positive development given the increased sales they believe to be directly attributable to online ordering that has been mentioned by several high profile fast casual chains and purveyors of pizza over the last few months.
5) Price Increase – did not seem to have a negative impact on traffic as Pie Five is still priced as the value offering in the space and management does not expect to roll out additional price increases in the near future as they see a growing trend of value consciousness among consumers.
6) CEO Search – company is being “appropriately patient”.
Overall, we felt the tone of the conference call was very positive despite the challenging trends with Pie Five and the fast casual space in general. Investors were provided meaningful color on the company’s operations and strategy and the fact that they held the call is a most positive development for shareholders. We believe this is clearly indicative of RAVE’s BOD and management making a meaningful effort to become more transparent and communicative with shareholders – Bravo!
RAVE Update –
Rave Restaurant Group reported earnings last week that fell short of expectations on the top and bottom lines. While we were expecting Q4 to be very challenging, we were surprised at the degree to which same store sales declined (-12%) and even more surprised at the size of the decline in average weekly sales (-14.5%). While the same store sales figures are entirely based on corporate locations, the average weekly sales figures include franchise locations and we expected the sales results from non corporate locations to have more of a positive impact that they did. While the figures released did not allow for that level of granularity, we believe that those AWS figures were most heavily impacted by the sub-par corporate locations, some of which were closed during the period. While RAVE management held up a slight same store sales increase at Pizza Inn as a positive, the overall tone of the report was quite gloomy given management’s outlook on the current quarter where they indicated that Pie Five “… continued to experience difficult sales trends” and “Many of the newer restaurants that enter the comparable store base continue to experience a decline in sales from their initial year, particularly in the case of those stores that opened with very high sales volumes. The Pizza Inn system’s sales trends have been flat in the current quarter.”
In summary, Q4 was very disappointing and management did not give shareholders much reason for optimism based on current quarter-to-date trends or really much of anything. While we believe that the Pie Five concept and the product offered there are very good and among the best in the space, RAVE stock continues to languish due to poor execution and what appears to be a leadership vacuum. While this is obviously reflected in the trading of RAVE shares as they have continued to hit new multi-year lows in the trading sessions since the release, we remain bullish on the long term outlook for Pie Five and RAVE based on the strength of the concept as proven by multiple successful franchisees whose revenues dwarf those produced by corporate owned locations. We also believe that the rising tide of strong valuations in the fast casual build your own pizza space will eventually cause RAVE’s valuation to be pushed higher as Blaze, MOD, Pieology and others continue to bring the concept mainstream and extend valuations that are already multiples of the relative valuation for RAVE’s Pie Five. Additionally, we believe that the valuation for RAVE has fallen so low that it may start to attract attention from non strategic buyers in addition to restaurant industry players looking to take down two demonstrably good concepts that appear to be valued substantially below their industry peers.
JRJR Update –
We continue to get queries from Groove participants about JRJR Networks. We believe investors should avoid JRJR for a number of reasons, the most obvious being that the 4th quarter of 2016 just started and the most recent financial data that JRJR has filed with the SEC covers only until the end of the 4th quarter of 2015. There is no good way to gauge where the company currently stands with regards to the fundamentals that determine whether the company’s stock is trading at a level that represents an attractive valuation and management has continued to issue stock at implied prices that suggest they see a much lower valuation than the market currently does. While the company did release some preliminary numbers for its quarter ended March 31, 2016, they still haven’t filed the 10Q for that period that was due by May 16 and the company is now just two weeks from the NYSE Mkt imposed deadline for filing that is necessary to keep their shares listed. If JRJR does not meet that deadline and moves to the OTCBB or Pink Sheets, we believe the stock would fall substantially from current levels. While we would like to believe that the company would go to great lengths to avoid that result, we also note that the company recently issued over 100,000 shares of stock to the holders of its 9.756% debentures to get a default waiver that would allow them until December 31, 2016 to file.
Additionally, we note that the company recently filed an 8k to warn investors not to rely on any of its quarterly filings in 2015 and that the Company’s internal control over financial reporting and its disclosure controls and procedures were not effective as of December 31, 2015 and all quarterly periods of that year. This calls into question JRJR’s financials going back to the beginning of last year, which could lead to lawsuits from investors who bought shares in reliance on those filings. Given the continued lack of transparency, the historical results that suggest the company will likely need to raise capital in the very near future and management’s demonstrable indifference towards the negative impact of dilution for current investors, we recommend that investors avoid JRJR if you do not own it and that Groove participants who still own the stock take advantage of the current $1.15 – $1.25 trading range to take their money off the table.
Remark Media Update –
We continue to be intrigued by the developments at Remark Media, though we are still unsure exactly how to value this company as it evolves into a very different animal than what we were originally hunting. The recent closing of the China Branding Group acquisition goes further down the path of growth in a direction that seems very different from the previous transformative acquisition (Vegas.com). As the company continues to pour resources into content and the development of the Kan Kan platform, the opportunity for growth appears to be enormous, almost to the degree that it is hard to fully grasp in the context of its being addressed by a company the size of Remark. While the dilution and material change to the company’s capital structure that has accompanied these acquisitions requires us to take pause in recommending that investors buy the shares, we do believe that Groove investors who still own “house money” shares may want to hold and watch to see how this develops.
Inuvo Update –
Great article on Inuvo out last week that has brought some positive attention. Much of the focus was on the transformative potential of Searchlinks. We agree wholeheartedly with this thesis generally and while the very low valuation makes it tempting, we are not yet seeing the traction from Searchlinks that we believe to be necessary to see the stock continue to rally significantly absent some additional catalyst.