CVSL- JRJR Networks and the Elephant in the Room
A very well written article by Hedge Fund analyst Henry Davies makes a strong fundamental case for CVSL’s (now JRJR Networks) potential as a ten bagger if future execution is in line with recent results, but shows how returns could be even greater if management returns the acquired businesses to industry standard margins. The article also shows how subpar execution that results in EBITDA margins at only 10% could make the current value as low as $2.59. The article is very thorough and does a great job of plotting the different valuation scenarios based on the differing performance metrics achieved. Also, I think the author also does a good job of making the case for JRJR chairman and CEO’s status as a whale in the direct sales industry, citing Mr. Rochon’s 92% IRR over 27 years through his Richmont Holdings investment vehicle. Such returns significantly outpace the long term return for most of the hedge fund managers usually tossed around in the whale watching discussions. So while the article does a great job of making the core JRJR case, it does not discuss the elephant in the room that many (including JRJR management apparently) believe to be the real reason shares have been mired in such a low trading range. It appears that right before the Agel executive departures mentioned in the article were announced, some very aggressive and somewhat sophisticated short sellers established a short position of just over 2 million shares. Around that same time, an unusual trading pattern emerged and since has been occurring almost daily – CVSL shares would trade higher on smallish volume all day long but then sell off in the last ten minutes of trading on volume that exceeded the volume of the previous six hours and twenty minutes combined in what appeared to be an attempt to push the stock back down into the red. CVSL/JRJR hired Share Intel, a “trading forensics” firm to investigate the situation, presumably due to the aforementioned factors and because its stock was continuing in a general downtrend in spite of demonstrable improvement in the operational performance of the company’s key divisions. We have discussed the hiring of Share Intel and some of these details in this forum previously, but one of our contributors wrote a nice synopsis over the weekend so we are including the highlights along with updated specifics on relevant share counts below.
CVSL had shown marked improvement in every major significant measurable including operating margins, number of active sales reps, balance sheet and most importantly, increasing quarterly revenue by 50% year over year with the expectation of a vastly improved bottom line. As evidence of these operating improvements trickled forth over the course of the last six months, the stock traded lower and lower, even down below $1 vs. the $6-$8 range it traded when the company was struggling so mightily earlier in 2015. So the company turned to Share Intel to get answers and a share imbalance in excess of 2 million shares was discovered through their investigation. In a recent conversation with CVSL chairman John Rochon, he made it clear that he believes share imbalance represents a naked short position, describing it as being established by “manipulators” and as being done offshore so it doesn’t show up anywhere except as an imbalance. But Mr. Rochon said that at some point the manipulators would have to prove that there is a borrow in describing what he called a “prescription” for curing the ills of naked short selling and he said further that there are a number of steps that a company with rational management often takes when they are under such an attack. Mr. Rochon mentioned a similar scenario that occurred when he was on the board of a smaller company (Youngevity – OTCBB: YGYI) that discovered a large naked short position had been established. While we can not say with certainty that the price increase that followed the discovery of that short position was driven by a naked short squeeze, we do know that the company implemented a few of the steps in this “prescription” and by the time the naked short position was covered, the little $5m revenue company with a $25m market cap had seen it’s market cap swell to nearly $800 million. While CVSL is 5x the size YGYI was then from a revenue standpoint, CVSL’s market cap is only slightly higher ($34m) than YGYI’s was when it discovered the large naked short position. In the weeks since our conversation with Mr. Rochon, CVSL has announced what appears to possibly be the first part of this “prescription”, as CVSL pre-announced a very solid top line range for Q4 2015 ($49-$50m) and also announced that the company will be changing its name, stock symbol and cusip number, steps that appear to be very similar to happenings that occurred in the lead up to YGYI’s enormous increase in price.
Reader’s should not miss that CVSL’s revenue pre-announcement suggests that the company is tracking on a $190m-$200m revenue run rate for 2016 if there are no additional acquisitions and we believe the prior quarter’s trend towards improving margins in each division could result in the company reporting its first profit in 2016. Absent the manipulation of a naked short seller, it is difficult to imagine how a company approaching profitability with a nearly $200m annual revenue run rate and enough cash on its balance sheet to buy back its entire public float at a double digit premium to current prices might find itself with a $35 million market cap. But that is where CVSL is currently trading and it will be interesting to see if the 2 million + share naked short position will be covered over the next few weeks as the DTC accounting and share exchange process gets underway.
Reported Short Interest per report of 1/29/16 – 265,000
Naked Short Interest per SI report of 2/01/16 – 1,950,000
Total Short Interest per reports of 2/01/16 – 2,215,000
10 Day Average Trading Volume as of 2/15/16 – 82,975
Trading Days to Cover if 100% Cover Transactions – 27
Trading Days Until DTC exchange Process (Expected) – 5-7
While Mr. Rochon never flatly stated that the company was going to make an attempt to squeeze out the naked short position, his manner of discussing the situation made it clear that he was more than a little perturbed and I would even say offended that speculators would target his company as a candidate for naked short selling. I was left with the distinct impression that the company would pursue every known legal means of eradicating a naked short position and that they might even develop a few new ones. With the trading volume drying up over the last few weeks and the 10 day average volume (as of 2/15/16) at 82,975 shares, any attempt to buy a significant number of shares in the projected 5-7 days before the DTC accounting and reissue process takes place seems likely to push the shares significantly higher. At that average daily volume, it would take 27 trading days (over 5 weeks) of 100% buy to cover transactions to cover the full 2,215,000 share short position. One would assume that normal buyers and possibly even short term momentum traders may attempt to buy shares during this period as well, potentially exacerbating an already illiquid situation. Altogether, this unusual set of circumstances should make CVSL/JRJR a very interesting stock to watch over the next few weeks. If the company’s steps do lead to a short squeeze, it will be interesting to see at what price the short interest will begin to cover and also if the frenzied buying that sometimes occurs in those situations emerges to push CVSL/JRJR to a price that is as out of whack on the upside as the current valuation appears to be on the downside.