It's Tough to be a Small Public Company

It's Tough to be a Small Public Company

by Scott Krisiloff, Avondale Asset Management

Each week we read dozens of transcripts from earnings calls and presentations as part of our investment process. Below is a weekly post which typically contains some of the most important quotes about the economy and industry trends from those transcripts.  Click here to receive these posts weekly via email.

This Week’s Post: A View of the World From Microcap Companies

This week’s post is a little different from usual because we spent this week at the LD Micro conference in Los Angeles. LD Micro is an bi-annual conference that is put together by Chris Lahiji and his team. He brings together a couple hundred companies with average market caps around $50m.  They do a great job.

Although we usually focus on larger companies, the LD Micro conference is always an enlightening few days. I think there is a general perception that if you’re a microcap company you’ve done something wrong, but there are still some very interesting stories and high quality management teams here each year. For instance, this week I met with a former CEO of Anadarko and a former Senior Manager from Abbot Labs. Each was running a company with a market cap lower than $30m.

There are certainly snake oil salesmen in the mix, but there are also people running these companies who have been extremely successful. The CEOs are often unpolished, but they are also scrappy, practical and often survivors. Many are multi-multi millionaires who have built their fortunes by traveling a road that was off the beaten track and hustling. Sometimes I get the sense that some of these CEOs are among the most gifted pure-businessmen that I encounter.

That said, I want to make it very clear that we are in no way shape or form recommending an investment in any of the companies that are mentioned below. We took most of these meetings at random and make no representations as to the quality of any of these companies in particular.

With that disclaimer out of the way, this week we take a peak inside Microcap land. It’s quite a trip.

The Macro Outlook: What is it like to be a Microcap company?

It’s tough to be a microcap company today

“Being a microcap is tough. There’s a perception that being OTC is not where up and coming companies are.” –Greg Cash, CEO BioSig (Medical Device)

Companies have to contend with a deeply ingrained stigma

“I think that bulletin board stocks are unfairly maligned. The accounting requirements are exactly the same” –Harold Montgomery, CEO Calpian (Payment Processing in India)

There aren’t a lot of investors interested in companies this size

“$2-10 million is a tough nut to crack. It’s a tough amount of money to raise. There aren’t a lot of investors looking to write that size check. You’re too big for private investors and too small for most institutions. It’s no man’s land” –Michael Oliver, CEO SpectraScience (Medical Device)

A lot of management teams voiced frustration with how government regulation has made it more difficult for microcaps

“Over-regulation has destroyed the microcap market. They’ve put all the small brokers out of business. They say it’s to protect the small investor, but then look what they allow, crowdfunding? Give me a break. It’s laughable, but it’s not funny.” –Harvey Bibicoff, Investor BG Staffing (Staffing Company)

Others recognized that this is just a part of life

“Regulations are a barrier to competition and they are a bigger barrier to smaller competition. But it’s like fish swim in the water. It’s part of who you are so you deal with it.” Michael Oliver, CEO SpectraScience (Medical Device)

So the question is, why be a public company at this size?

This is definitely the harder way to go, but many see it as the right thing to do to protect shareholder value

“There’s no doubt that this is the harder way to go, but it’s what’s right for the company, patients and shareholders” –Greg Cash, CEO BioSig (Medical Device)

“Maybe if I were 30 years old and needed the money to support my family I would raise money from a VC. I can see that. But if you want to do what’s right for the company and employees, and you’re comfortable in your personal finances, then this is the way to do it.” –Andy Khanna, CEO Sonasoft (Email Archiving)

Most said that VC and PE funds want to take too much control over the company

“I knew this was going to be a multi year effort and we would have lost control if we had been funded by a VC. In order to have the time necessary and keep the founders in control, being a public company was the best option.” –Bill Caragol, CEO PositiveID Corporation (Biotech)

“I’ve worked with Private Equity partners in the past, we know them well, but ultimately it came down to the fact that they just want to take too much of the company.” –John Seitz, CEO GulfSlope Energy (Oil Exploration and Production)

International:

Sam Wu, CFO of a US listed Chinese company, told me that the reason so many Chinese companies are listed in the US is that it gives them credibility at home

“being publicly listed in the United States creates credibility at home in China. The government trusts us more because we are a US listed company. It shows that we have strong financial backing and can finish a job with quality” –Sam Wu, CFO Yu Long Eco-Materials (Chinese Construction Materials Company)

Financials:

Richard Prati is a former investment banker.  He is now CEO of a medical device company. He talked about the differences between his old job and his new one.

“Wall Street has changed a lot, regulation has changed it. It’s not as entrepreneurial as it used to be. It’s not as fun. People are just focused on keeping their jobs, not trying to figure out how to build a company…in this, I get to wake up every morning asking how do I make the patient and customer’s life better” –Richard Prati, CEO Life Care Medical Devices (Private Medical Device co)

Gene Cartwright was a top manager at Abbott Labs and then GE. He moved to a struggling Microcap because he saw an opportunity. He shared some lessons that he’s learned about managing the finances of a microcap company.

“Never do a floating deal. You’re better off giving up something significant early on for a fixed price. And cut your burn rate–even further than you think you can. You’ll always be ok.” –Gene Cartwright, CEO Guided Therapeutics (Medical Diagnostics)

Domenic Penna worked for Diageo and then then moved to Teva Pharmaceuticals before ending up at a small Pharmaceutical company in Canada. He talked about the importance of analytical thinking.

“The difference between being a good accountant and a good analyst is that an analyst can see a story through the data. I always say, don’t give me data, give me information. Unless you can bridge the gap, you’ll be stuck as an accountant.” –Domenic Penna, CFO IntelliPharmaceutics (Pharmaceutical)

Consumer:

Leonard Mazur was responsible for a number of big consumer brands at Cooper in the 1980s. He helped build Oral B from $1m in sales to the largest toothbrush brand in the US. He shared his insights on marketing.

“It’s critical when you’re in a very competitive market, you have to be unique, you have to do something that makes people remember you. You’ve got to do something that gives you recognition and do it in a way that’s never been done before.” –Leonard Mazur, President Citius Pharma (Phamaceuticals)

Technology:

Peter Bloch is an “Eric Schmidt” figure to two bright young mechanical engineers in Toronto who are building a mechanical exoskeleton to help paraplegics walk again. He talked about the potential for robotics in Medicine.

“I believe that these products haven’t even begun to realize their potential in the market…engineering is important, but penetration is going to come from strong data” –Peter Bloch, CEO Bionik Labs (Medical Robotics)

Andy Khanna brings an old school mentality to a cloud based software company.  He talked about how they optimize the value of their engineering budget by hiring software engineers overseas

“We hire software engineers overseas, because you can’t find a software engineer in the US for less than $150k and you can’t afford that unless you’re financed by a VC. And then what ends up happening is management ends up owning 1% of the stock. From a quality standpoint we find that coding/testing is actually better overseas than here. What is lacking are design capabilities, so we do design here and then take it to where the skill-set is available.” –Andy Khanna, CEO SonaSoft (Email Archiving)

Healthcare:

There are a LOT of med-tech companies in the microcap space

Daron Evans and Jeff Baxter are two business focused CEOs with long term industry experience. Both stressed looking for base-hits rather than home runs as a med-tech investor.

“When you’re looking at a small company in the healthcare space, focus on whether you have a clear line of sight to a cash flow generating company. Focus on evolution, not revolution.” –Daron Evans, CEO Nephros (Medical Device)

“Focusing on unmet clinical needs, that’s BS, that’s not for small and mid-cap companies. You need to be pushing against an open door.” –Jeff Baxter, CEO VBI Vaccines (Biotech)

Doug Janzen also stressed going after base hits, but provided some pointers for investors who feel compelled to search for home runs

“Focus on products, things that you can touch. A scientist with an enzyme, that’s a concept, not a product. If you’re going to invest in biotech, look for products that have a huge benefit, not just some incremental improvement. Also, if someone’s in a sexy area of science, things will tend to roll down hill” –Doug Janzen, Co-Founder Aequus Pharmaceuticals (Pharmaceuticals)

Biotech companies have extremely long development cycles with uncertain outcomes. I asked Emanuel Bjorne for insight on what it’s like day-to-day to devote one’s life to a dream

“If you’re in clinical development, the work can be exciting every day. If you’re in pre-clinical development, it can be a bit like fighting a desert war” –Emanuel Bjorne, Corporate Development Director Hansa Medical (Biotech)

If you want to succeed as a biotech startup you have to be extremely disciplined about controlling expenses

“The key to success in biotech is to get really bright people together and make sure they have moderate, but not excessive resources. Biotech has to be lean, mean and rigorously focused. You have to bring scientific expertise together with good business expertise. Scientists will figure out a way to spend money if you let them.” –Jeff Baxter, CEO VBI Vaccines (Biotech)

Ultimately, everything comes down to the phase III trial

“The last trial is Phase III, this is to be or not to be. You know Hamlet? It’s like that.” –Rob Babecoff, CEO BiondVax (Biotech)

These management teams have everything riding on a highly uncertain outcome

“We have all our chips on the table. We’re all in.” –Jerome Jabbour, Chief Business Officer Matinas Biopharma (Biotech)

Not everyone is going to make it

“There is going to be some failure, there has to be some failure. That’s the history of science.” –Albert Scardino, Chairman ImmunoVaccine (Biotech)

Materials, Industrials, Energy:

John Seitz, who is the former CEO of Anadarko, shared his secret to success in oil exploration. The key is good people.

“The formula for success in oil exploration isn’t terribly complicated: Pick a basin where oil has been found, acquire all the data (seismic and well), put a highly experienced team to work on it and give them the time and support they need. In other words, get out of the way and it just works.” –John Seitz, CEO GulfSlope Energy (Oil Exploration and Production)

One CEO I spoke to talked about how the US should think more about the importance of manufacturing

“People are very interested in software today, but as my old boss used to say, it’s not a real business unless you ship things out the back door. I think it would serve the US well to think about that more often.” –Tom Steipp, CEO Liquidmetal Technologies (Injection molded metal)

Miscellaneous Nuggets of Wisdom:

Ironclad’s CEO sells a lot of gloves to oil and gas industry workers.  He reminded me that the strongest relationships can be built when customers are hurting.

“At this point in the cycle, that’s the time when you make friends” –Jeff Cordes, CEO Ironclad Performance Wear (Work Gloves)

Antonio Tremenino is a passionate Nicaraguan-born businessman. He shared insights on investing and on life.

“In moments of crisis and moments of success you need two things: stay healthy and stay focused” –Antonio Tremenino, Co-Founder ROI Land Investments (Land Development)

A. Paul Gill went from a government worker to mining tycoon when he made a 9000% return buying a discarded copper mine from Rio Tinto in the late 90s. He had some uplifting advice.

“Don’t let anyone tell you it can’t be done. It can be done. Buy low, build high” –A. Paul Gill, CEO Lomiko Metals (Graphite mining and processing)

Albert Scardino was a Pulitzer Prize winning journalist who made 22x his money investing in Canadian broadcasting rights and then even more in mining. He shared what he looks for in investments.  It comes down to people.

“I look for people, for people I can trust and work with. I don’t have a financial background, but I’ve found I can never get as much out of the financial statements as I can out of the people. I find that if you have the right people, you don’t have to worry as much because you trust them and can take them at their word.” –Albert Scardino, Chairman ImmunoVaccine (Biotech)

Full transcripts can be found at www.seekingalpha.com

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