Surviving in the age of monopoly

To say that we live in an era of giants would be stating the obvious.

Large companies have been growing larger since before today’s generation can remember. This is naturally to the chagrin of academics and progressive policymakers alike; one of many recent angry articles reads “Britain is over-tolerant of monopolies.” Whether this is true or not, change is probably as likely to come as Donald Trump is to remain silent after he leaves the White House. The facts are on the table: power, financial or otherwise, is concentrating in the hands of a few at the top. From Amazon hoovering up 49% of the US ecommerce market in 2018 to Uber gaining a mammoth 55% of the UK ride hailing and taxi market, large firms dominating markets has become an indomitable maxim.

The point of this piece is not to opine on the various drawbacks and positives of today’s market structures, but to identify where this shift to the top leaves an investor interested in smaller companies. What moat can be relied on when the Alphabets and Apples can plough seemingly unlimited cash and technical expertise into a sector? Which nails can remain intact when giants have infinite multi-purpose hammers?

Let’s go through some of the options.

Cash/Balance Sheet: No. The giants will certainly have more cash than the minnows. Even if upstarts can somehow outspend their competition, the resultant dilution and/or leverage would considerably weaken the investment case. Examples like Amazon famously bullying Diapers.com into submission are notoriously difficult to ignore, not only because they have recently become commonplace.

Contacts/Distribution Channels: This is a common so-called ‘differentiator’ touted by firms who, to me, do not really have many others. Large conglomerates are involved in many, many markets. They thus have deep and broad relationships across the spectrum. To me, distribution is but a temporary hurdle to overcome. It’s not “sticky” enough to be a durable defence. Superior contacts only persist so far as the product is superior or of comparable quality.

Brand Reputation: As with the previous factor, this will only persist so long as one actually has a superior, or at least similar quality product. BlackBerry used to have a great reputation for phones; good luck finding anyone who uses a BlackBerry now. Without product, the company’s ‘moat’ isn’t so much a moat as a ticking time bomb.

This brings me to the question: how can you maintain quality and thus market position as a small firm vis-a-vis your mammoth competition?

I see two ways, the first of which is relatively obvious and the second of which has become a key additional component of my investment process.

Patents/Intellectual Property: It’s hard for a large firm to compete on price when they don’t have a good product. A good way to ensure you have the best product (until it is replicated using another method) are patents.

Arm Holdings, which was taken over for $31.4bn in 2016 by SoftBank, had this. In fact, over 4500 of these (either granted or pending). That is a huge part of why it survived. Defensible intellectual property is more than a speed bump to giants, it is a closed road altogether. This is because they must start again at point A, and redesign the wheel just to get on the same level as the company with patented technology. One of my favourite holdings, a pharma company without pharma risk, 4d Pharma (LON:DDDD), has over 950 patents, the largest number in its sector. A robust defence indeed. But in my mind, not the only one.

Data: In my mind, the fifth factor of production. It could be easily argued that data is just as important as established factors like land, labour or capital (without enterprise, we wouldn’t have the whole shebang). Large companies cannot hold a candle to this, no matter how significant the cash and resources invested are. This is because data is a tangible manifestation of the time invested in a project. Small companies may have an abundance, because they got there first. Instead of or in conjunction with an intellectual property estate, this is a must to brave harsh waters. Again, two of my relatively large holdings provide good examples of where data can be useful:

Seeing Machines (LON: SEE): SEE‘s Guardian tech has logged over 5 billion kilometres of naturalistic driving data from its various customers. This is a hugely important resource to optimise their Human Factors technology: understanding from a driver’s facial expressions and movements whether they are drowsy, distracted or intoxicated. You just can’t be as accurate if you don’t have enough data to go on. This veritable moat helps them save lives: as the CEO Paul McGlone likes to say, “everyone deserves to get home safely”. In addition to this, it’s a huge reason a larger competitor can’t just swoop in and take a significant percentage of the global driver monitoring market.

DeepVerge (LON: DVRG): This is a company that has many different revenue streams, but for the purposes of this article Labskin is most relevant. It is “the only commercially available lab-grown, full thickness human skin model with entirely human collagen production for cruelty free skin testing.” In the words of CEO Gerard Brandon at an investor presentation, it is “ring-fenced by 13 years of data collection”. As with Seeing Machines, this is not something that someone can wake up someday and do. Optimising the technology needs real world application, which Labskin have done plenty. This is what cements it as not only a market leader now, but in the future too.

Let’s be honest with ourselves: the avenues for small companies to compete are closing. This presents significant challenges to an investor focusing on these upstarts. It is now imperative for them to crystallise their first-mover advantage; patents work, but so, crucially, does data. This is why, to me, data is hugely underlooked and just as hugely valuable to the investment case for small companies.

Without it (or patents), you are at a large competitor’s mercy. With it, you can get that rare one up on today’s Goliaths.

Diversifying into pharma

It’s not often that I’ll buy a share that’s up over 400% from where it was just 6 months ago. It’s even rarer that I’ll speculate in pharmaceutical companies, so notorious for having success or failure contingent on a lone trial. On first glance, I would be sorely against spending hard-earned money on such a company, let alone an AIM-listed one.

But if even the best of us can eat our words, who am I to not U-turn every so often?

As part of my move into smaller companies with more asymmetric risk-reward ratios, I’ve been searching for undervalued businesses that could grow into the type of company lauded as an AIM success story. On this quest I’ve taken a deeper look into 4d Pharma (LON: DDDD), a company that, while certainly on the up, has not yet hit the stratosphere like I hope for. Let me be clear: a look at the financials alone does nothing to back up my statement. For a company with an almost £200m market cap, paltry revenues of £0.21m in the financial year to 31 December 2019 do not give my theory much credence. Let me show you what does.

DDDD (what a mouthful!)’s USP is that it specialises in the use of non-engineered single strains of bacteria, originally isolated from the gut microbiome of healthy human donors. Strains of bacteria are then chosen to treat particular diseases, ranging from cancer to COVID-19. The benefits of this “Live Biotherapeutics” approach are perhaps best explained by the CEO himself:

“Live Biotherapeutics as a new class of drug have a number of advantages over traditional therapies. As living bacteria, LBPs produce multiple products, proteins and metabolites, and as a result have ‘poly-pharmacy’ effects, able to hit more than one target simultaneously.  For this reason, Live Biotherapeutics may be able to address multi-component diseases where previous approaches have failed. This includes Parkinson’s disease, cancer and immune-mediated diseases.

The perfect drug is both safe and effective; Live Biotherapeutics, by definition, are expected to meet the safety criteria, and we are currently demonstrating efficacy through our clinical trials. This safety profile significantly accelerates the development pathway, allowing us to go from discovery to clinical proof of concept in as little as four years, much faster than traditional drug types.”

It reminds me somewhat of stem cell treatment, which can be modified to treat a wide variety of ailments. From this, 4D appears the Swiss Army Knife of pharmaceuticals. Although, who would invest based on the words of a small-cap CEO? (without substantial proof of concept backing them!) Of course, we as even vaguely prudent investors need more than that.

I now direct you to their prospective treatments, of which there are no less than 16. If any one of these pass any of the regulatory hoops all the way to Phase 3, the current £187m market cap is a mere fraction of fair value. Take the Irritable Bowel Syndrome (IBS) treatment, currently in a Phase II trial. With the market for IBS treatment set to reach $1.5 billion by 2023, and with no treatment as of now tackling the problem’s source, we can easily see the potential. Combined with their so-called largest intellectual property estate in the microbiome sector, with granted patents in the US, across Europe and globally, with over 400 patents, this could be a future source of recurring cash flow for 4D.

What’s more, investors are circling, just not so much in the UK. 4D competitor Seres Therapeutics currently boasts a $2.48 billion market capitalisation, a potential sign of what to come if even one of the 16 therapeutics listed above receives regulatory approval.

Finally, from a balance sheet perspective, the fact that a July equity placing raised just over £7m to strengthen the company’s liquidity position mitigates the risk of further placings in the near term. If a fund raise does occur in the future, in my opinion it likely will be accompanied by a potentially transformative piece of news that can send the market capitalisation into the billions (if it isn’t there already! With risk diversified across treatments in an innovative new sector, I find the investment to be a potential multi-bagger (even if I wish I got in a little earlier). Let’s see if my entry price of around 125p a share looks downright cheap in the future!

Disclaimer: All content provided on Shrey’s Notepad is for informational purposes only. The owner of this blog makes no representations as to the accuracy or completeness of any information on this site or found by following any link on this site.

The owner of Shrey’s Notepad will not be liable for any errors or omissions in this information nor for the availability of this information. The owner will not be liable for any losses, financial or otherwise, injuries, or damages from the display or use of this information.This article does not constitute financial advice in any way, shape or form.

I currently hold shares in 4d Pharma (LON: DDDD). 

Trash to cash?

Would you invest in a company that could turn trash to cash?

I have to make two apologies straight away here, the first of which is to my British readers for the Americanism, and the second of which is for generalising. Of course it would depend on whether another company could do it more cheaply, profit margins, and so on and so forth. The broad point stands strong, though: at first glance, it sounds like a business model with legs.

Recently, I’ve come about a company that does just this: EQTEC (LON: EQT). The Irish minnow specialises in gasification, a process that converts biomass to combustible gas, namely producer gas, or syngas. This is itself a fuel and can be used for a variety of applications, generating, for example, heat energy in the industrial sector. To me, the share price has a significant way to go from here on a relative value basis (compared to rivals such as PowerHouse Energy) and also of its own accord. This is because it has secured multiple projects and because its technology is proven to work and is already operational.

Their projects include one at Billingham, where it partnered with the energy company COBRA for the 25 MW £150-180m project. This looks to be a headline cash cow in the future. There also exists a proposed “1.18 MW net biomass gasification power plant project in Gratens, France”. All of this, of course, is in addition to their numerous Spanish projects, including Movialsa, that have already run for over 111,000 hours without major issue. Despite these developments, the market capitalisation remains at a measly £33.37m as of 13 August 2020!

Of course there has to be a reason for pessimists to justify the low valuation, and in this case it is the financials (mostly). The company is still loss-making, which may turn off some prudent investors. What I would say in response is that a recent equity placing to the tune of £10m leaves the company fully funded. Moreover, Align Research projects the company to reach profitability in FY2021, with a €5.39m pre-tax profit.

A caveat to this is that should the company not reach this optimistic projection, we as (hopefully!) diligent investors should not fret. This is, of course, so long as the company continues to expand its list of potential projects and memorandums of understanding, with significant signs of converting these leads to hard cash. I, personally, can stomach free cash flow a few more years into the future so long as it is worth the wait. After all, the world’s central banks seem determined on keeping that risk free rate as low as possible, so future cash flows are still highly appetising.

At a broader level the global waste-to-energy market is projected to grow by $12.26b from 2020 to 2024. Covid-19 is poised to turn the wheels of ESG revolution, which brings companies like EQTEC all the more to the forefront globally. Though the sector is growing and, in my opinion, will grow for a long time into the future, investors haven’t yet been too keen to agree with my prognosis. PowerHouse Energy, a waste-to-energy company with, to be kind, many fewer projects in action, is currently valued at a lofty £121.27m on the Alternative Investment Market. I believe EQTEC’s proven technology, strong deal flow, and cash at hand position it to close this valuation gap, and to grow as the market grows. It’s why I topped up on my initial position a few months ago.

Though I initially purchased at 0.18p, which looks like a downright steal today, it is my firm belief that EQTEC has much further to go, and for a 3-5 year investment (at least!) it presents an extremely strong investment opportunity. You don’t often see a green tech company’s potential pre-tax profit five years down the line exceed its current market capitalisation.

Of course, tailwind risks do include further dilutive equity issuance (although if this is to fund more projects you might even be grateful for it). In addition, EQTEC partners with China Energy for the Billingham project. If you’re of the persuasion that Western governments will rip off the China band-aid (or, to be more accurate, the full limb), you may have your reservations about this. EQTEC is also facing a lawsuit from Aries Clean Energy LLC in the US for patent infringement (though EQTEC has denied this in the strongest possible terms and I, personally, find it an opportunistic and baseless claim).

If you find yourself disappointed by the line of risks, it’s the reason why I’m remaining cautious with this investment (it doesn’t take up nearly as large a share of my portfolio as Seeing Machines, for example). AIM investing is a rollercoaster and it’s inevitable that you’ll sit through a few peaks and troughs trying to find the diamonds in the rough. But with EQTEC, a company that quite literally is the future, I’m willing to endure them.

Disclaimer:
All content provided on Shrey’s Notepad is for informational purposes only. The owner of this blog makes no representations as to the accuracy or completeness of any information on this site or found by following any link on this site.

The owner of Shrey’s Notepad will not be liable for any errors or omissions in this information nor for the availability of this information. The owner will not be liable for any losses, financial or otherwise, injuries, or damages from the display or use of this information.This article does not constitute financial advice in any way, shape or form.

I currently hold shares in EQTEC (LON: EQT). 

 

Does technical analysis actually work?

Photo Attribution-ShareAlike 4.0 International(CC BY-SA 4.0)

Many traders have claimed to use technical analysis to guide their forecasts and hence make money on the financial markets using this method of analysis, however in this article I will actually argue my case against it. But firstly, what does it actually mean?

Technical analysis essentially entails the use of past price information to predict future price movements. For example, a basic (albeit crude) way to use technical analysis would be to say that if Stock A has currently established a support level of $25 a share over a period of, say, a few months, and today it reaches that level again, but breaks it, dropping to $24.50 a share, then that is a bearish signal on Stock A in the near term future. To me, the first problem with this is that you ONLY use price to inform your trading decisions.

The theory of value investing can give us a valuable lesson to relate to this point – human beings are irrational and hence the market does not always accurately value different companies. For example, during the euphoria associated with the early stages of the dot-com bubble Pets.com shares rose to a high of $14, with the company becoming defunct not even one year later. Such behaviour is indicative of the fact that share price does not always tell the full story of a company’s basic fundamentals, and simply trading on technical indicators is to rely on human emotion rather than solid fundamentals, which is a recipe for potential losses. This illustrates the first deficiency of technical analysis: the fact that the share price of a company is not the sole indicator of its business fundamentals.

However, a counterargument to this point would be that it is indeed possible to use technical and fundamental analysis in tandem to achieve profitable results. While this may be true, it’s interesting to question how much of this profitability is down to the technical analysis itself, and how much is down to just luck. Technical analysis is fraught with ambiguity; different methods of technical analysis have been seen to be contradictory to each other and, moreso, applying different methods of analysis to different financial instruments can possibly yield the same result. There is little room for nuance or financial instrument-specific related analysis actually related to the company or currency pair (for example) itself. This is surmised well in a quote from Warren Buffett, where he says “I realised technical analysis didn’t work when I turned the charts upside down and didn’t get a different answer.” Much of technical analysis is also based on human psychology, which renders it increasingly invalid given the increasing prevalence of algorithm-based trading strategies in the financial markets.

Moreso, arguably for technical analysis to work in analysing different financial instruments an implicit assumption is that traders and investors have perfect information about the underlying instrument being traded. To falsify this, let’s use a case study:

Volkswagen AW

On the 21st of September, 2015, the first trading day after which the Environmental Protection Agency (EPA)’s Notice of Violation to Volkswagen (VW) was made public, the share price of Volkswagen AG fell by 20% on the Frankfurt Stock Exchange. Hence, all forecasts of this share price before the EPA’s announcement based on technical analysis were either completely wrong, or simply correct due to pure chance. While, indeed, fundamental analysis would have also been unable to predict this happening, the 24.7% decline in sales of Volkswagen vehicles in the US in November 2015 from November 2014 at least provides a fundamental indicator of a potential impact on VW’s bottom line, which share price (although it may have done in this case) is not at all guaranteed to do, as there may be other, external influences on the share price that cloud the impact of this scandal.

To conclude, in my opinion technical analysis is a flawed method of analysis of financial market instruments for three main reasons, the first of which is that price does not always reflect all information freely available. In addition to this, the fact that the analysis leaves little room for financial instrument-specific related nuance and also that there may be other information which is not freely available and thus not reflected in, for example, share prices, discredits the notion of technical analysis as a feasible method of analysing the financial markets. Although many traders claim to have successfully traded the financial markets using technical analysis, for the reasons mentioned above I personally do not find technical indicators worth the time compared to fundamental indicators.

Sorry for not writing for so long – public exams really took my time away!