A dummies guide to spotting a PUMP AND DUMP on AIM

Anyone who has seen The Wolf of Wall Street movie will be familiar with Jordan Belfort (played by Leonardo de Caprio) and his exploits in ‘pump and dump’ boiler room scams involving US Penny Stocks. The movie is sadly based on a true story which took place in the late 80s and eventually let to Mr Belfort’s downfall, rewarding him with a 22 month custodial sentence for his scheming. The events may have taken place some time ago but the sophistication of these schemes has not changed much in the almost 20 years since, these schemes are very much still alive and kicking on many international markets, including the UK’s AIM market.

wolf-of-wall-street-48

A SUMMARY OF THE AIM PUMP AND DUMP

The AIM pump and dumps come in all shapes and sizes, from the well organised boiler room scheme scams to a very loose and decentralized pump. Many of the ‘pump and dumps’ now operate exclusively online rather than through the traditional cold calling method used during Mr Belfort’s heyday in the late 80s. I will focus today on the typical social media promoted ‘pump and dump’, which tend to be low level and unsophisticated, but that is not to say significant financial loss does not occur. The typical schemes have some some or all of the following symptoms and follow a certain pattern:

Which companies are targeted for the pump and dump?

Some market commentators tend to exaggerate the extent to which stocks are pumped and dumped on AIM. It is actually a very small minority of the 973 companies quoted on AIM. My own experiences would suggest there are only a handful of stocks under the complete control of the P&Ders at any one time. These stocks though are almost always micro cap ‘penny stocks’, i.e. stocks with a market capitalisation of less than £30m. This tends to mean that with limited shares in existence that the price will jump quickly with any liquidity.

The other criteria is a stock in a sector which lends itself to speculation, this means junior resource stocks, junior biotech and other blue sky technology stocks. These sectors are the ones that capture the imaginations of gullible private investors, the ‘willy wonka’ effect where investors dream of the hallowed ’10 bag’ i.e. returning 1000% or 10x your initial capital. Two recent stocks that fell victim to these schemes were African Potash (Booted off AIM to the limited liquidity ISDX market) and Cloudtag (Booted off, private and I would guess soon to be in liquidation). There typically also usually needs to be expected news flow to drive interest and speculation.

Stage 1 – The Pump Takes Hold

It usually starts by one or a few experienced ‘pumpers’ purchasing stock in a company. The experienced pumpers will have a large following on the bulletin boards and increasingly also on twitter. The pumper will normally go by an ‘alias’ and often have pictures of flash cars, money and other tacky photos as part of his/her profile avatar or wallpaper. You can spot them a mile off.

The pumper will write confirming they have bought the stock and usually post some ludicrous claims about the company concerned. I will invent one, company XXX:

Screen Shot 2017-04-21 at 15.34.15Rocket emoticons or a similar GIF is normally posted for dramatic effect.

The statements usually have some ‘tie back’ to official company news. For example, the 1bn barrels could be the gross oil in place and this figure multiplied by current oil price gets to £100bn. The pumper has though conveniently forgotten the resource recovery factor, the CAPEX needs, the OPEX and critically that the company XXX owns just 10% of the licence, let alone commercial chances of success for this pre drill prospect.

The other method is to quote ‘a rumour in the city’ to imply they have inside knowledge, which may or may not be true.

Stage 2 – The Pump is Maintained

The next step is for ‘Sub Pumpers’ to join in, they have probably already had reasonable success on other stocks just hanging off the coat tails of big pumpers. Sub pumpers will typically have a reasonable following too, perhaps 300 or so followers on twitter. They will also use rocket emojis…

Screen Shot 2017-04-21 at 15.35.34A common tactic of sub pumpers is to outline how difficult it is to buy shares, comment on the Buy price being about to move up based on the Level 2 order book or they might instead post charts prophesying how the share is about to breach a key resistance level. This plays on the human phycology that you are about to miss out on the golden ticket. Simple but very effective.

These posts may also be genuine and relate to good shares too, so it is not always easy to sort the wheat from the chav (chaff). The surefire way though is to ensure ‘sceptical’ is always your default mindset when investing in small caps. For example, the easy way to test whether it is indeed difficult to buy the share is get a quote on the stock from your broker, don’t go in blind. IG Stockbrokers are particularly good as they allow you to get quotes from the market makers irrespective of whether you have funds in your account. Try obtaining a £10,000 BUY and SELL quote. It is normally very easy to buy these stocks at any level but very hard to sell with any size. This implies there is limited real demand for the shares and sub pumper is lying.

Stage 3 – Peak Pump is reached

Once critical mass is gained a whatsapp or twitter private group will typically be created where all bulls will be invited to join. This is where naive and inexperienced investors begin to think they have the golden ticket, as in these forums they will only hear as to how fantastic the company’s prospects are. As a result they begin to tell the ‘offline’ friends, family and may even place large sums of their savings into the share. Significant volume is generated which can see sometimes 10-100x the average volume of shares changing hand in a day.

The bears will beginning to take note at this stage too, this includes experienced bearish investors such as Waseem Shakoor, Tom Winifrith, Gary Newman and many others. These guys usually highlight the flaws, or in the case of Waseem declare a short position. At this point the pumpers and ordinary investors who have far too much at stake will become aggressive and attempt smear campaigns. Any bearish posts will usually be reported on bulletin boards or twitter. This combined with ‘bulls only private groups’ means it is very difficult to receive any bearish commentary on the stock on question. At this stage the stock is likely to have achieved a valuation well in excess of fair value. This is the final stage of the pump and now it we are ready for…

Stage 4 – The DUMP.

The typical catalyst for the dump will be some sort of funding, usually a heavily discounted placing or other quasi equity issue. The price may have already come off a little ahead of the announcement as some participants in the placements (which may even be the same original pumpers) forward sell stock (sell stock with a delivery date in the future).

The dump can be horrific, for example the CloudTag Pump and Dump, dropped 40% on the day when the financing was announced. Those investors who bought into the Pump late could be nursing extreme losses over a very short period of time.

Once denial is overcome the usual reaction will be anger towards the various stakeholders in this order 1) The bears, 2) The board and 3) The broker. The individuals who actualy pumped the stock don’t get much flack. Quite often a lot of the social media accounts disappear often after the dump has landed and the cycle just repeats again…. Same tactics, different stock…..

REFLECTIONS

Pumping is grey area, how is it defined?

There is often a grey area with stock promotion, particularly for those in wave 2 or 3 of the pumping. The acid test for market abuse is ‘deliberate dissemination of false or misleading information’.

The issue is that some involved in distribution of information on bulletin boards and twitter might well believe what they are writing. The FCA Market Abuse Regulation does though not require the person engaging in such market abuse to actually intend to commit market abuse, however the FCA does define the below in MAR 1.8 as a factor to be taken into account in determining whether behaviour amounts to dissemination:

A normal and reasonable person would know or ought to have known in all the circumstances that the information was false or misleading, that indicates that the person disseminating the information knew or ought to have known that it was false or misleading.

It is though natural to be bullish on the stocks you own, I post positively about the stocks I own on twitter and on my own blog. The difference between blogers and other commentators such as I and the pumpers is that I genuinely believe in the investment case for the stocks I own and make considerable effort to verify what I post. I also have a financial background and post a transparent history of all my tips. On top of this I also outline the downside risks and make it clear to followers that this is not a recommendation to buy.

The FCA is not prescriptive on what is ‘false’ and ‘misleading’ but I believe the following factors are likely to be relevant if a case is bought:

  1. Posting content which you know to be false or misleading, which are deliberately designed to to make profit. As mentioned above.
  2. Correspondence proving intent to create a flase market. e.g. emails showing collusion between ‘pumpers’ and other documentation showing an organised ‘effort’.
  3. Your ability to impact the share price. If you have a significant following on social media or twitter then you have a higher degree of responsibility to verify your content in my opinion. Also important is the size of the company, with my 700 or so followers on twitter I can pump a FTSE100 company all day long, but it would not have a material impact on the share price. This does not make that activity moral though, as it still has the ability to cause financial loss to others.
  4. Selling your position whilst encouraging others to buy. It is natural to derisk some positions but to sell a large proportion of your holding substantially around the same time as promoting the share could be decisive factor as provide evidence as to whether there was an intention to make profit from the ‘false and misleading’ information or whether you had a genuine belief of the company as a long term investment.
  5. The level of financial gain made.

So Surely Convictions every week then?

Sadly there are limited convictions for ‘pumping and dumping’ on AIM. The FCA has limited  resources and simply does not have the time to investigate every case and naturally focuses on the market abuse at the higher end of the scale.

Unfortunately the best you can do for now is raise awareness of the ‘pump and dump’, which is the reasoning behind this blog post.

Are the companies concerned complicit?

There are four types of companies who find themselves those on the end of a pump and dump.

  1. Those directly responsible.
  2. Those indirectly responsible.
  3. Those who tolerate it.
  4. Those who extinguish it.

At the bottom end of AIM it is one of the CEO’s key roles to be able promote the company to enable it to raise money. The company leaking inside information directly to stock promoters is extremely rare though, two cases centre on African Potash and Cloudtag where both have been accused of lying in RNSs and therefore creating a false market. The information in these cases, if proven, also relates to deliberate dissemination of false information, albeit this is via the company directly rather than through a boiler room scam or a ‘pump and dump’

A source of inside information can also be from the city advisors of the company, i.e. indirectly. The broker arguably has the biggest conflict of interest in this context, they have an incentive to generate volume to enable the company to raise finance, and take a hefty commission as part of that process. This is of course is not sanctioned by the broker as a corporate but individual sales traders can lack the integrity and leak select information to known stock promoters.

Many companies tolerate the pump and dump, a single day pump and dump occurred on Fitbug where the company released a non regulatory news release (see article for details) which led to pumpers to propel the price to 550% in a single day. Rather than FITBUG immediately extinguishing and clarifying the news the company allowed the shares to trade most of the day before the NOMAD towards the end of the day pulled the plug and forced a clarification. The company followed up with a fund raise the following week on the back of this volume.

Some companies though immediately issue ‘speeding tickets’ when the share price rises on the back of no news – the right thing to do. Unfortunately though this is fairly rare and companies often let the share price get well ahead of fair value before taking any action.

Is this a victimless crime?

No. Some individuals recklessly promoting or pushing stocks on social media do not believe they are committing a crime. Ultimately though, selling stock in a false market to another punter is not a victimless crime. I don’t deny riding the momentum created by a ‘pumper’ can make you a lot of money, but there will always be someone left ‘holding the baby’ and the process is ultimately transferring wealth from the ‘Mugs’ to the ‘Pumpers’. For example, according to posts on bulletin boards some individuals who bought stock in Cloudtag at peak ramp have lost entire life savings. Think about that for a moment…

SUMMARY

The last year has seen some incredible gains on some small AIM stocks and whilst some of this has been as a result of renewed sentiment towards junior resource stocks on the back of a recovery in commodity prices, some I believe is as a result of an increase in the ‘pump and dump’ method.

Hopefully this piece though has given you an ability to spot when a stock is in the midst of a ‘pump and dump’. It should equally give you some insight into what is Market Abuse so you don’t inadvertently become a pumper yourself.

The pump and dump is not a victimless crime, it is a transfer of wealth from naive new investors to experienced pumpers.

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CloudTag – Why delaying the L1 conversion RNS could be a major issue

Disclaimer: Shareinvestors is not authorised by the Financial Conduct Authority to give investment advice. Terms such as ‘Buy’, ‘Sell’ and ‘Hold’ are not recommendations to buy, sell or hold securities, these statements and other statements made by the author have the meaning only to express the author’s personal views on the quality of a security. Independent financial advice from an authorised investment professional should always be sought before making investments. CAPITAL AT RISK. Full Disclaimer here.


Yesterday I wrote here about the suspension of Cloudtag shares and commented on what I considered to be breach of Cloudtag through delaying the release of the Conversion Notice from L1 by 48 hours. There has been subsequent debate on social media whether Cloudtag is in breach or not.

In my view there is a clear moral breach, but let’s look into the regulations which cover CloudTag. The first question is whether the RNS was inside information, i.e. information which is price sensitive to the trading of CloudTag securities. The issue of 19m new shares represents around 5% of the current shares in issue so this is clearly material and price sensitive. There are also 19m warrants issued, these are currently in the money and represent a further 5% of the share capital. Let’s just follow this through to the end though for complete avoidance of doubt. Only information which is price sensitive should be RNSed and the company goes a step further in the RNS (as is required by law) to put the issue of ‘inside information’ beyond avoidance of doubt:

This announcement contains inside information for the purposes of Article 7 of EU Regulation 596/2014.

What is article 7 then? This relates to the Market Abuse Regulation (MAR) relating to EU regulated markets. As Cloudtag has shares traded on AIM it must comply with these rules. The MAR sits on top of the FCA DTR rules and the FCA handbook has been amended to include these rules. Let’s start with the golden rule on inside information as follows:

[There should be] prompt and fair disclosure of relevant information to the market [DTR 2.1.3]

There are though valid reasons when inside information can be delayed, the FCA handbook refers us back to EU regulation , which states:

[there are] cases where immediate disclosure of the inside information is likely to prejudice the issuers’ legitimate interests [Article 17(4) of MAR]

The ‘issuer’ in this context is Cloudtag and ‘legitimate interest’ is taken to mean something that is commercially sensitive or requires regulatory approval. There is no commercially sensitivity here as far as I am concerned, the conversion is based on an agreed contact which is in the public realm. The EU (useful for something then) have made a list of examples. I won’t copy them all down here but you can read them yourself, I can’t see how Cloudtag can meet any of them and thus has no excuse for delaying this RNS. Indeed is this why the shares were suspended by AIM?

Examples of when the FCA may require the suspension of trading of a financial instrument include:

  1. if an issuer fails to make an announcement as required by the Market Abuse Regulation within the applicable time-limits which the FCA considers could affect the interests of investors or affect the smooth operation of the market [DTR 1.4]

I also note an interesting article on ShareProphets which questions whether Cloudtag actually has authority before the EGM on Monday to issue the full 19m shares. This could be the reason for the delay, i.e. trying to sort out the mess. However, a holding statement should have been put out immediately after hours on 7th December or at 7am on 8th December with perhaps suspending the shares until the situation was clarified. I’ll get to my summary soon but just to kill a red herring which is doing the round on social media:

Red Herring

A lot of people have quoted DTR 5.8.3 on social media to claim that Cloudtag has acted appropriately.

The notification to the issuer shall be effected as soon as possible, but not later than four trading days in the case of a non-UKissuer and two trading days in all other cases, after the date on which the relevant person:

  1. learns of the acquisition or disposal or of the possibility of exercising voting rights, or on which, having regard to the circumstances, should have learned of it, regardless of the date on which the acquisition, disposal or possibility of exercising voting rights takes effect; or
  2. is informed about the event mentioned in DTR 5.1.2 R (2).

I am fairly sure this is a red herring and governs the ‘person’, i.e. L1 Global Fund in this case notifying ‘issuer’ of securities CloudTag. Once this notification was made to CloudTag it became inside information, which should have been released without delay in accordance with the above rules.

What about AIM rules? How do they interact with MAR/FCA DTR?

Cloudtag is listed on AIM and thus must also comply with these rules. Compliance with MAR does not mean that an AIM company will have satisfied its obligations under the AIM Rules, just as compliance with the AIM Rules does not mean that an AIM company will have satisfied its obligations under MAR. However, AIM is pretty clear though:

An AIM company must issue notification without delay of any new developments which are not public knowledge which, if made public, would be likely to lead to a significant movement in the price of its AIM securities [AIM rule 11]

Summary

Cloudtag allowed its securities  to open on December 8th at 15.25p, 2.5x greater than the L1 exercise price. Shareholders were unaware at this point that dilution by upto 10% was already in motion. This is a false market and potential evidence for market abuse. In my reading of the MAR and AIM rules I can see limited grounds for delaying the Conversion RNS. The market should have been notified and if Cloudtag were not in a position to do so the shares should have been suspended pending clarification on December 8th 7am.

I believe it could well be that the NOMAD is spending the weekend with Cloudtag getting to the bottom of this. I hope all works out for those locked in, even if my assessment is wrong those invested should ask themselves whether they are comfortable with the way this RNS has been dealt with?

Disclaimer – I have no positions in this stock and to my knowledge nor do any close family, friends nor associates. This post is purely my opinion and should not be taken as financial advice. I welcome any alternative comments and will consider adjusting posts based on information made available to me.

CloudTag – A nervous weekend for longs and shorts.

Disclaimer: Shareinvestors is not authorised by the Financial Conduct Authority to give investment advice. Terms such as ‘Buy’, ‘Sell’ and ‘Hold’ are not recommendations to buy, sell or hold securities, these statements and other statements made by the author have the meaning only to express the author’s personal views on the quality of a security. Independent financial advice from an authorised investment professional should always be sought before making investments. CAPITAL AT RISK. Full Disclaimer here.


wrote about Cloudtag earlier in the year and called this out as a SELL at the time. I was almost 100% down on my SELL call at one stage this autumn, however since then a very interesting financing arrangement has been entered into by Cloudtag. There has been some very good coverage of this agreement at Share Prophets so I won’t go over this again. However this financing agreement has seen the shares drift down from 20p at the October peak down to below 6p at the start of the month. This week though they exploded into life again jumping 166%, from 6p to 16p. After falling back somewhat again after two mid week ‘speeding tickets’ an announcement was made by AIM today that Cloudtag shares were suspended with immediate effect. Full text:

Trading on AIM for the under-mentioned securities has been temporarily suspended from 9/12/2016 3:26pm pending an announcement.

Speculation reached a frenzy on social media whereby everything from a Joint Venture with a Chinese mobile phone company to the Serious Fraud Office kicking CloudTags door down was speculated upon.

A hint may have been given though right at the close of the RNS day, a conversion notice was received in respect of the convertible loan notes as follows:

CloudTag (CTAG:LN), the company that brings personal monitoring to the wellbeing, fitness and digital health markets hereby announces that after market closing on 7 December 2016 it received a notice of conversion in respect of £1,150,000 of Tranche 1 Notes (based on the nominal value of such notes) issued to L1 Capital Global Opportunities Master Fund (“L1”).

The conversion of £1,150,000 of Tranche 1 Notes at a conversion price of 6.0 pence per Conversion Share (“Conversion”)

The plot thickens, Cloudtag has been sitting on this information for 48 hours, the notes were converted at 6p and yet the stock was allowed to open on December 8th at 15.25p, 2.5x greater than the L1 exercise price. L1 has made a killing here but that is not the primary issue actually even though it feels so immoral, 19m shares are to be issued as part of the conversion, i.e. almost 5% of the total shares in issue. This is a material amount and under AIM Rule 11 the market should have been notified immediately, i.e. as soon as Cloudtag knew – i.e 8th December 7am. Many questions, why did it take 2 days to notify the market? Was this deliberate or something more sinister? Is this connected to the suspension of the shares? It is very interesting to note an EGM on Monday morning (12th December) where resolutions are put forward to increase the authorised share capital to allow for further tranche of the convertible to be issued.

So Is there a connection between the conversion and the suspension?

My feeling is yes, but we will need to wait until at least 7am on Monday. Shares are generally ‘suspended pending an announcement’ for breaches of AIM rules or in order to comply with AIM rules, i.e. NOMAD quitting, directors quitting or an activity constituting a RTO. Another reason is potentially a credible leak of information which needs clarification, i.e. to prevent ‘those in the know’ from profiting. Any other price sensitive information should be released via a standard RNS and should not require a suspension. So why the suspension in this case? For the bears – In the case of cloudtag there have been a number of well documented Red Flags and the NOMAD could have decided to go if it feels it can’t act for Cloudtag. For the bulls maybe not – there is a new product launch due in a week, could it be that product details may have leaked?

I would probably land on the former rather than the latter, if the announcement relates to the product I would have thought a holding statement would have been put out. Why make shareholders suffer over the weekend? Also twice this week Cloudtag has stated in RNS that it is aware of no further news not in public realm. Bearing in mind most of the City is getting lashed at Christmas parties around EC1, it must be something very significant. That said I wouldn’t be popping the champagne if I was a short just yet either.

Cloudtag is an immensely popular retail stock and I hope genuine holders do not get burnt, especially so close to Christmas. One thing for sure this whole episode promises to be nothing short of a pantomime.

Final point just for information; here is the fate of the last 5 companies where an unexpected AIM ‘pending an announcement’ RNS has been put out…

picture1

Disclaimer – I have no positions in this stock and to my knowledge nor do any close family, friends nor associates. This post is purely my opinion and should not be taken as financial advice. I welcome any alternative comments and will consider adjusting posts based on information made available to me.

CloudTag – up over 500% in 2016, are investors heads in the cloud?

Disclaimer: Shareinvestors is not authorised by the Financial Conduct Authority to give investment advice. Terms such as ‘Buy’, ‘Sell’ and ‘Hold’ are not recommendations to buy, sell or hold securities, these statements and other statements made by the author have the meaning only to express the author’s personal views on the quality of a security. Independent financial advice from an authorised investment professional should always be sought before making investments. CAPITAL AT RISK. Full Disclaimer here.


CloudTag is probably one of the most promoted stocks among private investors at the moment, particularly on Twitter. The company has seen a meteoric rise from the start of January 2016, rising from 2.5p to 11.75p as of writing, valuing it today at £44.2m. It is always pleasing to see private investors doing well, but should they now be thinking about selling at these levels? For pre revenue companies like Cloudtag I tend to use a screening tool and if the company passes the screening I then follow up with some analytics for good measure. This is the approach I will follow below.

Wh0 are CloudTag?

CloudTag is pre revenue United Kingdom-based company that offers CloudTag Track. “The Company’s CloudTag Track and its associated smart device application range, provides personalized, weight-loss and fitness programs based on the latest clinical-grade, wearable fitness monitoring technology.”

screen-shot-2016-09-13-at-18-51-20

This is a competitive space, but does the CloudTag Track have a Unique Selling Point?

I thought long and hard about this one and actually I think the company may have a USP, based on CloudTags claims. My own experience as an Apple Watch user is that if I do gentle or moderate exercise then the watch seems to track calories and my heart rate fairly well, anything more vigorous and/or dynamic and the data is a load of codswollop. Looking at the fitbit range, they also seem to suffer from the same issue. The CloudTag allows you to get around this issue by wearing it on your wrist for casual use and chest for more vigorous exercise.

The CloudTag track also tracks activity and sleep automatically and claims to measure Heart Rate variability, this being a key measure of stress. I have to admit that these are all one ups on my apple watch. That said I can’t see any information on how the the Heart Rate Variability information is presented to the user from CloudTags website. Another concern is that the product is not yet released so we don’t know in reality how seamless the experience is. What concerns also is that I can see reviews here and here but none of them are a ‘hands on’ review, they both look like articles placed by PR people. Has the product been offered to any Tech bloggers? If so then why can’t I find any reviews? My final concern is that although I like the product does it ‘medical grade’ heart rate tracking needed for most users?

What’s the price? When is it available? 

The price will be £89.99 and was originally estimated to be available in summer 2016, we don’t yet have a launch date, the last news we have was the RNS here which quotes that the distributor Second Chance are looking to build an orderbook with ‘major retailers/etailers’. The cloudtag website still gives potential retail buyers no indication when the product will be available, other than ‘coming soon’. What are the reasons for the delay here? Are their teething problems with the product or is Second Chance struggling to fill orders? The following statement from the latest RNS seems a little ominous too, is this an attempt to drip feed investors to the possibility of things not being well? Perhaps I am paranoid, but I have been trading on AIM far too long!

Good progress is being made on all fronts but it should be noted that Cloudtag is entering a highly competitive market and faces many challenges commonly associated with such entry. Plans have been put in place to address such possibilities and we are confident that our team has the skill and determination to resolve any such possibilities should they arise.

Are there any other barriers to a successful launch here?

kantar-media-ad-spend-fitbitI think the product seems pretty good if all the claims are correct and for the price it seems competitive, the Fitbit Charge is the same price and yet the CloudTag has the advantage of the heart rate accuracy and potentially heart rate variability.I popped into Dixons though earlier before writing this article and I counted 15 different wearables, there is a lot of choice out there? Is the product sufficiently able to differentiate itself without a heavy marketing campaign. This is probably my biggest concern, can CloudTag really gets its product in front of enough potential customers?

The marketing budgets of the Top 20 wearable fitness companies are included to the left which illustrates how much they spent in 2014. Fitbit spent $21m (£16m) in 2014, where is CloudTag going to find the money to compete on this level and persuade customers that it’s product is different? This to me illustrates the challenges CloudTag face.

That said, Withings is a smaller company with a good selection of products that managed to get a buy out from Nokia this year and raise its profile enough on a shoestring marketing budget of $199k. However, Withings also was one of the earlier entrants to the wearables and ‘Internet of Things’ space (I hate hate that term) giving it a very big advantage, whereas CloudTag is much later to the party.

How does the Valuation look?

Let’s look at one of the potential competitors Fitbit, who in 2o15 managed to generate cashflow from its operating activities of $109m from $1.8bn of Sales, that is just 6% of revenue! This Cash from operations was subsequently eaten up by financing fees too, this really shows how tight the margins are, or in other words how competitive the market is and what an uphill task CloudTag has in front of it.

To justify Fitbit’s CFO multiple below it needs to make sales of $1.8bn or 54% of the market capitalisation. Let’s assume for a moment that CloudTag achieves the same margins as Fitbit. This would be £21m of sales equivalent for Cloudtag against it’s £43m capitalisation which all things being equal could generate £1.26m of CFO, giving a very generous CFO/E ratio over 30. I admit these are ‘back of fag packet’ type workings, but it does illustrate the level of sales needed to generate a return here to justify CloudTags market cap. Is £21m sales per annum, i.e 0.25m units achievable by Second Chance the distributor, when so far Sales are £nil? Even if it were to generate this level of sales, with just £2m in the bank this is a very tough working capital cycle for CloudTag to manage. We could of course assume CloudTag can get better margins, but given the lack of economies of scale available to smaller companies is this really realistic?

fitbit

To further compound the uphill battle, wearables is also a fast moving market sector, with pressure to keep new products coming. Even if against the odds the CloudTag product is a success, how long is the shelf life though? 2,3 maybe 5 years tops? The first couple of years post launch, even if CloudTag survives, are likely to be cash draining given some of the sunk costs needed to launch a product. Maybe by year 3 it could turn a profit and generate some cash? However, the R&D departments at some of the bigger players are vast and how long would it be before a superior product emerges from a competitor?

The other option of course to realise shareholder value is a buy out from a competitor, this is a possibility and much more likely than CloudTag being able to go alone. Let’s though return to Withings above, the acquisition was for $191m cash, i.e. £150m. The product range of Withings is larger, offering some real innovative and stylish products, winning tons of awards on the way. When you consider CloudTag is already valued at £43m, i.e. 0.3x Withings then this valuation looks very full to me. CloudTag has just one product, which is differentiated but certainly no more differentiated than any of Withings offerings in my opinion. I therefore believe there is no further upside on the CloudTag current valuation.

Summary

SELL – Target 5p

I do like the product but at this stage there is so much potential downside here which is not factored into the share price. To sum it up this is David vs Goliath and whilst the patents and/or product could be attractive to a competitor I can’t see the valuation being as high as £43m when looking at the Withings deal. My target of 5p capitalises the company at £20m or so, this could give some upside in any deal scenario, until then I won’t be getting in here.

I fully expect to get trolled on Social Media and the bulletin board for this article but i’ve got thick skin so bring it on, constructive comments preferred of course…

Disclaimer – I have no positions in this stock and to my knowledge nor do any close family, friends nor associates. This post is purely my opinion and should not be taken as financial advice. I welcome any alternative comments and will consider adjusting posts based on information made available to me.