POL - Artko Capital - Polished.Com: 2023 Could See A Substantial Reversal
Summary
- Losses from Polished.com warrants, as well as a broad portfolio pullback detracted from the overall performance.
- Our position in the warrants of Polished.com cost us over 6% in negative alpha in 2022, but we believe 2023 could see a substantial reversal.
- We are mostly excited that the end of this saga is near and look forward to updating you soon.
The following segment was excerpted from this fund letter .
Polished.com 6/26 $2.25 Warrants (POL)
On the one hand, this investment has been a disaster, of the kind we try to avoid. In 2022 the company hasn’t been able to publish its financial statements due to what can only be called shenanigans by its founder and now former CEO, Albert Fouerti, where he charged the company over $800,000 in personal expenses. In his dismissal and at the conclusion of the investigation he agreed to reimburse the company $3.7mm for the expenses and the cost of the investigation.
Sadly, while this doesn’t look great, these are typical inexperienced behaviors of microcap management teams that frankly do not know how to transition from private to public company executives. This is not unlike the situation with our former holding USA Technologies (USAT), now Cantaloupe ( CTLP ), where its CEO ran the company like a personal fiefdom with a pliant CFO and board, which resulted in his firing, financial statement restatements and an eventual activist battle resulting in a new management team and board.
A good business ran by inexperienced management. As a fun reminder, the USAT CEO Stephen Herbert, prior to his firing, once chased your portfolio manager down the hall of a conference to scream about embarrassing him on a public webcast when we asked about an unnecessary and dilutive secondary offering.
To add insult to injury while the company has communicated the investigation findings, hiring of the new auditor, and even broad strokes of its subdued financial guidance, it has refused to provide its net cash position, resulting in consistent worries by the market about its debt levels. For what its worth, we estimate that the company likely has $40mm in cash and a $100mm term loan, or approximately $60mm in net debt today. Of course this number can be off by $10mm to $20mm. And so in 2022 the stock dropped from around $1.50 trading levels to a low of $0.50, and the warrants dropped to around $0.10 costing us 600 to 700 basis points in performance.
This all seems bad. And yet despite the disappointment, we are actually a bit excited. In late January 2023, the company seems to have gotten the message from its (very) angry shareholders: sell the company.
While the shareholders approved a new board, they refused to approve an increase in issuable shares from 200mm to 250mm, where there are currently 105mm outstanding and 92mm warrants, which count against the cap. The intention of the vote was to allow the board to issue more options to attract new management, while the shareholders sent a message that it is time for Polished.com to end its short-lived run as a publicly traded company. So the company announced that after receiving “multiple expressions of interest” it has hired the Jeffreys investment bank to help manage the process. Positive news in a sea of disappointment and distrust.
Of course, everything is not as easy or as simply predictable as a sale of a company with unpublished financials amid an economic slowdown with a strained consumer. What is POL worth today? What are our warrants worth? This is an e-commerce company that can generate $500mm to $600mm in revenue and $30mm to $50mm in profitability, providing its working capital levels are no longer underfunded. This can result in offers of $200mm to $600mm, where possibly up to $100mm would go toward paying back the term loan. What happens with the warrants that have 3.5 years left and a $2.25 strike price if the offer is below the strike price?
These are all questions we’ve spent the last few weeks trying to answer. We’ve come away positive with at least one portion of the situation: our warrant holder rights. Much like our US Ecology warrants which were bought out by Republic Management in 2022, the POL warrants in any fundamental transaction are required to be converted into the warrants for the equity of the new owner. This is great and easy if the acquirer is a public company and this is a strategic acquisition for someone fetching a higher price, but it is likely to be a private equity company. In fact, we wouldn’t be surprised if the former CEO comes back with a private equity backing to buy the company back.
This would obviously be a concern. However, since the warrants are unlikely to be converted into new equity, they will have to be bought out, even if the final sale price is below exercise price. The next concern that comes: at what value? While the company’s filings on the warrant agent agreement tend to be poorly written at best, it seems likely that they would be bought out at “fair value” which tend to have varying ranges due to the volatility input into the Black Sholes formula.
We have a strong concern that that is the part where there may big differences between the warrant holders assessment of fair value and the company’s acquirer. So in the end we believe that these warrants maybe worth as little as $0.40, around our new cost average as we’ve added some more recently, but up from $0.10 today, to well over $2.00 if the business is in good shape. The real downside is of course that they stay at the $0.10 level for a long time if no deal is consummated, and we lose a little on liquidation, another realistic risk.
For what it is worth, we have communicated our concerns and reminded management of warrant holder rights in a private letter. We are mostly excited that the end of this saga is near and look forward to updating you soon.
Legal DisclosureThe Partnership’s performance is based on operations during a period of general market growth and extraordinary market volatility during part of the period, and is not necessarily indicative of results the Partnership may achieve in the future. In addition, the results are based on the periods as a whole, but results for individual months or quarters within each period have been more favorable or less favorable than the average, as the case may be. The foregoing data have been prepared by the General Partner and have not been compiled, reviewed or audited by an independent accountant and non-year end results are subject to adjustment. The results portrayed are for an investor since inception in the Partnership and the results reflect the reinvestment of dividends and other earnings and the deduction of costs, the management fees charged to the Partnership and a pro forma reduction of the General Partner’s special profit allocation, if applicable. The General Partner believes that the comparison of Partnership performance to any single market index is inappropriate. The Partnership’s portfolio may contain options and other derivative securities, fixed income investments, may include short sales of securities and margin trading and is not as diversified as the indices, shown. The Standard & Poor's 500 Index contains 500 industrial, transportation, utility and financial companies and is generally representative of the large capitalization US stock market. The Russell 2000 Index is comprised of the smallest 2000 companies in the Russell 3000 Index and is generally representative of the small capitalization U.S. stock market. The Russell Microcap Index is comprised of the smallest 1,000 securities in the Russell 2000 Index plus the next 1,000 securities (traded on national exchanges). The Russell Microcap is generally representative of the microcap segment of the U.S. stock market. All of the indices are unmanaged, market weighted and reflect the reinvestment of dividends. Due to the differences among the Partnership’s portfolio and the performance of the equity market indices shown above, however, the General Partner cautions potential investors that no such index is directly comparable to the investment strategy of the Partnership. While the General Partner believes that to date the Partnership has been managed with an investment philosophy and methodology similar to that described in the Partnership’s Offering Circular and to that which will be used to manage the Partnership in the future, future investments will be made under different economic conditions and in different securities. Further, the performance discussed herein does not reflect the General Partner’s performance in all different economic cycles. It should not be assumed that investors will experience returns in the future, if any, comparable to those discussed above. The information given above is historic and should not be taken as any indication of future performance. It should not be assumed that recommendations made in the future will be profitable, or will equal, the performance of the securities discussed in this material. Upon request, the General Partner will provide to you a list of all the recommendations made by it within the past year. This document is not intended as and does not constitute an offer to sell any securities to any person or a solicitation of any person of any offer to purchase any securities. Such an offer or solicitation can only be made by the confidential Offering Circular of the Partnership. This information omits most of the information material to a decision whether to invest in the Partnership. No person should rely on any information in this document, but should rely exclusively on the Offering Circular in considering whether to invest in the Partnership. |
Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.
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Artko Capital - Polished.Com: 2023 Could See A Substantial Reversal