When you got an experienced management team, as well as independent directors such as Paul Walsh from Diageo and Lord Rose (formerly Stuart Rose from M&S), along with a famous investor in Neil Woodford, whom fund holds the biggest stake in the company (35%).
You think you are on a winner.
Instead, RM2 is one of the worst performers in the market. Since January 2014, the shares collapsed from 88 pence to 14 pence.
Worse still, the company wasted hundreds of millions of pounds by initially pursuing the wrong strategy. Despite this, it needs hundreds of millions of pounds to meet the terms of agreements with their new outsourcing partners.
If you think the share price of 14 pence is cheap, do some research before taking a punt on this stock.
Here are nine to consider: -
An ONE Product Company (Red Flag No. 1)
RM2 has one “high-tech” pallet product called BLOCKPal. However, high-tech this product possesses it’s still a pallet. Secondly, the price of industrial pallets aren’t expensive, you can buy pallets on eBay and on Alibaba.
With prices at single digits, this makes BLOCKPal pallet (with a tracking device) looks expensive to rent and buy.
On top of that, RM2 is in collaboration with AT&T to develop a new tracking device pallet called ELIoT pallets.
We know the product is real, but can they sell enough of it to make RM2 a self-sufficient business.
Manufacture First without Testing the Market (Red Flag No. 2)
When the company raise £130.8m in net proceeds, investors should question the business model.
As a fan of Shark Tank (the U.S. version of Dragons Den), the one question they always ask “wannabe” entrepreneurs are: “What are you going to do with my money?”
And, if the reply is: “I will use it to manufacture and stock up on goods.”
Then, the reply is always the same: “Do you have the orders coming in?”
And, if this turns out to be NO, the sharks will start ripping into their business model (no pun intended).
Apparently, that was the mistake RM2 International has made and they paid a price with their reputation, along with going down the drain.
Even worse, they decided to manufacture the pallets themselves for a time, before outsourcing it to China and Mexico (Q3 2017).
Instead, management should have outsourced their product in the first place, which was obviously the cheaper option!! These actions strike me as suspicious, given the “quality” of their board members.
They should have known better!
Not a Very “HI-TECH” company (Red Flag No. 3)
Looking at the IPO admission, the R&D Spending on developing the pallet is minimal.
From 2010-2013, R&D totals less than $1m or £700,000 (before the company discontinued reporting R&D separately).
So, much for the proprietary technology!
Now, on the fundamentals of the company.
Big Losses are No Surprise (Red Flag No. 4)
The initial decision to self-manufacture didn’t help the company finances. Since 2012, capital investment totalled $68.5m (£52m), however, the real loss came from business strategy to stock up on pallets. That caused total operational losses of $257m or £200m in the same period.
How does it make business sense to build-up inventory without having enough customers to sell to?
That’s the real question. Also, this strategy makes it hard for analysts to project the break-even point, which is why no analysts are covering the stock.
Given the change to outsourcing, expect lower operating costs in the future.
The Curious Case of High Staff Costs (Red Flag No. 5)
The costs per employee are $74,000 last year, or £57,000. These salaries are what software employees get paid for, not manufacturers of pallets.
Here is the trend: -
If you working for RM2 then you are getting paid out up until last year (employees number cut from 500 to 180, due to outsourcing).
Lesson: - Analysts need to recognise if the skill-level is sophisticated enough to warrant higher pay. Right now, this isn’t warranted.
Paying Off Your Suppliers (Red Flag No. 6)
When trade payables ballooned to $12m in 2015 (which was more than their sales) it is not surprising to see RM2 pay off their suppliers the following year, as payables collapsed to $2.7m.
Furthermore, it wouldn’t surprise if the suppliers’ excuse was RM2 doesn’t generate enough sales, so, therefore, we are shortening their credit period.
If you look at RM2 average payment period, it fell from 77 days to 27 days. Below, it shows the “over-manufacturing” when you are paying your suppliers five times more than you generate in sales.
All the Risks are with RM2 (Red Flag No. 7)
In 2016, it outsourced manufacturing to two partners in Jabil Circuit Inc. and Zhenshi (of China).
However, there is serious risks and exposure to RM2.
Jabil Circuit Inc. agreement
The agreement is to acquire at least 188k pallets per quarter over a five-year period. That is 752k pallets per year, a total of 3.76m pallets.
There is a penalty of USD 5.68 per pallet ordered below 143k pallets per quarter. So, if it failed to order pallets for one full quarter, RM2 is liable for a maximum of $812,240 fine.
The penalty applies from April 2017, as they started production in March.
The 143k pallets per quarter equate to 572,000 pallets per year or 47,666 pallets per month. The rate of production in June close to 30k per month.
Also, it will be responsible for excess and obsolete material and inventory.
Zhenshi Holding Group agreement
RM2 agreed to purchase twice as much from their Chinese manufacturer of at least 1.5m pallets per year. Further details of this agreement are kept secret.
These agreements may be normal terms for other businesses, but the projection of manufacturing 2.3m pallets per annum looks unrealistic if they don’t have the sales to back this up.
Double Accounting in financial statements (Red Flag No. 8)
Read their cash flow statement and will notice that Interest Paid and Finance Income, which are both reported on the operating section, also appeared in their investing and financing section.
That is called “double-counting”, and distort the numbers. Here is the screenshot: -
And continues here: -
Selling price and Rental lease per pallet (NOT RED FLAG)
In 2015, it sold of circa 30,000 pallets which generated $3.7m in revenue. That works out as over $120 per pallet. Also, it rented out 230,000 pallets, which created $2.7m in sales or $11.74 per pellet (though most of these pallets weren’t rented for the full-year).
So, in 2016, the number of pallets rented went up by 35k to 265,000. This generated rental sales of $5.7m, or $21.51 per pallet. However, pallet sales fell to $400,000 with the number of pallets sold being undisclosed.
Renting these pallets are five times cheaper than buying.
OUTLOOK (NOT RED FLAG)
The following information is interpreted as I understand with some assumptions made. Please critique and offer your interpretations.
Expect lower cash burn
Before it outsourced manufacturing, the cash burn was $1.9m per month in the last six months of 2016. However, that fell to $1.4m per month in the first five months of 2017, but expect cash burn to increase to $1.7m per month, as it includes the wind-down from their Canadian operations. A total of $18.9m.
Add in one-time costs of $5.1m and $0.6m on Luxembourg VAT.
Forecast Sales
I wish the company would draw up a table to illustrate future orders.
According to the 2016’s annual report, here is their outlook for 2017: -
1. Annual full-year production is expected at 467,000 pellets.
2. The company acquires minimum funding of USD 34.0m to cover issued purchase orders and forecasts orders.
3. It will shortly undertake negotiations to arrange a larger additional financing which is expected to amount to at least USD 65.0m or £50m.
4. It says it has 1.6m pallet opportunities constitute the current commercial pipeline, of which 9% represent straight sales and 91% rentals (either flat fee or per trip) and of which 62% are ELIoT pallets and 38% are BLOCKPal pallets.
Despite all that, there aren’t any projection of 2017’s sales, only the costs of manufacturing.
Management Not So Confident (Red Flag No. 9)
Management didn’t appear confident in the business and made several suggestions that the purchase orders were dependent on the success of external funding.
When looking beyond 2017, management made funding concerns their number one major factor.
To anyone, it is sending a clear signal that funding is no guarantee.
Despite these long-term uncertainties, in the short-term, the business remains operational until the end of this year.
That’s not good enough for long-term investors!!
Convertible Preferred Shares (NOT RED FLAG)
Of the total 92,487,729 Convertible Preferred Shares to be issued, the following were issued as follows: -
No. of shares Type Price Financing (£m)
4,591,743 Class B £0.35 1.6
41,580,215 Normal £0.16125 6.76
46,315771 Normal £0.16125 7.53
A total of £15.9m or $20m.
That will to further dilution to the share price, but more worryingly is the further fundraising at the end of this year. The size is as big as £50m.
Valuation and Strategy (NOT RED FLAG)
The current market valuation of £52m at 14 pence is too high given that it destroyed hundreds of millions of pounds in value by pursuing the wrong business strategy.
What should you do?
If you are new to this company, then I suggest you wait for them to deliver their results.
Take their 1.6m pallets pipeline and using their assumptions. That is 91% rental sales at $22 per unit. It would give a sale forecast of $32m with the remaining outright sales of $110 per unit makes it $15.84m, giving a grand total of $48m in revenue.
That is only achieved in a few years’ time.
Leaving you to ponder, if this represents breakeven. If not, then the current valuation of £52m looks too high.
Also, people shouldn’t forget about the future rise of shares outstanding and dilute the share price. For example, the company can be worth £52m, and trades at 5 pence per share, just because of the increase in the share count.
The best strategy is to observe it for two years and see if it genuinely has a business worth investing. More importantly, is to avoid investing at current levels because the risk of dilution is at 100% and there is a real potential of failure.
Verdict: - Best avoid for a few years.
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Disclosure
The opinions expressed by the writer is for entertainment and research purposes. It does not constitute professional investment advice. Data is correct on available information at the time.
Finally, the writer does not own the company’s stock, unless stated otherwise.
