For VCs It's Deja Vu All Over Again

It seems like the Venture Capital (VC) sector has just emerged healthy again from the tech bubble, when now it faces a potentially greater challenge as it deals with larger systemic financial problems. A Survey done by the National Venture Capital Association (NVCA), and reported on by the Associated Press, paints a bleak portrait for the next several quarters.


During the period of 1998 to 2001, Venture Capital was investing in "new business models" associated with the emerging information technology economy. Investment decisions were clearly flawed by greed and speed and a lot of dubious business concepts were funded. Everyone has heard the legends of multi-million dollar investments made into business plans drawn on the back of paper napkins.

I'm not so sure about the legends, but one thing I am more certain about is that there were some pretty important business models that have emerged from that period. Some models that were expected to be dominant became fairly minor relative to some surprising ones. Most of the big bets were placed on e-commerce because everyone was going to buy online. People definitely buy online, but not at the rate expected - and a lot of investments went bust. Remember trading networks? A lot of capital was placed on this model, and it never really materialized. Whoda thunk that the Cost-per-Click (CPC) ad model would be the single most valuable revenue model of the information economy? Investors in Google (GOOG-Q) got it right. I remember the buzz surrounding the Application Service Provider (ASP) model. Although the details of that business model may have been flawed, it has spawned some key variations such as Software as a Service (SaaS), which may be a model that ensures survivability for many software companies during this brutal economic period. The bottom line is that, although the VCs made some dubious investments, the era spawned a bunch of tough-as-nails tech companies with cashflow, earnings, visibility, and , frankly, a lot of happy investors.

The ASP model itself could be considered an ancestor of Cloud Computing which many, including myself, believe could be a foundational element to IT innovation when capital budgets are tight. And according to the NVCA survey, there is likely to be very little IT venture funding to go around for a while. As VCs continue to deploy a greater share of increasingly constrained capital towards cleantech, venture investments in information technology should decline. According to the survey and in my opionion, easily commoditized high risk technology like chips, firmware, and hardware should experience challenges, along with consumer facing innovation in media and entertainment (I think that social networking fits into this category).

From an IT perspective, innovation in mobile technology should continue to receive VC funding, as well as infrastructure plays that improve efficiency. Storage, virtualization, security, and network capacity should be general categories that may continue to attract VC capital. Although most capital is likely to be follow-on investing.

In general, start-up funding should be increasingly difficult to find throughout 2009. Entrpreneurs probably need to find ways to bootstrap and self-fund. As a result, we should see a few more greybeards with previous success among the next crop of upstarts. I think that we may have seen the last of the 25-year old billionaires for a while.

The NVCA survey infers that VCs are likely to try to fund more established IT operations with cashflow and scale that are cheap. There is not much venture in that capital. I think that VCs will struggle to compete with Private Equity funds and even some of the junior public indices for these type of deals.

Again, I believe that public companies with cash on balance sheets and liquid stock should be in great position to gobble up some pretty good venture enterprises cheaply, as VC capital dries up. Where there is pain, there is opportunity.


Delta Airlines (DAL.NYSE) Inflight internet plans and Guestlogix (GXI.V)

Yesterday, Delta Airlines announced that it has launched inflight internet access on a few east-coast shuttle flights with AirCell's GoGo Inflight Wi-Fi Service. According to the linked article below, Delta is planning on completing the roll out of this service to its entire fleet, including Northwest, by sometime in 2010. It is quite the commitment, including some rewiring of a plane.


The other beneficiary to this commitment by Delta Airlines is Guestlogix (GXI.V). According to the release, passengers are required to pay $9.95 for unlimited access on flights less than 3 hours, and $12.95 on flights more than 3 hours. According to Management at Guestlogix, its Mobile Virtual Store will be used by Delta to execute the financial transaction and invoke access.

Guestlogix has deployed its onboard retail network with Delta Airlines, American Airlines, Southwest Airlines, GermanWings, AirAsia X, and Saudi Airlines among others and receives a percentage transaction fee for every onboard retail transaction. It has a backlog that includes airlines such as Westjet, US Air, British Airways, and Ryanair among others. Guestlogix has integrated its retail systems with Thales onboard entertainment systems, and has a distribution partnership with logistics monster LSG Air Chefs.

I think that there are a couple key points for consideration. First, the increased transaction volumes and higher valued transactions should help to increase high margin revenue for GXI beginning in 2009. Second, the integration between AirCell and Guestlogix is interesting. Both Companies are heading towards dominance in their respective niches, which likely creates some future partnership synergies.

Guestlogix continues to be a high growth story defined by rate at which it can roll-out its platform to airlines and rail carriers worldwide, then by the scope of merchandise that it can transactthrough its platform. Last quarter, Management claimed that its solution was available on flights serving nearly 220 million passenger trips worldwide, and that it had nearly 700 million flights under contract, inferring that well over 400 million passengers trips were still to be rolled out.

There continue to be timing risks on deployments and I expect that the Company should perform to approximately $20 million to $22 million for 2009, up from a forecasted $11 million this fiscal year. I think that we may see the Company post a breakeven quarter for Q4 2008, with consistent earnings growth throughout 2009. Investors could see between $0.07 and $0.10 EPS next year, depending on the timing of roll-outs and the cost of equipment lease facilities. Regardless, GXI.V remains a solid early stage growth Company with a chance to become dominant in a niche. Although there are 7 to 9 analysts that cover the story, investors do not seem to care because the stock has been trading at $0.50 range for an extended period of time with little volume.

I do not own shares in GXI.V, nor do I receive compensation in any way from the Company.


Mobile Subscription Trends - WSJ article.

Yesterday, there was an article on the WSJ website that identifies the trend of people switching from post-paid subscriptions to pre-paid subscriptions.


This is a trend that I see could strengthen throughout 2009, and it is a concept that I attempted to encapsulate in a previous post on November 28th. I referred to the trend as "downchurning". Carriers with large post-paid subscriber bases risk losing customers to pre-paid carriers as financially stressed people switch to lower cost pay-as-you-go services. This trend should benefit Companies like Virgin, along with pre-paid payment networks like Euronet, Blackhawk and Vendtek Systems (among others) that support POSA (Point-of-sale-activation) and top-ups.

Hard card retailing should increase, although the profit margins should be stressed by increased crime related to "shrinkage" or theft. A box of pre-paid cards the size of a business card holder could be worth thousands of dollars. We should see more electronic distribution as a result.


Tech is Cheap; Do Something.

I would like to take this opportunity to link a blog post by Mark McQueen.


Mark has identified a handful of the Companies that intersect with my view of the top 30 and the top 80 stocks on the Toronto Stock Exchanges. Typically, the top 30 are companies with cashflow, excess cash and projected earnings growth (even in these markets). The remaining stocks are not cashflowing but are close and have oodles of cash to execute plans (even in these markets).

Mark is right. There are dozens of small cap and microcap companies with great assets, great technology, and great skills that are essentially valued at next to nothing. Another enigma is Grey Island Systems (GIS.V), a profitable telematics operation with no debt that, depending on the day, trades near or below cash value.

Smart CEOs with cash and a little moxy should be making some buy versus build decisions and bulk up as the world economy exits from this recession as a very different animal. Really ballsy CEOs may be seen divesting resources from R&D and investing resources in M&A. Why build something when you can buy it at a fraction of the expense? On the flip side, there are probably over 100 tech CEOs who should be working with their Boards and key shareholders right now to repair operations and maximize asset value for roll-ups and mergers. See my previous post.

I do not own shares in Grey Island Systems, nor do I receive compensation from the Company in any way.


After chaos; a new stasis with big implications for small cap.

The world economy is gyrating through a chaotic period, out of which should emerge a new stable complex; a new world economic order so to speak. And I think it may look a lot different than the one we are currently exiting. Here are some things that I think will be different based on some conversations that I have had with people close to capital over the past few weeks:

Risk is being recalibrated; destroying liquidity for small cap stocks – By their nature small cap and micro cap stocks are defined by their above average or speculative risk ratings by analysts. In a market where there is limited volatility, professional investors seek out higher risk/higher reward investments where they can benefit from imperfect information and market inefficiencies. Often, small cap portfolios have vastly outperformed the indices. Over the past 20 years, fortunes have been made as fund managers, and retail investors, have made bets on small cap growth stocks, and won. With the disappearance of many hedge funds seeking alpha, the market for small and micro cap stocks has largely dried up. Remaining investors are fleeing to “quality stocks” which are Companies with low beta, and low relative risk. In fact, many investors currently find equity altogether too risky and are fleeing to the bond market.

Equity risk capital is becoming scarcer for expansion and growth– As the world economy ultimately begins to recover (many call for the 2nd half of 2009), between $15 and $20 trillion dollars worth of wealth could be destroyed in the financial markets since August of 2007. This represents between $2000 and $3000 for every man woman and child on earth. One of the reasons that the VIX chart is at historical levels is because there is less equity capital and fewer parties trading stock then there were only 1 year ago. It’s like boiling water; when water level is high, the boil seems less violent then when water level is lower. As capital becomes scarcer, stock trading becomes less dense, but more focused on only a few stocks. The volatility scares away capital. Skittish equity capital is much less likely to fund growth and expansion, which is essential to many small cap and micro cap stocks. CEOs are going to need to focus on other ways to fund growth and expansion if they are not cashflowing or if balance sheets are not solid enough to self-finance.

A period of major consolidation for small caps- Without cashflow or balance sheet strength, many microcap and small cap companies are likely to consider being consolidated into larger, stronger entities. It appears that approximately 20% to 25% of small cap companies have adequate balance sheets to fund growth over the next period of time. Those with weak balance sheets and a distance to cashflow will need to conserve cash through restructuring, selling assets, or merging operations with larger players with cashflow and/or stronger balance sheets. For example, of the 260 or so small cap and micro cap technology stocks listed on the Toronto exchanges, only about 60 to 70 have adequate cash to execute plans. Only about 30 stocks have excess cash and consistent cashflow. These Companies are likely to emerge at the top of the food chain among small caps, although they will still not attract liquidity if they remain small.
Size Matters: Even among the top 30, it is likely that they will not have enough scale to attract enough liquidity to increase shareholder value any time soon. Acting reasonably, Managers should look at leveraging their position to consolidate smaller or complimentary operations. Their goals should be to gain the attributes of mid-cap stocks.

Share Price Does Not Matter Right Now- Almost all small caps are down by 50% to 60%. Share buybacks are akin to throwing money in a hole – in the end, if there is no business scale, it won’t matter how many shares are outstanding. Forward-thinking CEOs are using shares to acquire for scale because, for the most part, dilution is relative because all shares are depressed. When the chaos has subsided, with limited equity capital remaining in the market, scale and profitability will be the major attributes sought by investors as they return to the equity markets.

Cashflow Matters- Managers of small cap and micro cap enterprises need to accelerate towards cashflow by cutting expenses while focusing on only what is profitable. Unless self-financed, investments in innovation should, unfortunately, be delayed. Since the tech bubble, analysts have been enamored with recurring revenue stream models for good reason. With long-term contracts, minimum guarantees, and consistent monthly revenue streams, Companies are better able to maximize cashflow potential in a recurring revenue business model. These Companies are highly attractive to consolidators as well.

Cut Losses- CEOs with cash burn and dwindling reserves should take a hard look at assets and preserve shareholder value by considering asset sales, or distressed mergers. This is painful and demoralizing for many entrepreneurs, but as the new world economic order emerges, there is likely to be a serious gap in venture funding for many quarters to come. Responsible managers should consider preserving some shareholder value.

Adapt or Die- Within the Canadian tech sector, there is a possibility that a significant number of venture listed public Companies could simply disappear over the next year or so. The good and the lucky are likely to be acquired or merged, others will be forced to wind down and sell assets. Regardless, it will be a different environment for small cap and micro cap equities by the beginning of the next decade. There are likely to be a lot fewer listings, because many could be taken private, some merged into larger entities, and others simply go out of business. I continue to hear about Management teams of microcap Companies demanding 10x EBITDA or up to 2x sales for their businesses. Reality is likely less than half that – adapt or die.

The Tech Sector Advantage- The tech bubble toughened up the survivors. Notwithstanding the echo chamber that is now the small cap sector; many small cap technology companies have strong cashflow, emerging cashflow, or strong cashflow potential in relatively short order. There are a lot of solid companies among the carnage that, with a few effective moves, can create long-term shareholder value.

A New Era of Innovation- As all of this tumult unfolds, scores of very talented people will be laid off. Without the layoffs of the 1991 recession, we would not have seen the talent available for the myriad of startups in the 1990s that helped spawn some of the giants of our generation like Google (GOOG-Q), Amazon (AMZN-Q), and Yahoo (YHOO-Q). A decade from now, we are likely to see a new breed of giants that were germinated in 2009.

I do not own shares in any of the Companies mentioned above, nor do I receive compensation in any form from the Companies mentioned.


Canadian Politics: Whose hijacking Whom?

"I cannot have confidence in a prime minister who would throw the locks on the door of this place, knowing that he's about to lose a vote in the House of Commons. That's denying about as fundamental a right as one has in a democracy." Jack Layton

Yeah, right Jack. And creating a backroom coalition designed to deny an elected government the ability to govern immediately after it has been voted in by the people is a bastion of democracy. It may be constitutional in a parliamentary democracy, but it it certainly cannot be viewed as democratic. Jack, niether you nor Stephane Dion can claim that you have even come close to earning the honour of leading a government with each party earning below 25% of the vote.

Theoretically, Canadians vote for the party and not the Prime Minister. Theoretically. In reality Canadians cast their votes based on who will lead parliament. You are crying wolf because the Conservatives are not providing enough stimulus for the economy. How disingenuine! The Conservatives, and the Liberals before them, have spent the past decade putting the Canadian economy in a position of strength for inevitable recessions. The Canadian economy is in better shape than any of the other G20 countries as this recession deepens. And the Conservatives have stated all fall that they are about to spend to stimulate the economy. Despite voting confidence for the throne speech a week earlier, you have decide to take over government a week later because it wasn't planning on spending enough to stimulate the government - even though the budget was not to be released until January.

Jack, what you and Bob, Mike, Stephane, and Gilles are really pissed off about is that Steven Harper poked you in the eye by attempting to turn off the party subsidy spigot that you so much rely on for campaign financing. This is why you want to overthrow the government. Oh yeah, and I forgot that whatever CUPE wants, you want too. And when CUPE is potentially denied to the right to hold taxpayers hostage every three years or so, that makes you want to overthrow the government.

Steven Harper pulled a boneheaded move. It was arrogant and overly partisan to shut off the spigot. Your reaction is worse.

I hope that there is an election in January. At that time I bet that the voters will demonstrate what they really think about this move. And the Conservatives will run away with a majority.

Yeah, Jack. You are are a pillar of democratic procedure. But do you really care about the democratic will of voters? Errr...not so much.


Nokia (NOK-NYSE) has reduced outlook.

Errr...see my two latest posts, I think that Nokia is seeing the market conditions playing out as I postulated earlier this week.

The question now may be how long will this last?

I do not own shares in Nokia, nor do I receive compensation from the Company in any way.


RIM miss should not surprise.

This morning RIM (RIM-TSE) reported that it sold 300,000 units less than analyst expectations of 3 million.

Its a pretty big miss, but it should not surprise investors for the following reasons:

1. RIM and Apple (APPL-Q) are relying subscriber upgrades from regular cellphones to smartphones. In uncertain times, people are slower to make those decisions. The mobile subscription is essential; the latest and greatest handset is not.

2. RIM has lost a significant buying group. The financial services sector has been one of RIM's major customer segments. With the loss of hundreds of thousands of jobs, mergers and consolidations, this previously lucrative market cannot be relied upon to drive device sales, or BES server sales.

3. For similar economic reasons, RIM's entry into Europe and Asia should not be as explosive as originally expected. Although everyone seems to have a mobile device, fewer businesses or consumers are likely willing to spend the money to switch from their cheap and cheerful (mostly Nokia) devices to the more feature-laden RIM smartphones.

I expect to see dissapointing unit sale results from RIM along with Apple and Nokia (NOK-NYSE) for the next couple of quarters. Until US consumers feel confident enough to buy bling again, sales of the latest smartphones are likely to disappoint. For long-term investors, it should be noted that, despite reduced short-term performance, these three vendors are likely to consolidate their market dominance coming out of the recession. I suspect that the share price for RIM could be at multi-year lows for the next few weeks, which would be a good entry point for those who like the story, but couldn't swallow an $85.00 shareprice earlier this year.

As per my last blog entry, look for carriers to:

1. Maintain subscriber bases with lower churn rates.
2. Disappoint on growth in data services (related to lower smartphone growth)
3. Disappoint on migration from 2G to 3G networks.
4. Slow down investment into FTTH and FTTC initiatives.
5. Begin consolidating wideband and broadband wireless infrastructure.

Bottom line, unlike device manufacturers, many consumers are tied to long-term subscriber contracts, and those that are not, are prepaid and, due to economic conditions, are not likely to switch. Downchurning is the biggest risk, where post-paid consumers are no longer able to manage subscriptions, and need to move to prepaid services. One can anticipate that this is the major churn risk for carriers.

Due to credit constraints, and balance sheet caution, we should see a decline in the big capital intensive upgrades to the carrier networks in the short-term. The future of network upgrades is likely linked to President-Elect Obama's stimulus packages. If Internet is included (as it should be) in infrastructure related stimulus packages, then carriers are likely to go forward with plans.

See my previous post.

I do not own shares in any of the Companies that have been mentioned in this post, nor do I receive any compensation from these Companies.



Last week, Gartner released some market data on worldwide cell phone sales. For anyone with a reasonable understanding of the mobile handset market, these data should not be viewed as surprising:

- 3rd quarter mobile handset sales growth was about 40% less than the year earlier.
- Gartner forecasts a 1% to 4% decline in handset sales in 2009.
- As reported by various sources, most of the growth worldwide has been driven by first-time buyers in emerging economies such as China, India, and throughout the Middle East.
- Gartner predicts weakness in the replacement market - especially in advanced economies.

So what are the implications of this report?

First of all, the demand characteristics of mobile subscriptions need to be separated from the demand for mobile handsets. Subscriptions are less economically sensitive than devices.

People all over the world continue to indicate that their mobile phones are essential to them in an economic downturn. This infers that a mobile subscription (not the phone) is non-discretionary, and may be categorized as a staple utility - right up there in priority with electricity and heat and water. This means that carriers such as Verizon (VZ-NYSE), AT&T (T-NYSE), and Rogers Communications (RG-NYSE) among others in North America should benefit from subscriber stickiness despite the recession.

However, as consumer budgets tighten, marginal usage may decline over the next 2 quarters, which could reduce earnings outlooks. Similarly, the conversion rate from the 2G network to the 3G network may not be as dramatic as forecasted earlier this year because people are more inclined to wait until their economic situations improve in order to upgrade their subscriptions. Although the phone is essential, the bling is not.

Carriers use device subsidies and bundling to switch and commit people to long-term data contracts in return for access to the latest and greatest devices. The threat of switching (also known as churn) drives the handset business. Based on the data from Gartner, most people may be inclined to hold on to their current subscriptions and devices for the next 2 quarters, including the Holiday season.

So what does this mean?

Innovators should gain ground. Only the most innovative handset manufacturers, which attract early adoptors with aggressive product release schedules, should benefit from the replacement market. This means that in North America, we should see innovators like Research in Motion (RIMM-Q), and Apple (APPL-Q) continue to grow market share in a declining segment, at the expense of all other smartphone and cell phone manufacturers. More than ever, in these markets, innovation matters.

Even the market leaders should see muted growth over the next two to three quarters:

- Smartphone upgrade delayed in emerging markets. In the remainder of the world, where Nokia (NOK-NYSE) is dominant, there should be significant delays in handset upgrade cycles in most emerging economies. As a result, Nokia should be able to protect its market share against the market entries by both RIM and Apple.

- Downchurning. There is a greater than 50% chance of significant increases in subscriber churn as carriers attempt to hang on to economically stressed subscribers in increasingly commoditized emerging markets. This should cause pricing pressure, which could compress margins for both handset manufacturers and carriers worldwide. Downchurning could benefit re-design leaders such as Samsung and LG, who are leaders at offering solid low-cost handset versions to emerging populations. We may see that trend occuring in advanced economies now as well.

- Crime. There is likely to emerge a gap between the essential utility of mobile subscriptions and the ability to pay for access in many economies. Considering that up to 85% of these subscribers are prepay users, there is significant organized crime risks related to prepaid phone cards, and subscriber fraud. Emerging secure payment networks should benefit from this increased risk. Look for electronic prepaid network providers such as Euronet (EEFT-Q), and Safeway's (SWY-NYSE) Blackhawk Network to benefit from the need for more transaction security, along with Canadian-listed Vendtek Systems (VSI-TSXV).

So the bottom line is this: Unless a carrier has utilized a lot of debt to upgrade its capacity, network providers should fare relatively well during a recession, although with reduced earnings potential. Handset manufacturers, which are reliant on subscription upgrades should see a few more choppy quarters. Innovators should exit this current economic downturn will better market positioning than followers.

In the end, it may be all about the Operating System. RIM, Apple, Nokia, Microsoft (MSFT-Q), Google (GOOG-Q), and Palm have all made significant efforts to open up their operating systems to independent application developers. Increasingly, handset manufacturers will be blurring value proposition between themselves and carriers.

I do not own shares of any of the Companies mentioned above, nor do I receive compensation from any of the Companies mentioned.


With Shareholders Rights Plan, Vendtek Anticipates Potential Future Takeover.

After markets closed last night, Vendtek Systems (VSI.V) announced that it has adopted a Shareholders' Rights Plan (SRP). Clearly, this SRP is a prudent response to the accumulation of stock by its Middle East distribution partner. Through Privinvest, its UAE partner has acquired to date nearly 17% of VSI.V shares outstanding via the public markets. As far as I can tell, Privinvest has invested approximately $6.5 million to date based on the price range of accumulation. Within current stock price ranges, it would take approximately $1.0 to $1.2 million to acquire the remain 3.07% of the shares outstanding, which would give Privinvest effective beneficial interest in the Company. In other words, effective control.

The SRP is a tool that gives VSI shareholders an ability to block or delay unsolicited bids in order to maximize share value by creating a bid market through alternatives. Although I believe that a potential creeping takeover bid by Privinvest is essentially friendly, it is a prudent move by VSI management to protect shareholders. VSI is in a very good spot in the market that both its larger competitors, and complimentary payment networks would find valuable.

I suspect that there are to be some fairly major catalysts to be announced either at the end of this year, or early next year that could have positive impact on share value. The interesting question may be - will VSI still be an independent public entity when anticipated catalysts occur?

I do not own shares in Vendtek Systems, nor do I receive compensation from the Company, Management, or the Board.


Descartes Systems: In Dark Days The Sun Shines on DSG

Descartes Systems operates an unsexy SaaS messaging network for the worldwide supply chain that helps to lubricate the flow of goods across international borders by automating customs and regulatory filings associated with shipping. In addition, DSG provides logistics services for fleets, which has experienced increasing demand due to higher fuel and declining shipments.

Third Quarter was better than expected.

The Company was slightly below expectations in topline sales reporting $7.1 million versus my expectation of $7.3 million due to shipping headwinds. However EBITDA was higher than expected at $4.4 million versus my expectation of $4.1 million. I believe that this is due to greater demand for higher margin services during the quarter. Cashflow was reported at $5.9 million, substantially higher than our forecast of $4.9. This better than expected result was due partly to Days Sales Outstanding (DSO) declining from 53 days to 47 days versus our expectation that DSO would increase to 60 days due to the economic stress of its client base. Reported earnings were 64% higher than my forecast at $2.3 million versus $1.4 million. Part of this difference can be explain by lower than forecasted tax expenses. EPS was $0.04 and a penny higher than my expectations of $0.03 EPS. This Company is growing at a solid rate while many others are faltering.

Outlook Is Positive For Three Reasons.

1. Regulations will increase and make shipping more complex - With the announcement of the 10+2 regulation (aimed at improving product safety) in the US, DSG is well positioned to help its clients comply at minimal relative expense, while the US government continues to keep the supply chain lubricated. By 2011, European Union regulatory harmonization will boost demand again.
2. Worldwide Recession - Shippers will need to become more efficient to survive. Only 5% of all documentation is automated. More automation should be expected, and DSG is in a great position to benefit - especially in North America.
3. Volatility and Uncertainty - These two conditions benefit DSG the most because shippers will need to contend with increasingly complex orders and contracts that may be ammended by the second. This should benefit DSG in the near-term as the only way to deal with this is through automated messaging.

A Stock for the Times

Descartes Systems Group provides a boring but essential service to the Supply Chain. As conditions deteriorate, and volatility increases, while more regulations get enacted, Descartes Systems becomes more essential to Supply Chain.

The Company has no debt and $53.5 million in cash.

A Potential Consolidator

Descartes is in great position to use its balance sheet to accelerate its capture of more regulations worldwide for automation. Its acquisition of Dexx in Europe is an early foray. I expect more to come. I also believe that the Company can extend its messaging concept to other transactions in the value chain. Finally, DSG could leverage its balance sheet to evolve into an outsources fleet management system.

I do not own shares of Descartes Systems, nor do I receive any compensation from the Company, Management, or the Board.


Post 9/11 Head Fake

Yesterday, the Dow closed at 7552, below the lowest monthly close of 7591 in September of 2002. The 2002 bear market was caused by uncertainty related to post-9/11, post-tech bubble and various high profile accounting scandals. Mostly, consumers were feeling insecure about their future (due to the fear of more terrorist attacks) and investors were mistrustful of the stock market.

At the time, the U.S government intervened aggressively to prevent a further deterioration of the stock market, and to prevent its malaise from spreading to the general economy. Sarbanes Oxley legislation combined with aggressive monetary policy and credit deregulation was an attempt by the US government to restore faith in the stock markets and to induce consumers to spend more. By 2002, it was un-American not to spend. The problem was that the Consumer only had pocket change. Individual savings were at historical lows in 2002 and 2003, with less than 1% savings rates compared to the three previous decades when consumers typically saved 7% of their incomes. There was the proverbial problem of getting blood from a stone, a challenge that was solved (as we all know) through asset leverage.

Consumers were induced to leverage their net worth in order to buy more. According to testimony to Congress by Alan Greenspan on February 17, 2005, by 2004 consumers were creating disposable cash by leveraging increases in Net Worth driven primarily by the value of their real estate. According to Mr. Greenspan at the time, the Net Worth to Income ratios were at historically high levels and even higher than the ratios leading up to the tech bubble. Persistently low interest rates, combined with increasing home values and ongoing credit deregulation provided mortgage brokers and bankers incentives to create high risk credit products that were used to induce lower income families to become homeowners…and spend. Everyone was becoming upwardly mobile, consumerism ruled, and the American Dream was thriving. People leveraged their inflated Net Worth to spend above their economic bracket. Meanwhile, the financial engineers that created and managed the architecture underlying the Great Spend made gobs of money.

The US consumer spending frenzy became globalized. Suddenly Chinese, Indonesian, and Indian factories were deluged with orders to help fulfill the American Dream. Giant middle classes formed, creating their own spending power and consumer demand. Resulting materials shortages and the thirst for energy created possibly the single largest commodity boom ever, which persisted a full year beyond the beginning of the collapse starting in August 2007, and we know well what has transpired since.

Are we at the bottom? Earlier this year I was certain that the stock market would bottom at 2002 levels and then begin a slow recovery spanning the following 6 to 8 quarters. It was my belief that once the false post 9/11 boom was effectively wiped out, markets would regain momentum as consumer net worth to income ratios aligned to those of previous decades, and consumer savings rates returned to 5% to 7% of net income. With current deflationary pressures, caused by a clamp on consumer spending, we may in fact be seeing the front end of the adjustments happening right now. It should be an austere Christmas.

However, there remains risk that a bottom has yet to be reached. Unlike today, in 2002 the financial markets were fairly sound. Uncertainty was limited to unsavory accounting practices of a handful of high profile Companies. Despite continued intervention by Governments worldwide, the current state of the worldwide financial sector remains unstable at best – this a much greater scale of pain than illegal accounting practices by a handful of US companies. This is not a stock market issue; it is a fundamental financial issue.

In 2002, government intervention along with the underlying theme that, if American consumers didn’t spend, the terrorists would win, drove an already leveraged consumer to more leverage. But it worked, and the Wall Street declines did not spread to Main Street. In hindsight, maybe it should have. If the 2002 downturn became a natural recession as it probably should have, maybe we would be dealing with a less severe reality today.

Main Street is probably just as opaque as Wall Street. In the infamous words of Dick Rumsfeld “there are known knowns, known unknowns, and unknown unknowns”. What happens if the buffoons that lead the US auto sector are unable to convince Congress that they have a plan? What is the next big industry at risk of collapsing? Who will bail out the construction industry? And what happens to municipalities as the tax base declines? Are the Chinese and Indian middle classes real, or will they disappear? Is the American middle class real? Will all of this uncertainty foment the re-emergence of trade union power and the unrest associated with it? And while the world reels, what are the terrorists planning?

I am hopeful that we have reached the bottom that seemed apparent earlier this year based on a 20 year chart. If not, the next leg down could be 6500 based on a 50 year chart.

Although there are many risks, there are also bright spots including the new Presidency. Hope is a powerful emotion to harness. If the new Administration can execute the basics while instilling hope with the battered American middle class, there is more upside than downside to the economy by the second half of President-elect Obama’s first term.

By attacking world symbols of capitalism on 9/11, Al Qaeda had hoped to throw the world economy into turmoil and immediate economic collapse. It is widely believed that Al Qaeda failed because the American consumer threw the world economy on its back and dragged it out of perceived danger. The question now is how much danger was there, really? How much damage was done to the American consumer and how long will it take for it to recover? And what will it become? While the US consumer recuperates, where are we heading? What are the possibilities of worse things to come?


Guestlogix (GXI.V) Upgrades Onboard Devices: Watch for New EU Carriers


This device upgrade is targeted at European carriers, which all require industry certifications. Investors could expect to see announcements of new significant European carriers relatively soon - possibly before the end of calendar 2009. If you are an investor that considers the addition of new carriers like KLM/Air France, Luftansa, or Britith Airways to be meaningful, then today's announcement may telegraph these opportunities.

Some investors may have some lingering doubt as to whether GXI has the potential to manage all potential retail transactions on a flight including those done with mobile devices.

"The unit sports a large touch-screen interface for quick and easy use, and it supports a full spectrum of wireless communication technology, including Tri-band GSM/GPRS, WLAN 802.11 b/g and Bluetooth, to interface with other devices and services on-board."

Based on the above statement in the press release, I think that the communications support listed above should make the system extensible enough to potentially manage multiple commercial transaction on a flight including content downloads to consumer devices as well as onboard entertainment systems.

The Company has either deployed to, or has in its backlog over 700 million passenger trips worldwide. At between $0.036 and $0.04 in revenue per passenger trip, the Company has a potential aggregate revenue stream opportunity of between $25 million and $28 million in annualized sales. I estimate that, realistically, the Company could deploy 600 million by the end of Q1, which would put the Company on a 2009 run rate of approximately $21 million in sales. This could represent a double over 2008 sales (all organic growth) and the Company could be cashflow positive when it reports Q4 2008 results, which should be sustained during 2009.

Guestlogix is a Company to watch. There may be deployment bumps along the way, but the trajectory is impressive, especially in current markets. Based on its previous Q3 results, it had about $6 million in cash and short-term investments.

I do not own GXI shares, nor do I receive compensation from the Company, its Board, or Management.


Points Adds Midwest to the GPX...Now 8 Programs Live

This morning Points International announced that Midwest Airlines has joined the GPX. It is a modestly sized program representing 2.5 million members. As of today, 16% of the trades posted on the system included Midwest Miles.

Over the past few weeks, the total number of trades posted daily has been been between 100 and 110. However, it is difficult to understand the trading liquidity at this point. Does a trade typically stay posted for week? day? or hour before it gets executed?

Notwithstanding, more parters represent more liquidity, which can only contribute to the ultimate success of the concept as it leaves the beta phase, likely at the end of this year, or at the beginning of 2009. I believe that there are few more GPX partners that have been announced including Taca and Mexicana which have yet to launch. There is good possibility that the Company can exit 2008 with double-digit partner base for the GPX. This is ahead of my expectations going into the year. I have not attributed any Global Points Exchange revenue into my 2008 forecast of sales at $75.2 million. It looks like the Company could be poised to beat my, (and consensus) sales forecasts for the year.

Partner Accumulation of Vendtek System (VSI.V) Stock May Indicate Positive Catalysts

Yesterday, VSI announced that Privinvest Holding SAL of Beirut Lebanon has acquired 915,000 additional shares at between $0.75 anf $0.78, bringing the total effective shares outstanding held by Privinvest to 7,367,500 or 16.3% of the total equity.

The accumulation of shares by Privinvest is notable because it is the investment arm of Vendtek Systems' distribution partner for the Middle East. Earlier this year, VSI and Privinvest entered a 5 year regional deal which includes approximately 17 countries in MENA (Middle East North Africa).

I find it highly encouraging that VSI's operating partner has been accumulating stock throughout the year. The price range has been between $0.70 and $0.90. Currently, VSI generates about $1.0 million in net contribution per annum from the deployment of its software in the UAE, the first market in the region with a pre-paid subscriber based of approximately 6 million.

I estimate that the total number of mobile subscribers in the MENA region is approaching 130 million. Egypt, Saudi Arabia, Morrocco, and Algeria combined represent close to 100 million prepaid subscribers.

Privinvest has invested approximately $5.0 million in its partner VSI because it is likely confident that there are going to be some significant country rollouts soon. Saudi Arabia has been hinted at for for some time, although I think that there may be more than Saudi Arabia to come. If 6 million subscribers can generate $1.0 million in net contribution for VSI, a subscriber base of 30 million offers 5 times the potential income potential, or $0.11 per share in contribution. But that includes only Saudi Arabia. What if there is more?

In addition to its potential in the Middle East, VSI is finally ramping up its US rollout and is expected to be deployed on as many as 200 - 300 terminals per month by January. I firmly believe that the market conditions in the United States are aligned to VSI's success. As early as last December it was clear to me that Vendtek should benefit from an economic recession in the United States. Survey after survey in the United States indicate that consumers consider their mobile subscription to be essential. Surpisingly, most surveyed are willing to give up landline telephones, and cable TV ahead of their mobile phones. However, an increasing percentage of the population does not qualify for post-billing services. As more Americans prepay for their service, I expect that over-the-counter topups will increase in frequency. As the economy declines, and petty crime increases, more and more retailers are likely to opt for more secure electronic topup systems. These two trends should benefit VSI.If the rollouts in the US continue to pick up steam, Vendtek Systems is in an advantageous position.

Privinvest's accumulation of VSI stock hints at the potential for major rollouts in the Middle East, while the US recession pushes more American mobile subscribers towards VSI's solutions. As the world economy contracts, and many Companies struggle for earnings, the future couldn't be brighter for Vendtek Systems. Certainly Privinvest thinks so; and it likely has some pretty good insight on future demand.

I do not own shares of VSI, nor do I recieve compensation from the Company, its Directors, or its employees.


Nstein (EIN.V): Weak Q3 Results Leading Into a Rosier Q4

NStein reported Q3 yesterday with sales of $5.6 million, EBITDA loss of $0.8 million, and a net loss of $1.0 million or $0.02 loss per share. Although sales increase by 37% year over year, EBITDA losses increased. Late in 2007, the Company made incremental investments into its sales force to support scaling initiatives. Since that investment, the Company has been selling into a headwind of weakened balance sheets, and constrained credit. Although the sales pipeline remains solid, the ability of that pipeline to actually buy has been reduced.

On a relative basis, as I had expected, Q3 was a tough quarter due to continued delays in buying decisions by its prospects. The good news is that some of those delayed decisions have popped up during Q4 with major announcements with Hearst Newspapers, and Scripps Networks among others. As a result, I think that there is a better than 50% chance that EIN's Q4 could exceed my sales expectations of approximately $6.0 million and show positive earnings performance. Because a substantial percentage of sales to Nstein are in US$, and most of its expenses are in C$, there is also an expected benefit of between $0.3 and $0.4 million if the Canadian dollar remains below $0.85 compared to its US counterpart. If this market condition remains, EIN could gain additional marginal benefit from it.

Although there is an expected Q4 pop in sales, which has proven to be typical for this sector, it is unlikely to be as strong as Q4 performance during 2007. I expect that the company is likely to continue to reduce expenses in order to enhance marginal performance during 2009.

I think that 2009 could be as challenging a year as 2008 in terms of sales. Most of EIN's prospects are likely to continue to be careful with their capital, and time-to-revenue should remain extended for the foreseeable future. Also, its client base should continue to face uncertainty regarding online marketing revenues for at least the next two quarters. As the world economy continues to contract, I see CPA, and CPC advertising continuing to attract a greater percentage of a diminishing spend. In human speak, I see search advertising maintaining growth, with display advertising continuing to struggle. Most of Nstein publishers generate revenue from display ads.

The good news is that the Company has $6.3 million in treasury, and only $0.5 in long-term debt, which is easily serviceable. Although I doubt that the Company will engage in new acquisitions during the next 12 months, it has more than sufficient funds to survive even catastrophic market conditions.

Notwithstanding the market conditions, Nstein has developed an outstanding product that its market niche remains desperate for. The Company continues to innovate, and there are new applications of its semantic algorithms to come, just in time for a market upswing.

I really like this Company and, after holding up through much of the technology downturn earlier this year, the shareprice has come off quite a bit recently. It is currently trading at 2.4x cash and between .70x .75x forecasted sales for the year. If the Canadian dollar remains surpressed and the company remains vigilant on cost containment during 2009, there is probably a better than 30% chance that the Company could be cashflow positive next year even on modest sales growth. I expect that sales should grow between 8% and 15% next year with the Hearst contract representing over 5% of total sales.

I do not own Nstein shares, nor do I receive compensation in any form from the Company, its directors, or its employees.


Obama and Healthcare Technology

The Obama presidency is probably the most anticipated since Reagan. He has instilled a sense of hope in the world even as it sinks into the most severe economic recession since, well, the beginning of the Reagan era.

The man has a lot to do, although he is running out of levers even before he enters office. However, lets assume that he is able to do what he says he can do and he finds $100 billion or so to initiate his healthcare program. Is there a spillover effect that benefits Canadian IT vendors in the healthcare sector? Possibly. As I outline below, it depends on political will. Notwithstanding, I would argue that those Companies that are already in the US market and employing Americans may benefit most.

Throughout his campaign, Obama stated that one of the cornerstones to his healthcare plan was an investment in information technology. His objective is to find ways to consolidate medical records and to improve access by both health care workers and patients to consolidated medical information on every American securely.

Clearly the capacity and the capabilities already exist to do this. Most major internet portals and especially social networks have gathered significant amounts of data about hundreds of millions of people in a fairly short period of time. SaaS providers have been building sophisticated permission and privacy algorithms for years, so secure access to private information should be a no brainer. In fact, since the early stages of the commercial internet, the technical capability has been there to establish centralized healthcare databases that could help improve doctors' access to and understanding of a patient's health situation. There has been limited political will.

The medical and pharmaceutical lobbies are among the most powerful in the United States. For decades, doctors have been resistant to information technology to the point of intransigence. Underlying this resistance has been suspicion and a "doctor knows best" attitude that has resulted in failure for many initiatives. Let's assume that Obama can instill the political will - so far he seems capable.

There are a few Canadian IT vendors that already derive a good portion of business from the needs of US hospital administrators and pharmacies including CGI Group (GIB.A.TO), Systems Excellence (SXC.TO) and Logibec (LGI.TO) among others. All three generate cash, have relatively strong balance sheets, are net income profitable and have footholds into the US healthcare sector. Systems Excellence and Logibec are healthcare pureplays and are more sensitive to conditions in the healthcare sector. Both are acquisitive, and I expect that they will continue to make strategic acquisitions as the US healthcare system undergoes its upgrade.

As Obama begins to formulate his plans, keep an eye on SXC, LGI and GIB.A because they could each be positioned to gain incremental upside. The underlying risk is that the AMA and the pharma lobbies impede Obama's progress once he enters office, which would, in turn, reduce the potential for incremental upside for these Companies.

PTS Signs Middle East Partner for GPX

Deal with Turkish computer distributor Hitit is designed to establish extensions into the Middle East. Local partnerships are integral to success in the region. Management at both Guestlogix and Vendtek Systems can attest to that. However, it could take several months to see the first GPX partnership to come to fruition.

Success with the GPX rollout notwithstanding, I am hopeful that more outsourced principal deals continue to come on stream to offset the margin contraction of the Delta Airlines relationship. Over 90% of this Software as a Service (SaaS) provider's current revenue is derived from managing consumer solutions for approximately 25 major loyalty programs in the world.

The bottom line is that as long as PTS continues to execute (and doesn't give away margin), the world economic conditions should continue to benefit performance.


Nstein lands a big'un

Today, Nstein (EIN.V) announced that Hearst Newspapers has contracted the Nstein platform for its entire content supply chain - representing 16 newspapers. This is Nstein's largest single deal - probably worth over $1.5 million in licensing alone. Services could be valued at twice that.

During 2009, Hearst Newspapers could represent more than 10% of revenue streams to Nstein. In the meantime, it is my understanding that the Company could recognize revenue from licensing during Q4, 2008. This would mean that there is a greater than 50% chance that the Company could exceed my expectations for Q4 in terms of sales and profitability.

More importantly, this transaction reduced balance sheet risk. The Company likely has sufficient funds to be able to survive the current downturn in the markets. However, I think that it would be an excellent time for the Company to more aggressively look to offering some SaaS licensing options to its client base. Although revenue ramp may not be as fast, NStein would not lose many clients to "stand-pat" decisions used to preserve weakened balance sheets. A subscription or user-based licensing solution would probably entice reticent prospects to more aggressively adopt Nstein's content management solutions during 2009. The cost/benefit equation tips dramatically towards deriving more revenue when capital is preserved.


I am still going to direct some thought towards some of the companies that I have followed previously including Descartes Systems, Points International, Kaboose, Vendtek Systems, Guestlogix and Nstein. However, I expect to broaden my scope to other subject matter. From time to time I will comment on Companies that I have not covered in the past.

I will disclose if I own any shares of Companies that I talk about.

Kaboose (KAB.TO) I don't understand.

After reporting its 3rd quarter last week, the share price has fallen off a cliff. Currently, the market cap appears to be less than $60 million. Considering that sales should exceed $84 million this year, and EBITDA should surpass $8 million for the full year, shares are trading at less than 8x EBITDA. The company was inline with my expectations on EBITDA for Q3 at $2.7 million and ahead of forecasts regarding sales. Margins were a little weaker, although this trend should be reversed as the Company rolls out its vertical ad network. Three things are important to this stock:

1. 70% of its revenue comes from long-term contracts with PGCs.
2. Motherhood is not sensitive to economic swings - neither is household decision-making influence.
3. Company is likely to continue to jettison its money losing e-commerce properties. This is likely to help improve profit margins going forward - especially as the ad network expands.

I am looking at about $95 million in sales next year and between $15 million and $16 million in EBITDA.

This stock appears to be really undervalued at this point considering that its forecasted EBITDA is likely to nearly double. Worst case, the stock should be worth $0.80 in 12 months if the multiples remain contracted as they are. If multiples for the stock were to improve to 10x (which is still slightly below the sector performance), then we could see the stock worth $1.10 to $1.20 in twelve months, inferring nearly a triple from these current prices.

I do not own KAB.TO shares, nor do I receive any financial compensation from the Company.


Point International (PTS.TO); extends GPX - key to liquidity

Headline: InterContinental Hotels Group's Priority Club(R) Rewards Joins Loyalty Program Marketplace.

I think that this could be considered a fairly important milestone for the Global Points Exchange (GPX). People can now essentially trade hotel rooms for flights with other people, and vice versa. The extension beyond air travel enhances the value of the service, and further extensions into other sectors should continue to add value.

I hope that the loyalty program participants in this secondary market begin to more aggressively re-evaluate pricing. It appears that some like Aeroplan have already made the decision to reduce transaction fees. Hopefully other market participants will follow.

As PTS exits 2008 with around $75 million in sales and a couple of million in EBITDA, this Company is poised to be a near monopoly player in a market that appears to be somewhat insensitive to the current recessionary cycles.

At $0.52 share price and a fully dilute market cap of less than $80 million, PTS is a stock to own for the long-term. Three years from now when it has the potential to generate $25 to 30 million in EBITDA, it will seem remarkably inexpensive.

I do not own this stock, nor do I receive any financial benefit from Points International.

Remembrance Day

I cannot recall a Remembrance Day that has not been raw and gray. I am thankful to the generations before me for the sacrifices that they suffered so that I may be able to live my life free, with prosperity and peace. I hope that our children and our grandchildren live without the violence of war. Too many children today in the Middle East and Africa are born into violent conflict.

Based on human nature, it appears to be unlikely that future generations could live without being touched by war of some type. It is in our nature. I just hope that territorial aggression can be supressed and channeled enough to protect the world from the catastrophes of total world war - the tragedy of the 20th century.


Contact Us

Ron Shuttleworth

161 Bay Street
27th Floor
Toronto, ON
M5J 2S1

647-500-7371 (cell)

About RES

RES stands for Ronald Edward Shuttleworth. Yes that is a hefty moniker.

It was Andrew Abouchar at Tech Capital who began to refer to me as "RES", probably due to the ridiculous number of documents that I had to initial with him at one time in the past.  "Free Thinking" is more about removing the some of the constraints from opinion and analysis, and creating a dialogue.

I currently act as Technology Analyst at M Partners, Managing Partner at Razor Capital Partners and President, RES Group Inc. I hope that you reading this as much as I enjoy putting it together.

I have been VC, CEO, CTO. This blog is syndicated by Seeking Alpha and Backbone Online.



New Realities

With some notable exceptions, the Canadian technology sector has largely been ignored by investors for the past five to six years. After the tech wreck, and during the commodities boom, investment banking talent has been focused on mining, materials, and O&G. As institutional and retail brokers pumped exploration deals in far-flung barely functioning states, capital for innovation and research into information technology became harder to come buy, and more expensive. Investors didn't care because copper and moly were at historical levels.

I think that this may have a long-lasting impact on Canada's ability to compete once the world emerges from this current recession. Without adequate capital, our tech companies can no longer keep domestic talent, nor attract international talent.

As a veteran of the sector, I remember Canadian technology players attracting some of the best technical minds from Eastern Europe, China, and India. We are likely to see intellectual power flowing the other way for quite some time to come because China, Korea, and others may emerge as a major design and engineering centers once the world economy is shaken out by this recession. Capital follows innovation, which creates wealth.

The bottom line is that Canadian investors still feel compelled to invest in holes. Despite the the opportunity to become a significant world IT player during the past decade, we are likely to emerge as a middling player in the most important evolution in history. In the meantime, the Canadian economy will likely follow its traditional boom-bust trends of the past; tied to the holes.

Points International (PTS.TO) Reported Yesterday: Earnings Miss

Although sales were ahead of consensus expectations, margins were compressed and the Company missed on EBITDA and earnings. Based on the conference call, it sounds to me that the low margin Delta Airlines (DAL-NYSE) principal contract dominated sales for the quarter. Not only that, I think that Management increased its payment to Delta Airlines to induce the airline to promote Buy/Tranfer services more aggressively, which drove higher sales at lower margin.

The company needs to continue to sign large principal contracts and get them rolled out rapidly in order to diffuse the margin compression impact of Delta Airlines. This condition could become more acute as Delta rolls Northwest airlines into its loyalty operations over the next few months. The Company continues to announce new clients including three more during the conference call, although these are dwarfed in size by Delta.

During the conference call, Management adjusted its 2008 guidance towards the high end of its original guidance range of between $65 million and $75 million. I think that revenue could exceed its guidance for the year. However, due to the impact of a weakened economy on the airline sector, I don't believe that the earnings leverage is as strong as I had hoped for and forecasted at the beginning of the year.

Management has stated that it expects to return to EBITDA positive during Q4. This is due to an increase in sales from its dominant clients and the emergence of some of its newer, higher margin clients in its revenue mix. The mid-term outlook for the Company remains positive as consumers continue to leverage their loyalty points to get rewards during a U.S. recession.

We expect expenses to increase as the company invests in marketing for its core business, and for the launch and expansion of its GPX secondary trading platform. I think that the success of GPX will be dependent on the trading fees. Lower fees by the participating airlines would help drive more liquidity. Despite the investment, we still have a wait and see stance on this part of the business.

The Company has approximately $37 million of cash on its balance sheet and no debt, so it is in a very sound position to fund its growth towards market dominance during a period of constrained access to capital worldwide. During Q3, the Company invested in growth by sacrificing margin for market penetration.

In terms of earnings growth potential, cash, and cashflow, Points International ranks among the top 30 small cap tech stocks on the Toronto exchanges. I continue to think that Points International is great buy at current price levels. For long-term value investors, the stock is probably worth between $2.00 and $3.00 within 12 to 24 months. In the short-term, there is a greater than 50% chance that the stock could trade down to the $0.50 level again before recovering.