Special Situations: You're a big fan of micro-caps. Why is small
better in a world that, according to your recent The Portfolio Guru Post
newsletter, is experiencing weak global aggregate demand?
Jim Collins: I think small is better because small-cap company
stocks move based on factors that aren't necessarily driven by global
macroeconomics. That is particularly important in today's volatile market.
SS: Do you see the recent fall in the stock market as a temporary
blip because of headline news out of China, or are we shifting to a new stage
in the world market?
JC: I don't think it's a blip. I think it's a correction to more
reasonable levels of valuation. A lot of people expected that China, India
and the other emerging markets would generate marginal demand to soak up
excess supply from the U.S. and Europe, but that was too optimistic. All
markets are growing at much lower rates than the historical averages, and it
is very risky to depend on a market devoid of any middle class to pull the
world out of recession. We are seven years past the Lehman Brothers collapse
but we haven't come very far.
SS: Last year, you called the LD Micro Conference "a micro-cap
love-in," and shared the names of five companies that sounded
interesting as a way to gain portfolio immunity to larger market volatility.
You went back again this year. Was it just as alluring?
JC: The conference took place in the first week of June in the
midst of very strong national market performance. The Russell 2000, which is
generally looked at as the index for small- and micro-caps, was outperforming
the major market averages. At LD Micro, people were very optimistic, which
means there probably weren't as many bargains as the year before. The Russell
has since moved into correction territory, as people are selling all stocks.
SS: Can you update us on some of the companies from last year?
JC: Torchlight Energy Resources Inc. (TRCH:NASDAQ) was just
shifting to the operator role on its project in Texas when we talked. The
company is very optimistic. It drilled its first well on the Orogrande, but
instead of going to full production, it is collecting data. This is a large
prospect, 180,000 acres. Last week Torchlight announced a definitive
agreement with Founders Oil and Gas LLC. Founders will provide $5 million
($5M) in project reimbursement costs and an additional $45M in development
capital in exchange for a 50% working interest in the project. Founders will
also become the operator of record.
SS: It sounds as if you found some new prospects that look
interesting this year. What are some of the names you're following up on?
JC: I have been looking at Chanticleer
Holdings Inc. (HOTR:NASDAQ). It owns and operates 14 Hooters locations
around the world. It also has been moving aggressively into the better-burger
segment, the area where Shake Shack Inc. (SHAK:NYSE) has garnered buzz.
Chanticleer is also growing its business in Australia and South Africa.
Chanticleer recently closed a rights offering that raised $6.6M.
We should keep seeing revenue growth through the existing Hooters
franchises, a previous acquisition of a mid-Atlantic chain—The Burger
Joint—and the smaller, regional better-burger concept restaurants that were
funded in the most recent round. That could start adding to the bottom line
right away.
SS: Chanticleer has been in acquisition mode over the last year.
Revenue grew by 65% to just over $10M. Are you expecting it to continue
acquiring?
JC: Absolutely. The reason Chanticleer did the rights offering was
to complete an offering of Little Big Burger, a better-burger chain in the
Pacific Northwest based in Portland, and also to take a larger stake in two
of its Australian properties. Yes, it is absolutely out there, acquiring and
raising capital for that very purpose.
SS: Does geographic diversification in Australia, South Africa and
the U.S. help reduce the risk of the stock?
JC: The basic concept is somewhat recession resistant, but, yes, I
think that globally there is more growth than in the U.S. alone.
SS: What's another company that you saw at the conference you're
going to look into further?
JC: I've been looking at Newtek Business
Services Corp. (NEWT:NASDAQ). It is a strong and aggressive small
business lender. I think the underlying business is very solid, making small
business loans, having very low loan:value ratios and growing market share.
Newtek converted from a C corp to a business development corporation (BDC),
so it has to give all its retained earnings to shareholders. BDCs operate
like real estate investment trusts (REITs); they have to distribute at least
90% of pretax profit.
On Oct. 1, Newtek declared a special dividend of $3.29 per share, payable
on Dec. 31 to shareholders of record as of Nov. 18. Up to 27% of the dividend
can be in cash, while the remainder will be in the form of shares of the
company's common stock. The company's common dividend, based on quarterly
earnings, is already yielding about 11%. Even without the special dividend, I
think it's a great income play.
SS: The life sciences sector has been up all year. Did you see
anything in that sector that you liked?
JC: My favorite there is still Second
Sight Medical Products Inc. (EYES:NASDAQ). It is growing its install
base, implantations of its Argus II bionic eye. The company should be able to
increase the cadence of that, with 800 patients in its backlog. Those people
need to be medically screened first, but there are a lot of people who want
the product. It is seeing a great take-up in Italy, France and all over
Western Europe, so there's global growth.
The other catalyst for Second Sight is a trial in the United Kingdom for
patients with age-related macular degeneration. Right now, it's only
indicated in the U.S. for retinitis pigmentosa, which is less common.
SS: In Q2/15, Second Sight increased revenue by 335% compared to
the period one year prior, to $2.7M, and it brought in a new president/CEO.
Is that growth sustainable?
JC: Second Sight's growth comes from a small base. In Q1/15, it had
19 implantations, and in Q2/15, it had 20 implantations. Sequentially, it's
growing, but year-on-year obviously it's growing a lot more.
The new CEO, Will McGuire, is going to more aggressively market the
product. The former CEO, Bob Greenberg, has shifted to chairman of the board.
This is a transformational device. It quite literally allows a blind
person to see again. We are going through the transition now from "Does
it work?" to "How can we make it work better and how can we get it
in more patients?" It's a really interesting time. That's why the
company brought in new management to push this thing to the next level.
SS: Are you still following any telecom companies?
JC: Yes. One Horizon Group Inc. (HGI:NASDAQ) has a product called
Aishuo that allows for a mobile VoIP solution in China and many other
countries as well. Investors are giving up on China now, which is kind of
silly. The company has had over 7 million downloads so far and has been
approved for monetization through Alipay, which is part of Alibaba and
Tencent. Users pay to "top up" minutes and One Horizon gets a piece
of that. More than 90% of cellphones in the world are prepaid. People buy
minutes and use them through a VoIP solution where carrier coverage isn't
that good. One Horizon's software-based solution allows them to do that
easily. It's really a software solution for the problem of poor cell coverage
and for people who don't have a lot of minutes.
SS: One Horizon has had a lot of volatility as well.
JC: It has. Its former CEO sells shares periodically. I've found
the best time to buy the stock is after it does a follow-on offering or an
offering of secondary shares or both. That's what the company did on Aug. 4.
So it's a trading opportunity. When it goes to the market, the stock goes
down, you buy it and then it announces something on China, and then you might
want to sell it.
SS: Jim, can you leave us with some words of wisdom for investors
looking to get into new sectors with the same leverage that resource
investors have historically enjoyed?
JC: There are a couple of basic concepts that people need to
remember, especially when the market is going through a correction. From a
resource standpoint, basic economics dictates that if the commodity is
selling for less than it costs to produce, production will go down and that
commodity price will eventually go up. So, oil in the $40s per barrel in the
U.S., sooner or later, that has to reverse itself. I think it will be sooner
rather than later. It's already happening. If you look at capital expenditure
budgets for the oil companies—both the majors and the independents—they're
getting slashed dramatically. Production in 2016 should be down significantly
from 2015. My words of wisdom would be to respect the basic laws of supply
and demand.
SS: Thank you for your time, Jim.
Jim Collins is the founding partner of Portfolio Guru.
Collins preaches the gospel of income investing via his newsletter, The
Portfolio Guru Post, and uses income investing principles to manage money
for individuals on a fee-only, separately managed account basis. Previously,
Collins spent 10 years as an equity analyst in New York and London covering
the automotive sector for Lehman Brothers, Donaldson, Lufkin & Jenrette
and UBS. He holds a Bachelor of Arts in economics and history from Duke
University and has completed the academic requirements for the CFA
designation.