Thursday, 7 September 2017

Mission Ready Services: Bought Shares On $400 Million Deal With U.S. Military

Mission Ready Services (MRS) announced a distribution agreement to supply its products to a foreign military, with all signs pointing to that foreign military being the United States.

The Material Terms of the Agreement include:
  • Minimum Purchases (USD): Year 1 (2018), $50MM; Year 2 (2019), $50MM; Year 3 (2020), $100MM; Year 4 (2021), $100MM; Year 5 (2022), $100MM.
  • Advance Payments: Distributor agrees to pay Mission Ready (the “Manufacturer”) a down payment equal to forty percent (40%) of the purchase order amount within 10-days of submitting the purchase order.
  • Exclusivity: Manufacturer appoints Distributor, on an exclusive basis, as its sole distributor for the defined territory.
The total minimum guaranteed amount for this contract is $400 million over the next 5 years. The press release implies that the contract will start in 2018 but the material change report shows that the first $50 million could occur any time between now and the end of 2018. This is the largest deal I have ever seen relative to market cap in the Canadian junior world. While it's portrayed as something much more definite than an LOI, the caveat is that the anonymous distributor (possibly Federal Resources Supply Company, a distributor that MRS signed an agreement with in Q2 2017) isn't subject to a very strict punishment for not adhering to the minimum purchase volumes. Once the purchase order comes and the 40% down payment is sent to MRS, that's when we can be assured of the distributor's dedication to this deal.

With that being said, the risk-to-reward trade off from this deal is way out of whack. At 20 cents, the fully diluted market cap (~127M shares) is $25 million CAD. As soon as the stock opened yesterday at 11:30 I bought 200,000 shares with the intent to ride it for a short period of time since I thought it would take off. Instead the stock pulled back to 16 cents which allowed me to load up, really load up. That includes clearing out my U.S. account (well not DGLT) and using credit card debt. Not something that I wanted to do but when I was given this opportunity I took it. The pullback could be from profit takers as well as a significant amount of warrants at the 15 cent level. I get it. I was lambasted for selling a few hundred thousand of my six million shares/warrants of PKK when it hit 20 cents before buying that all back and then some as it seeped back down. So I won't fault others for taking huge profits. If you own a stock that is 10% of your portfolio and it suddenly triples, it has grown to become 25% of your portfolio. Selling parts of your holdings isn't being a weak hand, it's showing prudent portfolio management. The 30M+ volume on the sell side allowed me to become a participant in the 30M+ of the volume on the buy side relatively easily and at good prices. I thank the sellers.

I'd like to share a relevant link:

https://www.defense.gov/News/Contracts/

This is the U.S. Department of Defense contract announcement page. I have skimmed through the contract announcements over the past couple of days and haven't seen anything that could match the terms of the contract as announced by MRS. It's tricky though, as the contract name could be awarded to the anonymous distributor and it will likely be for more than $400M as that is only the cut to MRS as the role of manufacturer.  The announcement might still be to come. So investors should keep their eyes peeled and also have a look at the contract announcements over the past several days. The search function on the site is completely useless. So several more pairs of eyes might pick up something that I missed. It also means that I won't have to scour the website  - delegation of tasks to other shareholders with a large stake in this stock.

 I'm certainly not suggesting that the contract is bogus. I wouldn't load up if I thought it was, plus with the day long halt the Venture Exchange likely went through this deal quite carefully. The company has undertaken steps to put all its resources into fulfilling this deal, namely reneging on the Wild Things acquisition. But if this contract does show up on the DoD website that would be a huge boost to its credibility and basically assure us that the minimum threshold will be met. After all, if the distributor can sign a deal for $400 million plus markup with the U.S. Government, why wouldn't they fulfill their duty to MRS? That would be throwing away middle-man profits. MRS is the one sacked with the tough job of actually producing the goods.

Speaking of tough jobs, one of the prime causes for the stock not immediately spiking over 50 cents is likely the market's worry that MRS is going to have to finance through equity to garner some cash to fulfill its end of the deal. I don't share this view, particularly by reading this paragraph in the release:

"MediaTech Capital Partner’s Porter Bibb, who recently partnered with Mission Ready (see Company’s news release dated August 2, 2017), states, “Mission Ready’s impressive new management team has delivered on its promise to put Mission Ready on a fast track to rapid growth and significant profitability as a market leader in the burgeoning military and public safety tactical equipment sector.” MediaTech will assist the Company with obtaining bridge loan capital for raw materials, as required, and will help to facilitate the rapid expansion of the Company’s manufacturing and sales divisions."

It explicitly states that MediaTech and MRS will seek to obtain bridge loan financing. It makes sense to go with PO financing rather than equity with the new stage the company is about to enter as a major manufacturer. If equity financing is needed at a large scale (small financing for working capital requirements is acceptable) then the company and its capital partner completely dropped the ball on this one. Military spending is about as safe of an industry as you can be in with the current political climate in the Unites States. Interest rates are still very low in historical terms and the stock market is high. There should be firms lining up to finance this deal, seeking some alpha return on an investment that should result in an 8-12% coupon for a bridge loan.

Valuation

How much is MRS worth right now?  Not the easiest question to answer at this early stage but I think most people will answer "far higher than a $25 million market cap". The company hasn't given any EBITDA guidance on this deal yet so I think the most straightforward method to use is a revenue multiplier. Axon Enterprise, Inc. (AAXN), formerly Taser, is the first company that I can think of that manufacturers equipment for the law enforcement and defense industry. It has a Price/Sales ratio of 3.7x.

If we were to apply that 3.7x revenue multiple to the $50 million in revenue guaranteed by that contract in 2018, that would be a $185 million valuation or about $1.45 per fully diluted share US, which translates to to about $1.80 CAD. Now obviously there are a couple of issues with comparing AAXN's already existing revenue to MRS' supposed future revenue stream:
  • AAXN's revenue is multiple is based on past, audited results. The MRS contract is not yet 100% guaranteed.
  • AAXN is profitable at its current level of revenue. We don't know the gross margins on the MRS contract nor if this will be enough to get the company to profitability.
  • AAXN has an existing manufacturing process that can handle large volumes. MRS has yet to prove that it can do this (though it looks like the company brought in new CEO Jeff Schwartz specifically to tackle this issue).
There are also a couple of advantages:
  • We know that the revenue stream on this deal will double by 2021. AAXN will be challenged to double revenue by then.
  • This is just one contract and the $50 million is referred to as a minimum commitment. The revenue stream from this contract will be added to the existing marginal revenue stream as well as any other contracts signed in the near future. Revenue could be substantially higher than $50 million in 2018.
Rather than saying that MRS is definitely worth X price, I'll look at it from the perspective of how big of a discount the market is valuing MRS relative to AAXN and where I think it should be. If $1.80 is the price MRS is assuming all goes well with the contract, the manufacturing and the financial audit between now and 18 months from now, $0.20 means that the market is giving an 89% discount. That means it is giving MRS an 11% chance of success (or say, a 22% chance of getting half way there). I personally think that's way too low.

What's a reasonable target price in my opinion? Well, $0.50 is a nice round number that has a realistic shot based on MRS' current breakout and that would imply about a 28% chance of success. I think if everyone looks at it from this perspective, they'll figure out a comfortable level in which to take profits. That doesn't mean I would dump all my shares at exactly 50 cents nor would I recommend anyone else do that.

Offloading small lots from 25 to 75 cents would result in the same 50 cent average sell price and provide an opportunity to trade spikes and dips. You can never accurately predict when to sell or what will happen. Just look at DGLT as an example. Had I not starting selling in lots between $0.75 and $1.00 I'd be stuck with 100% of my money in a stock that has been halted for three weeks, even if I am technically up over 300%. At least in that case I recovered my original investment and then some and whatever ends up happening to that stock is gravy.

Final Note

Not only do I think MRS will move up, I think for the health of the Venture Exchange, it HAS to move up. If we can't make money trading a $25 million CAD market cap stock that has just signed a $400 million US contract to provide protective gear to the U.S. military, what chance do we have to make money on PKK, FGD, PEEK or any other stock not being chased by weed dreamers? This contract is the Holy Grail for junior investors. There are stocks on the NASDAQ with 5 to 10 times the market cap that would double if they announced a $400 million contract with the United States military. MRS should make all of us good money. If it doesn't, this market is completely broken.




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