TheDumbMoney (58.69)

Why I Bought a Penny Stock -- Artificial Life, Real Worries

January 22, 2011 – Comments (8) | RELATED TICKERS: ALIF , AAPL , MSFT

I just posted this as a pitch on ALIF.OB, which I bought RL on 1/6 after the first part of the big drop.  On the one hand, I'm not unhappy I bought, and think I can make money in the longish term.  On the other hand, this was excessive risk-taking for me, even though it was a tiny position (2%ish of my portfolio), and prompted my decision to step away from excitement about the market and not buy shares in any new companies until 2/22, as I posted in my BRF entry.  As always, I would love any bear takes and general criticism.

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What is it?, and catalysts:  Artificial Life (ALIF) is a mobile software company.  They are most well known on this site for developing games apps for the iPhone.  However, it also has a mobile participation television and augmented reality business, called MoPa TA, with more augmented reality coming.  It also is trying to push forward a business development/sales/inventory management sofware calle Opus-M, which is already a major revenue stream.  And it is pushing forward with attempts to do mobile health, in particular with a diabetics application called GluCoMo, and it appears to be gearing to expand into that mobile health area.  They are going to be launching a neurodermatitis mobile health application called NeuroDerMo.  The health apps are to do mobile monitoring of health conditions in conjunction with doctors.  Per the most recent 3rd quarter 2010 filing, Opus-M and the telemedicine products are what is really driving revenues and profits, NOT the iPhone games.  However, iPhone games downloads are growing hugely -- 8 million downloaded in 2009, and 12 million downloaded in just the first three quarters of 2010, 15.7 million through the end of 2010, making nearly 100% growth.  Note that about half of them are free downloads though....  New "social network business products" are planned for 2011.  This already describes some catalysts.   iPhone sales is the first one.  But also, ALIF has really just begun to get involved in Android, so that's a potential growth market -- it's planning 30 titles for Android in 2011, mostly porting iPhone games.  It is also just beginning to get on board with iPad, so that's a potential catalyst as well.  GluCoMo is in the top 50 health apps on iPad.  This is no fly-by-night company.  Another catalyst is that 3M, as in MMM, THE 3M.  In October 2009 3M bought 10% of ALIF for $6.5 million.  Basically it looks like the guy who worked with ALIF on its BMW game liked them and when he moved to 3M he got ALIF involved with 3M, from what I could tell on a blog.  There was a 14-month trial period during with ALIF gave 3M some demos, and now 3M and ALIF in 2011 are going to develop a few pilot projects.  I view the 3M partnership as a huge vote of confidence from a major company, and a nice potential catalyst.  Given ALIF's history with 3D games, and 3M's involvement in potential 3D mobile display technology, I suspect they are going to try to develop something along those lines -- games that will take advantage of 3Ms mobile 3D technology.  The fact that just this month 3M went moved forward with ALIF after a 14-month trial period is a big vote of confidence, happening now.  So it's a diversified little software company, risky, but unlike many of the other companies in this field they are making real money, increasing real revenue, and lots of "real" companies work with them and like them.

Valuation (and dilution):  ALIF has a P/E of 4.8 and trades at less than book value.  Perhaps the biggest concern about ALIF, as others on this site have noted, is dilution -- they have NO debt, but they keep issuing more shares.  That bothers me.  But it's making money, consistently profitable, it has a 21.5% earnings yield.  Free cash flow has turned positive for the first time, indicating the dilution may soon come to an end.  Can't really do a FCF analysis on this one.  Earnings aren't growing very fast because of the dilution, but at a P/E of 4.8 I think that is priced in.  And is dilution really so different from issuing debt?  I'm not sure it is, and I suspect that ALIF has used dilution to grow its business at a time when debt capital markets were, shall we say, not amenable to small businesses like this.  So I'm not sweating it too much.   It sems to me that there is potential for upside.

What's up with the ARE and M-Health deals on 1/5/2011 that tanked the stock? -- First, basically the company paid $650K for a 1/5 stake in a tech start up dealing with augmented reality.  what is that?  Well, it's a new use for mobile phones and pads; basically you get a live view of the world but with computer-generated objects and images as well. Picture this: you're house hunting, so you just point your phone at a block of houses and it tells you all the sales histories.  Or, you're in a new city and your phone will superimpose ads and store names over buildings on a real-time 3D basis while you look at your phone.  Etc.  It's much bigger in Europe so far than it is in the U.S.  A company called metaio (privately held) is probably the leader, but it's a major growth field.   Unfortunately, I cannot find ANY information about Augmented Reality Europe, which is troubling.  Turning to M-Heath, this clearly relates to the desire to leverage the mobile health applications.  Two things are hinky about this:  1) the paid in accounts receivable; 2) they don't say who the longtime partners/clients are with home they formed the joint venture.  What I'm worried about was them maybe taking partial control of a company that wasn't paying its bills to them.  I suspect that the market looked at the combo of these deals and got very worried that ALIF was either not allocating its profits well, and/or the M-Health deal smelled funny.  This is a big we-shall-see.  I'm excited more about the ARE deal, though ALIF did not invest in a market leader (the real market leader there is mataio, but it's privately held).

Why a penny stock?:  Well, it is a penny stock.  But it has a a total market cap of a respectably tiny $50 million or so.  Rocky Mountain Chocalate Factory (RMCF) is a micro-cap I respect, and it's total market cap is only $62 million (I have owned RMCF in the past, and will buy again if it gets to my price point, I sold stock in May 2010 to help maintain an emergency cash reserve fund after buying my house, but I had bought in at around $8.50 and regret selling).  AIRT is another micro cap I respect alot, and its market cap is only $27 million (it is a long-time subcontractor for FedEx, the government, some airlines, and sells de-icers; the only reason I don't own it is that its customer base is SO concentrated, but I would not feel bad owning it, and have in the past at the $8/share level).  So what's the difference?  ALIF has more shares, so a lower price.  How, I've discussed the dilution.  But fundamentally, what does price matter?  Obviously there are practical considerations in terms of volume, listings, etc., but in terms of value, the fact that ALIF trades at under a dollar per share and RMCF trades over $10/share really "makes me no-never-mind."

Risks, final thoughts:  My biggest worry is this M-Health transaction.   I bought after the drop that caused, and I would not buy more until I get some clarity on that.  There is a lot of upside potential here though, and I like the 3M partnership and the fact that it was extended this month.  Dilution is a worry, as is the fact that this is a micro cap, and volatile.  On the other hand, I did some perusals of shareholder boards, and ALIF is very much in the hands of the invidiual penny stock crowd.  These people are the antithesis of long-term investors.  They're looking for quick 10% pops and then they sell.  I say "on the other hand" because I think there may be opportunity there, in my standard "time arbitrage" schemata.  The company has its fingers in a lot of pots.  It SHOULD be able to continue growing modestly, and there is a very small chance for a really big pop if something takes off big-time.  This is a 1-Year hold stock for me, not a buy forever.  I will reassess ALIF in January 2012.

Buying Note:  I  bought this on January 6th, after the really big 15% drop.  That was a mistake.  I had been watching it for months, and I got too excited about the large drop, failed to fully evaluate the M-Health transaction, and let my emotions generally get the better of me.  Let that be a lesson!  I should have waited for another day, and I could have gotten it at $0.77/share instead of at $.085/share, which is where I bought in at a 1/2 position.  REALLY do you own research on this one.  This is a highly speculative and volatile micro-cap software stock.  I am an amateur with a low CAPS rating.  I do not take myself seriously and nobody else should either.

Here are some links:

http://www.prnewswire.com/news-releases/artificial-life-announces-q3-2010-results-and-2011-product-strategy-107454383.html
Third Quarter 2010 report.

http://www.cnbc.com/id/40922652/
News re: the M-Health investment that tanked shares on 1/6 and 1/7/2011.

http://seekingalpha.com/article/238025-gaming-the-mobile-app-microcaps-sold-glu-mobile-bought-artificial-life?source=feed
Showing competition with GLUU in the mobile diabetic market..

http://www.streetinsider.com/Press+Releases/Artificial+Life+Announces+Second+Healthcare+iPhoneiPad+App/6225256.html
http://geoinvesting.com/companies/guidance.aspx
Both re: announcing NeuroDerMo.

http://www.reuters.com/finance/stocks/keyDevelopments?symbol=MMM
http://investorshub.advfn.com/boards/read_msg.aspx?message_id=43835726
http://www.gearlog.com/2009/10/3m_brings_3d_to_mobile_devices.php
3M Partnership.

http://www.beaconequity.com/hot-otc-stock-alert-mixed-opinions-on-artificial-life-alif-strong-revenue-growth-and-lack-of-internally-generated-cash-2010-09-15/
Free iPhone games
Augmented Realtiy

http://finance.yahoo.com/news/Artificial-Life-Announces-Q3-prnews-3679490737.html?x=0&.v=22
Green Cortex

ARE and M-Health Transaction:  there are tons of BS articles all over the web about that transaction, all of which simply parrot ALIF's press-release.