4 thoughts on “PhotoChannel Rocking; Caution Warranted”

1. Dear Sir; Please give update on byth. I bought stock around 2.00 and, of course concerned about the offer of their health stock. Hopefully there is hope! Thanks, Thomas

   Editor: It is time for a full update on what’s happening at the company. I’ll communicate with management, and see what I can find out. As I have been saying, the key to this one starting to trade better is a refinancing of their debt. I know they are working very hard on it, but we need results. In the meantime they are moving forward with the spinoff- going through the regulatory process. You are quite correct, it is time for an update. 

2. Would you accumulate now or wait for the possible reverse split? Thanks

   Editor: I would accumulate now. Your question is from my BLOG when I suggested caution was warranted. The stock was $.26 then. It is now $.20- this is exactly what I was talking about. It has come down to the right level. Everyone already knows they are going to reverse split, so it’s already priced into the stock. 

3. THE COMPANY INSIDERS ARE MILKING THE COW!DON’T LIKE IT @ ALL!

   Editor: Not sure what you are referring to. This stock has been awesome. Not surprised to see a little pullback. 

4. Many people will lose significant amounts of money in PhotoChannel (PNWIF) over the coming months. It has been brought to my attention, through a handful of highly promotional emails and “homemade” reports (which are comical and scary to anybody with an accounting/financial analysis back round), that there is a massive pump-and-dump promote occurring in PhotoChannel. While this may come as a shock to many, because few “speculators” ever try to look under the hood of company whose stock price seems to go straight up, PNWIF will be below $2.00 in the near future. Please read on about the deep issues at PhotoChannel, all of which are supported with information found directly in the company filing’s and the highly promotional, self-serving research reports that have been making the rounds. Read on to understand why PhotoChannel shareholders have unwittingly become part of a major pyramid scheme that will end with a loss of great capital. The only question is when and from what levels.

   First, at the current price of $4.67, PhotoChannel has a market cap of $137 million (using 27.2M shares out and 2.1M deep in the money options for the share count). Yes a $137 million cap, AND with only ~ $2 million of cash, they also have an enterprise value of $135 million. What do you get for this whopping market cap? To start, you get a company that has LOST $56 million in shareholder’s equity since inception (makes you question the acumen of this management team huh?). That’s right; they have an accumulated deficit of $56 million! This is the same company that recently had to file Chapter 7 bankruptcy for their US subsidiary. This is the same company that has a going concern risk disclosure in the financials it JUST filed on 1/29/07:

   “The company has capital requirements in excess of its currently available resources and is dependent upon the proceeds of future financings to further finance the development and implementation of its business objectives. The company’s ability to continue its operations is dependent upon the continued support of its shareholders, obtaining additional financing and generating revenues sufficient to cover its operating costs in an industry characterized by rapid technological change. Management is implementing a plan to address these uncertainties and to enable the company to continue as a going concern through the end of fiscal year 2007 and beyond”

   It’s amazing that the company couldn’t put the $56M they have destroyed to better use. But the destruction of capital is a recent phenomenon as well. Let us not forget that they raised $5.7M in the fiscal year just ended. With only $2M on the balance sheet currently, they have already plowed through $3.7M of the money just raised (at the bargain price of $1.00 per share). Where did it all go? Definitely not to fund a sales build out. According to their 20F – they only have 20 full time employees. Yes, this $137M company only employs twenty people full time. Not exactly the headcount one would typically associate with a quarter-billion-dollar company (per Emerging Growth’s price target, and I’ll get to this report in a bit). Also, cautionary alarms should be ringing with the fact the CEO’s primary address of residence is listed as Herts, UK (per their 20F filing), while the company is located in British Columbia. How does he conduct business on a daily basis an ocean away?

   In the age of Sarbox and shareholder rights, it is appalling that PhotoChannel has paid consulting fees over the past three years totaling $454,167 to entities controlled by themselves and/or their directors (disclosed in their annual report). That is a lot of money for a company that has going concern risk statements in their audited financials and only $4M of sales. And of course, when your stock is hovering around a dime (pre-split), it probably made a lot of economic sense to spend $200,298 the past three years on “Investor Relations?” It is highly unusual for a company, let alone a penny stock, to have a line-item in their audited financials that discloses they are paying for investor relations. Why would they breakout “Investor Relations” from their G&A line? While I hate to speculate, it would be fair to ask if the related party transactions were also for “investor relations.” Can’t PNWIF find more appropriate places to waste shareholder’s capital than “investor relations.” As you are probably aware the huge bull in print has been Michael Shonstrom at Emerging Growth, with wildly bullish estimates and eye-popping price targets (both of which I’ll address in a bit). Are you also aware that Shonstrom spent much of this decade at a small shop writing research on companies that would PAY him to cover them? Doesn’t that sort of dilute the concept of balanced and fair research?

   While PhotoChannel management issued several press releases regarding their “great” fiscal year and fourth quarter, why have they chosen to issue a press release without financial tables? Instead, they issued a release exuberantly citing trends and growth figures in various metrics. Yet, now that they have audited financials that have been submitted to SEDAR, where is the press release that touts the anemic and troubling financials? A quick look at the numbers reveals that accounts receivable jumped from Q3 to Q4 by 30% while sales were basically flat. Why weren’t they able to collect from these tier-one customers? Their Days Sales Out (DSO’s) were 116 days (up sequentially from 85), which seems odd given the purported quality of their customer base. Why would it take customers nearly four months to pay them? Also, what is the point of growing sales if you have to spend unprofitably to do so? Their operating expenses were up 1.5M from FY’05 to FY’06, wiping out nearly all of the sales gain. While PhotoChannel and Shonstrom have trumpeted the fact the company was EBITDA positive in Q4′FY06, neither points out that despite being EBITDA positive, they still BURNED through another $350,000 of cash flow from operations. Also, how many sales-oriented companies, with a $137M market capitalization selling to large retailers, can only spend $38,000 on sales and marketing in a quarter? I don’t know many, but PhotoChannel only spent $38,000 in Q4. How can this be? Had they spent half, just half, of what they had been spending on sales and marketing in the preceding quarter (instead of the 89% decline in spending) then they would NOT have been EBITDA positive. No real business, that expects the type of growth Shonstrom has modeled, can only spend $38,000 in a quarter on sales and marketing. Period.

   And lastly, how dare I forget the ultimate risk with a one-product company, CUSTOMER CONCENTRATION. Does Shonstram, or the company, disclose anywhere in promotional research reports or press releases that one customer accounted for 65% of annual revenues and 75% of the sales change year-over-year? No. However, in their 20F, you will find that they disclose one customer was 65% of sales, hardly the granularity in a customer base that most investors look for.

   I guess, given the blind-buying, nobody has stopped to ask why in the world the auditors sent a letter to the company asking for an explanation of certain disclosures the company chose to make/not to make – with language such as:

   “We have reviewed the above referenced filings and have the following comments. Where indicated, we think you should revise your document in response to these comments.”
   -AND-

   “We urge all persons who are responsible for the accuracy and adequacy of the disclosure in the filing reviewed by the staff to be certain that they have provided all information investors require for an informed decision.”

   Finally, a few comments on Michael Shonstrom’s reports, which contain financial assumptions that would make real analysts’ scratch their heads. First, in his comp tables comparing PhotoChannel to the “industry” (page 3 of his 2/6/07 note), he does not highlight clearly (it is denoted in parenthesis) that PhotoChannel’s sales are in Canadian Dollars, which are currently ~ 1.2x US sales based on today’s FX rates (which optically over-inflates PNWIF sales vs. their comps). When one normalizes his earnings model and comp tables for US dollars, the optical compares get even more absurd in absolute dollars. For example, based on his price target, PhotoChannel would have an enterprise value roughly equal to Shutterfly. Shutterfly just announced they will do, at the mid-point of their guidance, $162 million in sales and $26 million of EBITDA (cash flow from the income statement). How in a non-manipulated stock market world can those financials be valued EQUALLY to a company that did $4m in sales and LOST $2.2M in EBITDA? Based on Shonstrom’s target, PhotoChannel would have an enterprise value that would be roughly the same as Shutterfly. That is the beauty of the stock market; there are always pockets of extreme speculation and price moves straight up (often followed by moves straight down).

   The actual valuation table on page 3 was interesting as well, in its own “something-doesn’t-pass-the-smell-test” sort of way. Shonstrom includes PhotoChannel IN the industry group when calculating the average multiples of the industry comps. Why wouldn’t he strip PNWIF out to present the mean averages without PNWIF???? The result makes PhotoChannel look only terribly expensive, instead of eyes-fall-out expensive. For example, had he excluded PhotoChannel from the comp group (the whole point of showing a comp table is to compare the company in question to the group excluding the company being analyzed) the average book value/share of the industry would have been 3x. This compares to PhotoChannel at 29x today. The price/sales multiple of the group if calculated correctly would have been 2.9x, which compares to PhotoChannel at 27x today. Needless to say, this reinforces the belief that there will be a monster gap down from where the momentum/pyramid scheme buyers can drive the stock, and the price a real investor would be willing to pay to own the company.

   The projections in Shonstrom’s report are the borderline equivalent to intellectually disingenuous financial analysis. There is a reason models are so dangerous…. they can say anything you want them to say, hence the slogan “garbage in, garbage out.” I wonder how PhotoChannel will hit these growth targets given the fact their service has been live since 2003. The company is currently fully deployed with its major customers and they were still only able to generate a few million of sales. From their 20F:

   “Also during fiscal 2006 and subsequent to the development and initial launch of its new platform in late 2005, the Company completed the rollout of this new platform to all of the Company’s largest retail customers. There are more than 8,000 retail locations worldwide now fulfilling print and gifting items from digital images received through the PhotoChannel solution.”

   With a mature install base, and revenues flat from the July to the September quarter, it makes one wonder how Shonstrom could project such out-of-this-world growth. One may argue this will be impossible because the company is fully deployed and still not producing enough revenue to afford Nick Saban’s annual contract. Why? Because their market is already toast. The whole incentive behind one hour development when we all had film-based cameras was the instant gratification of seeing the photos we took (in one hour). Now, with great digital cameras, not only can we see our pictures instantaneously, we can also delete them, edit them, print them from home, and share them with friends and family on-line. Further, we can order them on-line for next-to-nothing, saving us an unnecessary trip to the store, while storing our photo library for free on a 3rd party’s dime, like FlickR, Google Picasa, Shutterfly, oPhoto, Snapfish, etc. In-store photofinishing is going the way of the newspaper which is why PhotoChannel will never hit Shonstrom’s numbers. But, Shonstrom has also based his numbers on contract wins that don’t exist yet (Costco USA), not to mention that new opportunity he promotes in his last report about CD burning at a Wal-Mart store. Can you really envision consumers opting to forgo iTunes, or the other download services (both legal and illegal) where music is stored on a PC hard drive to burn (most PC’s have integrated burners now) or port to an mp3 player? I just can’t see this opportunity Shonstrom is baking into his numbers developing for a CD that is requested on-line, burned at Wal-Mart Canada, picked up later by the consumer, and then enjoyed on that CD player we recently replaced for an iPod….. DVD’s possibly, but there are already dozens of companies with in-store kiosks, for example HP – who Wal-Mart recently announced as a partner in their digital media experience.

   So why are Shonstram and these promotional “reports” I have seen so bullish? Possibly because there are financial rewards for individuals that are NOT left holding the bag. Emerging Growth is a full service firm and seeks to do banking with companies (this is stated from their website). PhotoChannel needs money (this is stated in their disclosures). There is nothing wrong with this equation, other than the objectivity of the research and the shameless promoting that is going on with PhotoChannel. However, I do find it very disturbing that Emerging Growth does not list PhotoChannel as a company they cover ( http://www.egequities.com/egeweb/research/researchstocks.asp)) given their extremely aggressive research reports. When the music stops, those without chairs will be left holding the bag of a company that is presently valued at $137M dollars with $4m of sales and a $56M accumulated deficit. In fact, I’ll leave you with the fact PhotoChannel has issued tens of millions of shares around ten cents over the past several years, including warrants along the way. Their board has granted management with “limitless” authorized shares that can be issued at their discretion (below, I have pasted parts of these transactions disclosed in their 20F). After PNWIF reports their holiday sales, which should be “strong” (maybe a 1.5M in sales) given their seasonality, I expect another wildly promotional report from Shonstrom, which may mark the top in the stock. This will likely be followed by a dilutive PIPE or secondary that is led by Emerging Growth. All the while, the “rah rah” emails will continue, originated from those individuals with the most to gain financially from the scheme – often referring to their own reports and how credible they are. As a victim in previous pump-and-dumps (many times well-intentioned by all those but the promoters), I just wanted to present the facts and another side of the coin. Best of luck and cautious investing to all.

   Shares issued:

   Fy’06 – Pursuant to a non-brokered private placement during the year ended September 30, 2006, the

   company issued 27,500,000 units for net proceeds of $2,540,720. Each unit consisted of one common

   share and one-half of one common share purchase warrant. Each whole common share purchase

   warrant entitles the holder to purchase one additional common share of the company at a price of

   $0.15 per share for a period of one year from the date of closing. The net proceeds of $2,540,720

   The common share purchase warrants expire on May 30, 2007.

   Pursuant to a non-brokered private placement during the year ended September 30, 2006, the

   company issued 17,000,000 units for net proceeds of $1,533,000. Each unit consisted of one common

   share and one-half of one common share purchase warrant. Each whole common share purchase

   warrant entitles the holder to purchase one additional common share of the company at a price of

   $0.15 per share for a period of one year from the date of closing. The net proceeds of $1,533,000. The

   common share purchase warrants expire on November 15, 2006.

   c) Warrants

   First Associates Investments Inc.

   500,000 common share purchase warrants, with immediate vesting, for

   services provided.

   TELUS Communications Inc.

   (the company had agreed to issue TELUS up to 2,100,000 common share purchase

   warrants, which were to be provided as earned during and under the terms of the agreement on

   (*****All of these services are provided from PhotoChannel’s partner hosting facility located at TELUS Communications Inc.’s co-location facility in Burnaby, BC.)

   NBJ Enterprises Ltd., dba Skana

   Photo-Lab Products (Skana), to act as a distributor for the company’s products in Canada, among

   other consideration, the company had agreed to issue

   Skana up to 2,000,000 common share purchase warrants, which were to be provided as earned during

   and under the terms of the agreement.

   Discovery Capital Corporation

   (Discovery) 4,325,000 common share purchase warrants for financial advisory services to the

   company, and 700,000 common share purchase warrants for a finder’s fee on the private placement of

   units of PhotoChannel LP as consideration.

   v) On May 11, 2000, the company granted a common share purchase warrant, exercisable for a period of

   five years, to purchase up to 1,000,000 common shares of the company at a price of US$1.75 per

   share. The common share purchase warrant was assigned a value of $1,700,000, which was recorded

   in equity. During the year ended September 30, 2005, this share purchase warrant expired
   Editor: This is the other side of the story, and I allow it to be published so people can get the negative side as well. For all I know, you could be right. Investors should also be aware I have read two internal research reports, generated by analysts at one hedge fund and one institutional house, projecting considerably higher levels for this stock. I would have them on the site, but the authors would not give their permission. It is impossible for either of those research reports to be the “pump and dump” tools you allude to. They are impartial and generated for internal use at the fund and the firm. They could be wrong. but they are not tools for what you suggest.
   

   To the contributor- diatribes this long are generally not allowed as your long winded presentation puts people to sleep. In the future, make your point in a much shorter time frame.