This has been my hardest post to publish yet. I debated whether or not I should publish information on a company that does not meet my quality standard. I had to think about what my ultimate goal for this blog is. I came to the conclusion that my goal is to learn myself, while also contributing my readers’ learning. In this sense, I think full transparency is best. I should talk about stocks that meet my quality standard, as well as stocks that do not.
I am by no means trying to identify “short” candidates. I am only saying there are things about the business I do not understand. And remember there is a difference between a high quality company and a high quality investment. A low quality company can make a great investment if bought at the right price.
I think being able to reject stocks is a prerequisite to becoming a good investor. The reasons for rejection deserve close scrutiny. I think I can enhance everyone’s learning by subjecting my reasons for rejection to close scrutiny.
One of my original thoughts was to use this blog as a platform so that company executives would be more willing to talk to me. This is what made the decision hard. By showing my willingness to publish both positive and negative views, executives may deny access. Ultimately, obtaining corporate access is not a primary goal for the blog, and this is why I have chosen the path I did. Besides, good companies should have nothing to hide and be willing to tell their story to anyone who will listen. So here’s to everyone learning!
With that preamble, the subject of this blog post is DMD Digital Connections (TSXV: DMG-H). Here are the things that cause me to question the quality of DMD:
- A weird debt structure
- High regulatory risk
- Weak publishing partners
- Listing on the NEX exchange
- Aggressive stock option grant in 2016
DMD owns a database containing the names, emails, specialties, and addresses of physicians, nurse practitioners and physician assistants. DMD is a database licensee authorized by the American Medical Association to maintain AMA physician professional data for mailing purposes. It is important to note that the AMA does not provide email data on physicians. DMD accesses email addresses through partnering with online content publishers that focus on the medical industry. When someone signs up for an email newsletter on a partner site, DMD cross references the name with its list of names from the AMA. If there is a match, the email is “authenticated” and DMD is now able to provide its customers (pharma companies) with a verified email for a physician.
The company has added to its email list offering with an offering known as Audience Identity Management. This tool allows pharma companies to figure out who is visiting what pages on their website even if the user is not logged in. The tool also helps to combat ad fraud. It allows medical publishers to prove to advertisers who their audience is (and that it contains their target; physicians).
The audience identity management tool (AIM) has been a huge success for DMD and I estimate most of the company’s growth has been attributable to this product over the past two years (DMD has gone form $21M of revenue in 2014 to $41M in 2016).
The AIM tool has been such a large success for DMD because there is no other tool like it on the market right now. The AMA makes public who the other Database licensees are: Medical Marketing Service, IQVIA, Redi-Mail Direct Marketing, J Knipper, Veeva Systems, and QPharma:
- Knipper and QPharma are focusing their business on samples and making sure drug companies are in compliance with sending out free samples by authenticating doctors receiving samples against the AMA list.
- For IQVIA and Veeva, the AMA list is part of a much broader offering; the goal of this offering is to identify who future Key Opinion Leaders will be with advanced segmentation. They do not appear to have offerings that allow a website to identify a user without them logging in. But it is worth noting that both companies are very large relative to DMD and have much greater resources.
- Medical Marketing Service has an email list; MMS also has a tool for publishers to identify their audience, but my impression is that it requires a user to login (unlike DMD which does not require login).
- Redi-mail has an audience tracking tool that can work without login, but it only works when the user has your app installed on their phone or tablet (as opposed to DMD which does not require an app download as it works with tags embedded in the browser).
As of the most recent financial statements (Q2 ended June 30, 2017), Cegedim had debt on its balance sheet of $6.7M. On the asset side, DMD has $0.3M of cash and $8.8M of restricted the cash. The debt has a weird covenant which means that DMD cannot pay out any of its cash it is generating until the debt is fully paid off. DMD recently renegotiated the debt so that it will not be fully repaid until October 2021. This means that shareholders will not be able to gain from any dividend or share buybacks until at least 2021.
Weird, but it gets weirder. Under the previous agreement, DMD had to pay the higher of US$125,000 per month or 1/12 of 35% of the last annual audited EBITDA. In 2016, DMD earned an operating profit of C$7.3 million and amortization was C$1.1 million so that EBITDA was C$8.4 million. The average USD/CAD fx rate during the year was 1.3249 so the EBITDA in US$ was US$6.3 million (C$8.4M / 1.3249). So based on the agreement DMD should have paid the higher of US$125,000 per month or US$184,000. The US$184,000 is equal to the annual EBITDA of US$6.3 million divide by 12. However, DMD did not pay the higher amount; they paid the lower amount. DMD paid C$1.987 million of debt repayments during the year which is equal to US$1.5 million (or US$125,000 per month). I’m willing to admit the debt covenants are complicated and I may be misunderstanding them – but any investor in DMD should be asking management about this.
Given the business model, there is a high amount of regulatory risk involved. Privacy laws are subject to change. DMD acknowledges this risk in its filings: “There are a large number of legislative proposals pending before domestic and foreign governments concerning privacy issues related to Internet-based business. It is not possible to predict whether or when such legislation may be adopted.”
The Digital Advertising Alliance is attempting to set standards for how people are tracked online. One of the key components is that data is de-identified. This is not what DMD is doing as a specific part of their offering is about providing personal contact information.
List of publishing Partners
I’d note that none of the websites appear to be the most prestigious in their field. There is nothing from Annals of Internal Medicine, or Nature, or Mayo Clinic Proceedings, or Journal of Pediatrics or Journal of Clinical Investigation – you get the point… I would say the list is mostly second or third-rate publishers trying to make a buck.
GlobalRPh.com, Aesthetics CME (continuing medical association), Fidelis partners – career search, PAH.tv (pulmonary arterial hypertension), Endocrine society, Diabetes in control, Oncology tomorrow, HMP Global, Delta Healthcare providers, Statnews.com, Gomerblog.com, The Oncologist, Medoptions.com Clinical Oncology – www.clinicaloncology.com, Healthline, Broadcastmed, Global Neurology Academy, Stem Cells Translational Medicine, The Doctor’s channel, Healthjobsnationwide.com, Global Women’s health academy, Reachmd.com, medlexicon.com, ehealth-news.com.
Another point of note is that Wolters Kluwer is a competitor in that they offer data on physicians. Wolters Kluwer owns Lippincott Williams & Wilkins (LWW) which publishes several medical journals. These journals are higher quality than any publisher DMD partners with.
DMD is a bit strange as the company trades on the NEX exchange. The NEX exchange is a rung below the TSX venture exchange, meaning most companies on it are dormant or not active. DMD is on the NEX exchange because the company stopped filing financial statements for a period of time. The company was late to file its 2011 financial statement because of a dispute with its auditor over fees. While this is obviously a red flag, I am willing to give them the benefit of the doubt as they were able to drastically reduce audit fees when they switched from their old auditor (KPMG) to their new auditor (Guimond Lavalee). See Figure 1.
The NEX exchange has lower listing maintenance fees than the venture which is likely why DMD has stayed listed on the NEX. DMD easily meets requirements around net tangible assets and operating income to list on the Venture exchange if it chose to.
In terms of financial reporting and incentive compensation, it is important to note that there is no difference between being listed on the NEX versus the Venture. Financial reporting and stock based compensation is governed by securities laws and not the exchanges. The securities laws do not differentiate between NEX-listed and venture-listed issuers. Both sets of issuers require need audited annual statements, interim statements and MD&A. An Annual Information Form is optional for both sets of issuers.
DMD made a very large option grant in 2016. The company has 199 million shares outstanding and made a grant of 16 million shares. This represents 8% of shares outstanding. Note that the maximum annual grant of stock options in a 12-month period allowed by securities laws is 10%; DMD is getting very close to this level. It is important to note that DMD has not always been a serial issuer of options. The grant in 2016 was the first large grant since 2009. At this point, it is unknown whether or not grants will start recurring on an annual basis. Of the 16M shares, 8.7M shares went to the Board, CEO, CFO and COO.
The job boards on the internet disclose that there has been a large executive management shake-up at the company. It is possible that the remainder of the options may have gone to some of the new executives.
The amount of options granted is concerning. So is the strike price. On the date the options were granted, DMD shares were trading at $0.20. One would think the strike price should be at least $0.20. But NO! DMD decided to issue options to its executives with a strike price of $0.15. This practice is legal; but just barely. The maximum discount you can put on option grants for shares under the price of $0.50 is 25%. DMD issued its options at precisely a 25% discount. So basically management will make money on these options as long as the share price does not decline by MORE than 25%.
It is important to note that related parties own 25.4% of shares outstanding at DMD. The shares have not been earned through options grants over time, they have had an interest since the beginning.
The Company’s website: http://www.dmdconnects.com/
Author Ownership: No TSXV: DMG-H
This article is for informational purposes only. This article is based on the author’s independent analysis and judgment and does not guarantee the information’s accuracy or completeness. The information contained in this article is subject to change without notice, and the author assumes no responsibility to update the information contained in this article. The information contained within this article should not be construed as offering of investment advice. Those seeking direct investment advice, should consult a qualified, registered, investment professional. This is not a direct or implied solicitation to buy or sell securities. Readers are advised to conduct their own due diligence prior to considering buying or selling any stock.
Qualitysmallcaps.com is not engaged in an investor relations agreement with DMD Digital Health Connections Group nor has it received any compensation from DMD Digital Health Connections Group for the preparation or distribution of this article.
The author of this article has acquired and may trade shares of DMD Digital Health Connections Group through open market transactions and for investment purposes only.