Resonance Health Limited not worth the risk (ASX:RHT)

In its most recent quarterly report, Resonance Health Limited (ASX: RHT) reported positive operating cashflow of $94,000 and $829,000 in the bank.

The company has successfully raised $500,000 at 5c per share, and currently has an open capital raising for up to $4.6 million more, which was supposed to be for the commercialisation of Hepafat Scan and R&D on the fibrosis scan. The company has a cashflow positive business line, the Ferriscan.

My thesis was that the funds raised would accelerate the Hepafat scan revenues, and that the company would be able to utilise the Ferriscan network to commercialise Hepafat scan much faster than they had commercialised Ferriscan. Either way, I expected operating leverage would make the company sustainable and cashflow positive in the short term.

In this context, the company has seen fit to announce a heads of agreement to buy another company, VueKlar Cardiovascular Limited.

One of the directors of Resonance Health Limited is Jason Loveridge. He is also a director of VueKlar Cardiovascular Limited.

I found what I believe to be Vueklar’s Annual Report from Jan 2013. You can see that the company had over 200,000 pounds cash and intangible assets valued “at cost” of about 223,000 pounds. Based on today’s exchange rate, that’s about $400,000 (Australian).

This $400,000 was spent on acquiring and maintaining patent rights as well as cardiovascular product development expenditure. Oh, and by January 2013 the Scottish Government had given the company grants of 185,000 pounds – over 80% of the cost of the patents and technology development. At any rate, that was over a year ago. Assuming it didn’t get more grants from the Scottish government, the company presumably has a fair bit less cash than the 200,000 pounds it had in January 2013 – especially given that it has 5 people in its “management team”. I doubt they are working for free.

VueKlar Cardiovascular Limited has 3 major shareholders: the Scottish Government fund that seeded it and the MD and the Medical Director. These 3 parties own 78% of the company.

Just 8 months ago, Jason Loveridge joined the board. Bloomberg states that Loveridge was also a director of Arthro Kinetics Plc from 2006. In fact, he was also CEO. Let us quote from the announcement that company made on 25 November 2008.

“Since the Company’s flotation on AIM, the share price of the Ordinary Shares has fallen substantially. Despite significant improvements in the strategic direction of the business, its strengthened management and financial performance in the last 18 months, the long term trend in the share price on AIM has been one of steady decline. The loss of shareholder value has been considerable, to the extent that the Company has a current market capitalisation of approximately £1.5m, below what it currently holds in cash.”

The company was delisted. Is that the success you’re dreaming of?

Oh wait, there’s more. Believe it or not, Arthro Kinetics was selling a revolutionary new implantable technology! It must have looked like a winner… it was even featured in a newspaper in 2007:

Dr Jason Loveridge, chief executive of Arthro Kinetics, which makes the system, said: “Our CaReS technology offers a genuine regeneration solution to patients and with over 1,000 patients already implanted in Europe we look forward to equally positive outcomes in the UK.” 

Resonance Health shareholders can only hope that VueKlar is better than Arthro Kinetics, which judging by its website is today languishing in obscurity.

In light of all this I spoke to Liza Dunne, the CEO of Resonance Health today, for a about 35 minutes. I was extremely irate because I do not believe that this acquisition is in the interests of shareholders, and I feel like this is reckless change of direction. I’m not going to quote her, but I will tell you my impressions.

Ms Dunne was adamant that the heads of agreement was in the interests of shareholders, and objected when I suggested that the parties suggesting this transaction were not putting their money where their mouth is. While understandable, her defensiveness was unjustified, especially as she did admit that there was a conflict of interest, Loveridge being on both boards. When the last Resonance Health annual report was published, it showed that Loveridge was not a shareholder.

Every transaction will have a winner and a loser. Given that this little start-up is presumably low on cash and miles from commercialisation, I would have thought it is worth very little – certainly not worth the risk of pumping in millions of dollars that could otherwise go to existing Resonance Health shareholders’ profits. On a purely logical level, if VueKlar is so promising, why is it unable to raise capital (or sell for cash) in the UK? After all, London has one of the most sophisticated capital markets in the world.

Given that Resonance Health Limited can scarcely afford to commercialise VueKlar based on its own cashflows, it will likely need to raise capital to develop the business. The UK company gains access to Australian capital markets, and existing Australian shareholders are diluted, and our right to the future cashflows of Ferriscan diminished to the extent that we stand little chance of actually seeing any of that money. Looks to me like this is a potential exit strategy for VueKlar shareholders and an opportunity for VueKlar to access our cashflow.

I do think Dunne genuinely believes it is a good move. However, I’d like to know if Loveridge was present at the Board meetings that discussed this potential takeover. I’d also like to know if Loveridge has any track record generating returns for shareholders of listed companies, because if he does, I can’t find it. If I was still a shareholder, I’d asked to see the minutes of any board meeting discussing the potential acquisition.

Unfortunately Dunne seems to think the risk/reward profile for the acquisition is favourable. She seemed to think it is an opportunity to diversify away from the growing scan revenue streams. The word diworsify is invented to describe this kind of strategy.

Dunne was unwilling or unable to give even a ballpark estimation of how much it would cost to take the stents that VueKlar are developing to market. She did agree that it is more expensive to get approval for internal medical devices than it is to get approval for the scans.

The worst bit was that she seemed to think that the addition of this miles-from-commercialisation speculative venture would improve the prospects of Resonance Health. It’s breathtaking to think that a loss-making venture with little more than a set of patents and an idea in development would improve a business that was on the verge of profitable and could replicate its service at virtually no cost.

Ms Dunne was quite enthusiastic about the patents. Incidentally, patents are not that useful if you don’t have enough money to enforce them. They are also not that useful if you don’t have an approved product that they protect. Also, patents expire. They do not generate cash on their own.

Your guess is as good as mine regarding how much it would cost to commercialise the VueKlar stents, but it would be a lot. They don’t let you just put things in people’s veins without some serious testing. It would seem likely that Resonance Health would have to spend a considerable amount – millions, if not tens of millions. After all, this is a device that is has to be safe to be inside someone’s artery. Getting this selling is a long and expensive road, with plenty of risks along the way.

If the capital raising for $5 million was intended to cover the costs of funding VueKlar, then that should have been disclosed from the outset. It looks to me like the broker expected the market to love this announcement, seduced by the unrealistic pie-in-the-sky potential of the VueKlar technology (that no-one in the UK even wants). Timed, as it was, just days before the end of the capital raising, it was obviously intended to have punters reaching for the cheque book. And it might have worked. Indeed, a couple more positive announcements and some positive cashflow could send the share price flying – but this is one for the traders, not the long term investors, in my opinion.

The big mystery in all of this is Director Simon Panton. He owns about 18% of the company going into the capital raising, and is up for over $800,000 in the capital raising, if he wants to take up his full entitlement. It is a gutsy investor that plunges $800,000 into a capital raising after the company has traded – largely – at a discount to the capital raising price, and has just announced plans to further dilute shareholders with the acquisition of a company that is making a loss, no proven product and is literally years away from earning a dollar.

This saga reminds me of another listed company, CO2 Group Limited (ASX:COZ), now called the Commodities Group (ASX:COZ). C02 Group made a successful bid to acquire a start up with a highly capital intensive project in August 2012 (incidentally, there were plenty of ties between the acquirer and the acquired company). You can see what the share price has done since then.

COZ share price since takeover

Oh, and “the Commodities Group” is currently raising up to $10 million in a 4 for 9 entitlement offer to fund their plans.

It is now plain for all to see that the priority is not to become cashflow positive. There will always be plenty of money for endless capital raising to fund technology that may or may not prove viable, let alone profitable. Some companies just continually raise capital forever. Mining tenements and biotechnology are traditional pursuits of such vehicles. However, I have zero interest in joining that endless capital raising merry go ’round.

If the priority was to return funds to shareholders, then the company would invest in selling its existing services. Instead it is considering an investment in a company that will require many millions more before it has a commercial product. That is not a game plan that generates wealth for shareholders (except those who sell at the right moment).

I remember a presentation by a world-renowned successful short seller. He said that Western Australia was literally the wild west of speculative companies, and that the way to spot potential short targets was to spot the people who were involved in past destruction of shareholder wealth. I am paraphrasing, but that was the message.

The Author does not own shares in Resonance Health. Nothing on this website is advice, ever. It is a blog of my investing, triumphs, and, in this case, mistakes.

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Comments

7 Responses to “Resonance Health Limited not worth the risk (ASX:RHT)”
  1. mickey mouse says:

    great blog coming from someone who sold out of RHT yesterday and now bags it…just like most other trolls and down rampers..find something better to do.

    • I’ve approved the trolling comment, above, simply because it is a good example of the sort of shareholders who are still supporting this company. Also I thought the name Mickey Mouse was apt.

      Speaking from experience, if I think a company is clearly undervalued I am too busy buying shares to comment on blogs I disagree with.

  2. Steve says:

    As there is a common director on both sides of the transaction, it will be classed by ASX as a related party transaction.

    A shareholder vote will be required, together with an independent valuation of both businesses. Will be interesting to see what the valuation of VueKlar is, and whether the transaction is found to be fair and reasonable

    • Thanks Steve,

      That’s a good point. In note, however, that one of the major shareholders is on the board (ie takes yearly remuneration) so they may well get shareholder support (although I also wonder what an independent report would say!) Even if the transaction is not approved, the proposal itself says everything you need to know about management, in my opinion.

  3. mike says:

    Great post Claude. It’s a shame there are quite a few smaller companies like this – with more regard for their paychecks than their retail shareholders.

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