Redline Communications a classic tale

The recent tale of Redline Communications (RDL:TSX) is a classic one.

Excitement surrounding the macro backdrop for the industry (WIMAX) led to a decent-sized equity offering and a TSX listing. The disconnect between the stock market’s expectations and the timing of the rollout of that macro market has just as quickly led to a slumping share price. Initial Public Offerings such as OnX, 180 Connect, Guest-Tek and Espial are all in that camp, and you can now add the TSX debut of Redline to that Hall of Fame.

Redline went out on the AIM some time ago (see post “Redline launches on AIM“, October 10-06), which served as source of some fodder for this space as the AIM offered so many Canadian tech companies all of the costs of being public, but none of the benefits (other than the capital raise, which didn’t require an IPO to complete). The firm’s plan went something like this: get some visibility, raise some money, and migrate to the Toronto Stock Exchange when good and ready. Perhaps it made some sense to the Board of Directors, even if the lack of trading on the AIM undermined the traditional concept of a floatation (“Bizarro AIMo 2“, February 9-07).

Having flawlessly executed on their capital markets plan, you’d assume they’d be delighted with the outcome. Not so, unless the “penalty box” was the goal.

Redline is right where they weren’t supposed to be after all of that time and consideration. The capital market’s plan was executed perfectly. The AIM offering was followed up by a TSX listing last October. They got some U.S. interest, and even a piece by Cramer-offshoot “Real Money“. With the TSX listing came a $40 million equity offering at $6.50/share. 1.5MM shares of the 6.15MM share sold were in the form of secondary (which means that original investors took some dough off the table). Lo and behold, just four months later, the quote is at $1.90.

Are we having fun yet?

You have to hand it to the shareholders that let some shares loose last October at $6.50:

– Original Angel Investor Philippe de Gasp´e Beaubien III went from 3,735,490 to 3,185,494

– Francois de Gaspe Beaubien went from 1,391,367 to 1,186,510

– VC fund Matrix Partners sold about 300k shares

– VC Fund US Venture Partners sold the same amount

– CEO Majed Sifri reduced his modest 3.9% stake to 2.5% post-offering with a $450,000 share/option sale

– CFO Thomas Hearne did the same, selling 12,000 of his 107,000 options

– Director Timothy Dibble and Executive Rene Arvin didn’t sell a drop of their positions.

This is where the “classic tale” comes into play. Go out on the AIM, get your feet wet, raise some money on Europe and be ready to roar when the time comes for the TSX outing. All on the way to the natural home on the NASDAQ. Right? No so fast.

A few weeks later, on January 4, 2008, the company releases updated guidance for 2008. Did we tell you that second half 2007 revenue would be $31 – $33 million? We meant less than $27 million. But it still represents year-over-year growth of 40%, which we all would agree is very respectable. Unless, of course, you bought equity from selling shareholders at $6.50 ten weeks earlier.

The institutional sales teams call it “expectations management”, and it hasn’t worked here. Here is the recent CIBC research note. According to their analyst, if you hold on you’ll get back to the $6.50/share level before too long:

“Q4 In Line With Profit Warning; 2008 Guidance Reduced

REDL reported Q4/07 in line with its profit warning. Revenue was negatively impacted by production delays and order push outs. The company reduced revenue guidance for 2008 and now expects 40% growth, down from 50%, and continues its expectation to be profitable by Q4/08.

Q4 revenue was $12.8M, down 6% q/q. Gross margin was 28% and was negatively impacted by 700-800 bp due to the delay in production and some small inventory write-downs. Opex increased as a percentage of sales as REDL was expecting a higher top line. EPS was -$0.27.

For Q1/08 we expect rev. of $13.1M (prior $15.4M), up 2% q/q as delayed orders get booked and commercial deployments continue. We expect EPS of -$0.14. For 2008 RDL expects rev. $73M (down from $80), with operating leverage playing out over the year reaching profitability by Q4/08.

We continue to rate RDL a SO-S, but have lowered our PT to $6.50 from $7. The WiMAX market is seeing good growth but catalysts for REDL’s stock will be the company’s execution over the next few quarters. RDL is undervalued trading at 0.3x 08 P/S vs. its closest competitor Alvarion at 1.1x.”

I think the sell-off is a shame. Redline is a good story with the right management and their products play an important role in the broadband market. The stock will recover, and some other victim will find their way into the penalty box. In the meantime, the story reminds us that even the best-laid plans don’t always work out.

Manage the expectations, or they’ll wind up managing you.

MRM