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Elevator Pitch
Hopto Inc (OOTC:HPTO) trades at a $3.5 million market cap, yet has a fully-recurring base business doing $3 million revenue per year, likely capable of generating up to $1 million in annual cash flow. The company also has $70 million in NOLs, whose value is being unlocked through a debt-funded acquisition strategy, and a patent portfolio likely worth several millions. An activist investor recently became CEO, purchasing the majority of his stake in private transactions at 50-150% premiums to market. He also replaced most of the board, with one board member also recently purchasing stock at a 50% premium to market. The new CEO and board members have significant experience in unlocking the value of patents. The story is extremely under the radar due to its: extreme illiquidity, ugly trailing financials, and faulty ownership reporting. I believe that with just a little bit gone right HopTo could see substantial speculative upside going forward.
Introduction
HopTo sells Go-Global, which is a remote-access Windows platform. This is a highly competitive space that has saturated the market. HopTo’s revenues have declined straight for 10 years now, and the company has only been profitable in one of those years. The company has an $80 million accumulated deficit, against a $3 million market cap. Near the end of 2016, HopTo cancelled all development of their supposedly revolutionary new product, HopTo, and now only sells Go-Global, the unprofitable “legacy” business. In 2017 most of HopTo’s former executives quit or took on other part-time jobs. The outlook was so bad that they considered going dark.
I believe, however, that HopTo could be a potential multi-bagger going forward.
What Changed
Significant historical data shows that this company has a weak business model and was badly managed before. However, on 4/2/2018, an unknown firm called Novelty Capital Partners filed a 13D on HopTo and changed the whole ballgame.
Novelty Capital is managed by Jonathon Skeels, a 36-year old with little previous experience in management. Skeels formerly worked at Davenport as an analyst focusing on IP, then at a notorious patent troll (IP Navigation) for a few years. Not the first person you’d think of to turn around a dying software business.
Skeels acquired his stake in HopTo in the beginning of 2018. I’ll talk more about Skeels’s stock buying in a subsequent section. What’s important for now is that, although there appears to have been some initial bellicosity between Skeels and HopTo’s existing management team, now Skeels is CEO of HopTo and successfully elected a brand new slate of directors to support him.
You may ask – so what? Some guy taking control of a dying company doesn’t change the fact that it’s a dying company.
The reason I am so excited about Skeels buying into HopTo so aggressively is because I believe that HopTo has hidden assets that are potentially worth multiples of its current price, but are very difficult to monetize. Skeels appears to be an ideal candidate to do this. The assets that I think have a lot of unrecognized value are HopTo’s patent portfolio and NOLs, as well as its base “legacy” business.
Patents
In making its previous “game-changer” technology called HopTo, HopTo created a patent portfolio of over 50 issued and 60 pending patents to defend the technology. Now, with HopTo discontinued as a product, the company is sitting on a completely un-monetized patent portfolio. This is where I think Skeels comes in handy. Skeels is young, but has a lot of experience in the IP industry. I believe he bought his large stake in HopTo at least in part believing that the patent portfolio could be further monetized – he had the following to say in his recent shareholder letter last November:
“Since the end of the third quarter, we have been focused on laying the groundwork for hopTo to pursue future growth opportunities. These efforts have included:
- ...reviving efforts to sell or dispose of the remaining portfolio of 49 patents”...
This suggests that Skeels sees potential value in selling parts or the whole patent portfolio.
HopTo had previously tried to sell its patent portfolio, but only managed to sell 7 of its initial 56 patents for $400,000 (it appears that the 7 it did sell weren’t even ones that it put up to the market either – they were forced to license them back). I’m not a patent expert, but Skeels and some of the new directors are. It’s possible they see something that previous management didn’t, which wouldn’t be surprising considering previous management left soon after HopTo was discontinued and new management only worked part time.
HopTo’s actual “HopTo” product was intended to facilitate doing corporate work on smaller devices such as tablets and iPads. Obviously, it failed (a key partner discontinued development), but HopTo appears to have filed a significant number of patents with applications for devices in general. For example, they have a patent to track facial cues using a computer’s camera (e.g. scrolling the screen by moving your eyes), and a patent for activing a sort of touch screen by just holding your finger close to (but not actually touching) the screen. I can imagine these patents might be of some value to certain companies, but really have no expertise in the field to say this with certainty, much less peg an exact value onto the patent portfolio.
Also important to note is who was spearheading these new patent applications: John Cronin. Cronin was one of HopTo’s directors at the time, and ran IPCapital Group full time. Cronin is somewhat of a legend in the IP industry – he formerly worked at IBM, where he got over 100 patents and founded IBM’s Patent Factory, which is now world famous. HopTo contracted IPCapital to do work on the patents starting 2011, and Cronin himself is listed on many of HopTo’s patent applications. So basically there is solid intelligence and experience backing these patents. I would encourage interested investors to read HopTo’s Q2 2016 conference call transcript (the last one they held), where an investor essentially details why he believes that HopTo’s patents have significant value.
This analysis by their patent broker Aqua Licensing shows that HopTo’s patents are pretty relevant to the industry:
One concern I have on the patents is that HopTo previously already tried to sell the patents unsuccessfully. HopTo had previously contracted another one of Cronin’s companies, IPCapital Licensing Company I, to try and sell HopTo’s unused patents in 2013 for 10% of any consideration from a sale, and zero retainer. Nothing really happened since, and it now says that Cronin is no longer affiliated with IPCapital Licensing Company I (however he is still a part of the larger IPCapital company). Also, since discontinuing development of HopTo in Q2 2016, HopTo has also consistently disclosed in their filings that they’ve been trying to sell the HopTo patents.
My worry is if Cronin and HopTo were unable to previously sell the patents, what changed to make Skeels able to do it? I honestly have no idea but there does seem to be evidence that there’s at least some value to these patents. The above attempts to sell the IP were likely were not wholehearted, as management became very disinterested in the company after HopTo development was halted. It’s also possible that Skeels has been connections in the patent litigation industry than HopTo’s previous executives and Cronin.
HopTo was previously trying to sell their patents through the patent broker Aqua Licensing. One recent interesting development I just saw was that HopTo took down their listing on Aqua’s website. Does this mean HopTo is in advanced discussions for a sale of the IP and no longer wants to advertise their IP for sale? Or maybe just got tired of paying Aqua for its services that obviously weren’t bearing fruit? Who knows but we may find out soon.
I have no idea how much the patents are worth in a sale, but if it’s anything greater than zero it should be material to HopTo’s miniscule $3 million EV.
Net Operating Losses
Money previously sunk into the HopTo project and money lost a long time ago under a patent litigation business model now shows up as $70 million in NOLs for HopTo. I believe that Skeels wants to aggressively monetize these NOLs (they started expiring last year). About half of the NOLs should expire 2018-2024, and the other half should expire 2030-3038.
This was an interesting nugget I found in one of Skeels’s 13D amendments:
“On December 20, 2018, Novelty Capital, LLC submitted a commitment letter to the Issuer for an acquisition credit facility to be funded by Novelty Capital, LLC or its affiliated investment vehicles.
On December 26, 2018, the Issuer’s board of directors accepted Novelty Capital, LLC’s lending commitment and granted a waiver under the Issuer’s tax benefits preservation rights agreement for the Reporting Persons to acquire up to 19.9% of the outstanding shares of Common Stock.”
This is a bit of information arbitrage as this was not disclosed via 8-K and therefore investors may not realize that HopTo is now also pursuing acquisition candidates.
Skeels also mentioned the NOL balance in his shareholder letter, and recently changed his fund’s website to state that they are involved in both “intellectual property and unique tax situations”, whereas before it only said “intellectual property”. So he likely recognizes and seeks to exploit the value of HopTo’s NOLs.
The idea here is to use a debt-funded acquisition strategy to “create” new earnings for HopTo, so that they can use their large NOL balance to increase those acquisitions’ cash flow. Debt-funded acquisitions to utilize large NOL balances in microcaps are a common successful strategy, as detailed in this excellent blog post. If Skeels can effectively unlock some of the value of HopTo’s $70 million in NOLs, upside could be tremendous.
The Existing Business
Go-Global is also a very strong existing business, that optically appears weak because of declining sub-segments and historic non-related losses. It does ~$3 million per year in revenues, has a nearly 100% gross margin, and is currently 75% recurring revenue. The company has several clients that have used the service for decades. In fact, although optically the top-line appears to have been in decline for several years now, that entire decline was actually concentrated only in the company’s UNIX product. Their Windows product has actually had consistent and even somewhat growing revenues the past few years, even as it was consistently neglected by prior management:
There are a couple of important things to note here. First, the red bars in the above graphs are service fees, whereas the blue bars are license sales. License sales relate to the one-time initial sales of a perpetual software license for Go-Global use (either to a distributor/reseller or directly to an end customer). Therefore, license sales are often very lumpy. Service fees are ongoing fees that HopTo collects for recurring maintenance services they perform for customers. Service fees are the most important revenue sources IMO, as they are almost fully recurring, very steady, and very high margin.
What is clear here is that a) the UNIX product is in decline, in both license sales and service fees, and b) the Windows product used to grow very strongly (almost every quarter sequentially), but this growth suddenly stopped starting Q3 2013 (yellow bar). Incidentally, Q3 2013 was exactly the quarter that HopTo released its HopTo work product publicly for the first time. Therefore, I believe that the growth in the Windows business has stalled not because the product is no longer as liked by customers, but rather because management shifted focus to HopTo. Management had often attributed declines in Go-Global revenue in 2014-15 to shifts in focus to the HopTo product, and zero investment into Go-Global. Management discontinued development of the HopTo product in 2016 (yellow bar) and as you can see growth started picking up again soon afterwards.
Therefore, I believe that the Windows product alone can generate ~$3 million in annual recurring revenues and possibly grow, even as the UNIX product trends towards $0. So what is that worth to a market cap of $3 million?
The company spends ~$1 million per year on R&D which makes Go-Global about breakeven. Before they were only breakeven before R&D, now they’ve straightened the cost structure out enough to be breakeven after R&D. I think if you just get rid of some small expenses (i.e. the high salaries ($300k for two execs) of prior management or some other G&A/R&D functions), the business could easily do a couple hundred thousand per year in cash flow. In fact, Go-Global was profitable in 2017 after development of HopTo was discontinued, and management claims it was cash flow positive before that too. This is what previous management had to say about the Go-Global business in the: “Having said that, the GO-Global business itself only costs us about $0.5 million a quarter to support and it produces anywhere from -- depending on the quarter -- anywhere from $700,000, $800,000 to $1 million in bookings -- or billings.”If the business only takes $0.5 million / quarter to support and does $0.75 million in quarterly recurring revenue, that implies yearly cash flow of $1 million.
Go-Global’s software also has some advantages over the competition, that they detail on their website, including the ability for multiple users to use the software simultaneously, and to more easily integrate with independent software vendors and hosting service providers.
So if Skeels can just cut some expenses, Go-Global could throw off a lot of cash flow (several $100k). And if he can turnaround the revenue decline, the business is actually likely worth $5-10 million. Skeels said that he previously offered to buy the Go-Global business, but management failed to engage him in discussions, so he likely thinks highly of it.
YTD Go-Global’s Windows services revenues were actually up yoy. Go-Global just released Go-Global 6.0, and completely revamped its website. Skeels also claims that they’re pursuing rebranding initiatives. We should see over the next few quarters if these actions stem the decline of the business.
Summary
If Skeels can unlock literally any value from the patent portfolio, NOLs, or turn around the Go-Global business, the stock could have substantial upside. Of course, if things go wrong and they burn through the cash as Skeels is unable to turnaround Go-Global, sell the patent portfolio, or consummate an accretive acquisition, the equity likely goes to zero. You’re taking a risk here because on its current trajectory, the stock will be worth <50% of its current price soon (this is where it traded for years prior to Skeels buying and pushing the stock up 3x). Therefore, both timing and impact of Skeels’s actions matter.
The Biggest Reason I Like It
There is one more aspect of this investment that is the biggest reason I am buying the stock: Skeels acquired his current stake in the company at 50-150% premiums to market, and none of this is accurately depicted in public filings. Another one of Skeels’s elected directors also just bought $40,000 of stock at a 50% premium to market, which is also inaccurately shown in public filings.
Skeels’s initial 13D indicated that he bought 975k shares for an aggregate cost of $300k, representing a price per share of $0.31. The stock traded for a range of $0.05 - $0.26 in the preceding months. So we can already see that Skeels’s buys were at an average premium to market.
However, the body of the 13D omits just how much of a premium it was. In fact, the exhibits to the 13D make it clear that what Skeels did was initially buy 475k shares of stock on the open market at a weighted average cost of $0.10 per share, then buy 500k shares in a block trade at $0.50 per share. The $0.50 block trade occurred when the stock was trading at $0.20 per share on the open market, indicating that Skeels willingly bought half of his stock position at a 150% premium to market.
This was in the beginning of 2018. Skeels likely did the block trade because it’s so difficult to accumulate the stock on the open market (the big jump in price from 5c to 20c in late 2017 was likely caused by Skeels’s initial 475k share purchase over time). This purchase at a premium to market is impossible to tell from just reading the body of the 13D.
Further, Skeels recently bought another block of stock at a premium to market... and misreported it. In a confusing 8-K filed on 1/2/19, HopTo disclosed that it had reached an agreement to repurchase 500k shares of stock from an existing holder at a price per share of $0.30. The stock was trading at ~$0.23 at the time, so this again represents an ~50% premium to market.
HopTo also said that it “assigned” this purchase option to Skeels and one of the new directors. Skeels and the new director later filed Form 4s showing that they were awarded(code “A” on Form 4), rather than purchased (code “P” on Form 4) an aggregate of 500k shares of stock at $0.30 per share. Here and here are the two Form 4s. I believe that this was a filing error and in fact what happened was Skeels and the director purchased 500k aggregate shares of stock from the selling holder at $0.30 per share, a premium to market.
This is what is clearly stated in Skeels’s amended 13D filed soon after. Anyone tracking insider transactions at HopTo would however see the acquired stock as awards from HopTo, rather than transactions where Skeels and the director laid down cash to acquire the shares. This is a commonly made error with microcaps, writing “A” (award) instead of “P” (purchase) in the transaction code box of the Form 4.
I believe that Skeels will continue to purchase HopTo’s stock, as he was previously given authorization by the board to bypass HopTo’s 5% poison pill up to 19.9%. Even after the above purchases Skeels currently only owns 13% of HopTo. I believe over the next months we should see Skeels make additional purchases of HopTo’s stock as he identifies purchasable blocks... and hopefully report them clearly this time.
What’s important to note here is that Skeels and a director both bought 500k shares of stock at a 50% premium to market, and Skeels previously did the same at an 150% premium to market. Keep in mind that Skeels was buying stock as low as $0.05 per share just a few months ago. It’s telling when an investor is seemingly ambivalent to paying 10x his previous cost basis to buy a stock, despite the company seeing no fundamental changes in the meantime. Even better is that these transactions were so badly disclosed that investors today can continue to purchase the common stock at significant discounts to some of Skeels’s purchases.
Skeels buying HopTo’s stock so aggressively signifies that he already sees low-hanging value in HopTo. For example, it wouldn’t surprise me if he already has suitors lined up for HopTo’s IP, or an acquisition in mind to utilize the NOLs. He’s not an idiot – anyone can see here the downside to the stock if you don’t change something quickly, and it's likely very difficult for him to exit a position of his size in this illiquid of a stock.
Risks/Caveats
- Skeels does a non-accretive acquisition and destroys instead of creating value. He appears to have little experience in the industry of capital allocation.
- They are unable to sell the IP. They have previously not been able to do this and there’s no immediate reason to believe that Skeels can do it now.
- Mis-management of Go-Global. Skeels appears to have little experience in actually managing a company.
- Go-Global is unable to generate cash flow. Again, Skeels does not have immediate experience in turnarounds.
- Extreme illiquidity.
- All upside is predicated on speculative new developments going forward. It’s hard to get substantial information regarding the existing business and I have not done substantial in-depth research into them.
Overall, this is an extremely high risk investment with no downside protection. Very much could go wrong so I would not recommend taking a large position in the stock. However, I believe that recent developments, especially Skeels’s aggressive buying of the stock, suggest that he is on the cusp of unlocking significant value for shareholders. Therefore, I have a speculative position in the stock.
Reasons for Mispricing
By now it’s probably obvious why HopTo’s stock is so unloved. The company appears to be a horrible investment optically, with consistently declining revenues and ineffective or inexperienced management. Almost everything positive that has happened over the past few months to HopTo has been under the radar, and either poorly or inaccurately reported.
Further, pretty much no one can buy into the stock in size. Only 5000 shares trade on average per day. It’s telling that Skeels had to buy most of his stake in block trades with other holders. Further, there is an active poison pill that activates once someone passes 5% ownership (~500,000 shares) without board authorization. At current prices this represents just $150,000 worth of stock, limiting the purchasing power of large(ish) investors.
Conclusion
HPTO is a left-for-dead company trading at a $3 million market cap, that could potentially multiples more in unlockable value through hidden assets such as its base business, patent portfolio, and NOL balance. Jonathon Skeels recently became CEO of the company and him and his elected directors have been aggressively buying into the stock at 50-150% premiums to market. I believe that he has a plan for unlocking at least some of the hidden value of the company. This is a highly speculative position as there is no guarantee of Skeels succeeding at this endeavor, and if he doesn’t there is little downside protection to the stock.
