BNY Mellon, the global leader in investment management and investment services, has been appointed by Oesterreichische Post AG (Austrian Post) as the depositary bank for its American depositary receipt (ADR) program.

via Pocket http://www.bobsguide.com//guide/news/2013/Apr/5/bny-mellon-appointed-as-depositary-bank-by-austrian-post.html April 05, 2013 at 02:35PM

Early gold miners wearing Levis. Photo courtesy of andrewhennigan.blogspot.com

Second, and possibly more important, the number of business bankruptcies has fallen and is on track to finish the year at its lowest level since prior to the beginning of the “Great Recession.”  The comes chockablock on top of a truly boffo month of June for consumers, especially people buying cars.

There are storm clouds – European and Chinese wobblies specifically, with interest rates dropping, which is likely to push the value of the US dollar up, making our goods more expensive overseas.  Actually though, two of our biggest trading partners are virtually (but not officially) pegged to the US dollar (Mexico & Canada), and many other economies, such as Australia — resource rich and recessionless — are fairly stable with regard to the greenback. 

So the question is, if we are seeing all these lights at the end of the tunnel — what should we be doing as investors?  We at SmallCapWorld have no answers, no recommendations, because we are not financial advisors,  but we are finding some areas more interesting than others.  Infrastructure continues to be a big agenda item, for instance.  For those with a longer horizon and some patience, homebuilders are looking more interesting.  And an intriguing article in the New York Times last weekend theorized that the electric vehicle market, in spite of the highly publicized obituaries of the lithium-ion battery companies,  may not be dead in the water: http://www.nytimes.com/2012/07/01/automobiles/evs-are-merging-into-californias-traffic.html?_r=1&ref=automobiles.

Many investors look at sectors like these when economic reports are positive, hoping to find bargains like four-leaf clovers.  An article this morning in Motley Fool may be a case in point, for instance: http://beta.fool.com/jonathanyates13/2012/07/05/it-time-togo-sir-john-templeton-european-stocks/6140/?source=eogyholnk0000001.  Heck, even Warren Buffett is out in the weeds looking for something special, buying up newspapers (talk about last century!). 

I’d like to suggest that there is a larger pond to splash about in, and it is not sector-specific: cross-border companies, especially those trading in the USA as ADRs (American Depositary Receipts).  It seems as though ADRs tend to trade at a significant discount to the valuations given their peers on US markets.  That is less true of largecap ADRs, a fast-growing group, by the way, but largely controlled in valuation by trading in their home exchanges.   But it seems to be increasingly true across the board in smallcap ADRs.  After all, what was the biggest success story of the California Gold Rush?  I think it was Levi Strauss, which did nothing more than invent blue jeans for the miners.  Facilitators tend to be ignored at times.

Why would this be so?  Well, maybe it is that they are farther away than US-headquartered companies; they use currencies that may be more volatile these days; they tend not to market themselves well to US investors; they seldom trade on Nasdaq or the NYSE.  In fact, most of them trade in the regulatory twilight zone that used to be universally referred to as The Pink Sheets.  However that may be, there are some very big, very prosperous, very well-known companies now trading on the “pinks” after having delisted from the big exchanges when Congress started tightening the regulatory screws a couple of financial bubbles and several Ponzi schemes ago.

If there are bargains in the ADR world, they will be found eventually — at least that is the theory behind the “if you build it they will come” philosophy that used to be called “build a better mousetrap” or “stick to your knitting.”  And for the Sherlock Holmes types among us, there are all kinds of companies worth looking on the upgraded “pink sheets” listings called OTCQX and OTCQB.  With the not-so-slow decline of the Bulletin Board, these listings may look like the Wild West, but they are not the typical old “pennystocks” that many investors remember.  And the JOBS Act is breathing new life into these small newcomers by suspending a lot of the draconian rules that govern fund-raising for larger companies:  http://www.forbes.com/sites/alanhall/2012/06/28/hearings-on-jobs-prepare-the-u-s-for-expanded-crowdfunding-accelerating-startup-activity-creation-of-jobs/. 

Anyway, the point of this article is not to pick out stocks in the pink sheets, it is to look for stocks that could benefit from a gold rush pointed at the pink sheets.  The first and most obvious is OTC Markets Group itself (OTCQX: OTCM), the proprietor of the Pinks, the OTCQX and OTCQB.  OTCM, headquartered in New York City (http://www.otcmarkets.com/home) , is chugging along at an increasing revenue rate that looks to be in the range of at least $32 million to $35 million this year, and bringing about 15%  (or $0.12 per share) to the bottom line in the most recently reported quarter.  Just to put this in perspective, the market cap is around $73 million and OTCM is handling 10,000 over-the-counter securities.  The volume of trading in OTCM is under 1,000 shares per day, which puts a bit of a technical barrier up for some people — but it is hard to imagine this part of the market NOT growing.

Another you-never-heard-of-it company that stands to benefit is one of the Fortune 500: INTL FCStone Inc (Nasdaq: INTL).  One of the busiest traders in the market, INTL is said to be the largest marketmaker of cross-border stocks in the US, and they are an increasingly prominent advisor to OTCQX and OTCQB companies under the “PAL” or Principal American Liaison designation.  They are also one of the largest buyers of gold in the world.    The shares are trading at $19.61, not far off their lows; the market cap is $375 million, and the average daily trading volume is 84,000 shares.  This article in SeekingAlpha addresses the value that might be there: http://seekingalpha.com/article/667071-4-undervalued-small-cap-financials-with-analyst-love?source=yahoo. 

There are some very small dark horses, like San Francisco-based Merriman Holdings (OTC: MERR; http://www.merrimanco.com), which claims to be the largest PAL operation with regard to OTCQX companies.  MERR is quite small and has a recent history of management change and financial distress, but their newswires are busy virtually every day with new OTCQX clients. 

And there are some much larger companies that stand to benefit, like the Australian whiz-kid, Computershare Ltd (OTCQX: CMSQY and ASX: CPU).  Their market cap is well out of our ballpark at $4+ billion, but they have come out of the pack like Secretariat at the Derby, recently taking over the stock servicing portfolio at Bank of New York Mellon.

We own none of the securities discussed in this article.

LCD or LED signage, as well as plasma displays or projected images, have taken over cities, retail stores, hotels, restaurants, corporate buildings, even bathrooms and elevators. Smartphones, too, use the same digital media technology.

You can use digital media technology for integrating social and location-based interactivity so you can send Twitter messages, SMS and text messages to advertising displays. Digital signage displays can be controlled by personal computers or servers via proprietary software programs.

To date, China has led the world in the number of digital signage displays with the country’s largest digital signage firm, Focus Media Holding (Nasdaq: FMCN), operating thousands of displays. San Antonio, TX-based Clear Channel Outdoor Holdings (NYSE: CCO) is another huge outdoor advertising company with close to 1 million displays in more than 40 countries across five continents. But those are large companies with market capitalizations in the billions of dollars.

Smallcap investors have opportunities to invest in digital media, too, by focusing on such things as the hardware, software or network infrastructure that support

Times Square, New Year's Eve

the industry.

Brookings, SDbased Daktronics (Nasdaq: DAKT, http://www.daktronics.com/) designs, manufactures, and sells various electronic display systems and related products. It offers indoor and outdoor scoreboards, digit displays, scoring and timing controllers, statistics software, and transportation products comprising various light emitting diodes-based displays for road management, parking, mass transit, and aviation applications. The company did pay a dividend in December, even lumping an additional $0.40 on top of the regular payout, which is now twice rather than once per year. DAKT trades about 150,000 shares daily, has a market cap of $340 million and a 52-week range of $8.00 – $12.25. It closed April 20 at $8.08, up 1 cent.

Cincinnati, OH-based LSI Industries (Nasdaq: LYTS, http://www.lsi-industries.com/) provides corporate visual image solutions around the world.  The company offers exterior and interior visual image elements related to graphics for use in graphics displays and visual image programs. Its graphics products include signage and solid state LED video screens for the sports and advertising markets designing and engineering custom designed electronic circuit boards, assemblies, and sub-assemblies used in various applications.  LYTS trades near $7 with a $165 million market cap and an average daily volume of about 600,000 shares.  The 52-week range is $5.45 – $8.91. It closed April 20 at $6.71, no change on the day.

Prague-based Kit Digital (Nasdaq: KITD, http://www.kitd.com/) provides end-to-end video asset management software and related services to enterprise clients. It offers the KIT Video platform for managing Internet protocol (IP)-based video assets across browser environments, mobile and tablet devices, and connected television (TV) sets and Digital Signage. KITD also enables delivery of social video apps to connected TVs, set-top boxes, game consoles, tablets and smart phones.  KITD has had some hiccups lately. Its stock has a 52 week range of $5.93 – $12.73, a market cap of about $360 million and an average daily volume of about 1, 265,000 shares.  In March and April 2011, the company announced delayed their 10-K filing and announced changes in the board of directors and management as well as some indications that the company may be putting itself up for sale.  But it appears there has been some short covering and buying in the past weeks. The stock closed April 20 at $6.99, down 51 cents on the day.

Seattle-based RealNetworks (Nasdaq: RNWK, http://www.realnetworks.com/) makes the RealPlayer media player software on computers, including features and services that enable consumers to discover, play, download, manage, and edit digital video. RNWK develops and markets software products and services that enable the creation, distribution, and consumption of digital media and signage, including audio and video.   RNWK has a 52-week range of $6.81 – $15.08, trades nearly 140,000 shares daily, and has a $326 million market cap. It closed April 20 at $9.43, up 3 cents on the day.

A more vertically and horizontally integrated company is Poland-based ADV Group* (ADV’s ADR is GPVSY, http://www.grupa-adv.pl/) which trades on the OTCQX market in the U.S. (www.otcqx.com.) (ADV shares also trade on the main floor of the Warsaw Stock Exchange under symbol ADV.) A fast-growing internet and digital media advertising company, ADV is the leading new-media agency in Poland operating in digital communications, innovative new technologies, IT outsourcing, dedicated application design, and mobile device applications.  GPVSY has enjoyed revenue and earnings growth for the past few years, including 74 percent revenue growth in 2011.  GPVSY is a relatively unknown stock in the U.S. with very little analyst coverage. Its market cap is just under $50 million and its average daily trading volume is less than 100,000 shares daily.  The Polish ordinary listed ADV stock trades over 14 PLN or zloty – the Polish currency. (1 Polish zloty = 0.31 US dollars as of April 12) and has a 52-week range of 7.10 – 15.59 PLN.

*Client of Allen & Caron, publisher of this blog.

We find that if you exclude momentum-driven exchanges, many foreign companies are valued at lower multiples or in lower quartiles than US-based companies that might be considered peers or comparables.  And since most ADRs are initiated by the companies without doing a US offering or even a US roadshow, many ADRs languish on US exchanges, with very low levels of trading that can scare off investors.

The trick to capturing value in an ADR is to realize that the ADR is a security that you can create when you need it and then convert back to its original form on demand.  So if you buy the shares of a foreign company on, say, a European exchange, you can convert them to ADRs on demand if there is an ADR program with one of the depositary banks. 

 Once the foreign shares are converted to ADRs they can be handled as US securities, reported on statements in US dollars, and, depending on individual broker-dealer rules, may be marginable.  If the trading liquidity of the ADR in the US is not satisfactory, the ADR can be converted back to the original form as an “ordinary” share, and sold on the home exchange. 

 So while it is convenient if there is a liquid trading market in the ADR, it is not essential if there is a liquid market in the home exchange. 

OTCQX International

The OTCQX International is aUSelectronic trading market that is primarily for cross-border companies represented by ADRs.  Founded in 2007, the OTCQX has become a haven for large and small non-US companies who might, in former times, have been listed on Nasdaq or on the NYSE in order to make their securities available to US investors. 

With the high cost of duplicative filing rules, D&O insurance and compliance with US laws & regulations such as Sarbanes-Oxley, many cross-border companies have elected to move their listings to OTCQX International, where costs are considerably lower than they are maintaining a full NYSE listing, but respectability is assured.  Large-cap international companies like Deutsche Telekom, easyjet, BNP Paribas, Gazprom, Roche, and AXA trade on the OTCQX, alongside small-cap and mid-cap companies.

 Each company trading on the OTCQX has a Principal American Liaison (PAL) or a Designated Advisor for Disclosure (DAD) as a guide to the regulatory environment, and, in some cases, as a helper in navigating US markets.  These PALs and DADs are investment banks, broker-dealers, law firms, accountancies – companies that bring helpful expertise to the task.

 Unlike London’s AIM (Alternative Investment Market), to which many compare it, the companies listed on the OTCQX International do not use their listings to raise financings, but simply to facilitate trading of the ADRs.  The “Level 1” ADRs listed on the OTCQX International are not empowered to do US financings without complying with more of the full panoply of US laws & regulations. 

Two other ADR examples include:

Poland-based Grupa ADV (www.grupa-adv.pl) is a group of companies in three developing areas: integrated market communication, innovative technologies and e-commerce. The companies offer a variety of interactive media and e-marketing services including online campaigning, email marketing, viral marketing and advertising production. It trades as ADV on theWarsaw exchange and GPVSY on the OTC in theU.S.

Mauritius-based Essar Energy (www.essarenergy.com, a subsidiary of the Essar Group, is a low-cost, integrated energy company focused onIndia. It has interests in both the power generation and petroleum industries. It trades on the London Stock Exchange as ESSR and is a constituent of the FTSE 100 Index. Its ADRs trade on OTC as ERERY.

For further information

For more information on ADRs, please contact us at info@allencaron.com.  We are NOT financial advisors and do NOT trade or sell securities or make markets.  We are an investor relations agency with strong experience in cross-border securities.

One-year trading chart for VirnetX (VHC) courtesy BigCharts.com

More than 150 smallcap stocks were covered by this blog throughout 2010. Many of these stocks enjoyed a good year based on stock price, while a few others enjoyed a great 2010. Here is a list of some of those that did very well:

Scotts Valley, CA-based VirnetX Holding Corp. (Amex: VHC, http://www.virnetx.com/), a developer of software and technology for securing real time security solutions over the Internet, had a huge year, up nearly 400 percent, from $3.36 to more than $15.30 by Jan. 13. This stock traded as low as $1.95 last November. One huge catalyst last May helped propel the move: a successful patent infringement lawsuit that led to a $200 million from Microsoft. Based in part of the same patent infringement argument, VHC has follwed that lawsuit with another suit against Siemens AG and Mitel Networks, among others.

Bellevue, WA, Radiant Logistics (OTCBB:  RLGT, http://www.radiant-logistics.com/), a global transportation and supply chain management company, jumped more than 400 percent, from just 23 cents in January 2010 to $1.18 the week of January 10. “We are seeing encouraging trends with the improving economy and glad to see the benefits of our scalable non-asset based business model beginning to show themselves,” said Bohn Crain, Chairman and CEO in early November while discussing the results of the first quarter of FY2011. He added that although the stock has enjoyed a sharp appreciation and is trading at approximately seven times this year’s projected earnings per share, “our stock trades at a significant discount to our competitors.”

Wilmington, OH-based Air Transport Services Group (Nasdaq: ATSG, http://www.atsginc.com/), a provider of aircraft, airline operations and other related services primarily to the shipping and transportation industries, ran up more than 300 percent in 2010, landing at $7.84 in early January 2011. Despite already tripling in 12 months, Motley Fool picked ATSG as a “stock ready to roar” in 2011. Over the past year, as the S&P 500 rose 11 percent, the CAPS Freight Services sector, led by ATSG, has doubled those gains, Motley Fool noted.

Israel-based Allot Communications (Nasdaq: ALLT, http://www.allot.com/), a global developer and marketer of Internet protocol service optimization solutions that trades as an ADR, enjoyed a sharp rise in stock price–nearly 300 percent–starting in early August. Kate Stalter, writing for Real Money on TheStreet.com, notes “there is still plenty of opportunity among network optimization stocks” like Allot. To check on their progress, management will discuss first quarter results on Feb. 8.

Evansville IN-based Escalade Inc (Nasdaq: ESCA, http://www.escaladeinc.com/), a sporting goods manufacturer and seller, saw its stock rise nearly 300 percent. Escalade announced a 10 cents/share dividend last November 9. As noted in a Seeking Alpha article, the company has paid an annual divdend in 2004-2008 but had to skip the dividend in 2009.

On the one hand, a weak euro makes US exports more expensive in one of our largest markets, and that’s not something most of us want.  But on the other hand, that same weak euro can create some unusual bargains if you’re holding a handful of USD.  So what comes to mind?  Cars, probably, but the fact is that most “European” cars are now being made in the US, so the extent of the bargain may be less than might be hoped.  But what about stocks?

What’s an ADR?

An ADR is an American Depositary Receipt, which is a fancy way of saying, it is a bank-verified receipt that allows foreign stocks to be traded in the US as domestic securities.  So, for example, if you wanted to buy shares of Fiat, which is the majority owner of Chrysler these days, you could buy shares of Fiat on a variety of foreign exchanges that operate in a variety of different currencies, or you could buy shares of Fiat via ADRs on the Pink Sheets, where the symbol is FIATY (all Pink Sheets ADRs have 5 letters in their symbols).  FIATY is trading for $11.54, vs a 52-week range of $9.76 – $14.98.  The catch is that the average daily volume for FIATY is only about 10,000 shares, whereas FIAT shares trade heavily in other places — but communications being what they are, there is seldom a gap in value, and if there were, the “arbs” would be all over it like white on rice.

If you want to use your strong dollars to buy some shares that will probably go up in value vs dollars when the euro and other currencies move back up — ADRs can be the answer to an investor’s prayer.  There are some extra steps you might want to take when you’re looking around.  Most ADRs trade on the Pink Sheets, but there’s nothing stopping them from trading on Nasdaq or the NYSE — nothing, that is, but the requirement to comply with all SEC rules & regs including Sarbanes Oxley.  If they trade on the Pink Sheets, they skip having to file with the SEC and instead do their filings at home — London, Frankfurt, Oslo, Singapore, Shanghai, Sydney, etc.

The company that owns the Pink Sheets, OTC Markets Inc (http://www.otcmarkets.com/) , has created a “premium” listing space called OTCQX, which imposes some quality requirements on the ADRs that trade there.  Chief among those is the adoption of a system not unlike that at the junior AIM market in London — where larger, savvy financial institutions are hired to keep an eye on things, and to make sure that the companies that are listed are aware of the ins and outs of the US markets.  There are numerous of these guiding or helping financial institutions, which are termed with the acronym DAD or PAL, including the depositary banks themselves (primarily Bank of NY Mellon, JP Morgan, Deutsche Bank and Citi), but also including some accounting firms, some law firms, and some broker-dealers.  The broker-dealers who seem to have the largest “market share” in this small but very fast-growing segment are Madison Williams (a management buyout of the investment banking ops at Sanders Morris Harris), Merriman Curhan Ford, Dahlman Rose, B. Riley and CK Cooper.  The largest industry segment on the OTCQX seems to be shaping up to be resources & energy, though the parent company is agnostic as to the segments of the companies it lists.

You may find some of the hottest technology companies in the world in the ADR crowd in the Pink Sheets.  The fact that they are headquartered in Oslo or Hanover or Milan or Mumbai makes the ADR route an eminently sensible way to get their feet wet in the US markets. 

The “Y” Factor

One thing to keep in mind as you go shopping for bargains on the OTCQX or the Pink Sheets, is that you may want to confine your search to the companies whose tickers end with the letter “Y.”  Frequently there will be more than one ADR symbol for a company, and the only difference will be the final letter — most commonly a “Y” or an “F.”  The “Y” tickers indicate ADRs that are sponsored by the company whose shares are being traded, and that settle in USD as a local security.  The “F” tickers indicate ADRs that are arranged by someone other than the company — usually a shareholder or a broker or trader, and the markets for “F” tickers can be very episodic, and sometimes can even end up settling in the currencies of the home markets.

There are many big companies whose ADRs trade on the Pink Sheets, and generally one finds that if there is vigorous trading of shares on the company’s primary or home exchange, the ADR market will stay in the range set by the home traders.  But there are also many very small companies, or lesser-known companies, whose ADRs have never “caught on” in the US, so their trading volumes can be very low. 

Frequently what happens with an illiquid or sluggish ADR (one that doesn’t trade a lot) is that if there is a bid, a market maker will fill the bid by creating a technical “short” position, and then will cover his short position by buying shares on the home exchange and causing them to be converted to ADRs — a quick and easy transition.  But it is true that small orders may have a harder time being filled for a low-trading ADR — because it is less tempting to the market makers when there are fewer shares (and less revenue) involved.  So to the brave go the spoils; do your diligence, bid and stand your ground.  The worst that can happen is that your bid won’t get hit, which doesn’t cost you anything.

And if and when the euro gains in value against the USD — bingo, your investment can go up (in dollars).