Show me the money!

I’m talking about profits, you know, EBITDA (Earnings before interest, tax, depreciation and amortisation. Excluding items outside the ordinary operations of the business such as asset sales a positive EBITDA number basically tells you that the company gets more money for the goods it sells or services it provides than it costs to sell those goods or provide those services and because EBITDA usually approximates a company’s cashflow we can say that there is more money coming into the business than going out. This is a positive sign if we want to stay in business and something we should be looking for when investing in a business. Of course a heavily debt laden company can be EBITDA positive and cash flow negative because of interest payments but lets put those aside for now and assume a modest level of gearing.

This is very basic stuff yet the management of some listed companies seem to forget it or at least they wish investors would forget it. Instead they chatter incessantly about revenue growth but neglect to mention the word profitability. Cygenics (CYN) is a prime example. Cygenics, who are in the business of blood banking have been busy scurrying around South East Asia setting up blood banks and achieved impressive revenue growth of 130% in FY06. What is less impressive is the increase in the loss they made of -6.2m at the EBITDA level up from -5.1m in FY05, and FY06 NPAT of -6.6m up from -5.6m in FY05.

I lost count of the times 'revenue growth’ was mentioned in CYN's FY06 annual report but not once did I see any mention of profitability or an estimate of when they expect to become profitable. In the same report the company claims “The group has sufficient funds to finance its operations.” (CYN annual report FY06, p.37). The following day the company released its 1Q07 cashflow report which tells a different story, 1Q07 revenue increased 56% on pcp “more clients were signed up during the quarter than any previous quarter,” great! However CYN burnt a total of $1.8m in the quarter. At that rate, even if they fully utilized their overdraft facility of $0.43m they would be out of cash before the end of FY07. Then just less than a month later at the AGM the company announces a placement of 10.2m shares at $0.32 raising an additional $3.26m.

Obviously then they didn't have the funds to finance their operations. Amazing how management wasn't appraised of the situation 1 month earlier, actually barring complete incompetence management most certainly knew about their predicament so why wasn't it alluded to in the annual report? Obviously the extra $3.26m will come in handy, at current cash burn levels giving them aproximately 5 more months of working capital. However as a shareholder I think I would be more than a bit annoyed after reading the annual report and believing the company had adequate working capital only to find out one month later that my shareholding had been diluted 15% because the company was underfunded. Oh sorry, how silly of me, I forgot shareholders don't read annual reports.

Interestingly in a presentation made by the company at the end of November 2006 the second last slide gives 5 reasons why the company believes they are a “compelling investment opportunity.” The third reason being that they have a “scalable and proven business model.” Well not yet they don’t, they have proven there is demand for their products and services, what they haven’t proven is that they can run a profitable business.