Why LUNA just got REALLY interesting
I have been talking about LUNA previously and the thesis in a nutshell has been that this is a solid business that ran into accounting issues mostly related to revenue recognition and thus being delinquent on SEC filings. Once they would be up to date on that the stock was going to quickly rebound especially with the new management team all basically former National Instruments people. Fast forward to Thursday and this was announced:
The business is now definitely up for sale and the clock is ticking. Let me summarize the situation again:
Luna is a leading supplier of fiber optic sensing and Communication Testing equipment with market-leading technology in the growing field of fiber optic measurement. There are two sides to the business -- Sensing (ca 70%) and Communications Testing ( ca 30%). Their Sensing products measure physical parameters of materials and monitor health, usage, and security of assets eg for Airbus planes. It could also be used for semiconductor chips to measure consistency or in data rooms. Another segment called Terahertz improves EV batteries and was a main growth driver. Communications Test measures and controls light, enabling and analyzing next gen optical systems and instruments. Industries are data center connectivity, silicon photonics, aerospace networks, guided robotics, etc. One example of a customer is Intuitive Surgical
LUNA is doing quite well and last year makes an acquisition funded by a $50 Million Strategic Investment from White Hat Capital Partners. This will become important later.
Shortly after they announce the revenue recognition issues and the stock absolutely tanks to basically where it is now still.
What follows is a complete leadership transition to a team of former National Instruments people including strategic initiatives. Unfortunately, part of prior mgmt is also fired for cause pointing to bigger issues than just revenue recognition. But we don't know and likely won't find out. A risk though.
In midst all this mess however, the company actually starts investor outreach and also Needham comes out with a bullish research note.
Finally, the CEO transition: Kevin Ilcisin will become president and CEO on Aug. 1, according to a filing Tuesday with the Securities and Exchange Commission. Ilcisin, 59, has been a top consultant to the embattled fiber-optic sensing company since April. Luna’s former top leader, Scott Graeff, retired the month before, following the company’s disclosure that earnings reporting discrepancies had caused it to indefinitely delay annual and quarterly reports.
Along with that comes a bridge loan from White Hat (rings a bell??). An initial draw of $9 million was made upon the closing of the Loan Facility, with up to an additional $6 million available for future draws, subject to certain conditions.
The company is up for sale and quickly. (SEC filing)
The CEO is a consultant with his own firm, is paid in cash monthly and the relationship can be ended any time by any party. Clearly no "proper" CEO wanted to do this job for just a couple of months! A fourth of his comp gets paid in March next year or when the biz gets sold. He also gets up to an $800k bonus and there have previously been 628k RSUs awarded.
The loan agreement defines a Sales Process Milestone in 2 (!) months
As it happens, missing it is an Event of Default
But if they do meet the milestone, the maturity of the loan can be extended beyond Dec 31, which to me is simply the bridge towards closing and additional draws can be made.
Default doesn't necessarily mean bankruptcy, but it could and also the interest rate increases. Most of all, why put in such a deadline and such a tight schedule if they were not already far progressed in finding a buyer? Recall they hired Evercore already in May.
Clearly, this is getting sorted out quickly ...or not and then it gets ugly. So to me if by end of September nothing is announced, the thesis is broken and I will get out.
Make no mistake, White Hat is running this process. They are the fulcrum security with $50M of prefs convertible at around $6.7.
There is additionally the new loan (offset by cash influx) and some PNC debt of around $15M or so.
Unfortunately, we don't have updated financials at all this year but presumably the bridge loan was necessary for a reason (not much cash left). The share count is also hard to tell exactly, but let's just work with 37M instead of the last number of 35M.
Leaves us with a current market cap of $107M. The EV is $172M. A quick and dirty overview:
You can spin this the other way as well
We need at least a $200M sales price to make (good) money. That would fall into the range of 1-2X sales, which could be well supported by this type of business with >50% gross margins.
Longer term guidance was once 20% EBITDA margins on $250M in sales and full year adj EBITDA was originally projected to be $14-18M in 2023. So those numbers are not far-fetched. Needham had them do 23ct; 32ct and 44ct EPS in 2023/24/25. All these numbers are of course not correct but maybe give us a potential.
The stock was around $7 before the issues began in the beginning of the year. Unless the business fell apart in the meantime, which frankly is possible, that looks like a nice ceiling and another guide post.
From my research, the technology was always deemed best in class and thus quite “valuable”.
The CEOs RSUs are 0ed in case the stock is.
They could have filed for bankruptcy as well if there was no hope for a sales price >$175M. (Weak argument I will admit since bankruptcy is expensive). But White Hat has put more money in for a reason (in a VERY seller friendly way) and the very tight sales process milestone was also chosen for a reason.
And let me emphasize again, the sales process has been ongoing for months. There is no way in my mind they have not gauged interest or even received indications of interest.
Overall, to me the setup looks great. There are risks but those are somewhat mitigated by the defined timeframe and our ability to pull the plug within the next 2 months should no deal be signed. This would indicate to me no big interest in the assets, a failure to sell or too low a price.
So the game plan would be: Stay long until Sept 30 and if no news exit around that time. By then they either have a signed deal or default….and I doubt they wait exactly until Sept 30 to sign and announce it. I Think the stock could run higher in anticipation. August 16 is the first date for another $3M draw of the loan, which may or may not go along with a fundamental development (a term sheet for example) and maybe something leaks…
Call spreads look also interesting with strikes $2.50/$5.00.
Author’s Disclosure: I have a beneficial long position in the shares of LUNA either through stock ownership, options, or other derivatives, and I may buy or sell any of the stocks when you are reading this. I wrote this post myself, and it expresses my own opinions. I have no business relationship with any company whose stock is mentioned in this article. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. I am not a licensed securities dealer, broker or US investment adviser or investment bank.
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