Cytosorbents’ Unique Financing Deal

My main speculative play over the past two years has been in a company called Cytosorbents Inc ($CTSO).  The video above gives a great 3 minute overview of the company’s technology and business model.  However, the main problem for the stock throughout 2012 was a pretty hefty dilutive financing deal.  Thankfully, the CEO – Dr. Phillip Chan – has promised to avoid any dilutive deals going forward and has mainly focused on obtaining grants from DARPA and other US Defense/Medical groups.  Last week, the company announced they had obtained $400,000 in non-dilutive financing, but the stock price still dropped 8%.  While the stock is thinly traded and has a small float, I still believe this was very positive news for the company – so I did some digging.

$CTSO released a press release on Monday stating they had sold their net operating losses (NOL) in order to acquire extra cash.  In all honesty, I had never heard of selling NOL’s or what that actually meant.  Turns out, there’s more to New Jersey than Ed Hardy and beach clubs.  In an effort to further promote the technology and biotech communities in NJ, the state has allowed any unprofitable company in the biotech/tech sector with less than 225 employees to sell their net operating losses.  All it takes is a $2,500 application fee and the state of New Jersey will allocate a portion of their $60M cap to your business and purchase your NOL’s.

But to figure out how NOL’s can be bought and sold I had to turn to an expert CFO (a.k.a my dad) – so bear with me for a bit of a “bean counter” explanation.  A net operating loss is the result of losses incurred over the years – i.e cumulative losses of a business.  According to Federal and State tax laws you’re allowed to “carry back” the losses you paid in the past if you are profitable or to “store up” the losses for when you eventually start becoming profitable and can offset the profits using the net operating losses.  Therefore, you don’t need to pay taxes until you’ve obtained a cumulative profit for your business.  For businesses that have already obtained a cumulative profit, there is an incentive to “buy” an unprofitable company’s NOL and write it off as a loss.  From a federal standpoint, NOL’s are not transferrable and can’t be bought/sold.  However, in order to spark investment and performance in certain industries, New Jersey has made this legal.

As for $CTSO, this is a sweet deal and in no way, shape, or form is it dilutive.  After watching the stock trade over the last two years, especially around news events, my hunch is that it’s mainly held by doctors – not financial types.  The company has a plethora of catalysts coming in 2013 and hopefully expectations will become more reasonable going forward.

For further details on the New Jersey’s net operating loss program take a look at the official description here and FAQ here.

Today’s Volatile Market Expectations

Market sentiment is something that has really piqued my interest lately.  Since the day I started in the markets, I’ve constantly been told that investors’ expectations of future earnings is what drives the stock market.  It wasn’t until I read an analogy, however, that the importance of this phrase truly clicked for me.  In a well-known McKinsey & Company book called “Valuation” by Copeland, Koller, and Murrin the authors describe managing the finances of a public company like running on a treadmill.  If you imagine the market’s expectations as the speed of a treadmill and a public company as the runner it begins to become more clear.  When investor expectations become more bullish, the speed of the treadmill increases (and continues running at that speed).  As a result, a company’s earnings/performance needs to be better than the market’s expectations in order to gain any ground on the treadmill (stock price increases).  If they fail to beat these expectations, the runner begins to fall farther and farther behind the speed of the treadmill.  However, it gets to a point where a company can have a history of beating expectations that the market’s expectations simply get raised too high.  As a result, the most profitable company in the world may still experience a falling stock price by not being able to beat these unrealistic expectations.

A great example of this over the last week has been $AAPL.  Everyone and their mother has written articles attempting to explain the falling share price of America’s beloved stock recently, and many of them may certainly be right.  To me, however, the answer is simple.  $AAPL has done so well over the years that expectations have simply gotten too high.  One slip up in iPhone 5 sales and we’ve experienced a massive sell-off in the stock.  Tim Cook and company just couldn’t continue running 5 minute miles.

Thankfully, I’m not hear to rant about $AAPL.  The treadmill analogy has caused me to pay a lot more attention to market expectations recently.  I think we can all agree the month or two leading up to Fiscal Cliff shenanigans consisted of some very bearish expectations.  Surprisingly, all of the press during this time almost completely disregarded the Euro Crisis.  I find it pretty hard to believe that Angela Merkel’s quote regarding the health of the EU has finally been listened to and acted upon by businesses and investors.  Nevertheless, we saw a nice rally in European equity indexes and especially select financials ($SAN is my current favorite).   Further, once January 1st came and went we’ve seen a nice pickup in US Equity markets as the majority of financial blogs have began focusing on the 2013 bull market…

Despite the large number of bullish articles and posts this weekend, bloggers/journalists are beginning to second guess themselves.  Debates about a secular bull market and fake rallies have all been argued for today.  Frankly, the vast majority of bullish articles have come in the last week and I can’t find any reasons why the bearish arguments (from former bullish investors, writers, and ranters) came out of the blue today.  While this has caused me a great deal of confusion, I think it’s actually a good sign.  It’s still very early in earnings season which means the bearish sentiment should give rise to some nice rallies after healthier than expected companies end up beating estimates.  $IBM was today’s prime example.  I’m hoping for a nice little sell off in order to pick up some names I’m confident in before they announce earnings and hopefully fetch some nice gains.

From here on out, I’ll be using this blog as a trade journal as well as to clear my thoughts and observations on the markets.  More to come this week!