• Brett Schafer

The Mini Mania is Here

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Nothing you read in this post will be ground-breaking, considered a hot take, or different than your daily stream on fintwit the past month. However, I want to timestamp my thoughts on why portions of the market are in a “Mini Mania” as we close out 2020. Specifically, in the non-FANMAG software stocks, SPACs, electric vehicles (EVs), and new IPOs like DoorDash and Airbnb.

Financial markets, as they do periodically, have morphed into a casino. Will the speculation end at some point? Probably. Will these stocks crash in the next few years? Maybe. Do I know for sure when these things will occur? Not a chance. But here’s what I do know (or, well, believe has a high probability of happening): most of these stocks will be dead money over the next three years. Even if the mania continues for another year (Tesla at a $2 trillion market cap, anyone?), no group of companies is immune to base rates, especially if they all compete with each other!

Unlike late 2019/early 2020, where someone could have argued overall market valuations had gotten stretched, the traditional signs of mania are out in full force:

  1. Large participation from individual investors

  2. “Concept” companies going public with billion-dollar valuations (this time with SPACs)

  3. IPOs popping 100% or more on the first day of trading

If you’re skeptical we are in a mania, please spend 10 minutes listening to the top financial analysts on Tik Tok and decide for yourself. The fear and greed index was at 89 one week ago (it has since fallen to 76). And to put the cherry on top, call option buying has exploded this year. I mean, just look at this chart and tell me greed isn’t back:

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This weaponization and speculation with securities by the use of call options, made famous by the degenerates on Wall Street Bets, is dangerous and will likely end poorly.

With certain pockets of the market infused with greed, I am starting to get fearful. Not in the way of shorting or going to all cash (market timing is a fool’s errand), but by staying away from SPACs, recent IPOs, EV companies, and SaaS stocks trading at 15-20x+ sales multiples. With too many eyeballs on these sections of the market, the opportunity for outperformance seems thin. You want to fish where the fish are, not where they used to be.

To close things out, I’m going to publish an article I was working on for the Motley Fool, but then realized it wasn’t meant for their website (market cap too small). It is an example of this “Mini Mania” and focuses on Clubhouse Media Group.

Why Investors Need to Stay Away From Clubhouse Media Group

Special Purpose Acquisition Companies, or SPACs, have had quite the 2020. 178 of these “blank check companies,” whose purpose is to acquire a private business and take them public, have raised $65 billion so far this year. This is already more than the last 10 years combined. Clubhouse Media Group (OTCMKTS: TONJ), a network of “content houses” for Tik Tok influencers, has gone public in a similar fashion. Here’s why investors should stay away from the stock.

Clubhouse Media Group emerged when the company West of Hudson (the original owner of these content houses) was acquired by Tongji Healthcare, a public company, in what is called a “reverse merger.” This occurs when the private company (in this case, West of Hudson) maintains control even though it is getting acquired by Tongji Healthcare. The deal closed on Wednesday, November 18th, with the new entity being renamed Clubhouse Media Group under the ticker TONJ.

Clubhouse Media Group (CMG) operates as a management company for popular Tik Tok creators. It takes a revenue cut from the creators who in-turn have the ability to live rent-free in fancy mansions and promote products CMG brings to them. This symbiotic relationship allows influencers to “incubate” at these content houses while CMG owns some of the upside if these creators become stars. Plans call for 2 to 4 of these houses opening each year, and are seen as a bet by CMG that all the views and followers these creators have on Tik Tok can be converted into future revenue sources.

The problem is, the numbers don’t show much of a real business.

For the six months ending June 30th in 2020, CMG had a meager $95,000 in sales across its businesses, gross profit of $5,000 (yes, thousands, not millions), and $974,000 in operating expenses. That gives the company a $968,000 operating loss on less than $100,000 in revenue. Who knew content houses were such capital intensive businesses? It is going to take a whole lot of growth, and fast, to get this company to profitability.

You might be thinking: why are you writing about this stock, isn’t it probably worth less than $5 million? Well, not exactly. CMG stock currently trades on the pink sheets for a valuation north of $350 million, giving it an annualized price-to-sales ratio (P/S) of 2,000. Zoom Video (NASDAQ: ZM), considered to be one of the fastest-growing businesses in the world, trades at a sales ratio under 100. While that is still expensive (the average P/S in the U.S. is 2.1), it makes some sense when you consider Zoom’s high gross margins and growth potential. CMG hasn’t proven it has either.

There are many reasons to stay away from CMG stock. Here a few big ones:

  1. It is a penny stock. These small, over-the-counter securities have a history of being scams, low trading volume (which affects your ability to buy and sell shares), and a lack of audited financials. Yes, you can buy shares at a lower “price,” but that doesn’t mean it will necessarily be a good investment.

  2. Buying CMG is investing in a story. The clubhouse business model has not proven sustainable and is far from producing a profit or getting to any scale. In fact, all the company has proven is that it can lose 10-times as much money as it brings in as revenue.

  3. It trades at an unsustainable valuation. There is no historical evidence that stocks trading at triple-digit sales multiples, let alone north of 1,000, will continue to do so over the long-term. If you own CMG with a goal of holding shares for a long time, your betting the company can grow sales at an obscenely high rate. Can they do it? Maybe. But that’s putting a lot of faith in an unproven business.

Shareholders in CMG might argue that Tik Tok is the next big social app and that signing the top talent from the platform will bring in millions in revenue when their followers start buying the promoted brands. However, internet influencers only bring in $100,000 – $1 million in revenue each year (depending on followings, platform, etc.), of which CMG only sees a small cut. Don’t forget the leases on these content mansions either. Is that business worth $350 million today?

Long-term, Foolish investors don’t bet on a story with no underlying business. The risk vs. reward, especially in a penny stock trading at a sky-high valuation, should make investors wary of Clubhouse Media Group.

#StockBubble #DoorDash #Airbnb #SPACs #Mania #IPOs #MiniMania

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