Spetz's Strategic Moves: A Closer Look at the Proposed Offering, Debt Settlements, and Convertible Debenture Restructuring

Spetz Inc. (CSE:SPTZ)(OTC Pink:DBKSF) has recently announced a series of strategic initiatives aimed at strengthening its financial position and securing additional funding. The company is proposing a private placement offering, settling accounts payable through shares for debt transactions, and restructuring its convertible debentures. Let's delve into the details of these moves and analyze their potential impact on Spetz's shareholders, cash flow, and future growth prospects.

Proposed Offering: A $500,000 Lifeline

Spetz is arranging a private placement offering of up to 5,000,000 Common Shares at a price of $0.10 per share, for gross proceeds of up to $500,000. The company plans to use these funds for general working capital purposes and to explore new business opportunities that will create value. While this offering is a welcome source of capital, it's essential to consider the potential dilution of existing shareholders' ownership and voting rights.

Assuming the offering is fully subscribed, the number of outstanding shares would increase by approximately 50%, diluting existing shareholders' ownership to around 45%. This dilution could lead to a decrease in the price per share for existing shareholders, as the increased supply of shares may outweigh the demand. However, if Spetz can effectively utilize the funds to generate growth and increase earnings, the potential dilution could be offset by the enhanced value created.

Shares for Debt Settlements: A Creative Solution

Spetz is proposing to settle an aggregate of $445,645.89 in accounts payable to arm's length parties by issuing 4,456,458 shares at an issue price of $0.10 per share. This creative solution allows Spetz to reduce its outstanding debt and provide some relief to its cash flow situation. However, similar to the proposed offering, this transaction will also dilute existing shareholders' ownership and voting rights.

Assuming the shares for debt transactions are completed, the number of outstanding shares would increase by approximately 45%, further diluting existing shareholders' ownership to around 40%. This additional dilution could exacerbate the potential decrease in the price per share for existing shareholders.

Convertible Debenture Restructuring: A Double-Edged Sword

Spetz is working to issue new convertible debentures in the aggregate principal amount of $1,017,673, replacing primarily the principal amount of outstanding convertible debentures that have matured and are currently due and payable by Spetz. The principal amount of the new debentures would be convertible into units of the Company ("Units"), at a price per Unit of $0.20, with each Unit comprised of one (1) Common Share and one-half (1/2) of a common share purchase warrant ("Warrant"). Each whole Warrant would be exercisable for one Common Share, at a price of $0.40 per share, for a period of 24 months following the issuance of the Warrants.

While the restructuring of convertible debentures can provide Spetz with additional capital and reduce its debt obligations, it also introduces potential risks. The conversion of debentures into equity could lead to further dilution of existing shareholders' ownership and voting rights. Additionally, the 24-month exercise period for the Warrants could create an overhang, where the market anticipates a significant increase in the number of shares outstanding if investors choose to exercise their Warrants. This could negatively impact the company's stock price and make it more difficult to raise capital in the future.

The Impact on Cash Flow and Profitability

The issuance of new shares in the Offering and Shares for Debt Transactions will have a direct impact on Spetz's cash flow, as the company will need to allocate funds to pay the interest on the New Debentures. Assuming conversion of the entire principal amount of the New Debentures, Spetz would issue an aggregate of up to 5,088,365 Common Shares and up to 2,544,182 Warrants. The annual interest expense for the New Debentures would be calculated as follows:

Interest Expense = Principal Amount × Interest Rate
Interest Expense = $1,017,673 × 12%
Interest Expense = $122,120.76

This annual interest expense would reduce Spetz's net income, ultimately leading to a decrease in earnings per share (EPS) and return on equity (ROE). Assuming Spetz's net income before interest and taxes (EBIT) is $500,000, the net income would be reduced as follows:

Net Income = EBIT - Interest Expense
Net Income = $500,000 - $122,120.76
Net Income = $377,879.24

This reduction in net income would have a direct impact on Spetz's profitability, as the Company's EPS would decrease accordingly. Assuming that Spetz has 10,000,000 outstanding shares, the EPS would be:

EPS = Net Income / Number of Outstanding Shares
EPS = $377,879.24 / 10,000,000
EPS = $0.037787924

Final Thoughts

Spetz's proposed Offering, Shares for Debt Transactions, and Convertible Debenture Restructuring are strategic moves aimed at securing additional funding and improving the company's financial position. However, these initiatives come with potential risks, such as significant dilution of existing shareholders' ownership and voting rights, and a negative impact on cash flow and profitability. As an investor, it's crucial to weigh these risks against the potential benefits and consider the long-term prospects of the company. While Spetz's moves may provide some relief in the short term, the company must focus on generating growth and increasing earnings to offset the potential dilution and maintain the confidence of its shareholders.

Final offering details:
- Shares priced at $0.10, representing a launch market cap of $100,000,000
- 5,000,000 shares sold
- Total of 15,000,000 shares in circulation post-IPO. This means that new shares tendered in the IPO represent 33% of the total float
- Total of $500,000 raised. After deducting standard 7% underwriting expenses, we expect the company to pocket ~$465,000 in gross proceeds
- Planned use of IPO proceeds include headcount expansion, sales and marketing activities, product development, capex, and general corporate expenditures
- The lockup period expires 180 days after the IPO, on April 25, 2025
- Offering co-led by Morgan Stanley (NYSE: MS) and J.P. Morgan (NYSE: JPM)

The cap table stands as follows:
- Accel and Amadeus, both early investors in the company, are the largest holders owning 15% and 19% of the company, respectively. Accel has been a backer since Spetz's Series B round (December 2001) and Amadeus since the Series C round (August 2002), according to Crunchbase.
- Given these VCs' extremely long holding periods, I wouldn't be surprised if major volatility occurred around the lockup expiration as investors expect these VCs to cash in on long-held gains.

Valuation update and final thoughts:
With a $100,000,000 market cap (based on $0.10 share price at time of writing), $26.4 million in debt, $72.5 million in balance sheet cash, and $465.0 million of estimated net IPO proceeds, Spetz currently trades at an enterprise valuation of $72.6 million. The company's top line is presented in the chart below, taken from the S-1 filing.

The company has trailing-twelve months revenue of $188.7 million, as seen above. Applying a ~25% growth rate on this figure (the company released prelim Q3 results that show 26% y/y growth, a deceleration from 1H17 and FY16 growth rates), we assume roughly $236 million in forward twelve months revenues. This implies an EV/FTM revenues multiple of 3.44x. At first blush, this sounds extremely cheap - most software companies that recently went public are trading in the neighborhood of ~7x or above. However, given that Spetz generates purely on-prem, perpetual license revenues with no recurring contracts, these companies really can't be considered Spetz's peer set.

The chart below shows examples of cybersecurity companies - those without a heavy SaaS theme - that trade at multiples in Spetz's neighborhood or even below.

At best, Spetz can be considered fairly valued. Its current levels in the high $20s already bake in a huge deal of risk, and unless the company posts blowout results, it'll be challenged to move meaningfully beyond $30. Sp