Hello readers! As promised, I’m happy to release my next article analyzing SIRC’s FY 2021 annual report. My first article focused more on high level performance and some key considerations from their financials.
This article will focus more on some interesting specifics I dug into from the audited financials. Many of these were not yet available as they hadn’t been specified in the prior quarterly (unaudited) filings, so we as investors can now get into the nitty gritty details on some things.
Today’s article will get into the mysterious Series C and Series D preferred shares that were issued during 2021… Enjoy!
Series C and Series D Preferred Shares
Background
To be honest, one of the first things I checked when this filing dropped was the terms of the Series C and Series D preferred shares. These were issued in conjunction with the purchases of Enerev LLC and Future Home Power, respectively.
I immediately fixated on these because SIRC issued these to the former owners of both companies as part of the purchase price. Up until now, it was basically impossible to fully ascertain the full purchase price of those two companies because the terms of these preferred shares were not disclosed (to my knowledge).
Not that I thought SIRC was into any funny business, but other companies on the OTC cram some insane terms into preferred shares in order to essentially “hide” extremely toxic terms. This happens ALL OF THE TIME on the OTC. Some are worse than others, but they generally protect company founders, early investors, directors, etc. and more likely than not erode common shareholders.
Because they don’t show up in the common share count, many investors overlook these and just see low market caps and don’t understand why. Many OTC companies secretly hope regular investors don’t do their homework and read about them. But I do! Thankfully, many companies are up-front about them and/or have audited financial statements in which they have to disclose the terms.
A worst-case example would be like this. Imagine we didn’t know the terms of the Series B (convertible into 10 common shares) and we saw that, for example, 50m Series B preferred shares were issued for an acquisition. We would have no idea that there were potentially 500m common shares potentially to be converted!
Terms
Anyways, needless to say, I breathed a big sigh of relief when I saw the actual terms of the Series C and Series D and they weren’t some obnoxious, toxic, instrument. They were:
- Series C: 49% of the future net profit of Enerev LLC in the form of a preferred dividend.
- Series D: 4% of the future net profit of Future Home Power in the form of a preferred dividend
Accounting Implications
As of FY 2021, SIRC has not yet accrued and paid any preferred dividends on for these two. Or if they did, it wasn’t listed as a separate item in calculating profit per common share, nor in their calculation of equity. This (I guess) means that neither of these businesses turned a profit in 2021, or the preferred dividends don’t begin until a later date.
Which brings me to my next point…
This profit sharing will be treated as a preferred dividend. This means it is not tax deductible and will not be treated as an expense on the income statement. The dividends will be deducted below the line that says “net profit (loss) attributable to the Company”.
Remember, net profit attributable to SIRC includes both common and preferred shareholders. So depending on how large these dividends get, please remember to remove them from your multiples, etc. when assessing the net income available to COMMON shareholders. If you don’t, you will be over-estimating profit.
Lastly, these are not carried as a liability on the balance sheet, and they will tend to overstate common shareholder equity. These are carried at their BOOK value on the balance sheet within the calculation of equity. The book value of each of the Series C is 0.00001, and the Series D is 0.00040. That’s because you carry these at their par value, which is extremely low.
HOWEVER! These preferred shares are worth extremely more than that! This could be a whole article in itself, but these preferred shares have some intrinsic value to them that the company is technically on the hook for. For example, if SIRC were purchased, the Series C and Series D holders would need to be compensated at their intrinsic value, not par. And this would come first before common shareholders.
What is the intrinsic value of these shares? Since they’re both a percent of net profit, you’d estimate 10, 20, 30, etc. years of net profit. Then, you’d apply the profit share amount and then take an NPV back to today. Depending on your assumptions, that could be a ton of money, or not much at all 😊.
So please just remember that these exist and exist almost like a liability to the company. Your guess is as good as mine at the actual value, so I’ll leave it at that.
My Take
So while what I talked about up there may have put some people to sleep, or made some people nervous, I am not concerned about these at all. Remember, these are percent of net PROFIT. So these guys are only getting paid if the business does well. And it’s a percentage, not a fixed amount. So they get paid more if the business does better.
Because of this, SIRC, the common shareholders, and the preferred shareholders are all in a win-win situation. I mean yea, it’ll blow if we’re paying out millions of dollars in preferred dividends every year and its super expensive to buy them out. But SIRC will be making so much money, does anyone really care?!
Another perspective… remember that these are acquired companies and the owners got some fat payouts for them before we consider the Series C and Series D. Also, these owners are now SIRC employees technically and have stayed on with their companies.
As we all know can happen, some of these business owners could simply stop trying because they already got paid. However, these owners likely took a pay cut in their buyout and instead received these preferred shares. These preferred shares of course will only pay out if the businesses do really well, so naturally it now incentivizes them perform, which is a win for everybody!
So I see no issues here. But everyone ABSOLUTELY needs to understand these and have some estimate for their value when calculating the value of SIRC’s common equity. If you don’t, you will likely be overstating the value of common equity and SIRC could look overvalued when it isn’t.
Just to clarify before I get angry Twitter DM’s… this is all relative. I’m not saying SIRC isn’t undervalued right now, quite the opposite actually. For example though, if these instruments are worth 100k, that’s a rounding error and you can just ignore these. But if they’re worth tens of millions of dollars one day, you need to remember that they’re there or your valuation will be off.
Anyways, hope this didn’t put you to sleep and you found it interesting! And as always, thanks for reading!
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DISCLAIMER – AT THE TIME OF WRITING THIS ARTICLE I HAVE A LONG POSITION IN $SIRC. THIS ARTICLE IS NOT FINANCIAL ADVICE AND IS INTENDED ONLY FOR EDUCATIONAL PURPOSES. I AM NOT A FINANCIAL ADVISOR. AT THE TIME OF WRITING THIS ARTICLE, PERSONS AFFILIATED WITH THE COMPANY ANALYZED ABOVE MAY BE PROVIDING MONETARY COMPENSATION AS MONTHLY PATRONS THROUGH MY PATREON. THIS COMPENSATION IS NOT PROVIDED IN RETURN FOR ANY SERVICE, WRITING ABOUT A PARTICULAR TOPIC, AND/OR FAVORABLE OR UNFAVORABLE OPINIONS. MY PATREON SUPPORTERS HAVE NO INFLUENCE ON THE CONTENT OF MY ARTICLES.
