Fake Phalange Corporation has been on the CPG short watch list for awhile now, but its results and movements have always seemed too good to be true. When the company last reported Q4 earnings, the stock saw a 40% drop the following day. This drop was likely triggered by the company's 20.6x net revenue multiple on a $206m market cap. Management subsequently announced that 50% of revenues represented sales to associates while the other half were "consumables." This announcement implied the company was worth only $50m based on a one year revenue retention rate of 1/2. This came as a surprise to the markets, and share prices quickly rebounded to its 50 day average, leaving a perfect buying opportunity for investors interested in seeing the company operate and earning a profit over a longer period.

Management recently released another earnings report that not only assuaged fears of self-dealings, but, unlike the past report, represents a plausible business model. The company now sells branded and generic products (including legacy branded products) at wholesale, with the wholesale business contributing two-thirds of all revenues. Specific to the company’s own brand, PHAC , the company conducts marketing activities to both educate professionals and distribute to patients. This is a comparatively honest model as patients can purchase supplies independent of the provision of therapeutic services, representing double- and triple-dipping.

Industry

Unsurprisingly, phlebotomy and clinical lab companies come with slim and stable margins, and high potential for enterprise value to revenues. Fake Phalange is well positioned to dominate the market for 3 reasons: 1) the company’s insiders own 60% of all outstanding shares; 2) ownership is dispersed; and 3) insiders have an equal distribution of capital on both long and short positions. Additionally, management holds the majority of its short sales in the form of call options, not the typical short positions in the common. The strategy will become less risky to the upside as prices rise over time.

Stock

Revenue retention is also tied directly to debt and share repurchases. As you may have noted, the company recently repurchased a sizeable amount of shares, and quickly reduced its dilutive shares outstanding (by shortening the average term of the shares remaining). It does appear that Fake Phalange will be able to significantly reduce debt over the next 6 quarters, putting in place a much more dynamic and more realistic outlook of free cash flow generation and overall expected return. Given that the company is already earning a profit and that free cash flow can now be reasonably estimated, I expect shares to be bid up if the stock is not already acquired at any price north of $20 per share.

Since starting this post yesterday, the stock has already moved from $16 to $18 on insider buying, suggesting analysts have been distracted by higher returning names such as Dream Works instead of a company that has found itself a niche in a high growth market. Look out for this one over the next two quarters.