Liberated Syndication

Liberated Syndication (OTCMKTS:LSYN) is a small company that provides podcast hosting services through a wholly owned subsidiary called Webmayhem.

The company looks cheap: incredibly cheap in fact. At the current market price of $0.48 and with 20.8m outstanding shares, LSYN’s market cap is $10.0m. For the nine month period ended September 30, 2016 the company showed operating income of $2.1m (2015: $2.0m). The company should make just below $3m in operating income for 2016 and is therefore trading for around 3.5x operating income. In addition LSYN has $3.8m in cash and only has liabilities of $0.5m. The hosting business can be a good business with modest capital expenditures. Much of the $3.8m in cash is probably not needed to maintain operations.

This company looks like a great bargain at first glance. Unfortunately, as I read more about LSYN, specifically about how it came into existence and about the insiders of the company, my enthusiasm went away. In this post I’ll share some of the things I found. The valuation looks so compelling that I would not be surprised if some value investors buy into LSYN’s story and end up disappointed. LSYN reports with the SEC, so the financials will probably show up in the databases of various stock screeners and the company will drift to the top ranks when searching on some criteria.

This post can serve as a warning and starting point for extra research to those investors who might do a few Google searches on the company before investing.

The spin-off from FAB Universal

Liberated Syndication is a spin-off from a company called FAB Universal Corp. (OTCMKTS:FABU). The spin-off took place in August, 2016 and LSYN has been an independent public company since. The first red flag you encounter when you look at the history of this company is that FAB Universal trades on the grey market for $0.0005 (yes, you read that right). Of course FABU is now trading ex-LSYN, but even before the spin-off the entire company was selling for less than a penny per share. What’s going on there?

I didn’t do a lot of work on FABU itself, because it wasn’t necessary, so I don’t know the full story. One article I found describes the settlement of a shareholder lawsuit and notes some of the main issues.

A couple of quotes from that article:

Fab’s troubles began in November 2013 as a result of allegations contained in various short-seller publications. That December, the company acknowledged it failed to disclose the $16.4 million Chinese bond issuance and said it also discovered “certain deficiencies” with its accounting procedures and would be hiring an independent third party to investigate.

In a February filing with the SEC, the company disclosed its chairman chairman [sic] Zhang Hongcheng had been detained in Beijing, and its business in China appeared to be abandoned.

Fab, a digital media firm, was created in a 2012 Chinese reverse merger of Pittsburgh-based Wizzard Software with Hong Kong-based Digital Entertainment International.

So, it seems that LSYN was spun-off from this questionable company that was the result of a Chinese reverse merger. The chairman of FABU was detained in Beijing.

The insiders

The directors and officers of LSYN can be found on page 19 of the prospectus that the company filed shortly before the spin-off. It includes most of the names that appear on page 13 of the last reported proxy statement (filed in May, 2013) of FABU. The one name missing is that of the Chinese chairman that was detained in China. He owned 11.2% of FABU in May, 2013. The CEO and CFO owned just 2.1% and 1.4% of FABU, respectively.

FABU itself reached a high of ~$7.80 in September, 2013 and the stock generally sold around a level of $3-$4 in 2013. Insiders took advantage of the elevated stock price to cash out some of their stock. Look for the form 4 filings on this page.

In the spin-off, each FABU shareholder received one share of LSYN. As a result, the FABU insiders also received their proportionate shares. The insider ownership of LSYN after the spin-off can be found on page 33 of the prospectus. Excluding the Chinese former chairman of FABU, current management and directors of LSYN owned just 1.7% of the outstanding shares after the spin-off.

Some value investors say they are looking to kill an investment idea as soon as possible. After finding the above, I felt I had done this for LSYN. There is no way I want to be a shareholder of this company as long as the old management that was involved with FABU is still in place.

Libsyn: a real and valuable business?

The main thing that makes this company interesting is that Liberated Syndication looks like a real business to me. More importantly: it’s probably pretty valuable.

Here are some links I found about Libsyn by users and reviewers of the software:

• Why do so many people prefer Libsyn to Soundcloud Unlimited?: a Reddit discussion about the Libsyn software versus another popular alternative.
• The Investor’s Field Guide: anecdotal evidence. 🙂 A podcast about investing that I found the other day, made by a portfolio manager. A Libsyn player is used on the website. It worked very well.
• The Best Way To Move Your Podcast Off SoundCloud
• Podcast media hosting explained and compared

Libsyn seems to provide a service that people are generally happy with and that is also preferred by many to some of the alternative providers of podcasting hosting.

I don’t trust management of the publicly traded LSYN at all, given the FABU history and their lack of skin in the game (almost no insider ownership). That doesn’t mean that Libsyn itself isn’t a real business with dedicated employees providing a service that is being valued by customers. If you do a poor job in the hosting business and provide poor service and software, customers will flock to alternative hosting providers. But Libsyn seems to have customers that are pretty happy with what they are receiving. The podcast industry itself seems to be growing steadily, with an increasing number of people offering a podcast in addition to their traditional web-content.

The ideal scenario for outside LSYN shareholders is for an activist to come in and take control of the board and remove anyone who was associated with FABU. There are some major obstacles for a dream scenario like this to play out though.

The largest shareholder of LSYN is the Chinese former chairman of FABU and he owns 11.2% of the shares outstanding. What is his current situation? Can he still vote his shares? Can he sell them to someone else? Does he support the current management?

Another potential red flag and obstacle can be found on page 38 of the amended registration statement for LSYN:

After completion of the Spin-Off, there will be approximately 20,805,860 Libsyn shares of its common stock outstanding, based upon the number of shares of FAB’s common stock outstanding on June 30, 2016. Of these shares, 18,136,503 will be freely transferable without restriction under the Securities Act, which excludes the shares that are owned by our “affiliates,” as that term is defined in Rule 144 under the Securities Act, which includes Libsyn’s directors, executive officers and significant stockholders. Shares of Libsyn’s common stock held by affiliates may not be sold unless they are registered under the Securities Act or are sold pursuant to an exemption from registration, including an exemption contained in Rule 144 under the Securities Act.

(emphasis mine, source: S-1/a filed on July 13, 2016)

Now look at this section of the document from an earlier filing of the registration statement:

After completion of the Spin-Off, there will be approximately 20,805,860 Libsyn shares of its common stock outstanding, based upon the number of shares of FAB’s common stock outstanding on January 31, 2016. Of these shares, 12,911,460 will be freely transferable without restriction under the Securities Act as well as the shares that are owned by our “affiliates,” as that term is defined in Rule 144 under the Securities Act, which includes Libsyn’s directors, executive officers and significant stockholders. Shares of Libsyn’s common stock held by affiliates may not be sold unless they are registered under the Securities Act or are sold pursuant to an exemption from registration, including an exemption contained in Rule 144 under the Securities Act.

(emphasis mine, source: S-1/a filed on May 20, 2016)

I’m not sure how to interpret this section. The number of freely transferable shares between these two filings has increased from 12.9 million to 18.1 million. Does this mean that ~5.2 million shares were first being labeled as owned by affiliates and that they are now being judged to be owned by non-affiliates? In that case, it could mean that 5.2 million shares or 25% of the outstanding shares are currently held by a group of people who might be more likely to side with management in the event of a dispute with an activist. The fact that they are not deemed to be affiliates does not mean they aren’t likely to be supportive of the current management.

The auditor

This is just an aside. The auditor of LSYN is Gregory & Associates, LLC: see page F-2 of this document.

I did a Google search and found out that this is the same auditor that is used by Armanino Foods of Distinction (OTCMKTS:AMNF), see: this page. I also verified this by checking the AMNF annual report and it is the same company, located in the same city and using the same address.

AMNF is probably one of the most well-known OTC stocks among value investors. It seems to be a high quality business that generates a lot of free cash. Armanino has always looked pretty expensive to me and I have never owned it. I do know that some investors have asked why a high quality company like Armanino Foods would use a small, unknown auditor like this. I don’t know the answer. Perhaps they are just cheap.

I don’t think this means anything necessarily, but it does raise more questions about why a high quality business like AMNF would use this auditor. The auditor should also know the history of LSYN and the involvement of the management with FABU. Why work for them? I assume you have the right to refuse business from a company.

Conclusion

Even though I don’t want to touch LSYN, my impression is that the underlying business is real and valuable. That’s what makes this company interesting to me to follow in the future. What is management going to do from here? What is their strategy, given their very low share ownership? How much will they pay themselves? Will they make acquisitions? Can any outside shareholder force a change?

My guess is that management will find a way to maximize their own compensation and that outside shareholders will not see anything of the large amounts of cash that Libsyn generates.

Disclosure: no position in LSYN, FABU or AMNF.