Description

Summary: 

Note: This is a low-liquidity idea suitable for PAs only. Average daily volume is 33k shares and over a 52-week period the share price has traded between $1.00-$1.49.

• Bsquare Corporation is a ~$24.7M market-cap net-net stock with ~$32.2M of net cash on the balance sheet, currently being valued by the market at a ($7.5M) negative enterprise value. The company has achieved roughly break-even cash burn over the last two quarters, and the net-cash balance is stable.

• The company has $13.3M in cash and equivalents and another $19.8M in short-term treasury investments for a total of $33.1M in liquid assets. There is no long-term debt other than $0.9M in long-term operating leases. Working capital needs are minimal: $4.3M in accounts receivable offsets $5.0M in current liabilities

• Bsquare’s management team is aware of the discount to net cash. They have reduced headcount and marketing costs significantly and look to be winding down current business operations in preparation for a sale or transformative acquisition in the near future. The company has hired a boutique investment bank, Telegraph Hill Advisors, in the most recent quarter to explore strategic alternatives to maximize shareholder value. Management has mentioned that they are evaluating a special dividend or a possible liquidation alongside other options. 

• The company has an asymmetric return profile: downside risk is mitigated by net cash/share of $1.54 which is 29.4% higher than the current market price. Upside in the event of a sale or special dividend would be significant, with strong near-term catalysts. 

Company Overview:

BSquare Corporation (NASDAQ: BSQR) went public in 1999, providing software services and tools for incorporating the Windows CE System into handheld computers and consumer appliances. The current company generates revenue through the following two segments:

Partner Solutions:

BSquare is a licensed distributor and installer of Microsoft Windows IoT Operating Systems for customers that manufacture or operate fleets of embedded IoT devices. BSquare only distributes the Windows IoT OS software exclusively. 

Edge to Cloud:

Bsquare provides IoT fleet management services to customers who would prefer to outsource. This segment includes the company’s in-house SaaS product SquareOne, which allows customers to monitor their IoT fleet in real-time.  

Customer concentration risk is limited as no customer accounts for > 10% of revenues.

The Partner Solutions segment, which represents 80%+ of total revenue, has been in secular decline due to the increased popularity of the Linux and Android operating systems versus Microsoft Windows. 

On the 2Q23 earnings call, CEO Ralph Derrickson addresses this trend:

“Embedded product developers are increasingly turning to Linux and Android for their operating system in an effort to lower their product costs, especially for the smaller footprint devices. Unfortunately, revenue from new customers is not keeping pace with erosion from customers whose products are going end of life or are switching to alternatives for their OS software. Our expectation is that keeping licensing revenue erosion under 15% would be an achievement.”

The company also attributes deterioration of Partner Solutions revenue to other Microsoft distributors offering deep discounts on Windows IoT OS software by bundling hardware and OS software, while BSquare only sells the Windows OS software. This segment is relatively commodified and has historical gross margins of 14-16%. The Edge to Cloud segment has slightly higher gross margins. 

In Q2 '23 gross margin was artifically elevated to 21.0% because of an accounting adjustment to COGs related to changed recognition of a Microsoft rebate. 

Opportunity Overview

Bsquare took advantage of a meme-stock rally in it's share price in 2021 to complete an opportunistic equity raise resulting in the large cash position. The company completed a shelf-offering in 3Q '21 when shares were trading at ~$5 due to meme stock speculation. The share count jumped from 13.2M in Dec. 2020 to 20.4M in Dec. 2021. After this original raise, they entered into a Side Letter with B.Riley Securities allowing them to sell an additional $25mm worth of shares which they did not exercise. 

Despite the large cash balance, management is concerned about preserving shareholder value and have taken initiatives to push operations to break-even profitability.  Recently they implemented a 20% reduction in headcount, cut marketing expenses for SquareOne, and allocated ~ $20mm of cash to short-term investments in 3 month T-Bills. With a current Q2 '23 run-rate EBITDA of ($2.1M) off-set by $1.6M in annual interest income, they are close to that goal. 

Management instituted a $5M share repurchase plan in 4Q ’22 for ~20% of shares outstanding. In 1H ‘23 they repurchased $0.9M, however announced in 2Q ‘23 they would be discontinuing this plan in conjunction with hiring Telegraph Hill Advisors to explore strategic options to maximize shareholder value. Telegraph Hill is a boutique investment bank with deal experience in the IoT space and other technology verticals. The firm has previously advised on sell-side transactions for sales of smaller companies to Apple, Intel and Oracle. Partners at the bank have significant deal experience, working at banks such as Bank of America, Morgan Stanley and Bear Stearns. 

Management has been prudent so far in allocating the capital generated from the offering, opting to stay very conservative and cautious about any investment in growth. The following quotes are excerpts from transcripts over the last 6 quarters which show management’s evolution in strategy over time. Based on these statements, it seems likely that the company may be exploring a sale of one or all of its segments. Management has stated they have considered a special dividend and a liquidation over the last 3 earnings calls. 

Transcript Excerpts:

4Q ‘21 to 2Q’22: Optimism About Growth: 

4Q ‘21: “The investments we make this year, we hope will establish multi-year customer relationships that can produce an annuity of revenue streams in future periods.”

1Q ‘22: “On the call last quarter, I said we’d be initiating the marketing of our connected device products, specifically device hardening and SquareOne. And that is what we’ve done.These initial efforts have allowed us to gather important data and to establish a baseline for decision making regarding future marketing spending.”

2Q ‘22: “Our new product offering, SquareOne, is central to our plans for organic growth. 

3Q ‘22 to 4Q’22: Failed Growth, Management Shift to Break-Even Optimization

3Q ‘22: “Adopting breakeven as a planning requirement will allow us to preserve cash for investing in organic growth as it is merited. It will also allow us to consider other opportunities for building value.”

3Q ‘22: “I reviewed our plans for investing in marketing Square One. Unfortunately, sales pipeline development has been slower than we modeled in our plan for 2022.”

3Q ‘22: “Earlier this year, we invested in strengthening our customer account management team. For reasons we've covered, these investments haven't yet paid off in top line revenue

4Q ‘22: “Our first initiative is to achieve breakeven operations. The first step towards this was the (headcount) reduction I discussed earlier. We also eliminated in our 2023 budget, any spending that wasn't generating revenue, or wasn't vital to our other initiatives. 

4Q ‘22: As a reminder, we announced a plan to repurchase up to $5 million worth of our common stock. The plan is intended to return value to our shareholders without compromising our ability to pursue organic growth or strategic alternatives.

1Q ‘23 to 2Q ‘23: Management Hires Investment Bank, Potentially Exploring Sale

1Q ‘23: 

“The Board and leadership team have been evaluating all options for creating shareholder value.

We could make a special dividend -- cash dividend to shareholders, but that decision, including the timing and the amount, is a function of the other options we're considering. What we are not going to do is to continue to dissipate cash to fund the status quo. None of us came here just to collect a paycheck.

Again, I don't have a specific timeline, but I expect it is more likely measured in months and quarters than in years. In the meantime, we will continue to operate the business as efficiently as possible like we did in the first quarter as evidenced by our $1 million improvement in loss from operations.”

2Q ‘23:

“During the Q1 2023 earnings call, I said that we were not going to continue the status quo, and that action would be taken in a timeline measured in months and quarters. As we shared in the earnings press release today, we have been working with Telegraph Hill Advisors, a San Francisco-based investment bank, to run a process to explore the full range of strategic options for generating shareholder value.

There isn't more information to share now, but rest assured, we are moving thoughtfully and as aggressively as the process allows. While the process is running, we opted not to renew the share repurchase program. We don't believe the current share price captures the full potential value of the company.”

Management Team / BOD Overview: 

There is a moderate amount of management team and BoD alignment with shareholders. CEO Derrickson has some experience leading companies to an acquisition; after leading healthcare startup Carena for 11 years through $37M of cumulative funding, he successfully facilitated a sale to telemedicine provider Avizia for an undisclosed amount. 

The Chairman of the Board, Ryan Vardeman of Palogic Value Management, owns ~0.8% of shares outstanding at an average price of $1.18. As of their most recent 13-F, his firm is the largest institutional shareholder owning ~ 8% of shares outstanding. They originally purchased shares in 2018 and have continued to incrementally add shares since. Given their cost basis of $2.89/share and the current share price, we can assume that it would be in their best interest to sell the company. 

Of note, in January 2022, the company replaced CFO Chris Wheaton with former controller Cheryl Wynne who has significant accounting experience including a long stint at Ernst & Young.

Richard Karp. Karp, a serial entrepreneur, originally purchased shares in 2019, selling them all during the run-up in 3Q21. He repurchased shares in early 2022 and currently owns ~ 7% of shares outstanding at an average price of $1.18. In October 2022, Karp leveraged his ownership to push management into a definitive agreement in which management agreed to declassify the board and nominate Karp as a director. Karp was voted in as a director in June 2023. It seems likely that Karp would hope to maximize shareholder value through a special dividend or sale to a strategic. 

Valuation 

In the event of a sale, Bsquare's existing two segments may be worth a small amount to a strategic acquirer. 

Partnership Solutions

Partnership Solutions is a slowly dying, 15% gross margin resale business with management stating they are hopeful to limit revenue erosion to 15% / year. The business currently has $23M of run-rate revenue. BSquare however is interestingly one of only five licensed Windows IoT distributors for the U.S. according to Microsoft. The other four distributors are Dell, Avnet Inc, Arrow Electronics, and Advantech Corp., all of which are significantly larger than BSquare and could be potentially interested in acquiring this segment.

If a strategic can get 5% operating margins out of this segment and hold revenue flat, they would add ~$1M in EBIT annually. Assuming they are willing to pay a 2-4x multiple for this EBIT, this segment could be worth $2-4M in a sale. 

Edge to Cloud

This segment is very small, generating only ~$3M of annual revenue. Gross margins have averaged 19.9% over the last 4 quarters. A potential bright-spot in a sale could be the SquareOne software, which management has invested $1.5M in developing and says has received customer interest from customers with potential revenue in the back half of 2023. As of now it seems that the SquareOne software is producing little to zero revenue. 

Liquidation Value

If the company were liquidated today, shareholders would receive in excess of $1.54 / share, representing a ~29.4% return. Any proceeds received from a sale of either or both segments would be incrementally positive. The company may also receive consideration in a sale process for $17.3M in NOL’s on the balance sheet.

 Catalysts:

• Special Dividend / Tender Offer

• Increasing Shareholder Engagement

  • On the 4Q’22 call an angry shareholder repeatedly badgers the CEO about winding down operations and returning cash to shareholders, or initiating a special dividend. 

• Sale of one or both segments

• Liquidation of the company

Risks:

• BSQR makes an acquisition – This seems to be the most significant risk to the thesis. Given that the company is considering strategic alternatives, there is the possibility that BSQR uses their cash balance to acquire another company. Management has mentioned inorganic growth possibilities and complementary acquisitions in prior earnings calls.

  • Given management’s track record in being hyper-focused on reducing expenses and managing cash-burn, it seems unlikely that they would do a large, splashy acquisition. Board chairman Ryan Vardeman owns 8.7% of the S/O, mostly through his investment fund Palogic but also through his personal investments. Richard Karp, the recently elected board member, owns another 6.7%. These two are the largest shareholders, and own a combined 15.4% of BSQR.

  • Even in the event of an acquisition, the downside risk is mitigated by the amount of net-cash on the balance sheet. 

• BSQR continues to burn cash and does not pursue a strategic alternative:

  • Given the recent hiring of Telegraph Hill Advisors, recent CEO comments about not continuing the status quo, and recent cost discipline and focus on break-even operations, this does not seem likely. The CEO is very clear that some development is coming in the next few months / quarters rather than years. 

• Significant Potential Dilution from Shelf Offering

  • Unlikely as management would have no incentive to issue more shares at current prices trading below NCAV / share. 

Catalyst

(Catalyst Section Included Above)