Sphere 3D (ANY.N): Where good money turns bad, but execs cover their asses

I talked to Peter Bookman back in late 2014 because I wanted to get the story behind a rather puzzling announcement made by Sphere 3D (ANY.NASDAQ) regarding its acquisition of 34-year data storage veteran outfit named Overland.

Sphere 3D is all about virtualization. You know, the stuff Citrix has been working on for years. In fact, as a technology, virtualization has been around since the 60s. By 2014, the market was already mature with VMWare, Microsoft, Oracle, Red Hat, Amazon, et al., all vying for the opportunity to take your computing needs into the cloud.

This fact didn’t appear to phase anybody at Sphere 3D however, and the company went into full-on M&A mode to reach its goals, as evidenced by the company’s acquisition of V3 Systems earlier that year.

V3 Systems, a privately-held start-up helmed by the same Peter Bookman I was talking to, was a self-proclaimed leader in providing VDI architecture, software and hybrid Desktop-as-a-Service (DaaS) solutions. This buy seemed in line with the company’s objectives as it upgraded the company’s flagship Glassware 2.0 virtualization suite with V3’s Desktop Cloud Orchestrator.

I like to root for the underdog and in this vein, Sphere 3D was about as underdog as you can get. A hopelessly small company with little customer base and market penetration, and beta-stage software solutions. Because nothing had happened yet, the world was still their oyster and Sphere 3D’s executive dreamed big. All investors could do was hold on and hope.

But that Overland deal…

confused

It wasn’t that the Overland acquisition was completely out of character for Sphere 3D, it just seemed like a giant step in the wrong direction.

First off, the company had chosen to focus on small to medium-sized businesses to stay under VMWare’s radar. I understood the approach, but small to medium-sized businesses don’t necessarily require a lot of virtualization support, so I didn’t see a massive amount of potential unless the company could differentiate itself more with a unique offering. So, I’m guessing in an effort to set themselves apart, the company decided to get into storage and provide on-site cloud solutions.

This was already smelling bad. If small to medium-sized businesses don’t need a lot of virtualization support, why would they want to add the complication and maintenance of on-site back-up and storage? Even the phrase ‘on-site cloud’ is problematic… isn’t an on-site cloud just a local server?

Let’s throw that to the side for a moment and consider the acquisition of Overland. When Sphere 3D stepped in to snap up Overland, it was already an industry dinosaur well on the way to becoming a vestigial organ.

Yes, Overland had 34 years in the industry as a tape storage provider and had 17,000 channel partners who had purchased in the 24 months before the acquisition, but who were those partners and just how much did they purchase? Were they buying new installations or just maintaining until a more modern solution could be found?

Again – this was a company that specialized in ‘tape storage’ systems. Because I guess dot matrix printers were too modern.

tape

Combine this ambiguity with the fact that Overland hadn’t made a profit in the five years previous to its acquisition by Sphere 3D and you’re left to ask, what was behind this seemingly lunatic buy that many critics at the time felt Sphere 3D’s management was too incompetent to run, never mind turn around?

That’s where it gets interesting.

There was a connection between the companies. Eric Kelly, then Overland CEO, was also Chairman of Sphere 3D. If one was conspiratorial and cynical, it might be easy to construe that Kelly had pressed Sphere 3D to bail out Overland with the purchase for no other reason but to save his own skin.

Maybe that wasn’t it. Maybe tape storage was just the next big thing none of us had ever cottoned on to yet. But probably not.

Call me crazy, but I’m not alone in suspecting rottenness. Sphere 3D had already been publicly called into question for its operations by Melissa Davis, a writer working for StreetSweeper.org, who went after the company with a vengeance, claiming Sphere 3D was overvalued due to stock manipulation and that its product line was nothing more than vaporware. She even went as far as travelling to the company’s Ontario headquarters to find that there was no one but a receptionist present during working hours to answer her questions, or to give her a tour of the office. She immediately told her readers to “deep six” their holdings in Sphere. Anyone who did owes her many beers.

Admittedly, StreetSweeper.org carried a short position in the company, but why wouldn’t you?

When I asked Peter about the Overland transaction, he explained, “Technologically, they are in a class of their own at a cost per gigabyte with enterprise features – there’s nobody there. They can offer comparable features to the most expensive enterprise products on the planet at a price per gigabyte that is lower than anybody else.”

Sure. Maybe that’s why they don’t turn a profit. I could sell gold bars for $13 per, and nobody would beat me on that price, but I’d also be a raving loon to do so.

I ended up giving Sphere 3D the benefit of the doubt, because both Midas Letter and SeekingAlpha.com had featured decidedly positive views of the company. In fact, equity research firm, Jacob Securities, had taken a BUY position with a $16 target price.

That was a little over a year ago. Where is Sphere 3D now? Did they slay Goliath and insert themselves as an integral provider in the virtualization and storage space?

nopenope

Net loss for the third quarter of 2016 was $43.3 million, or a net loss of $0.84 per share, compared to a net loss of $10.2 million, or a net loss of $0.26 per share, in the third quarter of 2015.

All this while net revenues remained relatively the same from Q3 2015.

How do you lose that much money when you have an empty office and a bored receptionist to pay for?

It’s vulture time. Sphere released a statement just over a week ago stating it had received its second unsolicited offer for certain company assets. This proposal followed another from a different third-party as previously announced by the company. The circling has commenced.

One of the company’s largest shareholders, Cyrus Capital Partners, has reached out and spanked the company with a highly critical letter calling for a complete restructuring for the company to fix “cost” and “underperformance” issues. Cyrus went on to state the company’s latest net-loss is typical of its performance and needs to change.

In a letter to the SEC, Cyrus stated, “Recently, we have become frustrated with numerous aspects of Sphere management’s ability to address the Company’s operating and costs structures as well as its ability to grow its revenue. This has led to significant financial hardships that, in our view, have endangered the Company’s long-term viability.”

Cyrus wants Sphere to grow up and separate its business segments instead of trying to boil the ocean with its overly diverse offerings. Cyrus also wants some of its debt back in equity as it shakes up a management team it feels has dropped the ball. All of this will guarantee further financing to keep the company afloat while Cyrus plugs the multitude of holes in Sphere 3D.

“Cyrus believes that the businesses of Sphere are currently significantly underperforming their potential and that a restructuring of the Company on the basis outlined in this letter would allow Sphere to reach its full potential substantially increasing and maximizing shareholder and stakeholder value. We look forward to working constructively with the Board and management team in the near future.”

Sphere 3D’s comeuppance is well-deserved. I may not have doubted Peter’s passion, but I doubted the focus and the vision of Sphere, and it seems those doubts were well-founded. Cyrus’ move at this point is damage control and since they are already lenders to the company, both their shares and their loans to Sphere 3D are at risk.

Will they be able to pull it off and bring Sphere 3D around to profitability? I gave them the benefit of the doubt once, I’m not so optimistic this time. As always, do your own due diligence before making any investment decision.

Like Kelly should have done.

–Gaalen Engen

http://twitter.com/gaalenengen

FULL DISCLOSURE: Sphere 3D is NOT a client of EQUITY.GURU, but if they want to tell their side of the story, I’d be more than willing to give them the opportunity. Maybe we can send them over a Dictaphone, which is apparently the next big thing in tech.

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