Tuesday, January 29, 2008

Danger-ous IPO?

Deutsche and UBS investment banks have teamed up again to bring a small initial common stock offering to the market - Danger, Inc. (proposed symbol on the Nasdaq is DNGR). Danger provides software solutions to mobile communications operators for mobile data and Internet services.

Intuitively that seems like a good growth market since our cell phones and PDAs now offer fairly robust computing capacity in the palm of your hand - or hip-side. We all know how frustrating it can be to get the various functions to work on the cell phone or PDA let alone achieving compatibility with desktop and laptop programs. Danger has grown revenue to $56.4 million in the twelve months ending September 2007 from $49.3 million in the prior period.

Danger is not the first to see the opportunity. The Open Handset Alliance, which was just formed in later 2007 mostly by telecom operators with a vested interest in developing open source software platforms. Many of these telecoms have already started developing in-house solutions for their own mobile devices.

There are also incumbents such as Research in Motion (RIMM: Nasdaq) with its BlackBerry series of smart-phones, Palm’s Treo (PALM: Nasdaq), and Apple’s iPhone (AAPL: Nasdaq). Handset manufacturers like Motorola (MOT: NYSE) and Samsung Electronics (SSNLF: OTC/PK) - both of which have smart-phones - as well as LG Electronics have the capacity to offer competing solutions. More importantly, these handset manufacturers have the relationships and experience with the large mobile operators to deliver a tailor-made solution. We note that Motorola has been a supporter of Danger and currently has an 11% stake in the company.

Danger set itself apart by offering its solution as software-as-a-service rather than the conventional box and license arrangement. This is a huge plus for Danger in offering a cost-effective solution to mobile operators and even more important for Danger’s profit margins. The company has managed to get its foot in several doors at T-Mobile - USA, UK, German and Austria. T-Mobile Venture Fund based in Germany also has a 13% stake in Danger.

As helpful as the T-Mobile relationship has been, it is also a point of vulnerability, since T-Mobile accounts for nearly 90% of Danger’s revenue. Danger is in place at Rogers Communications and Telstra, neither of which have significant subscriber bases. It is after all the subscriber base that is a key to Danger’s success, since revenue is driven by recurring monthly service fees for each subscriber that accesses Danger’s Service Delivery Engine (SDE).

Intimidating competition and customer concentration are not the only concerns for investors. Danger has yet to make a dime! The net loss on $56.4 million in the 9/07 TTM was a breathtaking $28.1 million. Danger is still spending heavily on research and development - 40% of sales in the 9/07 TTM.

So, like with most early stage companies that also fall into the small-cap category, it all comes down to leadership. Investors looking at this IPO must answer a couple fundamental questions:

1) Does this management team have the vision to see where consumer preferences are going and channel R&D resources in that direction?
2) Do senior officers and directors have the ability to execute on a challenging competitive strategy?

Sitting in the CEO and Chairman seats is Henry “Hank” Northhaft, formerly of Endforce, Inc., an internet protocol services software company. Sounds like a man who might know what he is doing. Northhaft had a short tenure at Endforce - May 2001 to April 2002. Prior to that Northhaft was at the helm of XO Holdings (XOHO: OTC/BB), a telecom services provider that was formed in June 2000 from the merger of Northhaft’s Concentric Network Corp. and NextLink Communications. Although cash flows from operations are positive, XO has yet to report positive net income and reported its deepest losses the year Northhaft jumped ship.

Joe Britt, one of Danger’s co-founders, is now chief technology officer and a director. He has a lengthy track record as a software engineer and was with WebTV Networks, an internet device and services operations bought out by Microsoft in 1997.

One of Britt’s colleagues at WebTV Networks, Rocky Pimental, is also on the Danger board of directors. Pimental is currently CFO at GLU Mobile (GLUU: Nasdaq), a mobile gaming developer. Before Pimental started keeping the books at WebTV Networks, he was a partner at Redpoint Ventures, a California-based venture capital firm. It is not surprising then that Redpoint Ventures has a 15% stake in Danger and a board representative, Jeff Brody.

Brody is not the only venture capitalist on Danger’s board of directors. There is also Gregory Gallanos from Mobius Venture Capital (18% stake in Danger) and Eric Hippeau of SoftBank Capital Partners (13% stake in Danger). The only independent director with real-world experience in the communications industry is Richard Gilbert of Kineto Wireless (private).

On paper Danger appears to have a great pedigree and clearly the board members have the connections to keep the capital flowing. However, the IPO looks a bit precarious with a board dominated by venture capitalists - people who are probably more adept at calculating their own near-term returns than making the tough choices for profitability.

Neither the author of the Small Cap Copy web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein.

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