Housekeeping: Here is a column Fabrice wrote in The Globe and Mail about Gold Standard Venture, a junior gold play with some impressive shareholders. Fabrice doesn't have the time to cover it in the newsletter but we own a few shares as part of my policy to always have some exposure to gold.

We spoke to Michael Dalsin on Monday Feb. 29 and are much more comfortable owning both Convalo (CXV) and Inspira (LND).

During our hour-long talk, we discussed the communication blunders surrounding both companies and the underlying businesses.

Here are the important notes:

Mr. Dalsin and Roger Green left the Convalo board to “unbuckle” the name from the disaster that is PHM. Mr. Dalsin said shareholders criticized the corporate governance at Convalo and that this was the board’s response. The pair remain deemed insiders and, therefore, any purchases or sales of stock must be reported.

Mr. Dalsin said that he had purchased a large amount of Convalo shares and is committed to the business, which he seems very bullish about.

The company is suing the former owners of a company it acquired for misrepresentation. They claimed to have a more expansive license than they actually had, which resulted in a small amount of lost revenue. The proper license has been acquired so the lost revenue should be recaptured.

Mr. Dalsin said Convalo discovered emails exchanged by the principals discussing the fraud and feels it will be an open and shut case. He is confident that the principals, all of whom have been fired, will be forced to return half the cash ($3 million US) and that the shares will be cancelled. This assumes they have the money, but the shares were escrowed so they haven’t been sold and can be cancelled by court order. That’s 12 million shares, so it’s not insignificant to EPS. All in all, this appears like a minor problem. As for how it happened, Mr. Dalsin explained that during due diligence they were only able to verify the existence of a license. The state is not allowed to disclose the scope of the license.

Convalo’s revenue run rate is currently about $30 million. The company has three active pods (with a pod consisting of a detox centre with 12-18 beds, a roughly 70-seat out-patient facility and a lab). It will, by year end, have eight active pods (plus a referral office in San Francisco) and therefore revenues should grow substantially. They should, if it all works out, multiply.

The business generates, according to Mr. Dalsin, 30% operating margins (which excludes corporate overhead, so meaning at the pod level), so this is an attractive business. A pod costs about $1 million US to set up.

This obviously raises the question of competition. If someone can invest $1 million and earn more than that per year, everyone will be doing it. And there is certainly competition. Mr. Dalsin explained, however, that the competition tends to be small operators who tend to produce 20% margins, and have limited access to capital. There are some bigger players, however, and the hope is that Convalo becomes one. These are being bought at 3-4 times revenues, so if Convalo executes properly there is the potential for significant upside.

With cash of 10 cents a share and limited cash burn, this still looks like a very interesting speculation.

The same holds for Inspira, which is behaving much better stock-wise recently. It also has significant cash resources and isn’t burning much of it.

The loan book is currently about $70 million US and breaks down into two categories: Small loans in the $1 million range that are extended to doctors to fund working capital in an era of lower and slower reimbursement. This business works well and is generating cash with net margins in the 10-11% range. The other category is larger loans of about $5 million. These loans produce set-up fees of $50,000, but the business isn’t working as well because those who get them usually then turn around and use their acceptance to get a better deal from a bigger institutional lender like a bank, at a lower rate. In other words, they’re happy to pay the $50,000 fee as a cost to get a bigger and cheaper loan from someone else

This clearly doesn’t help Inspira so the company will wind this down and sell what it has on the books to concentrate on the smaller loans, which are very well collateralized by highly rated receivables. The company is also exploring the idea of building up a $25 million loan book then selling that to a fund (hedge, pension or anyone looking for decent yield) and using the sale proceeds to start over again. Rinse and repeat. The compay would continue to earn modest fees for servicing the loan, similar to the way banks originate and service mortgages but sell the loans to other investors.

If this works out, Inspira would be a very high-ROE company with tremendous cash generation and earnings.

At the current price, it also looks like an attractive speculation. Mr. Dalsin also said he bought Inspira stock recently.

He also said that Convalo and Inspira management would start marketing the companies to investors fairly soon, getting the story out. Mr. Dalsin will not be part of these road trips as the companies want to put a fresh face forward.

All in all, it was a positive update and we think, barring any more shocks, that the stocks should improve. They are still in the doghouse but there are real businesses underlying them, and the market can't ignore financial performance forever.