I have written a few pieces with CONSTRUCTIVE criticisms of Kinesis. In my last one, I had a laundry list of some things I was hoping they would address. 90% of them, they have within the last two weeks, and I wanted to follow up to my criticisms and speak to how they have addressed each item. In this piece, standalone, I wanted to talk about the “going concern” issue I had, particularly with KAG/KAU investments, and how an investor would get that metal back in the unlikely event that Kinesis would close its doors years down the road.

I think I need to explain my going concern risk I brought up better for a lot of you to completely understand where I was coming from.

Risk

First, we need to address a concept I do a lot in my day job – risk management. I don’t talk about my job here, but I will give this sliver as part of a cyber job. You need to be able to understand risk. With risk you have events that can happen. You need to list possible events, and then choose to “accept, avoid, transfer, or mitigate”. I can avoid an earthquake by not living in California. I can mitigate the loss of fire to my home by having smoke detectors and fire extinguishers. I can just accept the risk of home ownership on a brand new home which exposes me to downside but buying a 150 year old home has risks of things breaking. I can insure my house against fire to transfer the risk.

Choosing your investment

Now, when you invest, you are investing in companies in different stages. Some have been around for 100+ years. Some started up the last 10. Some change their product lines. Some are in deep contraction industries. Yet others are startup and have no product yet. The INVESTOR needs to do their research to understand what they want to invest in, and what they have an appetite for with risk. Most tell people to hire a financial advisor who can walk them through this stuff. Others like myself educated ourselves with many years of schooling to be able to understand all aspects of this.

Case study 1: Junior Miners

I invest in a lot of junior miners, from those who are standing over a hole in the ground to those who are junior producers. They start off as SUPER high risk, as they have no gold and don’t know where it is. A BROWN FIELD explorer is going where gold has already been found, so they are less risky than a green field explorer. As they get a discovery, there’s less risk. They then drill the shit out of stuff for years to define the ore body and get a full account of what they own. They dilute shareholders during this process, but they also increase the value of the minerals underground. Dilution that can bring value is ok. Dilution that simply is a cry for more money is….a warning sign. Now we further de-risk the project by doing things like a PFS, PEA, and FS. These items try and tell you what the expected return would be, if the project is greenlit. Each step this goes further, investors are piling in as they show more confidence the project will become a mine. These companies, for the better part of 10 years or more may have ZERO OPERATING INCOME. They have to raise money and dilute share holders, borrow money with bonds, and perhaps sell royalties. By the time they DO take metal out of the ground, they may have hundreds of millions of shares, dozens of millions in debt, and have royalties taking off the top. I invest HEAVILY in companies like this – that may have NO OPERATING income for a decade or more. The upside on these from early on can be tremendous – Great Bear went something like 54x in 2 years. In the 1960s, the average junior silver miner went like 150x if I quoted Doug Casey correctly. That being said, one out of 3,000 mining projects become a mine, so you need to pick the right projects, with the right teams, in the right jurisdictions. The bet is that the projects you are picking are the thoroughbreds and can get perhaps a 5-10x. Those with 50x potential attract those like me AFTER an initial discovery.

A “junior miner” has going concern because they are burning through cash with little to no operating income. As these monies deplete, you may see another round of financing for another drill season which adds millions of more shares, dilutes the company, but through the drill, adds ounces in the ground.

I am VERY comfortable with this type of investing. You may not be.

Case study 2: Tech startups

I am investor in IONQ. They make quantum computers. I feel that combined with AI, that this also has tremendous potential in fields like battery chemistry. Finding the right chemistry with elements and compounds in the right conditions to make the best battery we can. There’s a million other applications for this, but this is an extension of my interest in minerals and battery metals. IONQ has half a billion or so in cash from startup capital, and they have a burn rate the last I saw of $9m a month. To me, they look like they can fund operations for 5 or so years with no operating income. Contracts have started up, and they are still severely underwater each month, but the tech is there. The right team is there – who invented a lot of this – AND they have the right backers with all of the right names. As time has gone on, the computing tech has gotten better, and operating revenues have started. The bet: within a few years operating revenue will be able to self sustain the company and further breakthroughs can make this a $50b company, giving investors perhaps a 100x on their return inside of a decade. This is sort of the same priciple that Amazon.com had – I believe it went like 10+ years underwater before it became profitable.

Kinesis going concern

I had voiced this as a legitimate risk as an investor. This is similar to the two items above. It was a startup that brought in a lot of money – between $60m and $197m depending on the sources. It could have been $60m immediately and another $130m over 1-2 years – I’m not splitting hairs. The point is, this company had a startup where they got working capital. Their business model involved paying yield on holding gold as well as using KAG/KAU as money – where you could spend your gold or silver. The KVT was a way to get paid in gold for usage in the system and was responsible for startup capital.

With this model, they needed to build out a team, infrastructure, and start to find projects that would then contribute to the fee pool. At day 1 in 2018, it was like a miner standing over a hole in the ground – super high risk. As time has gone on, and the team has matured, processes have improved, and revenues started coming in for the fees, this has further de-risked it for me.

Let’s review a model here again…because some on Twitter appear confused.

Operations are funded by:

  1. Initial startup capital
  2. Fees coming in, as a percent of total fees. CI wrote something where he conflated $50m in revenue with $21m in the master fee pool. He did not account for a portion of that revenue being cleaved off for operations.

Yields are funded by:

  1. Fees collected, as a percent of the revenue from fees.

In no way in this model are yields funded by KVT startup/sales capital.

Meaning…

If there are ZERO fees for the month, operations continue by a “cash burn” from the initial startup pool (sale of KVTs). We also do not know how much Tom Coughlin could have invested of his own money into this. It is common with companies in your accounting text books for day 1, hour 1, the first accounting ledger item could be a deposit from the sole proprietor to invest in his or her company. It could have come from personal funds, borrowing from a bank with a business plan, or raising capital through joint ventures.

MY concern was….

  1. I don’t know what pool of cash remains from the KVT. I don’t know the cash burn rate monthly. Is there going concern of Kinesis folding in the next year?
  2. IF Kinesis were to fold, how could I get my metals?

With respect to the first item, Kinesis is not a publicly traded company like the mining companies I invest in. So I could not look up a 10-k to get the financial information. With this, I had to make MY BEST GUESS as an investor to try and understand what capital they started with and then guess cash burn rate. I am comfortable with MY ANALYSIS they are good for another 5 years or so, just based on initial capital, approximate employee count, approximate rents, approximate continued revenue with KVT sales, approximate income from the Minting, and approximate $100k per year to store the metals.

Secret sauce

Here’s the problem that many have, that I do not. Many want the line by line accounting. They want to know how many people. Part of my day job is also Business Development – so I have been able in the past to guess somewhat accurately of how many people a job would take, along with the approximate costs per person and work entailed. This is part of the “Work Breakdown statement” in the PMP world I live. This is why I am comfortable making these financial commitments and YOU need to speak to a financial advisor. I used my best judgement for ME (not financial advice for you) to make a best guess on where we are.

What I have found over the last few weeks is that there are entities gunning for Kinesis. I don’t know why, but Kinesis is in a new field that threatens a lot of existing businesses – particularly a vaulting model that you have to pay to store. If Kinesis not only allows you to store your metal at no cost, but pays you a small yield to hold it with them, this provides incentive for enemies to go to great lengths to undermine their success.

That being said, it is SMART for Kinesis to keep a lot of cards they have close to the vest at the moment. They do not need to tell you or their competitors their amount they have in the piggy bank or their cash burn rate, because all their competitors would do would harp on this going concern non-stop, all day, every day. Going concern is a risk to the Kinesis exchange operating, but tellnig you how many employees they have, what strategic plans that have – may actually be attacked by their competitors. A few weeks ago, I was naive to this. Now, I have seen this play out in real time and these people will say or do anything to get attention and try to make them look bad.

Going concern versus KAG/KAU

My big argument I then had was, “IF Kinesis closed its doors tomorrow, how would I get the metals?” This was my biggest risk I had before I unleashed the hounds with buying KAG/KAU – a LOT. I am a KVT holder, and I know the going concern risk was there, and if Kinesis Exchange folded down the road, my KVT could go to zero. That is the same risk I have with betting on junior miners, but as junior miners de-risk, I add more to my positions.

What Kinesis has done since my initial blog a few weeks back was that they are going to, in DETAIL, document out the exact process how you can get your metals in the unlikely event the Exchange were to close its doors. Meaning, there is a system setup where the metals are not held on the Kinesis balance sheet – the KAU/KAG is title to the metal. They are funding a bailee agreement (I hope I got the wording correct) for 12 months so that if there was an issue, you would then have a process to contact an entity and pull your metals out.

What Bob brought up, which is fair, is assume that you own 103.4567 KAG. The agreement states that minimum of 200oz can be withdrawn and if kinesis only holds 100oz, 1KG, and 1,000 oz bars, how does one get the 103.4567 KAG. This answer wasn’t provided, and my hope is that they read this so they can clearly define it in the detailed process.

What my SUGGESTION would be is IF Kinesis were to close its doors, the bailee is instructed to pay out to the user the KAG they have in 100 oz denominations. If you own 103.4567, you would get a 100oz bar and the market price cash check for 3.4567 oz mailed to you, since Bob and everyone listened realize you cannot give someone 3.4567 oz out. So the PROCESS needs to be built out, cleanly.

That being said, is this is the growing pains of a startup, and not the failure of an unethical business.

Moving forward

In my blog post I refer to above, I see Kinesis as an explorer who paved the way, and now may need experienced mine builders to come in to navigate some of the waters ahead with processes, procedures, quality control, and project management. This will be my next blog sometime next week, but in this I wanted to address a misunderstanding of “going concern” that people had, and how Tom’s answers, to me, helped de-risk my KAG committment I’m now about to do every month. I’m awaiting the publishing of the process, but management has understood they need this process clear to show that even if the doors close tomorrow, the metals value (or equivalent on non-100 oz denominations) are safe. KVTs are still risky based on going concern, but the KAG/KAU has been further de-risked for me.

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