This is a very simple idea, a very small company and is perhaps the most pure “dollar for .50” I’ve seen in awhile. You will be able to know if you like it or not in about 15 minutes.
KDUS – Cadus Corp
By Shaun Noll, Stirling Capital Management
Cadus developed several proprietary technologies exploiting similarities between yeast and human genes to elucidate gene function and cell signaling pathways. In 1999 Cadus sold its business to OSI. The company retained ownership of some of its core technology and maintains a portfolio of patents based on its yeast technology (valued at $500k on balance sheet but I valued them at $0 to be conservative).
Until recently, the royalty stream and interest income has been more than expenses while the company has no debt. As a result, the company has been free cash flow positive until recently. KDUS has no employees other than one consultant who acts as the CEO and is paid $25k a year (essentially for accounting services), directors are paid $3k a year (why does Carl Icahn waste his time?!) and KDUS also leases some storage space for ~$12k a year. So this is a publicly traded shell company looking to do an acquisition.
Analysis and Valuation:
Current market cap is ~$19M while it has $24.06M in cash. KDUS also has ~$35M in R&D tax credits and NOLs from its previous years of losing money, and these expire in various amounts over the 2009-2027 time frame.
I estimate the liquidation value of the company at $24.3M by assigning $0 value to the $33M of tax assets, $0 in value to the publicly traded company shell and $0 to their patent portfolio. This gives the stock 22% upside in a liquidation scenario.
Discounting tax assets by 75% and patent portfolio by 50% while giving $0 value to the publicly traded shell creates a fair value of $33.3M, or ~76% upside.
|KDUS Valuation Analysis
|current market cap
|US net cash
|market cap discount to US net cash
|market cap discount to liquidation value
|total net cash PLUS fair value of NOLs and company shell
|market cap discount to net cash, st inv and fair value of NOLs
I know these are pretty weak catalysts but with a company with no operations trading at 25% discount to liquid cash I feel that this is acceptable.
Icahn owns ~40% while Moab Capital Partners own ~13%. I estimate Moab’s cost basis to be ~$1.75. Icahn bought in long ago (has been director at KDUS since 1993) and is likely deep under water. Note that both were increasing their position as recently as 2009 and while neither appears to be aggressively looking for deals, there have been a few deals proposed.
Commentary per Moab is that Icahn indicated he would be willing to exit at cash value and give up the tax and patent assets. While the stock has been “dead money” for a long time there are two factors now that will create new incentive for Icahn and Moab to be more active looking for a deal or liquidate the company.
- KDUS royalty revenue will expire 2010 while interest income on cash is extremely low right now. As a result, this will be the first year that the company will burn some cash (very small amount).
- At the same time the NOLs started expiring in 2009 so that value is evaporating as the company sits.
As long as the company was paying its own expenses there was little reason to be aggressive looking for deals but now that the company will be burning some cash and NOLs will start going away, this will create pressure to make a deal.
Also note that previously the company had cash locked up in the BAC fund and was having trouble redeeming that, creating incentive for the controlling shareholders to sit and wait. As of 12/31/09 shares in the fund have been redeemed giving them full liquidity.
Note the OSI license revenue ends as of 2010 and the purpose of the company is to make an acquisition. The 10k states that this acquisition could be in any industry so they are not limited to biotech. There is the risk that they could make a terrible acquisition.
Note that this works both ways, should they make a smart acquisition and apply some modest leverage, the company would likely began being valued based on earnings and the upside could be tremendous.
The most important risks in my view though are opportunity cost and liquidity.
Primary concern is this company simply sits for years. If I see no progress made over the next year I will simply cut the position depending on what other opportunities I see in the market.
The other risk is due to the laughable volume/liquidity of this stock, although this is also likely the reason for the valuation discrepancy. Simply keeping position size small will be an effective way to deal with this and this is obviously not for an institution.
The two largest risks are manageable and with no operations and 25% discount to cash value the downside risk is limited. With 2 large and smart activist shareholders who have majority control involved I’m betting they won’t let the company sit forever and that something intelligent gets done with the $24M given the distressed environment for small companies and the fact that this will be the first year company value will decrease if shareholders do nothing.
If I’m wrong though they could always liquidate and payout the company’s cash creating a 25% return 🙂
More from Shaun: A look at Cano Petroleum (CFW), an “absurdly cheap” energy stock.