October 14, 2001 - 4:09pm EST by
2001 2002
Price: 4.60 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 65 P/FCF
Net Debt (in $M): 0 EBIT 0 0

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CNS, Inc., is a consumer products company selling for less than half of its value as an acquisition. There is good reason to believe that it will be sold within a year or so. In addition, it has a cash heavy, debt-free balance sheet, and sells at less than ten times the coming year’s estimated earnings, thus providing some nice upside potential while awaiting a takeover.

PRODUCT: CNXS’s primary product is an odd one, the Breathe Right Nasal Strip (“BRNS”), that Band-Aid looking thing seen on the noses of many football players. It is a strip of plastic or fabric which sticks to the nostrils and pulls them out and open. To get an idea of its effect, first breathe through your nose, then try it again using your fingers to lift your nostrils away from your face. You’ll probably notice a big difference in air intake.

The BRNS line is one of the best selling products in the cough/cold product category in the US, and it has recently been reintroduced abroad after a several year hiatus. Each BRNS strip can only be used once. It is primarily sold in boxes of 12 and 30, and the retail price works out to about a half buck or so per strip. In addition to the original tan colored strips, there are clear plastic ones, tan ones impregnated with Vicks Vap-o-Rub, and a line of kids strips with Vicks, or with decorative designs. The adult strips come in two sizes to handle most nose sizes.

While a good source of publicity, the football player market is minuscule, and athletic use in the aggregate is probably not more than 10% of sales. The primary buyers are people who use BRNS while sleeping, either because they have a cold, or to prevent snoring, or because they have a deviated septum or other physical abnormality that prevents a comfortable night’s sleep. Nasal sprays and decongestant pills can accomplish some of the same goals, but they can have unwanted side effects, especially the sprays, while BRNS, other than the benign Vicks version, is drug free.

Many people find that BRNS has a dramatic effect on their ability to sleep, and use one nearly every night. This group of highly loyal users (one might even consider them addicts) represents a major part of BRNS sales. It makes BRNS relatively unique as a consumer package goods product, in that addicts do not require much, or possibly any, advertising to get them to keep buying the product.

Although many people, because of the shape of their nose or other reasons, won’t use the product, the market is still relatively untapped. Even if loyal users (I’ll define them as those using 300+ strips per year) accounted for 100% of BRNS sales, that still comes to well under 1 million people, a tiny percent of people who snore, have colds, or other difficulties where BRNS might help considerably.

Only some poorly designed private label nasal strips, that can’t use CNXS’s patents, stand in the way of CNXS having 100% market share of the nasal strip category, and those competitors account for well under 10% of the market.

Contrast that position with a typical brand of soap, deodorant, shampoo, hand cream, or toothpaste, where the markets are saturated, the competitive products are similar, and the consumer is fickle, requiring constant heavy advertising for a competitor to maintain market share. While CNXS has in fact been advertising very heavily (excessively so, IMO) in the last few years in order to build up its base of loyal users, were it to stop all advertising completely, sales would hold quite stable, and profits would explode.

In other words, much of the red ink in the last few years was, in a sense, voluntary, with current profits being sacrificed by heavy advertising in order to grow the brand. As a result, the BRNS line has finally grown enough that, despite continued heavy advertising, the company is turning nicely profitable. With 65% gross margins and a loyal customer base that mostly doesn’t need reminder advertising, CNXS could show massive earnings any time it wants to, once it is willing to start milking the brand rather than grow it.

VALUE AS AN INDEPENDENT COMPANY: Numbers for Q3 2001 will be out October 18. CNXS recently announced that EPS would be in the $0.32-.37 range untaxed on close to $19MM in sales, up from the $0.25-.30 projection for Q3 made when Q2 numbers were released. (CNXS has no analyst coverage, so therefore no consensus.) Given the sales weakness for the quarter reported by retailer CVS and other customers and companies in the health and beauty products area, this suggests that the loyal user base has grown nicely, allowing CNXS to buck the trend.

Note that Q3’s earnings are often the highest, even though BRNS sales are much stronger during the winter cold season, because there is minimal advertising over the summer. CNXS’s advertising is always a short term loser, although if it creates enough loyal users, it will pay over the long run.

Just looking at the near term financials, CNXS is cheap. Company guidance for next year, made with the Q2 earnings release and now looking conservative in view of recent trends, is for sales of $90-100MM and operating profits of $9-12MM, which works out to diluted EPS in the range of about $0.67-.87 untaxed, or $0.44-.57 as if taxed. With over $20MM in cash, no debt, and negligible capital needs, its EV of $45MM is modest at about one half sales.

Given the untapped growth potential, both in the US and overseas, a P/E of 15 times next year’s taxed EPS could have the stock in the $6.60-8.60 range, an adequate enough return, if nothing else happens. If the stock continues to lag, the company, which has reduced its shares outstanding from 19MM to 14MM in the last few years, could keep buying back stock.

VALUE AS AN ACQUISITION: CNXS should not exist as an independent company. It is nothing more than one major brand (BRNS) and one minor brand (FiberChoice fiber supplement), disguised as a company. If another health and beauty products company (think P&G as an example) were to acquire CNXS, the buyer could eliminate all of CNXS’s executives, its marketing staff, and the R&D people. The buyer could lower the advertising expense per ad because of superior purchasing power, and push the product into other channels, such as convenience stores, where CNXS’s marketing is weak.

The BRNS brand calls for a brand manager, not a complete company. Cost reduction that could be achieved by an industry buyer would probably be on the order of $8MM per year, and sales could be an extra $10MM per year higher, adding another $6.5MM to gross margin. So whatever CNXS is worth as a going concern, its EBITDA, were it part of another company, would be substantially higher. The logic of CNXS being bought out is compelling.

Fortunately for our analysis, branded package goods lines change hands often enough for one to get a sense of value. Negotiations normally take place in terms of price to sales, since the buyer, integrating the brands into its own organization, might have a considerably different cost structure than the seller. The most recent transaction, announced last week, is Smucker (SJM) buying Jif and Crisco from P&G at 1.7 times sales.

I’ve kept track of other transactions in the last few years, and they tend to go for between 1.5 and 2.5 times sales. (My guess is that the SJM/PG transaction was at the low end because this will double SJM’s size, implying SJM will need a lot more staff to handle it, and can’t cut costs as much as a larger buyer might.) Brands with a high gross margin and low continuing need for advertising, like BRNS, are potentially much more profitable and therefore tend to trade on the high end. Even some weak brands in competitive areas can fetch some surprisingly high prices to the right buyer, such as the sale a year ago of the declining BAN deodorant brand for 2 times sales.

At a lowly 1.5 times sales, CNXS would be worth about $10 per share, adding in its cash and receivables, subtracting all liabilities, and assuming all stock options get exercised. At 2 times sales, it comes to $13. I’ll take either.

Will CNXS be sold, or will management cling to its jobs at the expense of shareholders? One never knows. The fact that management has a lot of stock and options, but not so much as to fend off an unfriendly raid, suggests it will do the right thing.

I sense that management has been awaiting substantial and sustainable black ink before putting the company up for sale, to strengthen its stock price and negotiating position first. With the strong Q3 numbers, the clock is starting to tick.

ADDITIONAL INFO: Topics I can discuss in follow up notes if anyone cares, rather than further lengthen this post, include: Why did sales plummet so much between 1996-99? Why the weird swings in quarterly numbers in recent years? What about international markets? Do CNXS’s minor products (FiberChoice and Flair) have any value or potential? How strong and/or important is the patent protection for BRNS? What can go wrong?


1. Strong chance of CNXS being acquired by another consumer products company, with a value, based on comparable transactions and the huge consolidation savings available to the buyer, of more than $10.

2. P/E of under ten on rapidly growing earnings, from a company with about $1.50 per share of cash, no debt, and minimal capital spending needs.
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