|Shares Out. (in M):||10||P/E||N/A||N/A|
|Market Cap (in M):||16||P/FCF||N/A||N/A|
|Net Debt (in M):||0||EBIT||-1||-1|
Cosine (COSN.PK) is an opportunity to buy a "50 cent dollar" as the stock can be purchased for less than cash value. Plus, the net operating losses (NOLs), which we conservatively calculate are worth about 2x the market cap, are free. We believe the intrinsic value of Cosine is approximately $4.23 - $6.18 per share compared to the share price of $1.52 at May 11, 2009. We believe Cosine has limited downside and offers an opportunity to invest alongside an activist investment firm.
Stock price: $1.52
Basic shares outstanding: 10.1 M
Options outstanding: 161 K
Market value: $15.6 M
Cash: $23.0 M
Key points to our thesis are:
Cosine, founded in 1998 as a carrier network equipment provider, has undergone a complete overhaul in the last several years. The network equipment business has been shut down, and investors have taken control. Landmark events in the evolution of the company are:
Valuation of NOLs
Cosine has taken two very important steps that give us confidence that the NOLs are being protected and are worth something. First, Cosine (actually it was Steel Partners) hired NOL specialists to conduct in-depth impairment tests. For those unfamiliar with NOLs, on a very high level, the impairment test looks at the cumulative change in ownership for 5% or greater shareholders over a three-year rolling period. If the cumulative change of ownership for these shareholders exceeds 50%, there has been a "change of control" and the NOLs are impaired (see IRS Section 382 for more details on testing parameters). The result of the Cosine test showed that a maximum of $3 M of the federal NOLs had been impaired, $350 M are unimpaired. Furthermore, these NOL's don't start to expire until 2018 and don't completely expire until several years thereafter.
Second, in September 2005 Cosine passed a shareholder-approved stock trading restriction to limit shareholders from buying more than 5% of the outstanding shares. To read the details of the plan, see the 8-k filed on September 8, 2005. The 5% cap limits an investment to just over $1 M.
Note: What does impairment mean? Simply stated, impairment limits the amount of NOLs that can be used in a given year to a federally mandated percent (close to 5%) of the equity value (market value minus cash) at time of impairment. If Cosine's NOLs were impaired, they would be virtually worthless.
To value the federal NOLs we multiply the unimpaired NOLs by the federal corporate tax rate (35%).
$350 M x 35% = $119 M
We assume acquisitions will be made in the future, otherwise there would be no income to shield from taxes, and therefore no NOL value. We then discount the $119 M (12% discount rate) and assume a slow increase in taxable income over the life of the NOLs. Depending on how fast we assume taxable income increases, the present value could be anywhere from $10 M - $50 M (of course, the faster the NOLs are used, the higher the value). Our assumptions give us a present value of $20-40 M.
There are also $225 M of state-specific NOLs. But due to their limited duration (10 years vs. 20 years for federal) and the various state tax rates, we have chosen not to include the state NOLs in the valuation. Additionally, there are $7.1 M in federal tax credit carryforwards and $79 M in federal capital loss carryforwards. Suffice it to say, these should be worth more than $0 but we have assumed nothing in our intrinsic value calculation.
Cash $2.27 per share
NOLs @ $20M NPV $1.96 per share
NOLs @ $40M NPV $3.91 per share
Intrinsic value $4.23 - $6.18 per share
Time value of money - we don't know when an acquisition will occur.
Acquisition risk - Steel Partners is running the show and should make a good acquisition. We believe the probability of a poor acquisition to be a low.
Announcement of acquisition(s) with taxable income
Utilization of NOLs
Illiquid - Trading volume of COSN is thin
 118,000 options are near in-the-money, with an average exercise price of $2.55. Of the 118K options, 106K are exercisable at an average price of $2.57.
Announcement of acquisition(s) with taxable income.
|Subject||Leap of faith|
|Entry||05/12/2009 07:32 AM|
How is this company going to turn $23mm of cash into $350mm of taxable income?
If you are willing to ascribe value to the tax benefit on future earnings then why not also ascribe value to the earnings themselves? But there's nothing there.
If this were a simple story of a $15mm company that would return $23mm to shareholders then I would buy all the shares I could. But too often a tax NOL becomes like Sauron's ring of power, irresistible to value managers. They can't bear to see it destroyed. Instead of throwing the precious NOL in the fire we could use it ourselves...
Similar ideas like CLRS GTA and KDUS have been posted on VIC in the past and they have been value traps. Hard to lose money buying at a 30% discount to cash, but how patient can you be in waiting for something to happen? It's been 4 years already at COSN. Is there are evidence that somethign is actually going to happen here?
|Subject||RE: Leap of faith|
|Entry||05/12/2009 02:28 PM|
We're not asserting that Cosine will use up the entire $350 M of NOLs.
We believe that if Cosine makes a reasonable acquisition and reasonable subsequent capital allocation decisions, the present value of the NOLs should be worth at least $20 M. The NOLs could be worth much more depending on the quality of the business purchased, the purchase price paid, amount of leverage used, and reinvestment of the cash.
It is true that Cosine and some others have not done anything with their NOLs to date. As we discussed in the writeup, the key risk is that Cosine does nothing going forward. However, it does not seem reasonable to us that Cosine and Steel Partners would go to all the work of shutting down the operations of Cosine, hiring experts to prove the NOLs are not impaired, taking action to protect them and then do nothing. While Cosine has not yet made an acquisition, now is an ideal time to make cheap acquisitions.
While we are aware of a number of companies that have failed in trying to deploy cash to utilize NOLs to date, there are also historical examples of companies that have been successful. One of the best examples that we know of is Danaher (DHR), which started out as a cash and NOL shell when the Rales brothers took control and made it into the $21B EV business that it is today.
The key question on utilizing NOLs is the quality of the management team making capital allocation decisions. If management deploys the capital wisely then the NOLs have real value.
Since Cosine is trading at a 30% discount to cash, we believe this opportunity represents a good risk/reward with very little if any intrinsic value risk. The key risk is time value of money. As with any VIC ideas, that is up to you to handicap.
|Entry||05/12/2009 05:56 PM|
How many NOL positions / companies does Steel Partners control?
Generally, I value NOLs at 5% of face or less.
|Entry||05/12/2009 06:41 PM|
We're not aware of any other cash/NOL companies that Steel Partners controls.
|Subject||RE: RE: Cosine|
|Entry||05/12/2009 08:11 PM|
Steel Partners is trying to jam their investors into Webfinancial, formerlt Rose's Stores, instead of cashing them out. Carl Icahn, a limited, is suing. Webfinancial is a tax loss carry-forward vehicle. WHX is another tax loss vehicle Steel controls. Steel had a position in BKF, another vehicle, but it has exited. Steel has a long history of trying to use tax loss shells.
Steel Partners has had redemption demands from a large percentage of its limiteds. It has resisted, if not refused, to answer those demands with cash. It is trying to roll over their investor capital into shares of Webfinancial. I believe that this position will not work out if Steel is unable to use its investors funds.
|Entry||05/14/2009 07:11 AM|
The trick here is to find a business to buy. The three year clock on 382 has expired, and so consideration could include equity up to a ~45% stake pro forma.
Steel Partners guys are receptive to ideas, and admit that they have not come up with anything over the past three years. But there are other things on their plate (including Mr. Icahn) that are understandable distractions.
Am working on a couple of ideas, and am happy to hear others. VIC doesn't like ofline contact, but I think I can get an exemption from the powers that be if you have something interesting to discuss.
Ideally, an idea would include the following:
- stable business throwing off taxable income
- double digit earnings yield on price paid
- a management team able and willing to add additional assets over time
- valuation of at least $20m
Am happy to discuss further offline
|Entry||05/14/2009 08:57 AM|
It is rather amusing that it has taken Steel greater than 3 yrs to find a suitable acquistion. I admire that they are looking for the right fit, but with valuation currently at 20 year lows, it would seem that there should be a multitude of possible fits for this company. I also agree that the NOL's have small value since their size dwarfs what the company can purchase with its $23MM cash hoard.
|Subject||RE: RE: a deal|
|Entry||05/14/2009 11:11 AM|
Section 382 of the tax code - suggest you get tax advice
|Entry||05/14/2009 01:14 PM|
I like this idea but share the skepticism on the board regarding the temptation to wait for the ideal acquisition for utilizing the NOLs when my IRR would be better off with an immediate distribution.
The real purpose of this post is to thank John for his clever, offbeat Sauron's magic ring analogy. The brains of value investors seem to be congenitally wired to extract value out of these NOL morsels, even to the detriment of their own returns. I have already plagiarized this in a few discussions, and will likely use it in many more...
|Entry||05/14/2009 01:50 PM|
Clarus is another one of these w/ a cash balance that is large enough to actually utilize the NOL. The same problems mentioned here apply to Clarus, though. See the last CLRS vic writeup and messages for some discussion.
|Subject||RE: RE: Cosine|
|Entry||05/16/2009 02:38 AM|
though they may be able to issue equity in a deal, they are still limited to acquiring somehting in the same industry which generated the losses - ie whatever cosines original type of business was.
|Entry||05/17/2009 07:07 PM|
You are referring to Section 269, which only applies if a party acquires control, defined as 50%. If no party acquires control, then 269 does not apply. And 382 says nothing about type of business acquired.
So you are incorrect, so long as no party acquires control.
|Entry||08/05/2009 01:39 PM|
What's your take on Steel now directly owning the entire 45%?