Description

GDS was written up nearly 3 years ago on VIC. Now the story is simpler & the value is more apparent, but the stock is down a tad!

Gendis is a company with no operating business, no debt, a $2.25 stock, $3.20/sh of book value consisting of property & liquid securities, and an option on a further $2/sh if it gets a favourable tax ruling. So, upside is anywhere from 42-125%, with minimal downside & no beta. All figures are in Canadian $.

Recent History: GDS recently sold its money-losing retail business, SAAN Stores, to a group of US investors. The chain was a chronic money-loser & upon sale GDS recognized a $53.7m loss. SAAN was immediately put into bankruptcy by its new owners, who hope to bring it out again in Spring 2005. As a result, GDS now consists of 3 assets: (i) a real estate portfolio, (ii) some public securities, and (iii) a deposit with the Canadian tax authorities in a tax dispute. It has no liabilities at present.

Valuation:
Shares o/s = 15.3m
Stock Price = $2.25
Book Value/sh = $4.10
Book Value/sh excluding income tax deposit = $2.30
Book Value/sh excluding tax deposit, but marking assets to market = $3.20

The balance sheet below is post-SAAN (3Q’2005), with mark-to-market adjustments.

Assets Book Market
Cash 1.59m 1.59m
A/C Receivable 15.3m 15.3m
Liquid Investments 18.9m 29.2m
Income Tax Deposit 28.4m 28.4m
Property 12.3m 15.6m
Total 76.5m 90.1m

Liabilities & Equity
Bank Loan 8.5m 8.5m
A/C Payables & Liab 2.0m 2.0m
Discontinued Operations Net Liab 2.3m 2.3m
Shareholders’ Equity 63.7m 77.3m

Explanation of above:

1.) A/C Receivable consists of money owed to GDS by Manitoba Hydro for the sale of a parcel of properties to it for its new HQ building. In November 2004, GDS received $12.5m of that money & immediately repaid its bank loan outstanding of $8.5m. The remainder of the amount due will be paid to GDS when the properties are vacated before the end of FY’05 (Jan 31, 2005).

2.) Liquid Investments consist of 2.36m units of Fort Chicago Energy Partners LP (FCE-UN.TO on Yahoo!) and 50K shares of Opti Canada Inc. These securities are carried at cost on the balance sheet, though they could be easily liquidated & have a market value $10.3m above cost.

3.) Property of $12.3m consists of Land & Buildings which are carried for $2.5 & $9.7m respectively. The bulk ($8-9m) of this asset is the company HQ in Winnipeg, Manitoba. It is a 384,000 square foot building sitting on 20 acres of land, and a mile away from the major highway into the US. It was first constructed in 1971, with additions made in the mid-1970’s and late 1980’s, so it is probably worth at least book. GDS management says that since the sale of SAAN, which also operates out of the GDS building, it has received phone calls enquiring about whether GDS wants to sell the building. In a recent bankruptcy filing SAAN said that it had fired 2/3 of its HQ staff & would be moving from this building in Winnipeg to Toronto, so GDS may well end up selling it now. While it is probably worth much more I have conservatively assumed that this building is worth about $12m.The remaining $3-4m of PPE is represented by 8 other small real estate properties.

4.) The Income Tax asset of $28.4m relates to an amount that has been levied for additional taxes & interest on that unpaid amount (upto time of deposit in 2001), in relation to GDS’ sale of its stock in Sony of Canada in 1995 (FY’95 I believe, which is calendar 1994). At the time of this sale the Sony stock was held by a GDS subsidiary headquartered in Quebec, where there was no provincial tax at the time. Quebec had set up this tax structure in order to attract businesses there & many other companies did the same thing. So, upon sale of the stock, GDS paid its federal tax but no provincial tax. When GDS’ first tax assessment was done there were no problems with it. But in 1998 Manitoba brought in retroactive legislation, which was really aimed at preventing the NHL team Winnipeg Jets from moving to Phoenix, which said that you can not treat such assets as being held in another jurisdiction (province); i.e. they deem it to be held in Manitoba. Manitoba doesn’t have its own tax auditor or tax collector, rather this work is done by the federal agency; CRA. The Canada Revenue Agency (CRA) administers the income tax act of each province & is obligated to pursue this case on Manitoba’s behalf. So, in light of the retroactive legislative change the CRA went back & took a new look at a lot of transactions which would be affected by it. In 2000 it came back & said that GDS owed $28.4m in back taxes & interest. Upon the taxation authority advising Gendis Inc. in late 2001 that it was liable for taxes and interest, Gendis put on deposit with CRA $28.4 million in order to stop further interest from accruing. GDS is not disputing the retroactive legislation change, but rather the ability of the CRA to collect on behalf of Manitoba. Hence it is arguing that the CRA has no jurisdiction in this matter. Manitoba could try to collect itself, but as we noted it has no agency to do this & there is a statute of limitations on how far back you can go; it is around 7 years for many provincial taxes & 5 years for Federal taxes. And GDS feels that Manitoba could not argue that it had been indirectly filing the case itself since 2000 (when the CRA first filed the tax claim on Manitoba’s behalf). If it were to file now, it would be well outside the 7 year limit – since the sale of the asset occurred in calendar 1994. The only instance where the statute of limitations does not apply is if they can prove that fraud has occurred. On July 28, 2004, the Court of Queen's Bench of Manitoba ruled against GDS, deciding that the Minister of National Revenue of Canada has the authority to assess and collect tax as a result of the application of the Manitoba Income Tax Act. GDS will appeal the decision to the Manitoba Court of Appeal. I don’t have any special skills in handicapping legal cases, and it seems like GDS’ case is weak, but there is some probability they will win – say 10%, though management thinks it more like 50% - and in which case this would represent upto an extra $1.85/sh in value. If they lose, then shareholders lose nothing but the money already on deposit with the CRA.

5.) The bank loan of $8.5m is no longer outstanding since GDS repaid it with proceeds from the Manitoba Hydro cash payment in November 2004.

6.) Whether there is a tax hit to GDS from selling any of its remaining assets (public security investments and property) will depend on whether it can classify any of its SAAN losses as capital ones.

GDS has virtually no options o/s & those that do exist have a strike price ($13.7) which is significantly above the current stock price.

The main risk I see to GDS is that some of the creditors of the now-bankrupt SAAN may choose to sue GDS as a deep-pocketed former parent. Note, SAAN was not owned by GDS when it was put into bankruptcy…but by its new owners, and their intention is to bring it out of bankruptcy by spring 2005. According to SAAN’s bankruptcy filings its significant undischarged liabilities at present are (i) $13m to suppliers & trade creditors, and (ii) $91m of future operating lease payments to landlords. It has already announced that it will be shuttering a number of stores, which will undoubtedly result in the cancellation of some of these leases.

Management Incentives
GDS founder Albert Cohen owns 5.57m shares (36% of the stock), and thus is heavily incentivized to realize the remaining value in the company & distribute it to shareholders. Over the years he has often paid out large dividends to shareholders when the company has had excess capital. Now being over 90 years old he may well be looking to step back from GDS completely & liquidate it! With no operating businesses remaining, GDS has annual overhead of $1m & management says “we can’t just go on forever like this.” So, it looks like they want to do something to realize value, whether making new investments or liquidating the company. It seems the main hurdle restraining them from completely liquidating GDS is the potential for SAAN-related lawsuits. Once SAAN re-emerges from bankruptcy this would hopefully ease the way for GDS to act, assuming it is not embroiled in legal difficulties.

Catalyst

1.) Liquidation & distribution of remaining assets in GDS, or investment in a new line of business.

2.) Re-emergence of SAAN from bankruptcy, thus lifting the only potential (albeit small) negative hanging over the company.

3.) After the adverse court ruling regarding the income tax case in July 2004, there are no positive expectations concerning this asset. A favourable ruling upon appeal would provide a significant boost to the stock.