One of the things about me is that I am attracted to unusual things. Perhaps some of it is driven by my intellectual curiousity while some, no doubt, is driven by my boredom in life. This, for better or for worse, also extends to investing :) So anyone reading this blog should always keep in mind that I sometimes pursue investment opportunities that may be beyond me. With that in mind, here is an interesting one I have been tracking for a while.
I came across Clarus corporation (PK: CLRS) from a blog entry at Shadow Stock (for those interested in microcaps and special situations, this is a good blog to check out once in a while.) Presently Clarus is a penny stock with no operations and its whole purpose is to acquire another business. According to Clarus' website, it says the following of itself:
Stamford, CT based Clarus Corporation is executing an asset redeployment strategy where it will use its substantial cash resources to acquire or merge with an operating business that will serve as a platform company, enhancing future shareholder value. The Company is pursuing an opportunistic, value-focused investment strategy and is not targeting any specific industries. Clarus is seeking opportunities in both domestic and international markets and is targeting companies with substantial free cash flow, experienced management, significant size to serve as a platform company, and the opportunity to expand the business through organic growth and add-on acquisitions.
I'm not sure what the proper definition of what Clarus is, but I think it is probably considered a SPAC (special-purpose acquistion company). SPACs are companies that raise money from investors with some specific purpose in mind (e.g. to acquire another company.) The reason I'm not sure if Clarus is a proper SPAC is because Clarus was once a going concern that essentially terminated its business operations; in contrast, my impression is that a typical SPAC is a brand new listed company that raises money from investors and generally holds the money in a trust. I'm bringing up this issue over the definition because I'm not sure what the legal rights of Clarus is to its shareholders. From what I understand, a "typical" SPAC has strict conditions (e.g. have to purchase another company within a few years or else the money is returned to investors.) I'm not really sure what Clarus is required of Clarus. Is it possible for it to remain a shell for a decade? I'm not sure.
An Early Word
I have zero experience with SPACs; don't know the legal rights of investors; and quite frankly, this is all new for me. I am not 100% certain but I believe Clarus does not have to report to the SEC if it didn't want to. So anyone investing in companies like this should probably consider this as a high risk investment and, more importantly, as a long-term investment (imagine what happens if the company de-lists its shares or stops reporting for years.)
Before I go into the details, as is usual, anyone seriously interested after a preliminary look, should check out the official filings with the SEC. You should read the latest annual report (2008), and the latest quarterly report (1Q09). You should also check out their website and read as much as you can about the insiders who run the company.
What Is So Attractive?
So Clarus is just sitting there, waiting to acquire some company. It has around $85 million in cash and has done nothing for more than an year, so what is attractive about it?
Well, I have run into some SPAC or blank-check companies that were worth considering. A few weeks ago, for example, I ran across this story from Market Folly saying how Harbinger Capital is taking a stake in Zapata (ZAP), a shell company attempting to acquire other businesses. I also ran across some an year ago but I dismissed them after taking a quick look. The problem with many of them is that they rarely trade more than 10% or 15% below the book value of the shares. Given my lack of understanding of this business, and zero knowledge of the insiders and management running these schemes, I personally would not invest with a 10% discount. Professionals invest with a small margin because they are looking at the upside and know who is running the show. But I don't.
The thing about Clarus is that it may be possible to acquire it at prices way below book value or any reasonably pessimistic valuation. According to its unaudited 1Q09 quarterly report,
Book value = $85.6 million
Liquidation value* = ~$84.5m
Market cap @ $3.95/share (July 2 09) = $68.6m
(* I'm using a rough liquidation value of "cash + mkt securities - all liabilites", and I may be missing a few minor items related to employment contracts.)
So the shares are presently trading at a p/bv of around 0.8, which is also roughly the liquidation value (i.e. 20% below).
The chart below plots the share price over the last year.
I haven't purchased any shares because I am waiting for them to get cheaper. But it is possible that I may miss the opportunity forever. My feeling is that shares are really attractive around $3.50. I think the present prices are fine too but since there is a risk that this is a very long-term lock-up, I do not want to deploy capital into this at current prices. I'm speaking a concentrated investor but if you are a diversified investor or one with a very large portfolio then current prices are reasonable.
Is That All?
The 20% discount is not what making this intriguing. What makes this an interesting play is the fact that it has a large amount of NOLs (net operating losses.) I'm neither an accountant nor a lawyer but my understanding is that NOLs, which are produced by operating losses, can be carried forward and applied to net income, thus lowering taxable income in future years. The unaudited 1Q09 quarterly report contains the following breakdown of NOLs:
The NOLs expire over time but most of them don't expire until after 2020. Barring some unlikely, adverse, change in tax laws, Clarus has over $200 million of NOLs.
I have to look into how one figures out the potential benefit to shareholders from NOLs but this looks like sizeable tax savings if Clarus is able to purchase a profitable company. My wild guess is that Clarus, after acquiring someone, may not pay income tax for at least 2 or 3 years. The tax savings probably amount to 10% to 40% of (additional) market cap, depending on assumptions you use. So, overall, purchasing shares now will probably give you a margin of safety of about 30% to 50%, rather than 20% simply off the book value.
Cash Burn Rate
Clarus lost $601k, which is roughly 4 cents per share, in the quarter. The cash flow statement shows that it burned through $940k in cash from operating activities. The numbers depend on various factors including, most importantly, the interest it earns on its cash and marketable securities. Clarus pays for office space for the CEO and CFO (the space is also shared by another of the CEO's company).
Now that interest rates are really low, a conservative assumption would be a cash burn rate of $1 million per quarter or $4 million per year. This is roughly 5% of market cap. So, if Clarus doesn't do anything for 5 years, you will lose 25%.
What are the risks? The first thing to note is that fraud or some other dubious scenario is probably more likely in these cases. Who really knows what the company insiders and executives are doing? Even if you were a concentrated investor, I would be careful about putting too much money into this.
Secondly, the ethics of management doesn't seem like the best. I'm not saying it's really bad but I just wonder about the rent payments for the office, which is shared by another company the CEO owns. Clarus is paying more in rent than the CEO's company even though Clarus is nothing more than a 2-person company with zero operations. Image matters in cases like this, especially with potential companies you are trying to acquire, so who knows if Clarus' offices are located in high-end locations with nice interiors. But I just wonder.
Given how the CEO owns several other companies, including another one that is a blank check company I believe, a risk is that he may not spend much time with Clarus if he thinks the future for the others are better. I'm not a big fan of executives or insiders being involved in too many businesses (this is one reason I think board of directors are messed up--may CEOs sit on so many corporations that they likely have no idea what those companies do.)
The company burns a tiny amount of cash per year so the longer it takes, the more that shareholders lose. The CEO is already very rich (you'll see in the bullish note below) so even if Clarus burns money for years, he probably doesn't care.
There is a possibility that Clarus may dilute shareholders heavily by issuing a ton of shares if $80m isn't enough to buy a company it likes. This necessarily isn't bad if the company being purchased works out but it can also blow-up badly for current shareholders.
The CEO owns a large stake in the company and his interests are likely aligned with the public shareholders. If he didn't care about the company, he would be unloading his stake and wouldn't have purchased shares as recently as December (I believe).
The CEO, Warren B. Kanders, has been successful in the past with building companies. He turned around defense company, Armor Holdings, and created significant shareholder wealth, with Armor Holdings being finally sold to BAE Systems a few years ago.
I also believe that macro trends probably favour acquisitions by companies like Clarus. With the credit bust, some companies out there probably have credit problems. With the stock market bust, some traditional avenues such as IPOs are likely tougher. Similarly, private equity buyouts have declined. I think someone like Clarus, with essentially $80m cash with near-zero limitations (I believe Clarus doesn't even need a shareholder vote for a buyout), have a competitive advantage. From a purchase point of view, valuations are much lower than a few years ago so Clarus should be able to pick up something at a much lower price.
I have been tracking this for a few months now and may take a position if price drops much further, or am comfortable locking up money for a long time at current prices. There are a lot of unusual risks involved here so anyone venturing into this investment should be careful. As usual, I'll keep everyone updated if I ever decide to buy it.
Tags: Clarus (PK: CLRS)