Description

This consumer products company has bought back almost 30% of its stock, sells for 5.7x EBIT, has a ROTA of 25.8%, has a great balance sheet, and has over 90% market share in its major product area.

bibicif87 originally wrote this idea up in October 2001, and since the stock is up from $4.60, but the investment opportunity is even better today than it was then because the risk of the turnaround is less. Bibicif's write up and the question string were great, so I am focusing here on the current story, not the company history.

CNS's main product, accounting for over 90% of sales, is Breathe Right Nasal Strips (BRNS). This product mechanically dilates the nares enabling easier nasal airflow. The target markets are: snoring and cold/flu/allergy patients. BRNS have over 90% market share and 14 years of patent protection left. Schering Plough licensed the technology from the one company that had an exemption from the patent and has been unable to break into the market in any real way despite trying for the past 5 years. CNS also sells a fiber tablet and a throat spray that firms up the soft palate, which helps alleviate snoring in some people.

The company has spent several years executing on a turn around after mismanagement in the 90's. The CEO and 6 of the 10 other senior managers have been hired within the past 4 years (although the CFO has been there longer). During this time they bought back the rights to market BRNS overseas from 3M (who had effectively abandoned the product after licensing it from CNS), laid off 25% of the work force, and streamlined operations. Management has spent the past few years spending very heavily on advertising in order to position the product better with the target audience.

The relationship between revenue and advertising expense is shown in the following table:

Fiscal Year Rev Advert Exp
2003 (E) 76-82 31
2002 72 29 (of 14mm drop, over half came from Fiberchoice)
2001 72 43

Now that this investment in mind share has been made, they are dropping advertising to a maintenance level and targeting the different groups in a more specific way using knowledge acquired over the past two years. Going forward the plan is to keep advertising at about the same level as 2003, except when they introduce new product, which they will do if it can be breakeven or better in first year. They think they can get 10-15% total revenue growth pretty easily for several years.

Numbers:
This year the company changed its fiscal year end from December 31 to March 30th in order to get the entire cold/flu season in one fiscal year. The first three months of calendar 2002 are considered a transitional quarter and the fiscal year started on April 1, 2002. In order to avoid confusion, my numbers are going to refer to the trailing four Calendar quarters.

(Millions)

TSO: 14
Price/Share: 6.47
MVE: 86.1
Cash/investments: 33.3
Debt: 0
EV: 57.3

9/30 Rev: 17.4 (24%)
6/30 Rev: 14.5 (20%)
3/31 Rev: 19.1 (26%)
12/31 Rev: 21.4 (30%)
Total: 72.4 (100%)

9/30 EBIT: 5.6
6/30 EBIT: 2.3
3/31 EBIT: 0.7
12/31 EBIT: 1.5
Total: 10.1

Normalized TTM E (normalized for 38% tax rate): 6.3

Total Assets: 58.9
Tangible Assets: (Total assets-(cash+investments+intangibles)): 24.4

ROTA (using normalized E): 25.8%
EV/EBIT: 5.7
EV/FCF (nl E is about FCF): 9.2

Last year they had 1.2mm in depreciation and 0.4mm in capex, and going forward they expect these numbers to stay at these levels or decrease, so EBIT is a pretty good proxy for pre-tax free cash flow. Currently they have a tax asset that they are benefiting from (which will be used up within 3 quarters), but on a normalized basis, management expects a 38% tax rate.

In addition to decreasing advertising, CNXS has made operational improvements over the past year, which is reflected in lower SG&A. Going forward they think they can squeeze another 100 basis points from COGS and significantly more from SG&A (as sales increase on static infrastructure and advertising expense).

Management's guidance is for 10-15% growth rate in revenue and a normalized EBIT margin of 15-20%. They expect this revenue growth to come from overseas (where they are currently getting 5-10% growth in new users in countries they are currently in) and 3-5% revenue growth from domestic BRNS sales.

RISKS: The main risk that I can think of is that management is completely wrong about the needed advertising level and that BRNS actually require a very heavy level of advertising to maintain sales. Since I consider this a good branded product with a relatively low price point (usually a highly profitable type of product) I don't think this likely. The other risk is that management does something really dumb with the cash. They have been saying for years that they are looking for another branded product to buy and put through their distribution channels and this kind of talk usually worries value investors. On the phone the CFO made the point to me that while they have been looking, thus far they have rejected every deal because when they compared them to just buying back stock no acquisition looked good enough. Going forward they would like to continue buying back shares but are constrained by the lack of block sales available. This kind of thinking is exactly what I want in a management team - disciplined and rational capital allocators, but looking for good deals.

In summary, this company is selling for an EV/EBIT of 5.7, an EV/FCF of 9.2, has huge returns on tangible assets, a bullet proof balance sheet, is buying back shares, has over 90% market share and could double EBIT in the next 3-5 years.

Catalyst

1. FCF Growth and share buybacks.
2. Management is willing to sell compnay in a few years after they post several quarters of FCF growth.