Description

CoSine Communications - $2.07

Note: This is a very illiquid stock, so suitable just for PAs unless you can locate a block for sale.

This is a fairly simple story. CoSine is an NOL shell corporation trading at 87% of NAV, not including the tax asset. They have an NAV of $62mm, and federal carryforwards available to cover $325mm of future profits, net of what they will have to use to cover existing taxable capital gains. They are doing deals that will allow them to turn their NOLs into cash, and shareholders should profit.

CoSine is 80% controlled by Steel Partners (SPLP), a publicly traded limited partnership that aggressively uses NOL shells to goose returns on the companies it buys and invests in. COSN itself has been written up twice on VIC, and you can look at past write-ups on SPLP, SXCL/ADPT, DGTC, SPLP, MLNK, and IGOI for more discussion on Steel’s track record. The consensus seems to be that their investing record is a bit mixed, but they get full marks for their ability to avoid taxes.

Steel has controlled CoSine for several years, never finding a use for it until now. Last week, SPLP did a tax free exchange where they dropped a huge pile of assets into CoSine in exchange for CoSine stock. They did it at a price that raised the NAV of COSN (again excluding the NOL) from $1.80 to $2.40 per share. It preserved the value of the NOL and set in motion a process for the NOL to actually be realized.

The details of the transaction are here. The transaction was done to facilitate a bid for SPLP (via COSN) to gain control API Group plc (API.L), an AIM traded specialty packaging manufacturer. API produces a lot of CPG packaging that involves foil and lamination, like what you see on some cigarette cartons, vodka bottles, etc. Most of the business is in Europe but they have a sizable Americas business as well. SPLP has been the largest shareholder in this business for several years, owning a 32% stake, and chose to go all in instead of getting out.

The exchange is a fairly clever deal. SPLP gave COSN their 32% stake in API, worth $23 million, and their 10% stake in Nathan’s Famous (NATH), worth $36 million, in exchange for 16.5mm newly created COSN shares (63% of the combined company), and newly created preferred stock worth $12.8 million. They then extended COSN a $37mm loan, backed by the assets they exchanged, so that COSN can buy the remaining 68% of API they don’t already own.

From a tax standpoint, this doesn’t create a 382 issue (as far as I can tell) because 382 requires that ownership not change by more than 50 percentage points in 3 years. SPLP has owned over 45% of COSN for over 3 years, and this deal only takes them to 80% ownership (including the dilution), so no problem. Also, since SPLP owns more than 80% of the company post-transaction, this qualifies as a 351(a) tax free exchange – important because SPLP has a massive built-in gain on NATH, which they bought for pennies many years ago. COSN can sell the NATH stake if they want and pay no taxes – it will just eat into their the NOL a tiny bit. And at the end of it, COSN will own an operating business that will make some use of their NOL. Tax magic!

COSN is offering to pay 60p per share for API, or GBP 45mm. API made about GBP7mm in operating income each year for the last 3 years, and should end the year with no net debt but with some pension deficit. The second largest shareholder, Wynnefield Capital, has already agreed to the deal, and they own 30% so no matter what, COSN will own at least 62% of the company, and they will probably end up with full control (shades of HCHC/SHFK). It seems like a decent deal, though maybe it won’t make the most efficient use of the NOL as a permanent holding since it is a UK based company. They might sell it on in a couple of years for that reason.

Nathan’s Famous has been written up on VIC before – a great niche brand that management has squeezed a lot of value out of in the last few years. They own a few restaurants, but mostly they make money from royalty payments from franchisees and licensees. At the current price, they have an EV of about $300mm, and this year they probably end up with $20mm or $25mm in operating income. Not the cheapest stock in the world, but they’re showing good growth and might be attractive to an acquirer. I don’t know what Steel’s long-term plan is – at this point they could sell the stake, hold on to it, or even eventually try to swallow it whole if the price was right (though that would involve a lot of debt and another asset drop down).

I think there are more catalysts down the road here. This is an interesting situation since COSN has a parent that can drop assets into it instead of having to rely on raising outside capital to do acquisitions. SPLP owns some other appreciated stock, including a 25% stake in SLI, and they have operating assets like WebBank as well. They’ve shown they’re willing to do fair deals with their subs, so hopefully minority shareholders here can ride along and profit.

There will be more dilution, but I think current shareholders can realize a big chunk of the value from the NOL. As of the end of 2013, COSN had $357mm in federal carryforwards, and even if we set aside $32mm for NATH, that leaves us with $325mm. They also had a sizeable California state NOL which is expiring but still useful. At a 35% rate, the remaining federal NOL would be worth $114mm. We have to discount this quite a bit for present value and future dilution, but I think the NOL could be worth $25mm - $50mm to shareholders today, or $1 to $2 per share on top of NAV, bringing fair value to $3.50 - $4.50 per share.

Catalyst

More deals that allow COSN to realize the value of their NOL.