Description

Thesis:
Coventree Inc (COF CN or COF.TO; figures in CAD) is a low-risk liquidation as 88.5% of assets are in cash and liabilities are minimal.  COF closed at $3.55 vs. estimated mid-point liquidation proceeds of $5.64, a return of 58.7%. It is likely proceeds will be distributed within 12 months and it is possible for a faster partial or full distribution. 

Unless you're managing a relatively small fund, this is an idea for your personal account although COF did trade 262k shares today so there are days of reasonable volume.  If you have excess cash in your personal account or want a bit of diversification out of USD, COF appears superior to earning T-Bill rates. 

Estimated Liquidation Proceeds from 3/31/09 Balance Sheet:

ASSETS
Cash and cash equivalents                     90.0
Restricted cash                                       0.9
Accounts receivable                                 1.7
Investment in transactions                       0.3
Promissory notes                                    2.9 << 9/30/08 Annual report, Footnote 7 & 10, page 36
Other investments                                  2.7 << 2.66mm shares of XMC.TO, current market value of $2.9mm
Capital assets, net                                  0.0
Other assets                                          1.0
Future income taxes                               2.2
Total assets:                                      101.6

LIABILITIES
Accounts payable and accrued liabilities     7.8
Limited recourse debentures                    2.9 << Offsetting asset in Promissory notes
Income taxes payable                             0.1
Future income taxes                                0.1
Total Liabilities:                                    10.9

Net Asset Value                                     90.7

LOW-END ADJUSTMENTS
Adjustment to assets                             (2.9) << 50% reduction to Other Investments, Other Assets, and Future Income Taxes
Additional severance                              (0.8) << Severance for execs let go on 5/21/09 that was not in prior reserves
OSC penalty/fees                                  (2.5) << A fine seems very unlikely; this is 50% of largest fine ever imposed by OSC
Interest income                                      0.8 << Will earn interest income on cash balance
Ongoing losses                                     (1.0) << Only 4 employees remain
Cost to liquidate                                    (2.5) << This is not included in restructuring expenses taken to date
Transitional Services                                1.0 << COF will generate profit from Transitional Services Agreement
Est Net Asset Value: Low-end                  82.7
S/O                                                     15.2
Per Share Value: Low-end                     $5.46

HIGH-END ADJUSTMENTS
Adjustment to assets                             (1.5) << 25% reduction to Other Investments, Other Assets, and Future Income Taxes
Additional severance                              (0.8) << Severance for execs let go on 5/21/09 that was not in prior reserves
OSC penalty/fees                                  (1.0) << A fine seems very unlikely; quite possible this is zero
Interest income                                      0.8 << Will earn interest income on cash balance
Ongoing losses                                     (1.0) << Only 4 employees remain
Cost to liquidate                                    (0.5) << This is not included in restructuring expenses taken to date
Transitional Services                                1.5 << Assume 50% higher than low-end
Est Net Asset Value: High-end                 88.1
S/O                                                     15.2
Per Share Value: High-end                    $5.82

Per Share Value: Mid-point                    $5.64
Current Price                                        $3.55
Upside                                                 58.7%  

Investment Merits:
#1: Low-risk liquidation as $90mm of cash (88.5% of assets)
While there are some assets, such as public stock in Xceed Mortgage of $2.7mm, that may not be worth carrying value, they are fairly modest relative to the $90.0mm of cash and I have haircut their values by 25%-50%.  The second largest asset is a $2.9mm promissory note, but this is offset by an associated $2.9mm of limited recourse debentures on the liability side of the balance sheet as both items relate to the same shareholder loan (see page 36 of annual report which also highlights that 1.0mm COF shares are pledged as security for the promissory notes).  Take the low-end estimate of $5.46, wipe out all non-cash assets other than the promissory note (because associated liability would also be wiped out) and you get $5.07/sh.   

#2: Significant insider ownership and track record of protecting shareholders
Founders Dean Tai and Geoffrey Cornish hold 7.5mm shares (49.6% of S/O) and management has ownership (not reported in Canadian proxy filings so can't quantify).  The CFO has stated that she owns "a lot of stock and is working very hard to distribute cash as quickly and cost effectively as possible." 

The interests of outside shareholders and insiders are aligned.  An example of this is the 4/16/09 press release stating, "In connection with the winding down of the operations of Coventree Inc., the independent directors of Coventree have reviewed the entitlement of Dean Tai, the former CEO of Coventree, and Geoff Cornish, Coventree's current CEO, to the 736,522 common shares of Coventree issued to each of them under Coventree's 2005 Share Allocation Plan.  As a result of their review, the independent directors have determined that the shares were not validly issued and have decided to cancel the common shares."  For outside shareholders, this reduction in the S/O increased per share value by 9.7%.

#3: Short timing
As outlined below in "Steps to Liquidate" there are just 2 remaining hurdles to clear and it seems reasonable they will be accomplished in the next 12 months, and potentially faster.  CFO is unable to share a forecast, but when asked if 12 months is reasonable, she chuckled and stated she certainly hopes it occurs in the next 12 months.  There will be a cost to liquidate (included in my estimates) and while the company cannot give formal guidance (likely will include in June 30^th results), when I guessed $5.0 million of costs, I was told "that would be a very expensive liquidation."  Therefore, this liquidation seems likely to occur fairly soon and the cost is likely fairly low.  Because of an indemnification agreement with 4 former directors, distributions cannot occur before September 1, 2009.

#4: COF is very easy to reach
Both the current and prior CFO are perplexed by the current share price and while I generally give little value to management's estimates of fair value, in the case of a liquidation I make an exception.  COF is in perpetual blackout so they are not allowed to buy.  The CFO is Ani Hotoyan-Joly and she can be reached at (416) 572-2086.

Investment Risks:
#1: Potential lawsuits
It is possible COF is sued and this slows the liquidation or reduces proceeds.  There are no current lawsuits against the company and management has stated they would issue a press release if sued.  As noted below, as part of the January 21, 2009 ABCP market restructuring COF received "comprehensive releases in respect of claims that might have been asserted against it in respect of its role as sponsor, administrator and financial agent for the Coventree-sponsored ABCP conduits." (see 3/31/09 MD&A, page 3).  A lawsuit does not appear feasible and the large gap between the current market cap of $53.8mm and expected liquidation proceeds of at least $82.7mm would require an extraordinarily expensive lawsuit before shareholders suffered a loss.

#2: OSC ABCP investigation and OSC IPO inquiry
Additional information is included below on both items, but simply put, the OSC is a very weak regulatory body and it is focused on the future of the ABCP market in Canada.  As COF is liquidating and will not be part of that future, it is very unlikely that COF receives punishment.  When I spoke with the OSC earlier this year, they seemed to have no interest in COF, which is further illustrated by the OSC's ABCP Draft Regulatory Proposals not once mentioning Coventree by name.  Regarding the IPO inquiry (not a formal investigation), if the OSC decided to move forward, it would make sense to go after individuals, not the company, as the OSC should not penalize shareholders for IPO transgressions. 

#3: Delay in liquidation
It is possible that unforeseen events occur delaying the liquidation.  While not ideal, the current price includes a margin of safety.  To date the company has taken steps that are consistent with creating as much shareholder value as possible.

#4: FX risk
If concerned the C$ is over-valued you may wish to hedge currency.

Company Description/Background:
On August 13, 2007 the non-bank Canadian asset-backed commercial paper (ABCP) market seized up.  Prior to August 13, 2007, COF was a non-bank that manufactured ABCP and serviced ABCP conduits.  After August 13, 2007, COF was no longer a viable business.

A comprehensive Canada-wide restructuring plan was implemented on January 21, 2009 and the assets of the COF-sponsored ABCP conduits were transferred to new special purpose vehicles that issued new notes to holders in exchange for existing securities, thus terminating the COF-sponsored ABCP conduits.  The assets in the new special purpose vehicles are now administered by third party administrators although COF provided transitional administrative services from 1/21/2009-5/21/2009.  Per a 5/21/09 press release announcing layoffs at the completion of the transitional administrative services agreement, COF has just 4 remaining employees.   It is important to note that "in accordance with the restructuring plan, Coventree received comprehensive releases in respect of claims that might have been asserted against it in respect of its role as sponsor, administrator and financial agent for the Coventree-sponsored ABCP conduits." 

Following the events of the summer of 2007, COF formed a special committee which determined on February 1, 2008 that "the Company will seek an orderly wind down of its operations and, in conjunction therewith, the distribution to shareholders of any funds remaining after setting aside appropriate amounts to cover the Company's expected future costs and liabilities, including known and other related liabilities." (see 3/31/09 MD&A, page 4)  For further detail, please see the company's quarterly or annual reports.

Steps to Liquidate:
1. OSC ABCP investigation
In early 2008, the Ontario Securities Commission (OSC) and the Investment Industry Regulatory Organization of Canada (IIROC) began examining the ABCP market.  As part of the investigation, the OSC inquired into Coventree's participation in the ABCP market and COF formed a special committee to oversee COF's response.  In October 2008, draft regulatory proposals were released.  Having reviewed the proposals, it seems reasonable to conclude COF will not be fined.  In fact, COF isn't specifically mentioned as the paper focuses on proactive changes and highlights the actions of the DBRS rating agency and ABCP distributors, such as RBC and CIBC.  The public comment period was closed on February 16, 2009.  In speaking with the OSC, I was told COF is not of interest and to expect a final report in the summer of 2009.  It seems the most likely outcome of the OSC ABCP investigation is the final report is released in the next couple months and there is no mention or fine of COF.  If for some reason the OSC decides to go after COF, the OSC told me $5.0mm is the largest fine they have ever imposed.  While it seems very unlikely COF receives any fine, a $5.0mm fine lowers liquidation proceeds by $0.33.  To be conservative I have included a $2.5 million penalty in my low-end estimate although I do not believe this will occur.

2. OSC IPO inquiry
Unlike the ABCP investigation, this is simply an inquiry and not a formal investigation.  I have not found the exact date the inquiry was launched, but judging from when it was included in COF press releases, it was approximately 1/1/09.  COF has said they provided everything the OSC has asked for and that there has not been a response or follow-up request from the OSC.  It is possible that the OSC launches a formal investigation of COF's IPO, but that isn't my impression from COF management.  Also, when I asked the OSC about this inquiry, they stated they had no reply as "it's not a formal investigation."  If the OSC did decide to proceed, a formal investigation of individuals associated with the IPO, rather than COF, seems most appropriate. 

The most likely outcome appears to be the OSC files its final report on the ABCP market shortly and there is no mention of COF (and no fine).  Likewise, the OSC's IPO inquiry seems a nonissue.  The indemnification is set to expire on Sept 1, 2009, which will allow COF to distribute proceeds. Nothing proceeds as smoothly as one would like, but it seems very feasible for these events to occur in less than 12 months.

I am happy to further elaborate on my diligence in Q&A, but wanted to avoid a long write-up.

Catalyst

1. Resolution of OSC ABCP investigation

2. Partial or full distribution of liquidation proceeds.