Clarus is a shell company controlled by a smart successful investor that is offered at 65 percent of its net asset value. Its NAV consists of cash and an NOL. There are no other assets. The catalyst to realize the NAV—perhaps greater than the NAV—is clear. The risk of value destruction in advance of the catalyst is nil, and the risk of value destruction through the catalyst is minimal. The primary risk is timing, but the risk of loss is very small, and the potential return is high. The risk reward offered by the stock is compelling.
Warren Kanders controls CLRS. Kanders owns 2 million shares of CLRS stock, and 1 million stock options that are in the money. He controls 18% of the outstanding shares. Kanders is best known as the chairman and founder of Armor Holdings (NYSE: AH). Kanders has overseen growth in Armor shareholder value of more than $2 billion since making his initial founding investment in 1997. Armor has generated compound annual returns of approximately 29.5% for investors over that time.
Kanders gained control of CLRS in a proxy fight in 2003. Prior to 2003, CLRS was a software business that blew up with the bursting of the bubble. It raised capital in a well subscribed IPO in 1998, and its stock peaked at $140 in 2000. After the bubble burst, it generated little revenue, lots of losses, and burned through a large portion of its cash. Kanders ran his CLRS proxy campaign on the platform of stop the losses, sell the software business, and reinvest the net cash on the balance sheet in a stable, profitable business with growth opportunities, thereby generating value from the company’s substantial NOL. Kanders’ initial involvement in AH was driven by a similar theme. Shareholders backed Kanders, the software business was sold, and the old management team resigned.
CLRS now has 83.6 million in cash, 16.6 million basic shares, and 1.6 million options which, if exercised, would bring another 10.2 million in cash to the company. Fully diluted cash per share is $5.13. There is no other meaningful item on the balance sheet. The NOL is $222 million, or $12.13/share, nominally. I discuss a present value for that NOL below, which we estimate at $4.53 per share. That makes the NAV $9.66. G&A for salaries for the 6 current employees and facilities are offset by interest income on the cash. Outside of due diligence expenses for acquisition opportunities, cash burn is nil. Since taking control, Kanders and his small team has been seeking the right acquisition opportunity for CLRS. As the financials reveal, due diligence has spiked a few times in the past 3 years, and management feels they have gotten close a couple of times to attractive deals. They have not pulled the trigger.
There are 2 primary risks. First, they don’t act for some time, and it has been some time already. This is the primary pushback I get on the idea. 6 employees continue to take in the interest income on the cash, and thus, the argument goes, don’t bear the brunt of excessive caution or delay. My reaction is I am willing to wait at this price; management is incented to do something eventually; and the salary income they are receiving is not excessive. Second, there is a risk they buy something dumb. My reaction is I am willing to run that risk at this price, and I think the risk is very small, given the track record. Skeptics point to another source of risk and conflict. They argue it makes more sense for Kanders to spend time on non-CLRS business activities and less time on CLRS. This is of course true. But it still makes all the sense in the world for him to buy something stable, that he can earn tax protected income with, and use as a platform for growth through incremental acquisitions. I don’t think it’s far fetched to think he does both.
How do we value the NOL? CLRS intends to use its cash balance to provide the equity financing for what is effectively an LBO. Using leverage in an acquisition makes sense, as the greater the income they can buy (after interest expense), the faster they can monetize the NOL. The NOL does not begin to expire until 2009. We assume CLRS buys a business generating $44 million in EBIT for $350 million (8x), and borrows $266 million in the transaction (6x). We assume an 8% interest rate, which implies 22.4mm pretax income, or 7.9mm of owed tax using a 35% tax rate. Saving 7.9mm per year, the NOL is eaten through in 27 years. The NOL’s expiration is staggered, and protects income for that full lifetime. More likely, however, whatever CLRS buys, it adds to with incremental deals over time, accelerating the realization of NOL value, and raising its present valuation. We use a 10% discount rate to present value the NOL.
Can you quibble with this assumption or that one? Sure. I think our base case is neither aggressive nor conservative. Importantly, if CLRS buys something cheap, its NAV will increase. If it adds to value over time with deals, we will do better. One way to think about the potential for valuation upon an acquisition is to model the proforma net income per share, using our hypothetical deal model. Given the NOL, net income in our deal would be equal to pretax income, and would equal 22.4mm, or $1.35 per share. At this price, we are paying 4.7x that number.
One last thought. Not comfortable with the hypothetical modeling, or entrusting capital to Kanders, given the dynamics? Understood. Pass on it. But for the group of investors that entrusts capital to holding companies, or spacs, or shells, take a look at this one. I cannot find one priced so low in the public market.