Clarus Corporation (CLRS) was well written up almost exactly a year ago and the issues were well fleshed out.  Not much has happened since for the business.  The stock got has high as $10 and has retreated to roughly where it was at the time of the write-up, $7.10.  It is a pretty simple story although with some tricky dynamics.  However, I think the risk-reward is excellent.

 

The company has been and continues to look for acquisitions with $25mm or + of cash flow.

 

To review, Clarus, a former internet darling was taken over by Warren Kanders, a highly able and successful entrepreneur/investor in 2002 as a result of a proxy fight.  Kanders most notable success (as best I know) is his success in building up Armor Holdings (NYSE—AH) which has compounded at 30+ percent a year since he took it over.  However, he is no one-time wonder, having had numerous successes. 

 

Clarus has $85mm of book value, all of which is all cash.  This is $4.95 a share.  It has $220mm of NOL’s.  There are many ways to value NOL’s.  The market value of the debt-free company is

 

17.2mm shares x $7.2= equals $122mm. 

 

This values the NOL’s at $37mm.  This values them at just shy of 16c per dollar of NOL’s.  This is not a rich valuation, and they do not start expiring in size for north of 10 years. 

 

In what I think is a worst case for the NOL’s, let’s say that CLRS were acquired tomorrow and there was a full change of control of the company.  This brings in the annual limitation where the market value of the company times the annual federal limitation rate determines the amount that can be used in any given year.  Let’s say the company were bought at current market value, or $122mm.  The Federal rate is currently 4.3% so only $5.25mm of NOL’s could be used every year.  After tax, that would be about $2.2mm.  Their use to a profitable company is highly certain so the discount rate one would use to PV the $2.2mm a year is very low.  I would use the 4.3% rate.  This PV’s to about $24mm, or .11c on the dollar.  The only catch here is that the higher the NOL’s are valued, the more they are actually worth and vice versa due to how the above calculations work.   

 

$24mm + the $85mm of cash creates an Enterprise Value of $109mm or $6.22 a share, which I think defines represents the downside. 

 

The company has been and continues to look for acquisitions with $25mm + of cash flow.  It is obviously being careful.  I think the optionality for paying almost nothing for the opportunity to invest with Kanders continues to be highly appealing.

 

What prompted me to write up the stock up now is that I think the odds of something interesting happening at CLRS just increased dramatically. 

 

Last Wednesday, an S-1 for Kanders Acquisition Company (KAC), Inc. was filed.  This company is seeking to raise $400mm in a Specialized Acquisition Company or (SPAC).  40mm units are to be sold at $10 a share.  For putting up $10, holders will get 1 share of stock and the right to buy 1 share at $7.50.  Given existing insider ownership at basically no cost and underwriting costs, pro-forma cash/book value per share is $6.85 per share.  If shareholders exercise the warrants at $7.50, this brings book value per share to $7.20 and average cost per share down from $10 to $8.60 per share.  So shareholders will pay a 19% premium to value, all warrants exercised.  Not the smallest premium, but I think the deal gets done at or close to this level.  Interestingly, if one takes the cash value at Clarus, adds 15% to it, and values the NOL’s at .10c on the dollar, the total is $7.00 a share, meaning one is paying 10c ($1.7mm) for the positively value that will hopefully be created from Kanders doing deals. 

 

I think the IPO of KAC increases the likelihood of there being an acquisition where CLRS will be able to participate.  The odds of a bigger company being able to do a deal than CLRS seem higher to me.  The ability and desire to do bigger deals means more incentive for bankers to bring deals, particularly from Citibank and Wachovia as the lead bankers.   A larger shareholder base means the shareholder base will likely bring more deals to the table.  Larger public companies get more publicity as they do deals which brings more deal flow.  With financing being less available, all buyers with lots of cash and permanent capital are in a relatively stronger position now than they have been for a long time to buy companies which is good for CLRS and KAC. 

 

As for CLRS, I believe it likely CLRS will be able to participate in any deal KAC does, at least for the first deal or two.  From the KAC S-1:

 

“Messrs. Kanders, Baratelli and Julien have pre-existing fiduciary duties to (i) Clarus Corporation, a publicly-held company with no current operating business, net operating loss carryforwards of approximately $223 million and approximately $85 million of cash and cash equivalents that is currently seeking to acquire a target business in any industry and (ii) Highlands Acquisition Corp., a blank check company with a trust account valued at approximately $134,830,000 as of October 15, 2007 (including deferred underwriting discounts and commissions of approximately $3,990,000) and a focus on acquiring a target business in the healthcare industry. As a result, except for opportunities presented to Messrs. Kanders, Baratelli or Julien expressly for presentation to us, (i) with regard to Clarus Corporation, each of Messrs. Baratelli, Julien or Kanders will not present opportunities to us unless he has first presented the opportunity to Clarus Corporation and Clarus Corporation has rejected it, and (ii) with regard to Highlands Acquisition Corp., each of Messrs. Baratelli, Julien or Kanders will not present to us, without first presenting it to Highlands Acquisition Corp., any business opportunity to acquire a privately held operating business if, and only if, (a) the target entity has a fair market value between 80% of the balance in the Highlands Acquisition Corp. trust account (excluding deferred underwriting discounts and commissions) and $500 million, the target entity’s principal business operations are in the healthcare industry and the opportunity is to acquire substantially all of the assets or 50.1% or greater of the voting securities of the target entity or (b) the target entity’s principal business operations are outside of the healthcare industry and the opportunity to acquire such target entity is presented by a third party to one of them expressly for consideration by Highlands Acquisition Corp. Additionally, Messrs. Owens and Henning, two of our independent directors, are also directors of, and have fiduciary duties to, Highlands Acquisition Corp. Mr. Kanders has pre-existing fiduciary duties to Stamford Industrial Group, Inc., a publicly-held manufacturer of steel counterweights, which is seeking to build a diversified global industrial manufacturing group through organic growth and acquisition growth initiatives that will complement and diversify its existing business lines. Although neither Mr. Baratelli nor Mr. Julien are employed by or have a fiduciary duty to Stamford Industrial Group, Inc., both may from time to time render consulting services to Stamford Industrial Group, Inc. as a result of a consulting arrangement between Kanders & Company and Stamford Industrial Group, Inc.”

 

The language of “preexisting fiduciary duties” is pretty strong and protective.  Now bankers can be tricky and bring opportunities specifically to KAC which they will be incentivized to do given its greater size and therefore likely potential for greater deal fees.  At the end of the day, while Highlands seems to maybe come before CLRS in healthcare and Stamford potentially in certain types of businesses related to its current businesses, I think each company will get the deals it rightfully should be involved in.  For example, any deal that can best use some of CLRS’s NOL’s will most likely include CLRS.  I think that given scrutiny on Boards in general, it would be awkward for the Boards to do otherwise.  My guess is that in order to avoid complications, at least KAC and CLRS, which are pure cash companies, will end up doing deals together with CLRS perhaps getting rolled in to KAC in some way at some point.  It will be interesting to see the language in the CLRS 10Q that should be filed within the next couple of weeks.  Hard to see given the basically identical profile of the companies that common Board members could easily argue that a deal is better for one company than another. 

 

CLRS will have 18.9% of the total cash that it and KAC will have combined, less including warrant exercise.  So in particular deals, if desired, each company could participate on a pro-rata basis with KAC still being able to consolidate.  In this scenario however, the highest and best use of the CLRS NOL’s would remain uncertain. 

 

Of course, in a circumstance where a deal is too big for CLRS to do but not for KAC, then it may be easier for the common Board members, and particularly the independent ones to exclude CLRS from the deal.  There are 3 independent directors, two who are also on the board of Highlands.  One is a private investor.  If the CLRS affiliated directors are forced to recuse themselves out of being conflicted, this could be a problem for CLRS participating.  However, I think this issue is meaningfully mitigated because I think CLRS could find partners to participate in any deal it wanted to do, thereby making it hard for KAC to argue that it can do a deal that CLRS can’t do. 

 

In short, at the end of the day, I think that it will be complex for KAC to take a deal that CLRS would otherwise have tried to do by itself or with partners.   Also, given the small stake CLRS would own if a deal is done pro-rata by amount of cash, I do not see much incentive for KAC to try too hard to exclude CLRS.  (The companies have a comparable enough valuation as described above that I do not think that equity deals change the calculus materially for the moment.)  At the end of the day, big picture, I think it is easier for the companies to participate pro rata, diversify risk, include the NOL’s if possible, and work together. 

 

CLRS may not be able to generate the upside I am hoping for, but, if not, I do not see how its value would then be negatively impacted.  And more likely, I think CLRS post KAC IPO will be associated with a much bigger cash rich company, which increases the odds of the company being able to participate in value creating acquisitions. 

 

Of note, there was insider buying of CLRS in August, the time-frame when KAC was getting off the ground organizationally. 

 

Catalysts:  IPO of KAC with expectation of subsequent activity including CLRS, 2) actual acquisitions by Clarus on its own, with KAC, or in a joint transaction, and 3) 3^rd ¼ CLRS 10Q.

 

Risk.  1) NOL’s turn out to be worth less than anticipated, 2) value destroying acquisition, 3) Clarus is treated behind KAC, and 4) KAC IPO does not get done.