Description

This is a dark, thinly-traded, tiny market-cap, special situation suitable only for small investment.  It is also a compelling opportunity.

What can I say, it’s what we do.  

Summary

EDCI Holdings, Inc. (“EDCI”) is in liquidation, having received the requisite shareholder approval on January 7, 2010.  Early investors in the liquidation were rewarded with significant value for a number of assets originally estimated as being worthless for purposes of estimated distributions.

Today, EDCI has no assets remaining other than cash -- $3.4mm as of 6/30/18 or $0.57 per share according to the part-time CFO.  The only thing preventing EDCI from finalizing the liquidation and making a final distribution (of some amount) is a lawsuit in which a subsidiary of EDCI, Glenayre Electronics, Inc. is among the defendants.  

A recent development in this lawsuit may make its resolution, and thus the finalization of the liquidation, more likely. Given this, at or around the current ask price, the stock could provide a meaningful return.  Alternatively, if the pending motion for summary judgment is denied and the lawsuit drags on and/or has to be settled we believe there is an adequate margin of safety. Buying at a price you like, if possible, will require patience.

The Lawsuit

History

(Docket for lawsuit can be found here.  Links to certain documents included below - we obtained them via a public records request.)

In 2013, Carlos Tarazon sued the City of Phoenix (“the City”) and numerous co-defendants after he developed mesothelioma, allegedly resulting from long-term exposure to asbestos while installing and repairing water piping for various defendants.  The City filed a third-party complaint against 82 developers (“Developers”) and eight contractors (“Contractors”) alleging that they had agreed to defend and indemnify the City against negligence claims arising from the construction projects on which Tarazon worked.  One of the Developer defendants is Glenayre Electronics, Inc. a subsidiary of EDCI.

The Developers and Contractors moved to dismiss the City’s third-party claims arguing that the claims were “based in contract” and therefore barred by Arizona’s eight-year construction statute of repose (similar to a statute of limitations) given that the projects on which Mr. Tarazon worked were completed more than eight years before the City filed its complaint.  The Maricopa County Superior Court agreed and granted the motion to dismiss and the AZ Court of Appeals upheld this decision.

Despite these two defeats, the City appealed to the AZ Supreme Court.   The AZ Supreme Court agreed in its ruling that the eight-year limitation applies to actions “based in contract.”  

Due to the fact that the Contractors had a contractual relationship with the City, the Supreme Court upheld the ruling that barred indemnification claims against the Contractors.

However, the Court reversed the lower court rulings with respect to the Developers.  The AZ Supreme Court based its decision on the City’s representation to the Court that the only “agreement” between the Developers and the City for their projects was a permit.  The Court ruled that any relationship solely governed by a permit was, in fact, NOT an action “based in contract”, a condition precedent for the statute of repose eight-year limitation, and therefore the City was not barred from bringing its indemnity claims against the Developers.

This result at the Supreme Court in mid-2017 and the prospect of possibly paying a settlement caused a drop in EDCI’s stock price.

Importantly, EDCI is but one of many Developer defendants in the case.  According to the Motion (page 8 at line 23), and the City is seeking roughly $2.1mm for indemnification and legal costs.  Thus, EDCI’s exposure is likely just a fraction of the total amount being sought by the City (more on this below).

Motion for Summary Judgment

On August 14, 2018, EDCI and some of its Developer co-defendants filed a joint Motion for Summary Judgment (“the Motion”).  In the Motion, the Developers state that, contrary to the City of Phoenix’s statements in the previous proceedings, the Developers did, in fact, have a contractual relationship with the City.  

As Developers point out in the Motion:

“The truth is that the City’s representation to the Supreme Court (and other courts) - that it had no contractual indemnity relationship with Developers - was false.  The City knew of the existence of such agreements years ago and recently produced approximately 68 agreements with the Developers for the projects at issue in this case.” (Motion for Summary Judgment page 9 at line 9 - my emphasis added)

“On remand the City has now disclosed approximately 68 other written agreements with all of the developers who remain in the case... Each of these agreements contains the same (or substantially the same) indemnity provision found in contracts between the City and Contractors for CIP projects.” (Statement of Facts in Support of Third Party Defendants Joint Motion for Summary Judgment page 5 at line 20 - my emphasis added)

The Motion goes on to state:

“Now that it is clear that [Developers] did, in fact, have a contractual relationship with the City, the Arizona Statute of Repose is case-dispositive.” (Motion for Summary Judgment page 10 at line 9)

“[That] same type of contractual relationship existed between each of the Developers and the City (although the Court was unaware of it, having been told otherwise).  And just as with the Contractors, there can be no question that the development agreements fall squarely within the definition of “agreements” found in the statute of repose [8-year limitation].  Accordingly, the Developers occupy precisely the same position as the Contractors and the Court’s decision must be applied in the same manner.  This issue is case-dispositive” (Motion for Summary Judgment page 10 at line 20 - my emphasis added)

In other words, according to the Motion, discovery since the Supreme Court ruling has uncovered agreements between the Developers, including EDCI/Glenayre, and the City. According to the AZ Supreme Court’s May 2017 ruling on this matter, if the Developers had appropriate agreements with the City, the City had to have brought the indemnification claim within 8 years of Tarazon having completed work on the projects.  The City did not. Hence, the indemnification claim against Glenayre, as filed, fails to survive the statute of repose due to precisely the same analysis the AZ Supreme Court applied to uphold the dismissal of indemnity claims against the Contractors in 2017.

A reply from the City to the Motion is expected by the end of September (based on Rule 56 of Arizona Revised Statutes Annotated Rules of Civil Procedure for the Superior Courts of Arizona -- 30 days from service.)

Link to certain docs (in Dropbox as we had to make a public records request for some of them):

AZ Supreme Court Ruling - May 2017

Motion for Summary Judgment - August 2018

Exhibit H related to Glenayre (referenced in the Motion Statement of Fact page 5 at line 21) - August 2018

Valuation

Given the company has cut expenses to the bone is now non-reporting, or “dark”, what assets are left at EDCI?  

In addition to reaching out to management, we can use public information from the last few years to triangulate the remaining assets, starting with a press release in March 2016 announcing the sale of their last major asset, the facility at Kings Mountain, NC.  Here is a link to the press release.

As the public release notes, upon closing the sale of the Kings Mountain facility, the company had $4,000,000 in cash.  

In June 2016, the Company issued an update on the litigation in Phoenix and noted that no distribution was forthcoming until the matter is resolved:

In May 2017, the Company updated the litigation with the Supreme Court’s decision and again noted that there was no news on a pending distribution:

Conversations with management indicate that the annual burn has recently run between $200k-$300k including litigation expenses.  There are currently only two part-time staff and one director. Because there are multiple defendants working jointly in the City of Phoenix matter, overall litigation expenses for EDCI have been less than if EDCI were defending this matter alone.

Based on a recent conversation with management, we arrive at an estimated 6/30/18 cash balance of $3.4mm and a projected go forward annual burn, excluding any litigation settlement cost, of $250k.

Possible Outcomes

We see two outcome scenarios:  Summary judgment granted and Continued litigation/Settlement.

Scenario 1: Summary Judgment

Based on the information in the Developers’ Motion related to the recently discovered contracts between Developers and the City, we believe there is a reasonable chance for Summary Judgment.  The timing for such a ruling, however, is uncertain.

A footnote in the Motion (page 21, note 12) indicates there is the potential for EDCI/Glenayre to recover attorney’s fees if they are successful in summary judgment.  We have not included any upside for this.

Scenario 2: Continued Litigation/Settlement

The Motion for Summary Judgment may fail.  If it does, and if EDCI is faced with more litigation to resolve the issue, the Company may choose to continue litigation or settle.

According to the Motion, the City of Phoenix seeks indemnity for approximately $1.6mm in attorney’s fees and costs, plus $500k paid in settlement of the Tarazon litigation.  The City is pursuing its claim actively against 16 Developers of which Glenayre is one. If Glenayre paid 1/16 of the requested amount, the cost would be $131k. However, based on a footnote in the Motion (on page 8) it appears that some of the 16 “served” parties may have already settled with the City.  As you will see below, we have increased this potential EDCI/Glenayre cost of settlement considerably as we do not know ultimately how settlement cost could be allocated/negotiated and what continued litigation would cost.

In 000s, except per share.  EDCI purchase price assumed to be 8/29/18 ask.

Why is EDCI Cheap? (let me count the ways….)

• Company in liquidation
• Thinly traded
• Dark
• Litigation - and we had to make public records requests to get documents
• Patience is required

Risks

• Thinly traded with very low liquidity
• We have yet to see a response to the Motion for Summary Judgment from the City of Phoenix  
• The Motion for Summary Judgment could be denied and EDCI might have to settle with the City in Tarazon matter
• While the Company’s outside counsel and management indicated they have, to date, found no records of any other projects similar to those in which Tarazon was involved, there is a tail risk that other lawsuits could appear.  A settlement/deal with the City of Phoenix that involved indemnification for EDCI/Glenayre for future matters could be more costly
• There are no recent audited financials. However, we have spoken with the acting CEO/CFO over the years and reported changes in cash balances are consistent with the Company’s representation of annual cash needs

Note: The company “closed its transfer books” effective 1/23/13.  However, there are still market makers in the stock OTC including NITE, CANTOR, MAXIM, CANACCORD, CITADEL

• From 9/4/13 press release:

Catalyst

• Ruling on Motion for Summary Judgment
• Final distribution