P10 Industries Inc. (PX)

[BioHunter]

$PIOI DD thoughts here:



TAX CREDITS
First a slight correction to my last post, P10 has to be the “acquirer” to unlock NOL’s value. Normally one would target a company that has steady and strong history of high margin pretax earnings. See below excerpt from the bankruptcy filing

https://media.wix.com/ugd/cd6d58_d6fe4a9d8f4f46a4841a830cdfdf5235.pdf

the Debtor has U.S. federal income tax net operating loss carryovers (“NOLs”) of approximately $274.6 million and research and development credit carry-forwards of approximately $4.1 million, each as of December 31, 2016 (“Development Credits” and together with the NOLs, the “Tax Attributes”). The Debtor is operating its business in a manner that is intended to preserve these Tax Attributes for use in reducing future income tax liabilities.

R&D tax credits are a General Business Credit and are carried forward on a rolling 20-year basis from the year in which they are claimed. In some cases, the Credit can be carried back and in the event, that the credits are not fully used at the end of a 20-year period, they become a deduction in that year, which in turn would create an NOL carry forward.

The R&D tax credits can be used to offset any Federal Income Tax due that would not be covered by the NOL’s and could potentially be used to offset some payroll taxes (in limited cases) even if a company is not profitable.

Unknown and not core to my trade thesis is whether any State NOL’s or R&D tax credits exist, these could only add to the value of the Tax Attributes.

See below comments about NOL limitations if an “ownership change” is triggered

PATENTS
The useful life on many of the patents is getting short and I have not been able to get a handle on value or monetization opportunities. My base valuation assumption is the $3.5m which is in the bankruptcy filing (link above), here is an excerpt below.

In the fall of 2016, a study was conducted on the Patents by patent expert Jack Lu, PhD, CFA, the Founding Partner and Chief Economist of Intellectual Property Market Advisory Partners LLC. Dr. Lu concluded, through extensive analysis, that the most likely valuation of the Patents (not including the foreign patents), was in excess of $3.5 million. As is typical in patent analysis, there were plenty of caveats, which could make the patent valuation either materially higher, or lower. Importantly, however, Dr. Lu concluded that the Patents covered technology that can be adopted in a wide range of fields of use, including industrial and commercial building, process control and automation, and certain areas of manufacturing.

Since the study conducted by Dr. Lu, the Debtor has engaged Novelty Capital LLC (“Novelty”) to assist the Debtor in pursuing a targeted plan to monetize the intellectual property covered by the Patents. The Debtor and Novelty have agreed upon a multi-phase plan that involves 1) reviewing technology related to the Patents to determine evidence of use; 2) preparing detailed claim charts, conducting validity and financial analysis to determine fair market values for the Patents; 3) preparing a monetization plan for the Patents, including potential sale or licensing; 4) searching for, identifying and sourcing potential patent sale and licensing opportunities; and 5) structuring each individual patent transaction.

The Debtor and Novelty expect this process to take time. Initial progress has been encouraging, with early phases of the plan already complete. Going forward, the Debtor intends to vigorously continue pursuing the business plan of maximizing the value of its intellectual property. The Debtor believes the ultimate value for the Debtor’s stakeholders could be material. Moreover, given the nature of the intangible assets involved, the Debtor and Novelty intend to be thoughtful in their approach. The optimal path for monetization may differ for each patent: for some, a sale may be optimal; for others, licensing may generate the highest net present value; and for others, a contribution to a joint venture with other “related patent” holders may make the most economic sense for the Debtor’s stakeholders. The Debtor intends to fully explore every option in pursuit of a detailed and nuanced plan that seeks to maximize value for its stakeholders.

P10 is clearly motivated in the bankruptcy court to have lower assets and higher liabilities, so I think it is safe to assume management and those more “in the know” think the patents are more valuable than $3.5m Some of the high price target speculations you see, seem to be from optimistic views on patent value. It’s not core to my trade thesis.

VALUATION/PRICE TARGET
My napkin model is the following value PER SHARE for these assets (using a 47M fully diluted post-bankruptcy common share count, including dilution from new investor and issuance of new options to CEO and net of most current options being retired)

Federal NOL’s (at 35% Corporate Tax Rate) - $2.05
R&D Credits (at Par Value) - $0.087
Estimated Value of Patents (based on $3.5m above) - $0.075

Old Cash Post Bankruptcy (estimated at $500,000) - $0.01
New Cash ($4.654m from 210 Capital) - $0.10

Gross Value $2.32 PER SHARE post-bankruptcy and deal, now fun part… what discount rate do you want to give to those assets today. I am going to use 50% which many would argue is high, that gives me PV of P10 today $1.16 PER SHARE

Next logical question is how is that unlocked. My view is coming out of bankruptcy at the end of April will begin that process, but I would not assume necessarily we get a revaluation at that point, it’s really step one. It’s more about what asset/company P10 has or does not have lined up to acquire that will allow investors to better model the future value and apply DCF which would take into account the present value of the Tax Attributes.

We have no idea how far along P10 is targeting in an acquisition, my base assumption is they already have a target which probably allowed them to find the lead investor 210 Capital, LLC. But we really don’t know.

Next value creation point is a better understanding of the patent value and how and if that gets unlocked. I really can’t say so my model is only showing a 50% discounted $0.075 which I am sure many of those following the story would take issue.

RISKS
Besides the standard…there are always lots of risk from confirmation bias to forward looking blah blah blah, here are some that I think one should take into consideration.

Braker Facility Lease - technically the lease could not be assigned or sub-leased without consent of landlord.

https://www.sec.gov/Archives/edgar/data/1044435/000089924301000587/0000899243-01-000587-0002.txt

The Asset Purchase Agreement with Langley contemplated that Langley would lease 100% of the space for 12 months and would lease one-third of the space for the remaining term of the lease (until 2021) and required the sub-lease as a condition of closing.

https://www.sec.gov/Archives/edgar/data/1044435/000104443516000139/acpwexhibit21assetpurchase.htm

At the Closing the Buyer shall enter into a sublease of Headquarters Facility. The sublease of the Headquarters Facility will provide for a sublease by the Buyer of one third of the rentable space of the Headquarters Facility for the full remaining term of the prime lease and for a sublease of the balance of the rentable space for a term of twelve months, subject to early termination of the sublease of the balance of the rentable space if the Seller or the landlord finds another tenant willing and able to rent the space. The rent payable and other obligations of the Buyer thereunder shall be the same amount per square foot rented that is payable by the Seller under its prime lease of the Headquarters Facility.

Prior to closing, the landlord did not consent to the sub-lease but Langley agreed to waive the requirement (along with a few others) and closed the deal with a Letter Agreement

https://www.sec.gov/Archives/edgar/data/1044435/000104443516000161/exhibit101closing.htm

Waiver of Requirement to Enter into a Sublease. Pursuant to Section 4.8 of the Asset Purchase Agreement, at the Closing, the Buyer and the Seller shall enter into a sublease for the Headquarters Facility. The Parties hereby waive the requirement that the Buyer and the Seller enter into a sublease for the Headquarters Facility prior to the Closing. The Parties hereby agree to use their commercially reasonable efforts to reach a mutually agreeable solution to the issue of the Buyer’s access to the premises located at the Headquarters Facility within thirty (30) days of the Closing. The Buyer hereby agrees to remit to the Seller all rent and building and facilities expenses associated with the premises located at the Headquarters Facility for each month the Buyer has access to the Headquarters Facility.

Between the closing with Langley and the bankruptcy filing, no deal was reached with the Landlord and P10 / Langley needed to find a solution that would eliminate the liability for P10 and give Langley access to the space as long as they deemed necessary. Meanwhile, Langley has been paying 100% of the lease amounts to P10 who has in turn been paying the landlord.

The Langley RSA provides for the terms by which the lease will be assumed by P10 and then assigned to Langley.

http://docs.wixstatic.com/ugd/cd6d58_30414d02f5324d5ab5429c9ee3a1f8e8.pdf

My read of Bankruptcy law and the history around this liability leads me to believe that this important hurdle will be resolved thru the Bankruptcy process, which I general provides that even if a lease is not assignable without consent, the Bankruptcy laws will allow it to be assigned (without landlord consent) permitting that the assignor (P10) can provide “adequate assurance” that assignee “Langley” can perform under the financial obligations of the lease, which a quick read of Langley’s most recent annual report will demonstrate that they clearly can.

Further, as a condition of the Langley RSA and in consideration for the cash that P10 will give Langley, P10 will be released from all liabilities related to the lease.

Lastly, it is in the best interest of all parties to allow the assignment to Langley who already intends to use the facility and in whole or part, but in the end this is still a risk….

Preferred Stock/Credit Facility - this is a big unknown. We don’t know the structure and conditions of the preferred stock that will be issued to the lead investor, 210 Capital, LLC. The RSA with 210 Capital, LLC does not get into all of the details around the interest rate and other terms.

http://docs.wixstatic.com/ugd/cd6d58_e1f08079db504bd68f8ceebe41e31682.pdf

One positive caveat is that the structure should not be convertible to common shares because it would risk an “Ownership Change” that would limit the use of the NOL’s, the terms would have to be “plain vanilla” preferred stock to avoid this problem.

Unknown timing of acquisition - NOL’s have little value until that happens and profits generated

Unknown value of patents – They could never be monetized before expiration or a buyer/licensee could never be found

Unknown Chapter 11 Roadblocks – The Chapter 11 plan is pretty straightforward and is progressing quickly, but if for some reason, it is delayed or does not come to closure at all, the Langley RSA and 210 Capital RSA could/would be amended or terminated.

Unknown terms of the preferred shares - as stated above, this has not been disclosed, I assume it's favorable the preferred shareholders

So in conclusion, the planned bankruptcy and subsequent coming out of bankruptcy with a completely clean corporate balance sheet is in my new the best way to unlock the value of the assets. To date I applaud how management is executing their strategy. BUT predicting equity valuation and price is difficult and predicting when the market will properly reflect the underlying value is even more difficult. I provide the above as my insights and it’s not a recommendation to buy or sell.

This is an interesting risk reward trade at current levels in my view, I think more or less management is executing well and after recent court motions they are setting up for a very clean post bankruptcy story where value gets unlocked reasonably quickly.

Finally, I believe there are not many trade-able shares as most are locked up in strong hands, so trade carefully, it's thin IMO.

-BioHunter



Appendix:

MAX SHARES
1,053,985 (4.5%) max shares –

http://docs.wixstatic.com/ugd/cd6d58_5ddfd24dd827449ea37264172e9717d8.pdf

This restriction is to help prevent an “Ownership Change” in the view of the IRS which would severely limit the use of the NOL’s going forward. This type of restriction is very common when a corporate shell has NOL’s to protect. The IRS rules on this subject are VERY COMPLEX and companies do all that they can to avoid violating them and losing the value of the NOL’s

4.5% is not really max shares, it’s the max you can have without registering as a “Substantial Shareholder” which will require authorization of P10 and other parties in order buy or sell shares.

Current shareholders with more than 5% are currently not able to buy/sell without approval of P10 and other parties so this will limit the float going forward.

One other advantage of the Chapter 11 route is that 210 Capital, LLC was able to acquire a large portion of shares in the company without triggering an “Ownership Change”

FLOAT
A quick note on the float. Based on the fact that Insiders and 5%+ shareholders will be somewhat restricted in selling their shares at least during the Chapter 11 period, the float is relatively small at this point and will be even smaller when the deal is completed, being that 210 Capital, LLC is in this for the long haul.



This is all my opinion and not a recommendation to buy or sell.
full disclosure in case you missed it, I am long $PIOIQ