Cadus Corp. (fka KDUS)

[Wildbilly]

Cadus - Still A Net-Net Even After Management Completely Transformed The Company

Summary

Cadus remains a net-net, with cash and liquid real estate exceeding the market cap.
Management has so far shown very fast execution and already acquired a full portfolio of real estate assets.
Due to strong downside protection risk of permanent loss of capital is minimal.
Next catalyst will be the sell-down of properties which will show how profitability the acquired assets can be flipped. I would expect the markups to be in double digits.
I have already covered Cadus (OTCQB:KDUS) back in June. The recent pullback in the market brought the share price slightly below the levels where I have initiated the position, which warrants another look at the company. Quick recap of 3 key aspects of my initial investment thesis:

- Cadus is a net-net that recently switched from the shell company status and got engaged in real estate flipping/development business;

- Cadus is trading below cash+real estate at cost value. Operational cash burn rate is low and company has a further $20m in NOLs.

- Carl Icahn is majority (68%) shareholder and recently doubled his stake at $1.53/share and placed his son-in-law as CEO. Carl Icahn must truly believe in prospects of this business as otherwise this $25m investment would not be worth his time.

The latest quarterly report reveals couple interesting details about business of Kadus, these are detailed below.

Real Estate acquisition spree is completed

The company indicated that it does not intend to purchase any further properties until it monetizes the existing portfolio. As of August 2014, company had 10 residential properties (8 with homes and 2 vacant lots) which were acquired for $23.3m. In addition it had contracts to purchase two further vacant lots for $6.3m. As these contracts were expected to close in August, I assume they have gone through. Thus as of now Cadus should have 12 properties with a combined cost value of $29.4. Taking into account the recent purchases, the remaining balance sheet cash should stand at c. $12.5m.

Thus the company managed to complete the entry into the new business in less than 8 months, which seems to be quite efficient. I think the key to the speed was the expertise and local market insights of Bayswater Brokerage Florida, which is owned by Carl Icahn and provides free brokerage services for Cadus. The only problem is I did not manage to find any further info about this brokerage and the only thing that is clear about this relationship is that Cadus has saved / will save substantial brokerage fees on the real estate transactions.

Uncertainty increases - no longer a pure property flipping business

I initially had an impression that Cadus is purely involved in property flipping business and one of my valuation scenarios had it flipping properties two times a year at a premium. I do not consider this to be a viable assumption any longer. In the quarterly report Cadus indicated that:

"With respect to the Company's existing inventory of properties, three existing houses are under renovation and five others are being demolished. The Company is the process of engaging architectural firms with respect to the properties undergoing demolition as well as for its vacant lots."

I was expecting Cadus to invest a bit in renovation of the acquired real estate and then flip it shortly. What the management is doing instead is demolishing the houses in 5 properties and hiring architects for the vacant lots. This raises four concerns/questions for me:

1) It is no longer clear what is the business model of the company. Is Cadus going to sell the empty lots with some kind of architectural plans on top of that? Or will the new residential houses be built on each vacant lot? At the moment I can speculate what the final outcome will be.

2) Turnover of the existing property portfolio will not be as fast as initially expected as demolition / new house building clearly a much longer process than a simple real estate flipping.

3) These real estate development activities will require further investment. At the moment company has $12m of cash. Big part of this will be consumed by renovation on the 3 remaining residential buildings, demolition work and architect fees. On a flip side, these expenditures should increase the value of the properties by at least the amount spent.

4) If new homes will be built on the 9 vacant lots, how will these be financed? Clearly the remaining cash-pile will not be sufficient for that. Cadus could quite easily obtain bank credit (collateralized on its existing properties) for any further development. However, this would already be a drift from my net-net investment thesis with the added complication and risks from leveraged real estate. Also Cadus CEO does not have any expertise in house building, which raises questions on whether this can be carried out successfully and create value for shareholders.

All of items listed above increase the uncertainty of investing in Cadus, but this is not necessarily a bad thing. Cadus has very strong downside protection (risk of permanent loss of capital is minimal, see next section) and in such cases higher uncertainty translates directly into higher expected returns with hardly any change in the risk.

Side note: I recently had a chance to skim through Monish Pabrai "Dhandho Investor", and one of his core principles is investing in high uncertainty and low risk businesses. Cadus seems to fit this principle well.

A very strong downside protection

The company's balance sheet is now comprised of $29.4m in real estate, $12.5m in cash. Additionally Cadus has $20m in NOLs. This cash is unlikely to remain on the balance sheet for long and will most likely be used to increase the value of real estate portfolio through renovations, architectural planning or new house builds. Overall enterprise value is unlikely to change much and will remain at around $42m as the cash burn and administrative expenses are minimal. Investors can now purchase this business for $38.5m (market cap of Cadus), so at 8.5% discount and on top of that get all NOLs for free (I estimate value of NOLs in the range of $5m-$7m). So Cadus is still a clear net-net.

One could argue that real estate is illiquid and therefore deserves certain discount when added to the balance sheet. That might be true for some companies, but is definitely not the case for Cadus:

- Cadus purchased this real estate only for the purpose of selling it at a better price. So liquidation of these assets is expected in the short term;

- The real estate that Cadus purchased is very liquid. All properties except one are located in Miami-Dade County Florida, which is an active real estate market. E.g. Trulia indicates there are 590 land lots for sale in the county out of which 54 are above $2m price tag. The number of homes for sale stands even higher at 44,000. High real estate market activity is also confirmed while looking at Zillow's properties recently sold within the county.

- The price of the land lots and houses purchases is unlikely to decline sharply - real estate prices are only 33% above the lows of the crisis and would need to increase by another 50% to reach the exuberant levels of 2007.

(click to enlarge)


Source: S&P Dow Jones Indices

With all above said I would consider real estate on Cadus balance sheet to be close equivalent to cash with one crucial difference - real estate assets provide more upside than the cash.

Conclusion

Cadus remains a net-net, with cash and liquid real estate exceeding the market cap. Management has so far shown very fast execution and already acquired a full portfolio of real estate assets. Due to strong downside protection risk of permanent loss of capital is minimal. Management appears to have wider agenda than a simple property flipping, which should drive the expected returns higher.

The next catalyst will be the sale of one the properties which will show how profitability can the management flip the acquired assets. I would expect the markups to be in double digits.

So far this is mostly speculation on what exactly the management is going to do and how high the returns are going to be. The only thing certain is that with Cadus trading below liquidation value, I have nothing to lose by parking some cash in this company until situation becomes clearer.

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The Company - Cadus Corp. (OTCMKTS:KDUS) | Seeking Alpha
http://seekingalpha.com/article/2579585-cadus-still-a-net-net-even-after-management-completely-transformed-the-company?uprof=.

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