Description

Intro

Crosswinds Holdings Inc. (“CWI” or the “Company”) is a classic “net net”, or as certain godfathers of value investing have coined it “a cigar-butt” with a free puff left in it. Like most of these situations, it is small and illiquid (and underfollowed), thus making it only suitable for those of you who can trade PA ideas.  

In an nutshell, CWI offers an 22% return to net cash in the bank, with further upside based on any value ascribed for NOLs and its remaining business.  All the positives that you look for (and are typically not present in micro-cap land) are here: significant insider ownership and alignment, returning cash to shareholders via buybacks, risks of dilutive acquisitions, etc.

The near-term catalyst is that the Company reports Q4 results in the next few days, which should at least note the increased cash holdings on a pro-forma basis. Q1 results should have the cash as part of the Balance Sheet, which would then make the Company screen very well.

Summary

CWI’s balance sheet is not accurately captured by Bloomberg / Thomson / Capital IQ.  Bloomberg shows it as having an Enterprise Value of CAD$11.6mm. In reality, CWI actually has a negative EV.

Here is my calculation of EV:

The difference is that Bloomberg is not capturing a corporate transaction whereby CWI sold its principal asset, an ownership interest in Monarch National Insurance Company (“MNIC”). MNIC is a Florida-based property and casualty insurance carrier and CWI sold its stake in it to its joint venture partner, Federated National Insurance Company (NASDAQ:FNHC).

The deal closed on Feb. 22, and the cash is in the bank (see here: http://www.crosswindsinc.com/investors/news-releases/news-releases-details/2018/Crosswinds-Announces-Completion-of-Sale-of-Interests-in-Monarch/default.aspx).

Note that CWI received $10.5 million USD, whereas the Company reports in CAD and stock trades on the Canadian exchange.

There is no tax drag on the sale proceeds, given that CWI basically sold this asset for what it put into the business. As a source of further upside, the company does have CAD$17mm of non-capital loss carryforwards, with the earliest expiry in 2029.

Valuation

A very straightforward calculation, but I figure the stock is worth CAD$2.32 without ascribing any value to the NOLs or the remaining businesses (which arguably have some positive value). For example, CWI has entered into a consulting agreement whereby they are entitled to earn USD$300k in fees with FNHC.

Risks

The biggest risk in these micro-cap situations is typically an agency-principal conflict, where the management team does not want to lose their jobs and therefore continues burning cash while looking for an acquisition.  I will address these in turn:

1. Agency-principal conflict -  as luck would have it, this is one of few micro-cap situations I’ve seen where there is both a significant margin of safety, as well as alignment of interests between management and owners. Colin King, the CEO, owns 52.9% of the shares outstanding (via CDJ Global Catalyst). He is the largest holder by far, and appears to be taking a very pragmatic owner-centric view to the outlook for CWI.  One of the top priorities for the company is to continue to engage in share buybacks so long as they are accretive to net asset value per share. The company filed a Normal Course Issuer Bid with the TSX in Sep 2017 and has been actively using this to buy back shares below cash value (for those of you with Bloomberg, the Company has been buying through Integral Wealth). Note that the buyback has been on pause since the MNIC deal was near-closed; I believe this is due to a combination of black-out from the deal as well as approaching Q4 results.  

2. Cash Burn – the Company currently has a cash burn. In the 9 months ending Sep 2017, they burned $1.4mm.  I expect this will go down significantly as the Company should reduce the size of its Board. As well, the costs of the business will change from a holding company into more of a cash shell. I figure the cash inflows from their consulting agreement will partially offset cash burn in 2018.

3. Acquisitions – the Company has stated that they are looking at potential acquisitions, particularly in the asset management / insurance business. This is a real risk, as it is with most companies, but I gain comfort here over the fact that the CEO owns 52.9% of the Company and is unlikely to do anything to destroy his own value.

Catalyst

1. Reports Q4 results in a few days, which will note the close of sale of their principal asset. Q1 results in May 2018 will definitely show a significant increase in cash, giving the company a negative Enterprise Value at current share prices.
2. Continuation of share buybacks - which I believe have been put on pause due to black-out from the asset sale and pending Q4 results.
3. Potential Substantial Issuer Bid / Dutch Auction to return asset sale proceeds to shareholders.