Kobex Capital (C$0.53) – Some cash and a few shares at 30% off

Disclosure: One of the authors owns shares of this company and the other is holding out for a better price. You should conduct your own due diligence for this investment and, frankly, any investment you make.

Sometimes companies have an identity crisis. Sometimes these companies are public. Kobex Capital is one of these companies and they are running out of time.

Kobex Capital (“Kobex”, the “Company”) is currently a shell company based in rainy Vancouver, British Columbia, that is trading at a ~30% discount to net assets with a near-term catalyst. Kobex was a former mining exploration company that sold its interests for cash and although it has since made some small equity and debt investments, most of its assets are held in cash. The company was in the middle of trying to find a new identity (i.e. something to do or buy) but ran into some trouble following a campaign from a new activist shareholder, Kingsway Financial. Kingsway owns owns 14.95% of the Company and attempted to effectively wind up the Company (see below). Kobex fought back and won but only temporarily .There is now a February 2016 deadline for a strategic review, after which time it will i) distribute all assets, or ii) carry out a “strategic transaction,” both prior to March 2016 and subject to shareholder votes.

Net Asset Value

As of 09/30/2015 Kobex had current cash on hand of $28mm and a liquid equity investment of $4mm. Current cash burn is at ~$300-400k/year. Kobex also has $34mm of capital and non-capital tax losses, though these are off-balance sheet as the Company has no operations.

There are no material on-balance sheet liabilities, and we have not found any off-balance sheet/contingent liabilities other than i) an estimated ~$0.5mm of legal costs discussed below, which were incurred in 4Q 2015 resulting from a new activist shareholder’s lawsuit, and ii) likely another ~$0.5mm of costs from 4Q 2015 – 1Q 2016 including wind-up costs.

Kingsway Financial background and Sprott Inc involvement

In 2015, Kingsway bought a 13.1% stake in the company, and stated its intention to replace the Kobex Board and buy back stock. The Company then instituted a poison pill effective if any shareholder purchased more than 15% but made the exception for an existing large 18.5% shareholder (Sprott Inc) as long as the latter did not buy an incremental 0.1% stake. So Kingsway raised its stake to 14.95%, and it later came out that Sprott’s CEO, Rick Rule, tried to purchase another 2.5% through a private placement. Kingsway, which still owned less than 15%, argued this should have triggered the poison pill. Kingsway ended up taking the issue to court and lost, which will likely result in a material legal cost to Kobex recognized in Q4 – our estimate is a few hundred thousand since it went to the BC Supreme Court. This sums up what happened in the court ruling:

http://www.blakes.com/English/Resources/Bulletins/Pages/Details.aspx?BulletinID=2232

Sprott Inc has been a long-time shareholder, and Rick Rule was on the Board when the Company was still involved in mining exploration. Sprott opposed Kingsway’s plan, which then triggered the above-noted strategic review deadline.

Possible Events

1) Wind up - To us, the most risk-free decision from the Board would be to wind down and distribute its cash back (including its $4mm in stock in Mountain Province Diamonds, a $600mm market cap stock), despite the fact that there are tax loss carry forwards.

2) They buy something - Another possible option is that Kobex invests its cash in something, presumably metals & mining-related. There is a possibility that Kobex happens to find a Sprott-related company to invest in. We view this as our downside scenario, though we believe that at least Kingsway’s 15% stake will tip the balance of probabilities to at least a reasonable option if not a wind-up scenario.

In any case, compared with total NAV (again, consisting mostly of $28m cash - minus, say, $1m for the legal dispute and wind-up costs if the company goes that way - and the $4m equity investment is liquid enough to sell) of $31m, the market cap is $24m. There are stock options, but currently not dilutive as their strikes are either at or above current market prices.

Valuation (Assuming C$0.53/share average cost)

The upside is about 30% in 2 months if they wind-up. Downside is somewhat unclear, but can take some comfort in that discount to NAV, and knowing at least one major shareholder will push for a quick monetization option.

Kobex’s multi-year low is $0.46/share. If we assign a 50% probability to upside and assume Kobex will fall to its multi-year low as a downside, we come to an expected upside of ~7% over 2 months, which is ~50% on an annualized basis.