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Gal^Stad
Investments Inc.

spacer April 2007
Commentary

If the Contra portfolio were a movie, it would be the slickly edited version that gets released in theatres. But making a feature film involves shooting a lot more footage that ends up consigned to the cutting-room floor. Enterprising movie producers have taken advantage of the enormous storage capacity of DVDs to include all kinds of special features, including director's cuts, alternate endings, deleted scenes, interviews and bloopers.

This issue of Contra, in keeping with our regular April pattern, takes a look at stocks on the periphery that one or both of us own, but for various reasons didn't achieve the necessary consensus of opinion to merit inclusion in the portfolio. Some of what follows will be an update on enterprises that have been mentioned in previous years.

We begin with companies we both currently hold, though they may have been bought at different times and varying prices.

The end of the line is near for Clean Power Income Fund. For years the trust has suffered as the runt in a litter of power utility porkers, but its efforts to find a strategic partner have been in vain. Clean Power hoped that simplifying the business by getting rid of the GRS landfill power division and "firing up" the new Erie Shores wind farm would finally make it attractive enough to attract a suitor. It worked -- sort of -- but the terms of the deal that was negotiated betray more than a hint of desperation.

The buyer is good ol' Algonquin Power Income Fund, a trust we respect and know well, and one that we have owned off and on over the past several years. The proposal is an exchange offer that would see each unit of Clean Power swapped for .6152 units of Algonquin plus a contingency value receipt. Just how much this package is actually worth is a matter of conjecture. With Algonquin trading at $8.63, that portion can be currently valued at $5.31, but as the name suggests the remainder is contingent on some sticky factors.

When Clean Power sold the GRS facilities for $90 million USD, $7.6 million was placed in escrow until the buyer was assured that everything was copacetic. An additional $3.4 million was also tossed into the pot as Erie Shores qualified for a new government subsidy for renewable energy. This works out to seven cents per share. If the rest of these monies are collected, Algonquin will pay Clean Power shareholders another 20 cents a unit.

We plan to tender our units to the offer, which has a deadline of April 23 and requires a two-thirds majority to pass.

How about adding a trust that is a rock-bottom performer and openly loathed for its incompetence? No, we didn't nibble at the embattled pet-food maker Menu Foods; our contrarian credentials were burnished by adding True Energy, a trust that has been in the headlines for all the wrong reasons.

First, management realized that the distribution rate was too high, so they cut, and cut, and cut some more. Next, given the proposed government regs, True Energy decided to become the first trust to be reborn as a regular corporation. Dissidents pointed out that Ottawa hasn't passed any rules yet, and besides, even the tax proposal currently on the table doesn't take effect for four years.

We agreed and voted against the motion, and were de lighted to see that it failed. The trust has an impressive list of assets, and if management can succeed in raising production and dealing with the muddy balance sheet rather than being distracted by the corporate-structure issue, it has the potential to do well. Nevertheless, because of the debt level relative to revenues, this one is riskier than most of our investments.

Hartco was another high-payout trust picked up in the $3.02-to-$3.46 price range, down from a previous high of $5.10. One could argue that computer and telephone retailing is an awful fit for the trust model, but at least Hartco's management has the distinction of not foisting overpriced units on feckless investors; in 2005 they simply swapped common stock for units on a one-for-one basis. That corporate-tax thing.

The company was an old favourite of value investors, sporting low price/earnings, price/book and price/sales ratios while paying a moderate dividend. But since its conversion, annual distributions of 60 cents, especially while computer sales were down the tubes, have put Hartco in the hyper-aggressive camp. So far, the naysayers have been staved off and payments have not been cut, but with revenues down 12.2 percent last year and the CompuSmart division on the disabled list, a reduction to a more sustainable rate seems reasonable. However, the firm is shopping CompuSmart around, and perhaps a buyer will be found to take the whole salami.

Medisolution, a microcap software firm specializing in the healthcare market, was acquired at between 16 and 21 cents. Just after the turn of the millennium it traded at better than 15 times this price, but that was before the share count ballooned to its current level of 157 million, primarily due to conversion of debt by Brookfield Asset Management.

Detractors would say there is little to like about this dog, and the market response suggests they're right. However, the balance sheet contains little debt and the firm is a Canadian leader in its field. It has always been able to muddle along and pay the bills, and as long as Brookfield will support it, there's a good chance that that will continue to be the case.

The relationship with Brookfield is of particular interest; not so long ago, shares were bought back above market value at 34 cents. It was a questionable move from a business point of view, but they might do it again, and perhaps in larger numbers. In addition, restatements of past revenue should have the effect of pushing sales into 2007-08, making upcoming numbers look better. That could come in very handy, as a big chunk of the loss carry-forwards expire in 2008.

Finally, we both completed the sale of our positions in Stratex Networks. This was a very profitable play, though it would have been better to wait for the takeover from Harris, the same outfit that took out Leitch.

Next up, companies that only one of us currently owns. Sun Gro Horticulture Income Fund had a very successful year in the peat moss business, generating a record level of income and distributable cash of $24.3 million. The payout ratio, which was a very tight 99 percent in fiscal 2005, was slashed to 82 percent for 2006, which is lovely to see, though one year with a poor harvest could undo that progress easily.

The number of management and insiders who continue to accumulate units is astonishing; the SEDAR filings look like a page out of the telephone book. Some managers are even buying for their spousal RRSPs -- now that's sticking your neck out! One little ace in the hole for Sun Gro is that the corporation still has tax-loss carry-forwards. These haven't been needed under the current business-trust structure, but should the new tax proposals be implemented, they may come in very handy.

When RioCan was first mentioned in April 2004, units were trading at $14.50. The positives were good management, diversified geographic locations and high occupancy rates. Since then the units have moved to $24.84 and paid out a total of $3.83 in distributions.

All through that time, the main worry was that commercial real estate has had an extraordinary run and is overdue for a breather. Well, that really seems to be the case now, yet an annual review of RioCan's business offers compelling evidence that the REIT is in excellent shape to weather a downturn, as management has been anticipating one by reducing leverage. Is it enough?

RioCan will be monitored more closely for an appropriate time to be sent out to pasture, but for the time being this prize Holstein of cash cows will continue to be milked.

Norsat is a little satellite-equipment company that has been one fun roller-coaster ride. First bought in 2004 at 57 cents, it quickly gained orbit and about half the position was sold at $1.24. Last year it returned to earth with a thud, and the holding was quadrupled at 60 cents after Dr. Aimee Chan was promoted to CEO last September. She seems to have the right stuff to stop the revolving door of people who have come and gone from this position, plus the ability to reinvigorate the company.

Revenue for 2006 was $15.3 million, down from $18.1 million in 2005, but the fourth quarter saw sales jump and the outfit turn a profit. At a buck, the shares are getting pricey and would be more interesting if they cooled down.

Another that registers in the thinly-traded department is American outfit Spar Group. This company specializes in helping retailers develop in-store promotions and monitor product sales. It's a decent-sized business, with sales of $57.3 million in 2006, up from $51.6 million in 2005. The company has been meandering around the break-even point but is counting on an increased international presence to kick things up a notch.

Amongst the top brass there is uncertainty, as CEO Robert Brown will step aside when a replacement can be found. However, he will retain the chairman's seat. The stock was purchased from $1.04 to $1.21, a far cry from the $5 mark it has hit at various times in the past decade.

Teamstaff is in roughly the same headspace as our Contra holding Analysts International. There have been management changes, bringing in what appear to be good people. Operating slightly under break-even, this enterprise has revenues of about $75 million and a crisp, clean balance sheet. Purchased at $1.25, the company is doing the dance of strategic options and, if successful, could be history at a premium -- soon er, rather than later.

An interesting diamond play is Stornoway. After a bitter battle, the company successfully took over Ashton Mining to add to its earlier purchase of Contact. The explorer now has a number of promising candidates for the next commercial diamond mine in Canada, so the law of averages would seem to dictate that it'll hit the jackpot somewhere. Miner Agnico-Eagle holds a substantial interest.

South American Gold has confirmed its perennial canine status. New management is trying to jumpstart a joint venture with Anglo American, and a recent private placement worth $1.4 million provided enough cash to pay off some debt and keep the lights on. That will tack about another 28 million shares to an already bloated float, which may ultimately lead to the dreaded consolidation.

South American does appear to have an excellent property in Chile, though, and it was in production mode before an avalanche hit, forcing its closure. The facility will likely be operational again before the end of next year.

Stressgen hopes that it will have better luck with its new moniker, Nventa. Adventurers might find this an interesting spec, but others (particularly the less genteel) might simply conclude it's the same crap in a different pile. However, it continues to be held in the dogged faith that the Golden Fleece will yet be found buried under that steaming heap.

In the final category, companies mentioned in previous commentaries that only one of us owned, but have now been sold.

Atlas Cold Storage accepted a takeover offer from Icelandic Avion Group. The $583 million offer ($7.50 per unit) was a pretty good gain and a few distributions were thrown in to boot. Some unitholders complained that the price was too low, but there does seem to be something appropriate about the Icelanders being giants in cold storage. (For our reader in Gimli, we cite the immortal words of that Bard of the Bourse, Foghorn Leghorn: "That's a joke, son.")

Consolidation was the name of the game in the mining industry last year, and the ranks of the middle-tier gold producers became quickly depleted. That helped move Kinross up smartly, as it bulked up through its takeover of Bema Gold. The stock was sold at $16.65 for a 440-percent gain. Given the consolidation in this sector, Kinross could yet turn from hunter into prey.

The plug was pulled on network-solutions provider Verso Technologies at $1.05. After nearly drowning in shares, Verso made a couple of post-consolidation stabs at a higher price before returning to the usual form. With the stock now back under a dollar, the company's listing is once again in jeopardy.

Another danger with this company is a high-interest loan from Laurus Master Funds, the same sharks who have tapped into Cygnal.

Another one that got the boot was Twin Mining, sold at nine cents, less than a third of the purchase price. The firm is in the process of trying to reinvent itself, shifting focus from diamonds to gold and rechristening itself Atlanta Gold (sounds like an Arena Football League team).

There's also a fresh management slate and a 15-for-1 reverse split. Given the bad karma this explorer has accrued, it will have to do a lot better in this incarnation to atone for the sins of the past. Perhaps uranium or plutonium will be the future choice.

Bioresearcher Migenix was dumped for a spindly gain at less than the 75 cents where it trades now. Though the company was able to raise another $11.6 million in a private placement in December, the cash-burn rate is fierce. Given that licence revenue is nil, these guys will likely have to go back to the well in order to continue research.

A biotech spec that worked out -- for a brief shining moment, anyway -- was Inflazyme Pharmaceuticals. In January the stock spiked on rumours of positive results for a critical phase-two clinical trial of a new asthma medication. During the flurry, the entire position was sold for just under a double at 24.5 cents.

A good thing, too, because a few days later the stock hit the wall when the study results were officially an nounced -- and 70 percent of Inflazyme's employees got pink slips a week later. These days, you can buy a share and get change back from your dime.

As it turns out, the new medication did "work" quite well, but in one of those mysteries of science, the placebo had equally good results. Conclusions: if you have asthma, just joining a clinical trial seems to help your condition; and if you own a speculative biotech stock, strike while the iron is hot, because your profit may evaporate while you sit in the waiting room.


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