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Investments Inc.

spacer April 2008

It has been a scary few months as the spectre of the credit crisis stalks the land. Like the feared guards of Azkaban, the Debt Dementors arrive with little warning and suck the happiness out of their victims, who thought making money was the inevitable result of their financial acumen, perhaps because they were confusing a bull market with brains.

The trendy "Implode-O-Meter" website currently lists 249 major lending operations, 22 home builders and 74 hedge funds that have failed. Former Federal Reserve chair Paul Volker calls it the "mother of all crises." Considering the scale of the economic problems he tackled in 1979, that's saying something.

The turmoil has not only lightened America's wallet, it seems to have twisted a screw in the national psyche. As long as Wall Street was swimming in money and homeowners blithely tapped the rising equity in their homes, popular sentiment echoed the famous credo of Ronald Reagan, "Government is not the solution to our problems; government is the problem."

How things change. Seeing these paragons of capitalism collectively pleading for a bailout by the state is something to behold.

In such weird circumstances, it is more important than ever for investors to be well diversified. The notion of absolute safety is an illusion. Even cash, which we like a lot, is not without risk. Just consider Zimbabwe. A year ago, Z$1,000,000 would get you a few cases of beer. Now, just bringing back the empties would net you Z$140,000,000. Z$500 bills are -- literally -- cheaper than a single sheet of toilet paper. One ply.

The Contra portfolio embraces a measure of diversification by covering various industrial sectors and by including small, medium and large companies. Outside of these stocks, both of us hold other property and assets that comprise a mosaic of risk tolerance.

So, as is our wont in spring, let's take a look at some alternative investments that both of us own. Some have been written about in previous Aprils, for those keeping a Contra library.

Hartco Income Fund has continued to be a lovely little money spinner. Since its inception, the fund has steadily pumped out distributions of 60 cents a year, which is extraordinary given that the units are trading at $3.40. Evidently, the market doesn't think that yield is sustainable, but that has consistently been its view since day one.

Last year, Hartco closed the ailing CompuSmart retail division. That turned a relatively rosy net earnings picture of $5.6 million or 41 cents a unit from continuing operations into a decidedly half-empty glass of a consolidated loss of $2.7 million. It also took a bite out of shareholder equity, but with no debt outstanding the book value still rings in at $4.40 a unit.

With the weak link excised, management is concentrating on business with better margins that require less inventory. Nonetheless, a slowdown in IT spending can be anticipated. If that happens, it will be a struggle to keep up distributions, but given that net cash flow in 2007 was about double the $8 million paid out, there's some margin left yet. This one appears to remain a bargain.

Our experience with True Energy Trust has been less fortunate. We both bought this one too early while the price was careening downwards, and deservedly so. Management overpaid for assets, got involved in a ridiculous proxy fight about converting back to a corporation last year and has consistently been unrealistic about distribution levels. That meant constant cuts, a killer for the unit price.

Nevertheless, we averaged down last December at $2.81 and we feel a lot smarter about this purchase. Ma­nagement has assured us the distribution of four cents can be maintained, but the numbers don't make it a slam dunk by any means.

The company is finally getting serious about repairing its overly leveraged state, and the sale of one of its properties was just announced, with the proceeds of about $40 million to be used to pay down debt. Four properties are still on the block. That will firm up the saggy balance sheet. It's also reasonable to expect that previous capital expenditures will finally bear some fruit. For aggressive investors who reckon that higher gas prices are on the way, True Energy may be worth a look.

Another trust that's a real headscratcher is Macquarie Power and Infrastructure Fund. We received these units in an exchange for Clean Power, and decided to hang on to them, at least for a while.

On the face of it, Macquarie has a nice spread of assets. There is a diversified mix of power generated by hydro, biomass, wind and natural gas, sold under long-term contracts. Leisureworld operates seniors' residences, which is an interesting demographic play on an aging population. Both areas should show some resilience in a recession.

Recently, there have been a number of articles characterizing the Macquarie empire as a house of cards and suggesting that an implosion might occur. No question, the fund has been very profligate, taking on a lot of debt. Leisureworld recently completed a $67 million acquisition of seven long-term care homes and wants more.

The payout ratio, which was under 90 percent in both 2006 and 2007, is forecast to rise to close to 100 percent. We've seen too many of these kinds of consortiums crash nastily after they reach the limits of growth. It will be necessary to go over the quarterlies very carefully and make a quick exit if trouble ensues.

In the micro-cap department, our play in health care software provider Medisolution is showing signs of life. For the first nine months of the fiscal year, new system sales were up 37 percent and overall revenue improved to $34.2 million from $30.9 million.

The bottom line continues to be sullied by writedowns of intangible assets, but at least now the debt is paid off and cash is building up. The fourth quarter is normally the company's strongest, so there is a good chance that annual results will be the best reported in years.

Some might recall that Norsat was promoted from this alternate pile last December to the Contra portfolio. It would be lovely to say the same thing about our other little satellite project, Mitec Telecom. Alas, that is not the case as there are still major problems. While losses have diminished, they are still large enough to use much of the funding that occurred in the recapitalization supported by major shareholders in 2006.

Revenues finally stemmed their decline and increased year over year this past quarter, but more sales are needed at good margins. This re­mains a high-risk, high-reward proposition.

The following are some selections that only one of us owns.

Another small fry is Spar Group, which we both owned but one dumped simply for tax loss reasons last year. This enterprise came perilously close to losing its Nasdaq listing after trading below $1 for several months. After three desultory quarters the company helped its cause with more appealing fourth quarter results. Revenues were up by 16 percent while expenses dropped by nearly the same percentage.

CEO Gary Raymond got a pat on the back for increasing international revenue. Raymond has been with the company less than year, so if this is indeed indicative of his influence, rather than a fluke, Spar should move ahead smartly.

Enerflex Systems Income Fund was purchased last December at $8.76 for income and exposure to the oil-and-gas-services industry. The Calgary-based company has been growing with major overseas ventures. Total revenues were $828.2 mil­lion compared to $792.3 million in the prior year, while backlog at the end of 2007 swelled to $290.2 million from $171.2 million at year end 2006.

Unlike many trusts, Enerflex has healthy bottom-line earnings of $1.22 per unit for 2007. Annual distributions to unitholders totalled $46.7 million, or just 54 percent of distributable cash flow, a remarkably low figure. Also unusual for a trust has been the steadily increasing book value, from $6.18 in 2003 to the current $8.08 a unit.

Time for a quick review of a couple of income generators mentioned last year. RioCan had another excellent year in 2007, allowing distributions to be nudged upwards for the 14th year in a row, to its current $1.35 per unit annually. Sun Gro Horticulture was less fortunate as it got sideswiped by the U.S. housing crisis.

What does a sub-prime mortgage fiasco have to do with peat moss, you ask? In a word: landscaping. A reduction in the number of new homes being built means there's less money being spent on fresh greenery. Sun Gro tightened its belt, halving distributions to 45 cents a year, a move management says is temporary. In response to the news, investors mowed the company down. Senior management and directors, feeling unitholders' pain, took a 10-percent pay cut -- something other struggling trusts ought to emulate.

How about a junior oil company with zero debt and a P/E ratio of less than five? What's the catch? Investors in Montreal-based Pebercan have to accept political risk, as these oil wells are in Cuba, and the communist country has been very slow at paying its bills.

But this danger was deemed acceptable as the era of the Castro brothers is drawing to a close and there is a good chance that conditions for the exploitation of Cuba's resources will one day multiply. One of the problems is that the oil from these wells is heavy and requires refining, which is no mean task given the restrictions imposed by the U.S. trade embargo. Pebercan is one of this Contra Guy's favourite positions, though it took a while to build given the low trading volume.

AMEX-listed NTN Buzztime makes interactive gaming machines that some of you might have played while quaffing pints at your local. The corporation has revenues around $30 million, and a clean balance sheet. The problem? They cannot seem to turn a profit, although black ink is getting tantalizingly close. Purchased last November at 72 cents, it looks bedraggled now at the 50-cent level, and the Initial Sell Target of $3.49 is a steep climb. However, this one does have lots of potential if the whole world does not become transfixed by DSs and the like.

Bioject Medical Technologies has been played for a gain and a loss and was repurchased at 50 cents in December. New management might provide salvation, but the turnaround must prove relatively quick or investors who keep ponying up cash might pull the plug, necessitating Chapter 11 proceedings. That would put this needle-free technology provider out of its long-term unsuccessful misery.

For those who want to dance and pray with penny plays, one of us has acquired a bevy of tantalizing possibilities, some of which could fulfill dreams, while others fizzle into history. All are high-risk propositions, bought on the low end of the weighting scale.

Two are on the diamond front. Stornoway Diamond has some really big names and money behind it and has been finding its scratch, but not enough to excite the investing public. The second is Brazilian Diamonds, a real longshot given the dubious nature of management, but a firm that somehow manages a double almost every year, before receding back to a lower trading range. In the gold camp, Goldstake Explorations is of similar ilk, and last year it was played for a quick 73-percent gain.

Still with the pennies is Andrea Electronics, a former high flyer that once traded above $45. Unfortunately for those who held, shares have traded below a dime recently, which is where it was acquired. This is the second round with this pick and the last time worked out beautifully with an exit just below 18 cents. Burntsand Inc. was a Canadian software developer that hit $15.75 in those halcyon "new paradigm" days. It was acquired for 12 cents a share, with a target of 49 -- just over a quadruple.

Intrusion Inc. has computer security systems that almost no one must be buying, considering that revenues last quarter shrunk to half a million. Losses have been a constant, but management keeps throwing money at the firm. Might they have a few deals that change their face and turn this 20-cent investment into 30 and make this December 2007 speculation work?

Teamstaff, which operates in a similar field (employee outsourcing) to Analysts, was not successful in the "dance of strategic options" outlined last year. Since then, the stock price has dropped to the 70-cent range. Last week, shareholders approved a one-for-four consolidation to retain its Nasdaq listing. It looks like a tax loss sale may be in the offing this year.

In the gold sector, Kinross was dumped at $16.65, a beautiful gain from the $3.78 purchase price. However, the exit once again looks premature; the stock has moved up better than 50 percent since then.

South American Gold, on the other hand, has an appropriate symbol: SAG. But it looks as though its Chilean mine will be operational this summer. That will help. The float, at nearly half a billion shares, won't. Still being held and prayed for.

The Golden Fleece was not found as hoped with Nventa. It remains in the portfolio only because it is stuffed into an RSP. Oh, if only a tax loss could have been taken on this doggie. This is a problem when placing the wrong picks that dissolve into lint in the pocket of retirement.

Of course, there is still a bread basket of money invested in the boring old GICs and money market funds at some of the major banks. Interest rates from 3.5 to nearly 5 percent are not exciting, but more certain, and some of the funds wait to be deployed in more exciting vehicles.

Something that has not been mentioned by us for a while is the importance of paying down debt. This is a surefire way to obtain a return on investment. We remain exceptionally debt-averse, content in the knowledge that, even if bankers' folly and economic conditions force them to tighten the credit spigot, they won't be squeezing The Contra Guys.

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