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  Bombardier still not ready for Contra prime time

BENJ GALLANDER and BEN STADELMANN

Friday, April 15, 2005

One of the questions we often get is, "You guys are contrarians — are you buying XYZ (insert name of pathetically beat-up stock)?" Sometimes the query comes from a value hound, sniffing out potential bargains; sometimes a cheapskate thinking that anything whipped resembles value.

More often, it is a hapless shareholder who bought a position at much, much higher prices and is grasping at straws for a possible comeback.

We've been asked about Bombardier steadily since 2001, when it lost half its value. At the time, it was too early to even think about it. Once it got down to $5, it went onto our Stock Watch List. At that point, it merited such status; the company had a long track record, was in an out-of-favour industry, and had a stock price near 10-year lows.

The first part of the wait is de rigeur in our methodology — we avoid trying to catch the falling knife. That means some companies are missed that snap back quickly with a V pattern. We just feel more comfortable with a longer bottoming process, where the first steps in a corporate turnaround are established.

The addition of Paul Tellier as chief executive officer in early 2003 was an encouraging sign, but the sharp rally in the stock price that greeted his arrival was rather silly. In our view, investors were making a couple of basic errors.

First, they were underestimating the size of the job and were over-optimistic about how quickly a new chief executive could effect change. It took Tellier almost a decade to revitalize Canadian National.

Second, there was a palpable feeling that investors simply wanted the comeback to occur and were using it as an opportunity to average down. A better entry point is found when people have given up, taken their lumps, and the predominant sentiment is mistrust. Listless disinterest works well, too.

During this bottoming-out process we look for progress on the balance sheet. There was some, as Bombardier sold off its recreational division, and so our interest level grew. But a key warning flag was waved in May 2004, when Tellier negotiated a new compensation package for himself that foreshadowed a lower stock price and a possible exit.

So, where are we now? Tellier is gone, while the balance sheet remains weak, with a heavy debt load and too many intangibles in the asset column. In our view, there are more write-offs to come.

Value investing maven Ross Healy reckons the stock would have to get down to around a dollar a share to be tempting. That sort of evaluation doesn't suggest much downside protection if anything goes wrong.

The recent elimination of the dividend helps to conserve cash and removes a potential obstacle to receiving government aid. But the dual voting structure remains a thorn in the side of institutional investors. The combination of high debt, poor asset value and sensitivity to the economy means we could be watching Bombardier from the sidelines for a long time.


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