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  Sea Containers runs aground

BENJ GALLANDER and BEN STADELMANN

Friday, April 21, 2006

While readers look to us for ideas, we also take a gander from time to time at what other value investors are doing. One of these is noted maven Irwin Michael, who has managed ABC Funds since its inception in 1988.

Globefund reports a 15-year annualized return of 18.1 percent for the ABC Fundamental Value fund. That ranks it fifth among 422 funds that have been around for at least that long — an enviable track record, to be sure.

Besides making bags of money for his investors, Michael is also unusually generous about giving the general public access to his analysis and views of some of his "deep value" picks.

The Value Investigator is a frequently updated website and a worthwhile stop for investors wishing to learn more about the nuts and bolts of the fundamental approach. It also includes commentary on about 25 of Mr. Michael's favourite stock picks.

Which brings us to Sea Containers Ltd., a Bermuda-based transportation conglomerate with interests in ferry services, cargo container leasing, hotels and a high-speed train.

Like many complicated corporations with diversified operations, Sea Containers has long traded at a discount to the net asset value of the individual businesses. When Mr. Michael bought into the company in 2004, it was at a huge discount to its book value of $30.82 (U.S.) a share.

At Contra the Heard, we also like buying assets on sale, but in our Point Tally System, a sterling book value receives a maximum of two points. We knock off a point for businesses that are hard to understand, and excessive debt will cost a company a couple more.

Our interest, however, grew last November when Sea Containers sold its interest in Orient Express Hotels for $267 million. That move improved the balance sheet and was a step towards simplifying the operation. Also encouraging was a plan to sell the money-losing European ferry division.

We kept snooping around. A friend in London who regularly makes the trip up to Glasgow was asked what he thought of Sea Containers' Great North Eastern Railway.

Well, it turns out he used to take it, but with the one-hour flight selling for 60 to 80 return, about the same as a rail ticket, he was now a frequent flyer.

Not to put too much weight on such anecdotal evidence, but it's an important point. Only in France and Japan are "high-speed" trains really as advertised. And though train stocks such as Canadian National and Canadian Pacific have done marvellously well for their shareholders, the money is being made on freight, not passengers.

Last month, the bombshell. The event was foreshadowed by the departure on March 21 of chief executive and founder James B. Sherwood.

On the face of it, this exit was unexceptional; he had been at the helm for 40 years, and at 72, retirement was logical. But there was a darker reason to get the captain off the bridge. On March 23, the company announced that the entire ferry business was being discontinued and an impairment charge of $415 million would be taken.

A further $85 million was being written off on the container business, firing a half billion-dollar torpedo into the guts of the firm's book value. Kaboom!

It gets worse. When this sort of thing happens, companies always emphasize that such write-offs are non-cash charges. That's true, as far as it goes, but it makes it sound like they aren't very important.

Assets are used as collateral for loans, so when assets are devalued, debt covenants go into default. And that's a very, very bad thing. To top it off, the company admitted that mistakes were made in the accounting of the hotel sale, overstating the gains reported in SEC filings by $10.3 million.

Ring the dinner bell for the lawyers! It's not unusual for any sudden corporate misfortune to bring a shark or two to the gangplank, but this is a full-blown feeding frenzy. A lucky 13 law firms have filed class-action lawsuits so far.

As for Irwin Michael, an update on his website explains he is maintaining his position and monitoring the situation very closely. And perhaps this will turn into a wonderful turnaround.

But we can understand why many investors are screaming, "Titanic!", grabbing the nearest lifeboat and bailing. Meanwhile, we ponder whether this stock might possibly return to form — or conversely, might be offering an excellent short possibility.


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