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  Clean Power zapped by Contra philosophy

BENJ GALLANDER and BEN STADELMANN

Friday, June 30, 2006

It wasn't the CBC's decision to pre-empt The National in favour of an American singing series that made one of us do a self-analysis of his investing strategy.

Rather, it was while he sat at the annual general meeting for Clean Power Income Fund, counting the money lost on this venture, that he decided to look at how this outlay diverged from the Contra the Heard philosophies. Not that this company had any chance of getting into the portfolio on a number of counts, but still, it is interesting to review why it doesn't fit the methodology.

Clean Power, as the name states, operates in the green realm of wood waste, landfill gas and wind power. They are the first income fund to be certified under Canada's Environmental Choice Program, as they offset approximately six million tonnes of harmful greenhouse gas emissions each year. That was an attractive reason to invest, as this corporation is doing the work necessary to improve the environment.

That made it a feel-good play. However, feeling first-rate and making money are different things.

One rule at Contra the Heard is to "invest only in organizations that have existed for at least 10 years." This is to make sure money is stashed only in corporations that have a clear track record. When acquired, Clean had only been around for three years, so where the stock price might go was iffier than iffy.

Another rule is to "focus on stocks that have the ability to increase in value by a minimum of 50 percent." When analyzing enterprises that have been around for a decade, it is evident whether they have traded at a much higher level for a good percentage of the time. When Clean was first acquired at $9.05, the highest historical trading price was $11.20, and that was only a momentary blip soon after issuance.

At Contra we "concentrate on turnaround situations and stocks which are currently unpopular but are likely to regain their lustre in the near future." One of the easiest ways to recognize something out-of-favour is when the stock price has taken a beating. Clean's had not. It had slipped when first acquired, but had not been whacked. A good pummelling interests us more.

We "carefully scrutinize corporations' financial statements, concentrating on debt ratios and book values." While this was done with Clean, perhaps focus was lost comparing the cash flow and bottom line with the distributions. Further investigation should have rendered it clear that the probability of maintaining distributions was dubious.

Analyzing management's ability to achieve stated goals is very important. While it seemed possible given the rosy pro forma, we have been around long enough to know that especially with initial public offerings and relatively new issues, the sellers always portray the positive hue. This is natural given that they want to receive the best price possible.

We often pick takeover candidates well before this occurs, for near-optimal returns. In this case, it looks like the takeover will happen. But the severe stock price downdraft means that the total return will be negative.

A possible bright spot for Clean is that it has put itself up for sale. An agreement has already been reached to sell the GRS division for $90 million, which seems a reasonable price. While the rest of the operation is shopped around, management has assured investors that distributions will be maintained at the current rate.

However, it is very unclear whether the enterprise will fetch better than the current trading price in the $5.75 range.

While some people look back and state that they would not do anything differently, one Contra Guy would dearly love to replay Clean Power in another way. Unfortunately, that is not possible. He'll tally the losses, and continue to learn. In the future, sticking closer to our philosophies will help.

While they might forget it at the CBC, it is important to know who you are, to be successful.


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