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  Atlas bears many burdens

BENJ GALLANDER and BEN STADELMANN

Friday, September 8, 2006

Clean-cut heroes and Hollywood might seem to go together like peanut butter and jelly, but what really turns Tinsel Town's crank is a saga of redemption. The erstwhile protagonist has to grovel in the gutter for a spell to set up the dramatic finish.

No, this article is not about Mad Mel, but concerns Atlas Cold Storage, the Toronto-based business investment trust that runs more refrigerated warehouse space than almost any other public firm in the world.

Atlas got to be so big through an acquisition spree that saw the enterprise gobble up assets of TCT Logistics, CoolStor Warehouse Services and CS Integrated in quick succession from 2001 to 2003. The binge was financed through $356 million in new equity and a mountain of debt. Investors liked what they saw, sending the units to a high of $13.42 in September 2003.

But the fairy tale unravelled with an anonymous poison-pen letter to the Ontario Securities Commission that questioned accounting practices. An audit indicated that expenses had been classified as capital investments, thereby artificially inflating net income.

This led to a violation of debt covenants, a restatement of results, the termination of distributions, a purge of top management, plus the requisite class-action lawsuit. And, not surprisingly, a deep freeze in the unit price to a low of $4.45 in November 2004.

However, these blows were not lethal, and the plucky enterprise has made excellent progress in rehabilitating itself. Brascan funded a refinancing, and a capable new chief executive and president was found in David Williamson.

Though it did not pass muster for the Contra portfolio for a variety of reasons, one of us purchased the units at $6.16. The catalyst for the buy was the reintroduction of distributions. Surprisingly, the units sank on the news, as investors had hoped for a higher level of payouts.

This strikes us as a perverse bit of logic. An unsustainable payout ratio that constrained Atlas from making needed capital improvements was one of the reasons the company got into such a mess in the first place. Atlas hardly deserved a poke in the eye for adopting a more prudent, conservative approach, but then Mr. Market can be a capricious cad with the memory of a hamster.

If the revival did not impress yield-hungry investors, it did register with Iceland's Avion Group, a diversified transportation conglomerate that is one of Europe's fastest-growing companies.

Atlas has spurned Avion's $7-a-share offer as too low, and management quickly tried to implement a shareholder rights plan, but the Toronto Stock Exchange threw a wet blanket on the application, indicating that it would not consider acceptance of the plan while a takeover is brewing.

But Avion's bid requires a two-thirds majority of units to be tendered, and that is looking increasingly unlikely as some big unit-holders are not ready to capitulate to the Vikings.

Birch Hill Equity Partners and Brookfield Asset Management say they will hold out, and Irwin Michael of ABC Funds reckons Atlas is worth more than eight bucks. Such valuations emphasize the replacement cost of Atlas's physical assets, and the potential profitability if margins improve. This view seems to be carrying the day, with the units trading well above the $7 offer, currently at $7.52.

The really fascinating thing about Atlas is not whether Avion will succeed in its takeover, but how in its brief history this business has evolved from trust darling to goat to attractive value proposition.

The message here goes far beyond the particulars of Atlas and has implications for the entire business-trust model. Had Atlas gone to market at a cheaper price, kept its distributions lower, and expanded more slowly, it quite likely would have avoided the extremes and traded within a narrow range, all the while faithfully providing a steady income for shareholders.

But many trusts refuse to heed this lesson. Using globeinvestor.com's new and improved filter provides insight on the dimension of the problem. There are currently 166 trusts that produce a rich yield of 9 percent or better. Of those, 76 have payout ratios of greater than 100 percent. This creates the obvious issue of financial sustainability.

That's a sad state of affairs for Canada's industrial fabric, but should provide plenty of fodder for future contrarian bargains.


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