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  Hartco's hopping; we're happy to hold

BENJ GALLANDER and BEN STADELMANN

Friday, August 3, 2007

A general rule of investing is that the higher the potential rate of return, the greater the degree of risk. One way that this relationship expresses itself is when people chase yield. We did exactly that with our purchase of Hartco at prices from $3.02 to $3.46 over the past year or so.

With a monthly distribution of 5 cents, Hartco represented an income stream of better than 17 percent at these prices. That's a huge premium to a safe guaranteed investment certificate. The question was, and remains, Is this nickel sustainable? If it isn't, the trust unit's price will drop faster than the speed of a racing cyclist kicking steroids.

Prior to becoming an income trust, Hartco was one of those regular, boring corporations. One could say this company was more honest compared to many others that converted to the trust model. While many enterprises foisted overpriced units on feckless investors as management ran away with the spoils, in 2005 Hartco simply swapped common stock for units on a one-for-one basis.

Hartco is in the information technology business. It designs computer systems and retails hardware and software under the Metafore, MicroAge, Microserve and ZingPC brands, with more than 60 locations. It also operates the Telephone Booth, a chain of communications stores, and, until recently, CompuSmart, a national retailer of computer and electronic equipment.

That latter division proved to be a problem. Profitability was elusive over the past few years; in its place, there was a drain on cash to the tune of almost $14 million in 2006. So, in May, a decision was made to divest the division. Since then, all of the stores have either been closed or sold, although Hartco still has to get out of some of the leases.

For the year 2006, Hartco lost $3 million, which works out to 22 cents a share. Revenue slipped slightly from the year before, to the $577.7 million level. First-quarter 2007 results will be out shortly, by which point virtually all of the CompuSmart issues should be behind the company.

Harry Hart, the chairman and chief executive officer, owns about 60 percent of the business. He might find it worthwhile to pony up for the rest and take the corporation private. An alternative, given his advanced age, might be to sell the whole outfit, lock, stock and microchip barrel.

Recently, the trading volume has swollen. There is no indication that insiders are buying or selling, but there is definitely renewed interest in the company, sending the unit price to around $4. Might there be an acquisitor on the hunt? Though this is strictly speculation, the activity does lead us to wonder just what the heck is going on.

Carl Gavreau, vice-president and chief financial officer, told us: "We are growing in Ontario, which has about 40 percent of the Canadian market. But while we have to grow, it is not at all costs. Plus, the business-to-business model does not have big margins, so we have to be on the ball."

At this point, with the distribution working out to more than 15 percent, we remain happy to hold. It appears that this organization remains cheap relative to risk-reward, especially when the possible increase in the unit price is added to this value. While the major danger is that the distribution could be cut, the overall upside potential clearly supersedes the downside.


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