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  Takeover plays offer no guarantees

BENJ GALLANDER and BEN STADELMANN

Friday, July 11, 2008

At the heart of our investment system is discipline; we Contra Guys try to stick closely to a set of guidelines and numerical calculations that strongly increase our chances for success. However, that does not mean that forays aren't sometimes taken that stretch — and even step outside — the boundaries.

One of us recently got involved with a couple of takeover plays, chasing fast high percentage returns — a departure from our norm of longer-term investments.

The first was made last March, when BCE was purchased at $36.24. The logic was that the $42.75 takeover bid led by the Ontario Teachers' Pension Plan stood an 80 percent chance of going ahead. This meant a premium of almost 18 percent, likely achieved within six months. Toss in a dividend of about 4 percent and the profit would be lovely.

The downside risk, as estimated by this Contra Guy, was that the deal would not be sealed and the shares would plop into the $30 range. Still, the dividend would be obtained.

At this point, it appears that the end point will be less lucrative, but will still work out to a decent return. The closing of the compact is now expected to take place in December. This additional six months chops the value because the longer one waits for the same funds, the lower the percentage.

The dividend is not being paid, a bizarre twist of events that hurts shareholders. This bird in the hand since 1881 is being set aside for the "bird in the bush" of the deal price staying intact.

But will it? There remains no guarantee that the arrangement will be finalized as agreed, and banks have proven once again to be slippery, given how they were ready to walk away from an agreement where the ink was already dry. As their balance sheets are further sullied, it remains possible that they will again not fulfill their promise unless the terms are renegotiated once more. Given this risk, it would be much more meaningful for shareholders to be receiving dividends now than be expected to hope that, by leaving this money in the till, the deal really flies.

Still, with better than a 10 percent premium remaining and less than six months until the takeover is likely to close, the position is being held.

Another takeover play of lesser renown is Tarrant Apparel, purchased a couple of weeks ago at 65 cents (U.S.), above where it currently trades. The company's founders, Gerard Guez and Todd Kay, who own better than half the enterprise, have apparently offered 80 cents a share. A committee of independent directors has retained a financial adviser and law firm to evaluate whether the offer is fair.

Tarrant designs, manufactures and sells apparel to mass merchandisers. Sales last year were in the $240 million range, but fell 10 percent to $50 million on a year-over-year basis in the first quarter. Although cash-poor, the balance sheet has been improving. The firm was marginally profitable in two of the past three years, with a loss of around $22 million in 2006 and a slight loss of $43,000 in the first quarter this year, as compared to profit of $64,000 last year.

The market capitalization is a slight $20 million. The offer is at a premium to book value, which is in the mid-60-cents range. Knocking off goodwill takes this down to about 40 cents. The debt load that was getting out of hand earlier this decade now appears more manageable. It seems reasonable to conclude, to a probability of about 75 percent, that this knot will be tied before the end of the year, and perhaps at a slight premium to the current offer, with the company then being taken private.

If the deal does not transpire, the corporation will have to push the share price back over a dollar, or risk being delisted by the Nasdaq Stock Market, more of a challenge given that the stock price will likely fall further if the deal is not concluded.

Last year Tarrant traded at more than $2, in 2005 over $4, and prior to the millennium it was at better than $15. So undoubtedly, even if the takeover does not go through, this stock could have some legs, with a reasonable target price being north of $3. Hopefully though, the agreement will transpire before the end of 2008.

Playing the takeover game is certainly somewhat risky for as deals fall off the table, stock prices generally get hammered. While returns can be excellent, the stomach must be strong to play in this possible minefield.


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