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  Disciplined or obstinate?

BENJ GALLANDER and BEN STADELMANN

Friday, June 27, 2014

One of the toughest things for an investor is to know the difference between following a disciplined approach and outright stubbornness. Our success depends on carefully applying a contrarian methodology to choose promising turnarounds, and then, if they work out, riding them to the sell target.

Since a company's comeback never follows a neat straight line, it means paying little heed to the wobbles along the way and remaining focused on the prize. Given that targets are often a few multiples of our purchase price, it is usually a long ride.

If a rough quarter turns into a full U-turn, then a reassessment of the investing thesis is made, which may indicate that it is time to throw in the towel. But what if events unfold fairly well, yet the stock price refuses to behave as expected? That's a relatively pleasant problem to have, but a sticky one nonetheless.

When purchased in the fall of 2011 at $1.14, Axia NetMedia was a classic contrarian play. The Calgary-based telecom is a niche player providing high-performance fibre-optic infrastructure services.

From its early pioneering days of providing broadband to rural Albertan communities, the company had branched out to Massachusetts and joint ventures in France, Singapore and Spain. But investors were not content; Axia had provided neither a sharp growth curve nor attracted predatory interest from the giant players in the field.

Instead, Axia was a stodgy, albeit modestly profitable enterprise maintaining a conservative balance sheet. For a tech company, it was a fish out of water, and a minnow at that.

The initial sell target of $5.50 was ambitious, but nowhere near the historical high of $18.75 during the bubble days of 2000, and below the $7 mark in 2007 when the stock was in favour. The expectation was that Axia could lever its technology and strong cash flow to develop new projects, maximize the use of existing networks, increase profitability and eventually pay a dividend.

Fast forward two and half years, and Axia has done pretty well. The uptake on its fibre services has been decent, but not spectacular.

One concern — that Axia was too spread too thinly around the globe for a corporation its size — has been addressed. Last year, the assets in Spain and Singapore were sold off, though the proceeds of $39 million were lower than anticipated. The sales will sharpen the company's focus on operations in North America and France. Its contract with the government of Alberta was extended for three years. A quarterly dividend of 1.25 cents was initiated this past January.

In other words, Axia has performed closely to the optimistic investment thesis set out at the time of purchase. There's just one problem: instead of cruising comfortably over $5, the stock price remains under $3.

Perhaps that is because Axia's success appears somewhat flimsy. Net profit for 2013 was only $1.9 million, compared to $6.9 million in 2012. Both quarters since the dividend was implemented have resulted in net losses. That suggests that the new payout to shareholders is more akin to a capital return than a share of bottom-line profits.

Management is planning to invest a large portion of the cash balance into a Fibre-to-the-Premise initiative, bringing fibre directly into private homes. Just how many people want to pay up for this deluxe service is difficult to predict.

What we do know is that a similar program offered by New Zealand–based Chorus, another telecom holding, has been stricken by installation expenses far in excess of what had been budgeted.

All things considered, waiting patiently for Axia to break out to a higher plateau seems more like stubbornness rather than reasoned expectation. Consequently, the sights are being lowered from $5.50 to $3.25.


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