The Globe and Mail

  Follow your sold losers


Tuesday March 24, 2015

Almost eight years ago, we penned a column titled, “In the risk-reward game, Hartco worth holding.” At the time, the stock was trading just below $4. Alas, though close, it never quite reached the initial sell target of $5, and the fat distribution of a nickel a month was eliminated when the income trust morphed into a corporation.

As our handsome gains mounted on other holdings after the recession, a decision was made to sell Hartco Corp. at $2.52 in 2013 and take a tax loss. It was not so much that our favourable opinion of the company had turned, but using the rules offered by the Canada Revenue Agency to reduce taxes payable is often a wise decision. This allows more cash to remain “in the pocket” to be used to earn more money.

While many investors choose to sell their mistakes and store the company in the historical, I never want to look at this dog again' department, our modus operandi is different. We continue to watch the enterprise for another potential entry point if it seems attractive. After all, better the devil you know than the devil you don’t.

Hartco is in the information technology sector, and is an IT infrastructure provider to businesses. While the leaders in that arena have roared higher over the past few years, HCI has suffered. Sales that were almost $500 million annually when we bought in have tumbled to about half that level. Profitability has become elusive. Harry Hart, the company’s chairman and chief executive officer who owns the majority of the stock, apparently finally decided it was time to move on. In January, 2014, the company initiated a strategic review to sell the corporation. The company’s release stated his goal was “ to sell his majority stake in the company.”

A year later, the firm was still looking for a suitor and decided to pack in the showcase, taking the outfit off the market. Then, on Feb. 19, a company release stated that Mr. Hart was offering to buy the company and take it private at $3.25 a share, or a total of $16 million. Talk about a switcheroo! As with most takeovers, a premium to the trading price was offered, in this case valued at 32.65 percent greater than the trading price over the previous 20 trading days. The stock, relatively illiquid at the best of times, had not traded in over 10 days, with the previous transaction at $2.46. As my colleague Benj Gallander had continued to follow this enterprise, he noted that the bid and ask were $2.68 and $2.69 respectively. In a rare move, he hit the ask where the stock opened, feeling it was unlikely that the price would drop. Lowball limit orders are normal practice.

The probability of the deal going through is estimated to be better than 90 percent. If it does, that would represent a return on capital of 21 percent, with the transaction likely to happen in the next four months. Pretty sweet for a hit and run.

The assessment is that Mr. Hart can afford the $16 million it will take to make the deal happen. While another offer could transpire at a higher price, it is considered unlikely given that the enterprise has already been shopped around with no success.

If the deal falls off the rails, our guess is that the stock will retreat to the $2.50 range or so, where it was before the offer. That would not be a big loss, so ultimately the risk-reward parameters on this one are very reasonable.

The key here is that an eye was maintained on a corporation where money was previously lost. When the possibility for a fast gain presented itself, a finger was ready on the buy button.

Ultimately, every investor who is around this game for any length of time will have losers. While it is more fun and profitable to keep track of the gains, being mindful of the previous dogs can present some ultimately exciting, worthwhile opportunities.