We’re glad this one got away

Benj Gallander and Ben Stadelmann
Tuesday, May 24, 2005

Investors can be like fishermen who wistfully moan about the big one that got away.

Those who have spent a lot of time with a pole in the water know it’s inevitable that good investments will be missed; memories of lost opportunities need to be balanced with the appealing prospects that were wisely avoided.

We dodged a bullet with SR Telecom, which Contra the Heard had been watching for a few years. The Montreal-based company had several attributes that made it a potentially attractive candidate. Its specialty is wireless microwave systems to link remote areas, which gave it a shot at a largely untapped international market. The small-cap company was very successful in this field in the mid-1990s, reaching a split-adjusted price of more than $150.

When the telecoms cratered in 2001, SR started to look interesting. It had a reasonable balance sheet, including a healthy cash balance somewhat offset by substantial debt. Its stock traded below book value, and if it could get rid of the drain of its Chilean operation, it appeared poised for a turnaround. But nobody wanted to buy the debt-laden Chilean unit.

SR acquired the San Jose-based broadband wireless equipment maker Netro in March 2003. We didn’t like the terms of the deal: Netro stockholders got a $100 million (US) dividend and 43 per cent of the merged firm.

Another turnoff was SR’s announcement in late 2003 of a planned reverse stock split. A key reason was to get the stock price high enough to qualify for listing on the Nasdaq Stock Market. That desire for an increased profile in the United States made sense, but we know that companies that undergo stock consolidations usually trade for less for a year later.

After the one-for-10 consolidation, the stock traded at $7.80, fell, then rallied when some Chilean debt payments were deferred. In February 2004, $50 million (Canadian) worth of new shares were sold at $7. By May, the stock had fallen to less than $4 as the company scrambled to cut costs.

We did not bite. Partly, this was due to the dreadful debt situation, with $75 million coming due in April 2005; the revenue implosion, as major contracts were completed, also played a role. But in the right hands, those obstacles can be surmounted, which is where management’s credibility came in.

SR Telecom’s resplendent 2000 annual report contained this nugget: “It is expected that the uncertainty in the telecommunications industry will subside during the second half of 2001.” But things got much worse. Others made the same mistake, but each successive annual report from SR indicated the same disconnect with the reality of the marketplace. That did not inspire confidence.

Its stock now trades at 40 cents. Debenture holders have the firm by the throat and are dictating terms that will skin shareholders. A rule of fishing when seeking the “big one”: don’t capsize the boat.