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Bob Tattersall

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The value trap

Bob Tattersall

TORONTO (GlobeinvestorGOLD) — Many investors believe it is a good thing when management and the directors own a major block of their own company stock. After all, it "aligns management interests with those of other shareholders" in that cliché so often used to justify dilutive stock options.

I have no opinion on the merits of this argument in general, but my experience is that the logic doesn't apply when the company and senior management share the same last name. The potential for disaster is magnified when you add that uniquely-Canadian phenomenon; multiple and subordinate classes of voting shares. Take Irwin Toy, for example.

Most of the action took place a decade or more ago and we have thrown out the files, so my recollection of the numbers may be a little fuzzy, but the order of magnitude is correct. We bought Irwin Toy around $5 or $6 a share on the grounds that it was trading close to book value, had redundant real estate and was in the process of developing its own toys rather than simply distributing other companies' hot products.

On the negative side, it was clear from the compensation disclosure that it would be tough to break into the upper echelons if your last name wasn't Irwin. The company was into its second or third generation of Irwins, and the salary levels were suspiciously uniform, which suggested that keeping the peace between family units was equally important as rewarding merit.

A toy story

We held the stock for many years and I used to joke that the worst things got, the more likely there would be a palace revolt: the company had cut the dividend, the stock was going nowhere and there were more Irwin family members as mere shareholders than as salaried employees. We eventually sold the stock at a small dollar loss (but a large opportunity cost) after I reluctantly concluded that I wasn't going to outlive the next generation of Irwins coming down the pike.

Several years later, a group with financial backing and a strong marketing vision did in fact take over Irwin Toy, so my suspicions about family discord seem to be validated. In short order, however, the new group ran into financial difficulty in spite of its marketing acumen and I understand that George Irwin has bought back the rights to the corporate name. My guess is that the new company now has a better chance of survival with an experienced executive and no inter-generational issues.

To be fair, our experience with Irwin Toy is not solely a result of family control and subordinate voting shares. As the new investors discovered in short order, the toy business is brutal. Maybe the real moral of the story is captured by that great aphorism from Warren Buffett: "when management with a reputation for brilliance gets involved in an industry with a reputation for lousy economics, it is usually the industry which emerges with its reputation intact."

Robert Tattersall is President and partner at Howson Tattersall and a recognized expert on small cap stocks in Canada.

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