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Harry Koza

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Take a walk on the wild side

Harry Koza

 

To fight oppression, and to work as best we can for a sane organization of society, we do not have to abandon the state of mind of freedom. If we do that we are letting the same thuggery in by the back door that we are fighting off in front of the house.

— John Dos Passos

It's a little odd for me to be writing about high-risk speculative investment ideas. I mean, I don't generally go for the really long-shot punts as a rule, preferring to stick to my PC investing style, PC standing for preservation of capital, of course, and not President's Choice, progressive conservative or, least of all, politically correct. Oh sure, I've taken many a speculative punt in my day, some of them winners, some of them — okay, okay, many of them — losers.

And while nowadays, I tend to leave the sportier side of the investment spectrum to those with more of a penchant for risk, there are times when the siren song of the high-risk proposition becomes irresistible.

As Lou Reed used to sing, "Hey, Joe, take a walk on the wild side." Sometimes you've just got to say "what the hell," and take a flutter on something wacky. The first rule, naturally, has to be not to play this kind of game with any money that you're not prepared to kiss goodbye. Don't be trying any edgy investments with junior's college fund or the money you've earmarked for that house down payment. That's not speculating, it's just plain dumb.

But if you've got a little of what traders like to call play money, i.e., real money that you are prepared to risk, in an amount that won't hurt you if (when) it gets vapourized, and are interested in a speculative flyer, then I have one word for you: Asbestos.

Way back on October 21, 1977, the new Pequiste government of Quebec, flushed with at long last being "maitres chez nous" and giddy with the prospects for "Quebec Inc.," announced that it would nationalize the province's asbestos industry. Part of that process was acquiring control of Asbestos Corporation Limited (ACL) by buying the 54.6 per cent of the company then owned by General Dynamics Corporation (GDUS) through its wholly-owned subsidiary General Dynamics (Canada) Limited (GDC). Quebec offered $42 a share; General Dynamics wanted $90.

Quebec eventually (1982) cut a deal whereby, instead of expropriating ACL, (which would have seen both GDUS and the minority shareholders paid something around book value per share, around $54 at the time) they bought all of the shares in GDC from General Dynamics US on an installment plan. Quebec would pay GDUS $42 a share, plus 16 per cent interest over five years. GDUS got a put option that would allow it to force Quebec to buy the rest of the GDC shares all at once, and Quebec got a call option, which allowed the province to force GDUS to sell it all the shares of GDC at once. No matter which option was exercised, Quebec would end up with control of ACL.

To cut to the chase, GDUS exercised its put in December 1986, at $90 a share, making a tax-free gain of $170-million. Quebec now had full control of the provincial asbestos industry, and the minority shareholders, well; they were left holding the proverbial empty bag.

Now this is a long and complicated case, but at bottom, the minority shareholders in ACL (which is still listed on the TSX, symbol AB) were hosed. Even the OSC had some very strong words to say on the transaction, (though oddly enough, the OSC never took any action to relieve the oppression of the minority shareholders):

"It was suggested to us that the fact that the Quebec Government was acting in what it considered to be the interests of the people of that province somehow made it unnecessary for that government to concern itself with the ethical issues that underlie the take-over bid rules in this province. We do not agree. In our view, both the Quebec Government and GD US had a moral obligation to concern themselves with the interests of the minority shareholders of Asbestos, and about the propriety of GD US walking away with a sizable payment while the minority shareholders were left behind.

In our view, the actions of the Quebec Government and SNA failed to comply with the spirit underlying the take-over bid rules of the Act, were abusive of the minority shareholders of Asbestos and were manifestly unfair to them."

Anyway, for a variety of complex reasons, legal and otherwise, it has taken until now for a court action on behalf of the long-neglected minority shareholders of Asbestos Corporation Limited to finally come before a judge. Next month, shareholders will get their day in court.

There's nothing I like better than tilting at windmills by getting involved in a shareholder or bondholder rights issue, so I bought myself a couple of hundred shares of Asbestos Corporation recently for just under $10 each. It's currently trading around $11 or $12 a share. It's very illiquid and doesn't trade very much, so there is often a wide bid/asked spread. Note that this means it might make it hard to get out of the shares if you buy any.

Here's the upside: GDUS got $90 a share in 1986, and if the oppression suit Plaintiffs win their case, all the remaining ACL shareholders (including me) will also get $90, plus 20 years worth of interest (to be fair, it should be at the same 16 per cent rate that GDUS got paid) plus penalties for whatever malfeasance may have been perpetrated (and, frankly, it's at times like this that I wish Eliot Spitzer was a Canadian — it'd be fun to see him make, oh, some former politicians who can't be named here lest the Globe's lawyers get apoplexy, do the perp walk on the evening news).

The downside, on the other hand, is that if the plaintiffs lose, the shares are worth considerably less even than I paid for them — like zero, for instance — asbestos being about the only commodity that has not been participating in the recent commodities boom. Back when the nationalization of the industry was just a gleam in Jacques Parizeau's eye, ACL employed 30 or 40 thousand people. Today, over three-quarters of the jobs are gone, asbestos is out of favour, and the liability lawsuits for mesothelioma and asbestosis are sprouting up like mushrooms after a rain. People don't use asbestos any more — they're busy ripping it out (at great cost) from everywhere it was ever installed. Then they start looking for someone to sue over it. Book value isn't anywhere near $54 a share any more. Prospects for the stock on an ongoing basis are downright grim. So if you buy Asbestos Corporation on spec, and the plaintiffs lose, your money is essentially toast.

That's a very real risk. Recently an Ontario court ruled that OMERS could not "buy into the oppression remedy" in a case involving Ford Canada. That ruling, which is being appealed, demonstrates a total disregard (in my inexpert and humble opinion at least) of how capital markets properly function. If allowed to stand as a precedent, it would put the onus on investment dealers to keep track of who owned what shares when and for how long. This would impose a huge financial burden on the dealer community, and while they could just pass the cost on to the clients in the form of higher fees and commissions, I must say that I am disappointed that I am not hearing anything about them standing behind OMERS in their fight for shareholder rights in the Ford Canada takeover. (You can read up on that case if you want)

Also, the OMERS/Ford decision seems to fly in the face of the most fundamental piece of legislation governing corporate Canada and the treatment of shareholders, The Canada Business Corporations Act. Like I've said before, I'm no lawyer, but the framers of that Act put it clear enough for even a layman like me to understand. The Act states, in Section 60.1, that:

60. (1) On delivery of a security the purchaser acquires the rights in the security that the transferor had or had authority to convey, except that a purchaser who has been a party to any fraud or illegality affecting the security or who as a prior holder had notice of an adverse claim does not improve their position by taking from a later bona fide purchaser.

So, if you buy a share, you get all the rights that go with that share. As long as you came by the share honestly and not through fraud, if a past wrong is redressed, as the holder at that time you get the benefit, not some guy who sold it years, or even days before.

To my mind, you can indeed (and damn well should be able to) buy into the oppression remedy. Of course I could be completely and absolutely wrong on this. After all, the outcome depends on the courts, which frankly (no offense meant, your Honour) often seem far too busy inventing new rights for aggrieved special interest groups and not nearly busy enough protecting the rights of investors.

Whatever the outcome may be, I am willing to make this bet. The downside is I lose a little less than two grand. The upside is I make 10 or 20 times my original investment. That works for me. Just don't bet the mortgage money.

Harry Koza is Senior Analyst in Canadian markets for Thomson Financial/IFR. At various times in his career, Mr. Koza has been a prospector, metallurgist, project manager, engineer, as well as an institutional bond salesman for 15 years. His current area of expertise is in high-yield distressed securities and corporate bonds in general.

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