Market Buzz

Market Buzz – Bridgewater & Breakwater Buyouts a Boon in Broader Down Market – Gains of 71% & 167% Respectively

Another week, another sell off for Toronto`s main index. The S&P/TSX Composite index closed at its lowest level in seven months on Friday, dragged down by a sharp selloff in Research In Motion and sliding resource shares.

The main culprit for the slide in resource stocks was crude oil, which fell to around $92.91 a barrel on Friday. Today`s explanation – fears about Greece’s debt crisis and a slowing U.S. economic recovery. Add in fears of another Chinese rate hike and you have a recipe for a significant slide in crude and the resource laden TSX.

Sovereign debt in the euro zone remained a chief worry even though EU leaders reassured investors they would not be forced to write down the value of their bond holdings in the event of a new bailout.

Having said this, we are very happy to report that in a down market, value can still be recognized. In fact this past week, patience paid off and excellent returns were realized by Keystone’s clients in two long-term Focus BUYs – Breakwater Resources Ltd. (BWR:TSX) and Bridgewater Systems Corporation (BWC:TSX).

While both operate in completely different segments (resource vs. technology), there are some striking similarities behind each company. First, both company`s held pristine balance sheets with very strong cash positions and limited to no debt. Second, each company was profitable and compared very favourable on a fundamentals basis to their peers. Finally, each company generated strong cash-flow and a relatively conservative and patient management style.

In the end, both companies left our clients with excellent returns of 71% (in less than 10 months) and 167%, respectively.

On Wednesday, Breakwater Resources Ltd. entered into a binding agreement with Nyrstar NV under which Nyrstar agreed to make an all-cash offer to acquire all issued and outstanding shares of Breakwater. Total consideration for the transaction consists of the following:

1. $7.00 in cash per common share.
2. $0.50 cash special dividend per common share.

Breakwater is a mineral resource company engaged in the acquisition, exploration, development, and mining of base and precious metal deposits in the Americas. Breakwater has three producing zinc mines: Myra Falls in British Columbia, Canada; El Mochito in Honduras; and El Toqui in Chile.

Today, Bridgewater announced that it has entered into a definitive agreement to be acquired by Amdocs Limited (DOX:NYSE) through a plan of arrangement for $8.20 per share in cash, valuing the company at approximately $211 million. The cash consideration of $8.20 per share to be received by shareholders represents an implied premium of 30% to Bridgewater’s closing share price of $6.33 and an implied premium of 33% to the 20 day volume weighted average trading price of $6.17 on the Toronto Stock Exchange as at June 16, 2011.

Founded in 1997, Bridgewater Systems develops subscriber-centric service control solutions; including access control and policy management software for fixed, mobile, and converged networks. Using
Bridgewater solutions, global service providers can offer personalized services and experiences to their subscribers by maintaining a real time policy that controls how subscribers interact with networks, services, and their devices.

With both companies, their strong value propositions eventually made them too hard to ignore and they were bought out at handsome premiums providing clients with excellent value.

While it may not happen overnight, patience is often rewarded when you stick to a sound plan – buy good strong companies with strong balance sheets and good valuations.

Looniversity – Dividends

This week, we discuss the wonderful world of dividends. Most textbooks define dividends as the distribution of corporate earnings to shareholders. Usually (but not exclusively) paid on a quarterly basis, they essentially give share or unit holders (in the case of mutual funds or ETFs) a piece of the action right away, rather than rewarding investors with a capital gain (hopefully) when they sell.

In the case of public companies, dividends are typically paid in the form of cash or stock. Mutual fund and ETF dividends are paid out of income, usually on a quarterly basis from the fund’s investments. If the fund is Canadian, dividend income paid out by the fund is subject to the dividend tax credit, offering an approximate 25 per cent advantage to investors. A similar tax credit is available on Canadian company dividends. Income is taxed in full if the dividends are foreign.

Not all companies pay dividends, and frankly, dividends aren’t always desirable. For example, fast-growing smaller companies (yes, there are still a few around) typically don’t pay dividends, which is often just peachy with those investors, who may not want any more taxable income now, and who believe the company can employ its earnings more effectively internally or through acquisition to increase shareholder value.

Put it to Us?

Q. When I purchase a stock, I often look for companies that would be attractive “takeover targets” for a larger firm. I own one stock that appears to be a good takeover candidate; however, I recently heard it had a “chastity bond”. Please explain.

– Wendy Myers; Edmonton, Alberta

A. Chastity bond – sounds like something one would place on a bond with too attractive “coupons.” But, seriously, a chastity bond is essentially designed to prevent unwanted takeovers by maturing at par value once a takeover is complete.

The idea behind the chastity bond is that companies will be less inclined to take over a company if afterwards they will immediately be forced to pay bondholders. This is similar in nature to a “macaroni strategy” except that the redemption prices of the bonds are not inflated. Under a macaroni defence, the company issues a large number of bonds with the condition they must be redeemed at a high price if the company is taken over.
Why is it called macaroni defence? Because if a company is in danger, the redemption price of the bonds expands like the pasta in a pot! Ah, the wacky world of finance.

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