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A couple of activist money managers in New York last week announced they would be seeking representation on the board of Calgary-based engineering and construction company Stuart Olson Inc. at the upcoming annual general meeting.

In a letter published Friday afternoon, Crescendo Partners LP and Jamarant Capital LP state that they have been shareholders in Stuart Olson since 2010. They believe that the recent stock price of $5.04 represents a huge discount to their estimated intrinsic value of $9.70 based on cash-flow valuations of comparable companies. (No wonder they are upset. Back in 2010, the stock price was in the high teens.) They have become disillusioned with management and the board’s failure to close this valuation gap and are seeking one or more board seats. They also want the company to initiate a strategic review, which would include its possible sale through a competitive auction process.

As a shareholder of Stuart Olson in my small-cap value portfolio over a similar period, I share the activists' frustration with the laggard performance, so this development has my undivided attention. In fact, the only people who may be unhappy with the recent news are the short-sellers of this rather illiquid stock.

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Neither Crescendo Partners nor Jamarant Capital have disclosed the extent of their current holdings in the company, but in the absence of prior disclosure, we can assume that their combined total position represents less than 10 per cent of the 27.6 million shares outstanding. So are they tilting at windmills, or is there a distinct probability that they will achieve their objective and Stuart Olson stock will trade closer to its intrinsic value?

On the positive side, Crescendo managing member Eric Rosenfeld is a known quantity in the Canadian small-cap market, where he has enjoyed some success as a value-creating activist – see Aecon, Spar Aerospace and Forzani Group for examples (While Forzani did subsequently sell out to Canadian Tire, I believe his proxy battle set the ball in motion for others to take a look at the company.) He should have no problem arranging meetings with institutional shareholders to make his case, and the poor performance of the stock will be a persuasive opening argument.

According to the most recent management information circular, two shareholders each control about 15 per cent of the outstanding shares: Alberta Investment Management Co. and Letko, Brosseau & Associates in Montreal. If the activists cannot get these two shareholders onside, then it will be an uphill battle to gain board seats. Management and the board appear to control only about 1 per cent of the outstanding shares, so this is insufficient to block the process.

In a response to the letter, Stuart Olson confirmed that there had been an ongoing dialogue with Crescendo and Jamarant over the past few months. From the company’s viewpoint, the major stumbling block is the fact that the proposed nominee to the board is Gregory Monahan, managing member of Jamarant, while his associate at Crescendo, Mr. Rosenfeld, is on the board of Aecon Group Inc. – a direct competitor to Stuart Olson. Until this conflict is resolved, the company is not willing to accept the proposed nominee.

As for the suggestion that Stuart Olson put itself up for sale, needless to say, the company feels that it should focus on its current projects and backlog of $1.6-billion in order to maximize shareholder value.

Even if the campaign to secure seats on the board is successful, there is one more obstacle to overcome. The company has $80.5-million dollars of 6-per-cent convertible debentures coming due on Dec. 31 of this year. The debentures are convertible at a stock price of $14.15, so there is no danger of dilution from this source, but a change-of-control provision will require any potential acquirer to promptly pay them off at par. This may limit the enthusiasm of some bidders for the company. If Stuart Olson is not sold by the end of the year, this remains a problem for it to address. For a company with a market capitalization of $155-million and an EBITDA (cash flow) of $40-million, this is not a trivial issue.

On the subject of change of control, estimated termination payments to the management team following a sale of the company could range as high as $11.4-million – about 25 per cent of trailing EBITDA, the valuation measure used to establish intrinsic value in the letter.

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As a long-term shareholder, I wish Crescendo Partners and Jamarant Capital every success in their quest to reduce the valuation discount that we all see in the Stuart Olson stock price. Depending on whom they nominate for the board, I may very well vote for their candidates. But in spite of my optimism, I suspect that we have seen only the opening salvo of a protracted battle for the future of the company.

Robert Tattersall, CFA, is co-founder of the Saxon family of mutual funds and the retired chief investment officer of Mackenzie Investments.

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