stressed seller, page-8

The similarities between COF and another small cap I acquired about a year ago, namely Skilled Group (SKE.AX), are uncanny.

Both companies:
1. are exposed to the resources/infrastructure sectors of the economy,
2. generate significant revenues relative to their market caps (SKE Revenues = $1.7bn, Enterprise Value (at the time I bought) = $400m [Ratio = ~4.3 times], COF Revenues = $730m, EV = $200m [Ratio = ~3.7x times]
3. have been run over the past few years by acquisition-crazed MDs (Total value of acquistions over past 5 years: SKE = $270m (~70% of EV at the time I bought); COF = $160m (~80% of current EV)
4. have similar operating margins: SKE = 3.8%, COF = 4.3% (EBITDA/Revenue); SKE = 2.4%, COF = 2.9% (EBIT/Sales)
5. are relatively capital-light businesses: Throught-the-Cycle-Average OCF-to-Capex: SKE = >9x, COF = >5x; Average Working Capital-to-Sales: SKE = 6%, COF = 10%
6. have almost identical interest coverage metrics (NIBD/EBITDA: SKE = 2.9X, COF = 3.1x; EBITDA/NI: both are at 2.4x for the past 12 months)
7. have suspended dividend payments out of preference for balance sheet repair
8. have undergone Road-to-Damascus experiences and have recently disengaged their respective MD's and chairpersons, and are undergoing major restructuring exercises with a view to restoring value to shareholders

The only difference between these two companies is that, in a sequnce of events context, SKE is almost exactly 12 months ahead of COF on the turnaround time line. (Read the announcements from SKE from about this time last year, and you'll note the tone of the commentary, the clear desperation of the executives, and the sense of a need for urgent remedial action is remarkably similar to what COF is undergoing right now.)

12 months ago SKE was trading at around 110c, and had reported a poor result just like COF's last week, disappointing the market and causing complete capitulation by investors...exactly what happened to COF.

Fast forward twelve months and SKE is trading at 184 (having touched 200c), and the turnaround appears to be gaining traction.

I readily acknowledge that turnaround situations are notoriously difficult to execute succesfully, and normally take longer than one expects; however, as long as the business model is on reasonable footing to begin with, and the demand for the company's good and services are "real" and strong (COF's most redeeming feature, in my opinion) then with a bit of patience investors are ultimately rewarded, in my experience.

I think SKE provides a very useful precedent for COF's future prospects.

In COF's case, I have to admit the turnaround is taking longer than I had expected/hoped, and I think the original strategy of the MD (some 12 months ago) not to sack staff so that the business could be in a position to respond to the demand upturn when it occured was the right one.

I think the company has been a bit unlucky; the Mining Resources Rent Tax in the middle of 2010, and then the rain on the eastern seaboard of Australia in December both served to delay the inevitable improvement in demand for COF's services, which forced Roger Olds' hand and compelled him to reduce the size of the payroll. (No doubt the company's bankers were appplying the bunsen burner to his behind, too.)

The wholeseale acquistion strategy of the pasdt 5 years was flawed, and a child of the pre-GFC credit bubble. No doubt a lot of value has been impaired forever, but there will still be businesses within COF that the new MD and chairman will be able to sell easily given the robust business environment. One or two of these, plus the announcement of one or two contract wins, and I think the balance sheet pressure will be less acute, and the share price will respond. And that - in my view - is when the equity raising will occur.

In the meantime, needless to say this past week hasn't been a whole hill of beans of fund for you if you are a COF shareholder, but I have seen this movie before. I just think I was a bit too early in my entry on COF. However, I don't think the capital loss is in any way permanent. By this time next year, I expect the usual corporate turnaround script to have played out.

In Commiseration and Solidarity

Cam