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Wobbly HOMEQ deal a lesson in shareholder communications

Reverse mortgage company HOMEQ Corp. and private equity fund Birch Hill Equity Partners ran the proper process for a takeover, and yet the deal is in danger because the company's largest shareholder is fighting back.

If there's a lesson in the situation, it's this: know what your biggest shareholders are looking for.

Birch Hill announced at the end of March that it would pay $9.50 a share, or about $138-million, for HOMEQ. The deal was a nice 22 per cent premium for shareholders.

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Both sides hired top advisers, with RBC Dominion Securities and Torys advising the company and Scotia Capital Inc. and McCarthy Tetrault advising Birch Hill.

So far, so good.

But nobody asked Maxam Capital Corp., the largest shareholder of HOMEQ , what it wanted, and that may prove a costly mistake. Maxam announced Friday that it would be voting against the transaction. In Maxam's view, HOMEQ is getting scooped at too cheap a price for a company with a monopoly and a business that's about to boom.

Maxam has been adding to its stake, which now stands at 12.2 per cent. To succeed, the deal will need two thirds of the voting shareholders to vote in favour of the transaction. Maxam doesn't have an outright block, but if it can rally support, and if turnout at the meeting is low, Maxam could cause trouble and potentially derail the transaction.

Had HOMEQ and Birch Hill tried to reach out and lock up shareholder support, they might not be in this situation.

"They didn't want our involvement," said Maxam managing partner Sean Morrison. "When they decided to run this process, we weren't party to the process."

Maxam is no quick-buck hedge fund, jumping into a takeover, buying up a stake and looking to force a higher bid.

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Maxam argues that it knows management, having been a large shareholder for years. Mr. Morrison was one of the investment bankers hired to take the company public as an income trust in 2002.

Maxam took a big stake in Home when it announced in 2009 a conversion from an income trust so it could apply to become a bank. The thesis was that the bank license would be a boon, and that the company had a monopoly on a business with a big future. What's more, the balance sheet was very strong because the mortgages were small relative to the values of the homes that were backing them.

"We think this is on a megatrend: aging population [and]low loan to value," Mr. Morrison said.

The issue for Maxam is that private equity funds are looking for returns on the order of 20 per cent. So if Birch Hill sees that's possible, why would anyone sell? A red flag is that management is not selling -- it's staying invested -- Mr. Morrison said.

"When a private equity fund is buying and when management and most of the sophisticated directors on the board are rolling into the company, it's cause for concern," he said.

What if the deal fails, isn't Maxam facing a drop in the value of its holdings?

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"If the deal doesn't work and there's no other bid, we're happy to be holders of the company. We like the business. It's not a company in turmoil."

A Birch Hill partner did not immediately return a call seeking comment.

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