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Alaris Royalty Corp. Dropped 7%: Now What?

If I offered you a $10,000 investment that paid 17% interest annually and the potential for additional capital gains that would bring your annualized total return to 23% over 48 months, you’d beg, borrow, and steal the money necessary to get in on my proposition.

Well, Alaris Royalty Corp. (TSX:AD) just delivered such an investment to its long-time investors, but the markets, being finicky as they are, saw the alternative lender’s latest announcement in a much more negative light.

Alaris’s stock dropped 7% August 3 on the news to less than $21. Trading as high as $31.20 just 15 months ago in January 2015, a few problem investments it’s been working through the past year has investors carrying an itchy trigger finger when it comes to any news out of the Calgary-based company.

I don’t see the problem with the latest piece of news; you shouldn’t either. Here’s why.

One door opens, another closes

Here’s the news in a nutshell.

Alaris advanced US$66 million to Sequel Youth and Family Services, LLC, a U.S. company providing behavioural and mental health services, in July 2013. It made an additional US$7.5 investment one year later.

On August 2, Alaris announced that Sequel was merging with another company and, as a result, was redeeming all of Alaris’s units for US$96 million, ending a mutually prosperous four-year partnership.

The upside is that Alaris generates a US$71.2 million profit on its US$73.5 million investment — a 23% internal rate of return in U.S. funds and 29% in Canadian dollars.

Also, Alaris will use the funds it receives in September when the deal closes to pay down all of its outstanding debt, leaving it with some additional cash and a rock-solid balance sheet.

The downside is that it temporarily loses the monthly contribution from Sequel of US$1.06 million, which represents about 15% of its annual partner distributions.

Reading between the lines

The stock is down because income investors see this loss as a potential hit to Alaris’s monthly contribution of 14 cents.

Alaris CEO Steve King doesn’t see it that way.

“While losing a large revenue stream is not our goal, the premium we receive allows us to redeploy the capital very profitably and without requiring equity or debt financing for our next transactions,” King stated in Alaris’s press release. “We do not expect any reduction in our revenue expectations for the year but will have a stronger balance sheet with the excess cash that will remain from the Sequel proceeds.”

The company has some new partners to add to its roster that will generate accretive earnings. Both Alaris and Sequel benefited from their partnership; it was a real win/win relationship.

While the loss of income might come as a shock to investors, you can’t expect a partner to stick around for more than three to four years given the amount of interest paid on the preferred shares held by Alaris.

Eventually, if Sequel didn’t cash out, should the company run into financial difficulties, Alaris would be forced to work out an arrangement for repayment that would likely take months, if not years, to resolve itself.

That’s an unacceptable risk in my opinion.

Bottom line: Why this is good news

The Sequel announcement tells middle-market businesses that Alaris is a fair and reasonable alternative lender that cares about the success of its partner companies.

The announcement, in my opinion, is a validation of Alaris’s business model — not an indication it’s flawed in some way.

For me, the successful end of this partnership is a buy, not a sell, signal.

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Fool contributor Will Ashworth has no position in any stocks mentioned.

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