Report
Nicholas Cortellucci, CFA

Finding the Next Takeout in Canadian Small-Caps

What you need to know:
• Over the past two months, there have been seven takeouts of Canadian small/mid-caps. We think this demonstrates the major disconnect between fundamentals and valuation in the market today which financial and strategic buyers are taking advantage of.
• We outline six common characteristics of the acquisitions in order to create a framework for finding the next one and provide a list of stocks that meet the criteria.

What’s Going On Here?
Over the past two months, we have seen seven takeouts of Canadian small/mid-caps at significant premiums. This includes HS GovTech Solutions (HS:CSE), H2O Innovation (HEO:TSX), Neighbourly Pharmacy (NBLY:TSX), OpSens Inc. (OPS:TSX), Spark Power Group (SPG:TSX), Logistec Corporation (LGT.B:TSX), and Playmaker Capital (PMKR:TSXV). We believe this points to the major disconnect between fundamentals and valuation for small-cap Canadian equities which private equity firms and strategic buyers are taking advantage of.

How Do We Find the Next One?
Looking at the seven acquisitions that occurred in the Canadian small/mid-cap space over the last few months, we have identified a few common characteristics as outlined below.

1) Poor Stock Performance – On average, the acquired companies were down 27% compared to their last peak seen in 2021/2022. Most firms have improved fundamentals over that period while rising interest rates and multiple compression led to the stock price decline. We expect this to be a leading indicator as financial and strategic buyers look for discounts to normalized multiples.
2) Cheap vs. U.S. & International Peers – As seen across most Canadian equities, stocks trade at significant discounts compared to their U.S. and international peers. For example, H2O Innovation was taken out at ~15x 2024E EBITDA compared to U.S. peer Evoqua Water which was taken out for 25x earlier this year. This is a function of liquidity and lack of institutional capital in Canadian small/mid-caps, providing opportunities for acquirors to buy assets for less than their intrinsic value.
3) Profitable – Five of the seven acquired companies were profitable with the unprofitable two being on a solid path forward. HS GovTech was running small losses ($580K EBITDA loss last quarter) and OpSens was marketing the launch of a highly-important new product, yet its legacy business was profitable.
4) Solid Growth & Tailwinds – On average, the acquired companies grew 42% YoY over the LTM and were expected to grow 19% in 2024.
5) Market Cap Over $100M – Six of the seven acquired firms were taken out at a valuation over $100M. We note that the $100M-$500M range could be the sweet-spot given that micro-caps are not on the radar for most buyers (too small for multi-billion-dollar funds) and large-caps are out-of-reach given current interest rates and financial conditions.
6) Private Equity Friendly – Five of the seven companies were acquired by private equity firms, with OpSens and Playmaker being the outliers. Therefore, we should look for characteristics in small-caps that would fit into a private equity portfolio such as predictable revenue, clean balance sheet, profitability, etc.
Underlyings
10x Genomics Inc Class A

Algoma Central Corporation

Avante Logixx

Colabor Group Inc

Colabor and its subsidiaries is engaged in the business of distributing and marketing food and food-related products in Canada. Co. has two reportable segments, distribution to food distributors (Wholesale Segment) and distribution to foodservice enterprises (Distribution Segment).

Enterprise Group

Enterprise Group is a construction services company operating in the energy, utility and transportation infrastructure industry. Co.'s focus is primarily underground construction and maintenance and specialty equipment rentals. Co. provides directional drilling and installation of underground power, telecommunications and natural gas lines to the utility infrastructure segment of the construction industry. Co.'s heavy equipment rentals division, E One Limited, provides equipment rentals for both the oilfield and civil construction sectors and project crews constructing pipelines and facilities.

FORACO INTERNATIONAL SA

Foraco International is a drilling services company that provides turnkey solutions for the mining and water segments. Co. is organized in two business segments. The Mining segment covers drilling services offered to the mining and energy industry during the exploration, development and production phases of mining projects. The Water segment covers activities linked to the construction of water wells resulting in the supply of drinking water, the collection of mineral water, as well as the control, maintenance and renovation of the existing installations. This segment also includes drilling services offered such as geological exploration and geotechnical drilling.

Gatekeeper Systems Inc

HAIVISION SYSTEMS INC

Magellan Aerospace Corp.

Magellan Aerospace, through its subsidiaries, is engaged in the engineering, manufacture, repair and overhaul of components and assemblies for the aerospace industry; the modernization, repair and overhaul jet engines, defense aircraft and helicopters; the design and manufacture of rocket and satellite systems; and the design and production of magnesium and aluminium castings, primarily for the aerospace industry. Co. operates in two segments, Aerospace and Power Generation Project. Co. has operations in Canada, the U.S. and the U.K.

Major Drilling Group International Inc.

Major Drilling Group International is a drilling service company primarily serving the mining industry. Co. is engaged in the business of contract drilling for companies primarily involved in mining and mineral exploration. Co. provides all types of drilling services including surface and underground coring, directional, reverse circulation, sonic, geotechnical, environmental, water-well, coalbed methane and shallow gas. Co. has operations in Canada, the U.S., South and Central America, Australia, Asia and Africa.

NOW CORP

Now Corporation, formerly Information Capital Technology Ventures, Inc., is a Philippines-based technology, media, and telecommunications company. The Company operates through two segments: IT resource management segment, and IT products and services. The IT resource management segment is engaged in the deployment of information technology (IT) professionals to clients. The IT products and services segment provides products and services to clients. It provides telecommunications, media and information technology (IT) products and services, such as telecommunications value-added service (VAS) through companies licensed to engage in wired and wireless, fixed and mobile telecommunications; software and hardware technology, business process outsourcing, call center and other information technology applications; digital media and other media, and activities directly or indirectly connected to these. It caters to sectors, such as insurance, financial services, retail and manufacturing.

PATIENT HOME MONITORING CORP

Playmaker Capital Inc. (PMKR)

Quipt Home Medical Inc.

Redishred Capital Corp.

Redishred Capital is engaged in the granting and managing of shredding business franchises under the "Proshred" trademark.

Reitmans (Canada) Ltd. Cl A NV

Reitmans (Canada) is a ladies' wear specialty apparel retailer. Co. operates under seven banners: Reitmans, Smart Set, RW & CO., Thyme Maternity, Cassis, Penningtons and Addition Elle. Each banner has different marketing program as well as a specific website. Co.'s stores are located in malls, strip plazas, retail power centers and on shopping streets across Canada. Co. offers e-commerce website shopping in the Reitmans banner and its plus-size banners (Penningtons and Addition Elle).

Spark Power Group

Spark Power Group Inc Formerly known as Canaccord Genuity Acquisition Corp. Spark Power Group Inc, formerly known as Canaccord Genuity Acquisition Corp, is a Canada-based provider of electrical power services to industrial, commercial, institutional, renewable, agricultural and utility customers across North America. The Company provides variety of services, such as High voltage , Renewable, Laboratory and testing, Monitoring and maintenance, Crew assist and mutual aid and Sales and rentals. The Company is focused on achieving renewable and sustainable on-site power solutions, such as Green Energy Solution, Energy Storage, Energy Efficiency, Energy Aware, On-Site Power and Electrical Vehicle Charging. The Company serves the high, medium and low voltage industries with a range of equipment sales, rentals, modular substation installations, design and repair services.

Spectra7 Microsystems Inc

Spectra7 Microsystems is an analog semiconductor company delivering speed, resolution and signal fidelity to consumer and wireless infrastructure products. Co.'s new system-level components address throughput bottlenecks and satisfy the exponential demand for more bandwidth and lower costs in mobile and internet infrastructure equipment, including handsets, tablets, base stations and microwave backhaul systems.

Supremex Inc.

Supremex Income Fund is an unincorporated open-ended trust established under the laws of the Province of Quebec pursuant to a declaration of Trust dated Feb 10 2006, as may be amended, supplemented or restated from time to time. The Fund was created to indirectly acquire and hold all the shares of Supremex Inc. and the net assets of Cenveo Depew Division.

TANTALUS SYSTEMS HLDG INC

Wajax Corp.

Wajax is engaged in the sale and after-sales parts and service support of mobile equipment, industrial components and power systems, through a network of branches across Canada. Co. is a multi-line distributor and represents a number of worldwide manufacturers across its core businesses. Co.'s customer base is diversified, spanning natural resources, construction, transportation, manufacturing, industrial processing and utilities.

Provider
Atrium Research Corporation
Atrium Research Corporation

Atrium Research provides institutional quality issuer paid research on North American public equities using deep fundamental analysis. Our research reports are disseminated through Bloomberg, FactSet, Capital IQ, Reuters and many more, as well as through our social media and email distribution lists. 

Analysts
Nicholas Cortellucci, CFA

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