Finding the Next Takeout in Canadian Small-Caps - Part Three
What you need to know:• Since our last note in May, there have been 10 additional takeouts in Canadian small-caps, most of which coming in a significant premiums.
• The new acquisitions largely fit within the framework outlined in previous reports.
• Our potential takeouts portfolio is up 43% since inception (November 2023) and 17% since our last note, compared to the TSX up 18% and 3% respectively. We review the biggest winners and losers in the portfolio and present a list of new ideas on our radar.
How Have Things Progressed?
Since our last note on May 13th, takeouts of Canadian small-caps has accelerated, with 10 additional takeouts occurring (Figure 1). The acquisitions were across various industries and market caps, but the common themes mentioned in our criteria below stood true. This included 2 of the 6 companies profiled in our last note (read here), Xybion Digital and OneSoft.
While valuations in this space have slightly improved as the trend in strategics and private equity buying out Canadian small-caps has become evident, we still believe there are many misunderstood and overlooked stories. Our takeouts portfolio has performed tremendously well, being up 43% since our first report, and 17% since our second (vs. the TSX up 18% and 3% respectively). See page three for a review of our performance and changes to the portfolio going forward.
Do the New Acquisitions Fit Our Criteria?
Looking at the new takeouts since May, we outline how they fit into our 6-part framework below.
1) Poor Stock Performance – Amongst the 10 acquired firms, the average stock was down 22% compared to its previous ATH. This compares to 36% across the entire group, as valuations and stock prices have improved lately (perhaps due to the increased takeout activity). We continue to view this as a leading indicator that a firm is a takeout candidate given that acquirors are looking for discounted prices.
2) Cheap vs. U.S. & International Peers – We will reiterate that Canadian equities remain much cheaper than their U.S. and international peers due to the lack of liquidity and institutional capital. While retail and some smaller institutions are buying up these underfollowed stories, there is not enough capital in the small/micro-cap space in Canada at the moment to provide a full re-rate (hopefully this changes soon).
3) Profitable – 6/10 firms were profitable on an EBITDA basis over the last twelve months. This was fairly consistent with the past acquisitions, but we will note that the average EBITDA margin has declined, potentially speaking to the low-hanging fruit already being acquired.
4) Solid Growth & Tailwinds – On average, the newly acquired companies grew revenue by 11% over the LTM and were expected to grow revenue by 21% in the next year. Again, a step down from the previous cohorts.
5) Market Cap Over $30M – All 10 of the takeouts occurred at an equity valuation of over $30M, with the average being $495M. This demonstrates that we should not be fishing in the nano-cap pond.
6) Private Equity Friendly – 4 of the 10 companies were acquired by private equity firms, a decline compared to the previous cohorts that were dominated by private equity. However, we are choosing to maintain this criterion in our framework given its history (62% of takeouts).
ADF Group is engaged in the design and engineering of connections, fabrication and installation of complex steel superstructures, heavy steel built-ups, as well as architectural and miscellaneous metalwork for the five principal segments of the non-residential construction market namely, office towers and high-rises, commercial and recreational buildings, airport facilities, industrial complexes and nuclear facilities, and transport infrastructures.
BQE Water is engaged in the acquisition and development of processes to treat metal-laden, sulphate-rich waste water streams for acid neutralization and metal recovery. The principal operations of Co. are to build process plants and earn revenues from recovered metals, treatment fees, plant sales and process licenses.
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).
Covalon Technologies is a public medical technologies company that researches, patents, develops and commercializes medical technologies that improve patient outcomes and save lives.
Crescita Therapeutics is a Canadian drug development company with a portfolio of products and technologies. Co. operates two distinct business units: the Topical Products and Technology (TPT) Group and the Immunology Group. The TPT Group has one commercial product, a pipeline of topical and transdermal products focusing on pain and dermatology and multiple drug delivery platforms that support the development of patented formulations that can deliver actives into or through the skin. The Immunology Group has two commercial products: WF10™ and Oxoferin™.
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.
Imaflex is engaged in the design, manufacture and sale of packaging materials including custom-made polyethylene films suited for various packaging needs; polyethylene garbage bags for both the retail and industrial markets; and the metallization of polyethylene film for specific agricultural usage.
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.
Redishred Capital is engaged in the granting and managing of shredding business franchises under the "Proshred" trademark.
Sylogist is a software and services company providing enterprise information management solutions to municipal, education and private sector customers. Co. operates two division, the Enterprise Systems ("ES") division and Connectivity division. ES division provides an integrated suite of business applications to municipalities and school districts that serve their needs for revenue, finance and operations management. Solutions are delivered as customer installed solutions or supplied in a Softwareas-a-Service format. Connectivity division provides software to private and public sector customers that allows easier for integration between enterprise systems, mobile and custom applications.
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