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Finding the Next Takeout in Canadian Small-Caps - Part Two

What you need to know:
• Since our last note in November, there have been 9 more acquisitions in Canadian small-caps, all at significant premiums.
• In this report, we analyze how the 9 newly acquired firms fit into our 6-part framework for identifying takeout candidates.
• Our potential takeouts watchlist was up 22% vs. the TSX up 14% and XCS up 15% since November. We update the list for some new names on our radar and remove some that do not meet the criteria anymore.

How Have Things Progressed?
Since our last note on November 7th, there have been nine additional takeouts in Canadian small-caps as well as a few strategic reviews ongoing. This includes the acquisitions of BBTV Holdings, Q4, Farmers Edge, MediaValet, Indigo Books, IBEX Technologies, Think Research, MDF Commerce, and TrueContext.

We will reiterate that 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. The new acquisitions largely met the criteria laid out in our last note, which we will revisit below and provide an updated list of takeout candidates.

Do the New Acquisitions Fit Our Criteria?
Looking at the nine new acquisitions that occurred in the Canadian small/mid-cap space over the last few months, we explain how they fit into our 6-part framework.

1) Poor Stock Performance – Amongst the 9 acquired firms, the average stock was down 58% compared to its previous high seen in 2020/2021. Again, most firms have improved fundamentals over that period while rising interest rates and multiple compression led to the stock price decline. 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 reiterate that Canadian equities remain much cheaper than their U.S. and international peers due to the lack of liquidity and institutional capital. For example, Q4 was acquired for 2.3x 2024E sales compared to U.S. peers at 5.7x.
3) Profitable – 6 of the 9 firms were profitable on an EBITDA basis over the last twelve months. Two of the outliers were MDF Commerce and TrueContext which were expected to be profitable in 2024.
4) Solid Growth & Tailwinds – On average, the newly acquired companies grew revenue by 14% over the LTM; this was a step down from the previous cohort (42%) but reiterates that growth is a leading indicator.
5) Market Cap Over $100M – 3 of the 9 firms were acquired for an equity value of over $100M compared to 6 out of 7 in the last cohort. This emphasizes that acquirors exploring deeper into the Canadian markets for quality assets, as this is where most of the discounts occur. We will change this criterion to market cap over $30M moving forward.
6) Private Equity Friendly – 7 of the 9 companies were acquired by private equity firms, aligning with the data from our last report. Again, we should look for characteristics in small-caps that would fit into a private equity portfolio such as predictable revenue, simple business model, clean balance sheet, profitability, etc.