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raise capital over the last 12 months and you need capital then give your head a shake and get moving on it now. Concerns about dilution should take a back seat to the practical fact that there is an open window for capital markets activity that may shut down without notice at any time. For the executives of the smaller companies in our index missing this market window might be a terminal mistake.
A version of this report was last published as the Caseridge TechSys DealBook in 2010. Since then we have been experiencing a very strange financial climate. Over the last five years, under the weight of stimulus and the imposition of previously unrivaled market intervention and regulation, markets have lost their allure as a mechanism for efficient price discovery. The New York Times noted recently that the S&P 500 never once dropped below its December 31, 2011 closing price throughout all of 2012. This index also didnt drop below its closing price on December 31, 2012 throughout all of 2013. This hasnt happened since 1975-76 in the aftermath of the termination of the Bretton Woods Agreement in 1971. The recurrence of a similar phenomenon after a similar length of time following a monumental market event (the credit crisis in 2008) is certainly worth noting. Will this period of good results continue into 2014? It is exceedingly difficult to predict the future direction of prices given the aggressiveness of national governments in using market intervention to influence prices. We do know however that the trend identified by the New York Times wont be repeated in 2014. The S&P 500 was down in the first week of 2014 for the first time since 2008. If the market is moving from a period of lighterthan-air gains (as the New York Times put it) to a period of more interesting times what does this mean for the corporate clients that
2.
run over the last several years and if that run was driven by hikes in dividends or stock buybacks, its time to take a look at your payout ratios and to get them back in line. Theres been a lot of leverage to be had over the last 24 months from feeding yield to a yield starved market, however for the time being it appears that stock price performance has become uncoupled from dividend yields and stock buybacks. Maintain what you have but consider slowing down the rate of growth over the next 12 months. If the market and/or your share price declines you may get a natural yield boost. If you wish to increase dividends, a move in the last quarter might make for better timing than in the first two.
3.
markets hit an interim top more reliable than the sound of American dollars hitting Canadian bank accounts. This trend has gained momentum over the course of 2013 analysts covering the healthcare sectors are beginning to lose significant parts of their coverage universe. If your plan is to sell your business, its a pretty good time to do so as US-based investors continue to troll the Canadian shores for acquisitions. The recent rise in the USD is making our companies look even more appealing.
To track things from a Canadian perspective we developed the EPC Operating Company Index. This is a 250-company equalweighted index of Canadian (or Canadian-listed) companies that we will use to track activity in the Knowledge, Innovation and Growth sectors. It is a Canadian mid-cap index with an equalweighted average market capitalization of $275MM. The EPC Operating Company Index has gained 500% since January 2006.
We hope you enjoy this months The Bankers Note, and I look forward to reconnecting with you over the course of the year.
Adam Adamou CFA Managing Director, Knowledge, Innovation & Growth Investment Banking (647) 497-8816 | adam.adamou@europac.ca | #BringTechBack2Bay
We believe that this is the most comprehensive index in Canada for tracking the KIG sectors.
The Operating Company Index was established with a base level of 100 as at January 2, 2013 and ended the year at 144.52 for a gain of 44.52%. This compares to a gain of just over 8.6% for the S&P/TSX Composite Index and 26.4% for the S&P 500:
Over the course of last year Operating Company Index multiples expanded by about 30% and accounted for 70% of the gain in the index during that period. The GMM Model Index multiples expanded by about 18% and accounted for approximately 20% of the gains in the GMM Model Index during 2013.
Adam Adamou CFA Managing Director, Knowledge, Innovation & Growth Investment Banking (647) 497-8816 | adam.adamou@europac.ca | #BringTechBack2Bay
EBITDA multiples also offer a problematic basis of comparison as it is often impossible to calculate this multiple for companies that choose to focus on growth over profitability. Since there is a disproportionately larger number of companies in the KIG sectors with negative EBITDA, a multiple that selects only profitable companies leads to selection bias. EXAMPLE: HardCo Hardware Inc. vs. SoftCo Software Ltd.
($000s) Stock Market Value EBITDA EBITDA Multiple HardCo Hardware $60,000 $4,000 15.00x SoftCo Software $60,000 -$4,000 N/A
In our example, there is no way to apply an EBITDA multiple for SoftCo since EBITDA is negative. Further we can only compare HardCos 15.00x EBITDA multiple with those of other profitable companies.
We believe that gross profit multiples are a better indicator of relative value for growth stage companies in the KIG sectors.
Gross profits measure the incremental value that a business adds to its products and it is generally more comparable from industry to industry and from company to company than revenues or EBITDA: ($000s) Stock Market Value Gross Profit Gross Profit Multiple HardCo Hardware $60,000 $12,000 5.00x SoftCo Software $60,000 $12,000 5.00x
At a valuation of $60MM HardCo Hardware is trading at 1.00x revenue while SoftCo Software is trading at 3.00x revenue. Using this measure it appears that HardCo is less expensive than SoftCo. Digging deeper we discover that taking these multiples at face value is not a good idea: ($000s) Gross Margin Gross Profit HardCo Hardware 20% $12,000 SoftCo Software 60% $12,000
In the example above we see that with gross profit as our rule-ofthumb multiple that these two relatively different companies are compared on a relatively similar basis. Gross profit multiples are a simple and easy proxy to use for this purpose, and since almost every company has positive gross profit, they are superior to both revenue and EBITDA multiples:
Adam Adamou CFA Managing Director, Knowledge, Innovation & Growth Investment Banking (647) 497-8816 | adam.adamou@europac.ca | #BringTechBack2Bay
Caveats
A few caveats for the GMM model: 1.
Generating the same dollar value of gross profit at a higher gross margin is more valuable than generating that same gross profit at a lower gross margin. This is our core concept.
We developed the concept of a gross margin multiple (GMM) and incorporated it into our approach to reflect this observation. The GMM is a rule-of-thumb that assigns higher gross profit multiples to companies that generate higher gross margins as follows: Gross Margin of <=20% Gross Margin of 30% Gross Margin of 40% Gross Margin of 50% Gross Margin >= 60% TEV = 2x Gross Profit TEV = 3x Gross Profit TEV = 4x Gross Profit TEV = 5x Gross Profit TEV = 6x Gross Profit
for example, take into account the solvency risk of companies that are unprofitable on an on-going basis. In our example above, SoftCo may very well deserve a significantly lower GMM given its cash burn if the market believes that it will go out of business before it can reach profitability. Often times a low GMM is a signal that a company is in trouble. For this reason we use solvency measures in conjunction with our GMMs;
2.
The model is best used on forward estimates for gross profits and gross margins rather than for trailing estimates. Future growth is a big factor in
valuations and companies that are growing rapidly deserve higher multiples. Using a forward estimate for gross profit and gross margin is more appropriate than using trailing or historical figures. GMMs on trailing financials are typically greater than 1.00x to reflect the markets consensus view of future growth; and
3.
The GMM model does not appear to maintain this relationship for large capitalization companies. As companies grow to sufficient size they
are no longer growth companies and are more appropriately measured using other techniques.
This relationship combines all of the key elements of our model. We measure this relationship as our gross margin multiple and set it at a value of 1.00x when a companys valuation is in accordance with this relationship. ($000s) Stock Market Value Gross Profit GMM VALUATION Gross Margin Rule-of-Thumb GMM GMM Implied Valuation Actual GMM Multiple HardCo Hardware
$60,000 $12,000 20% 2.00x $24,000 2.50x
SoftCo Software
$60,000 $12,000 60% 6.00x $72,000 0.83x
Adam Adamou CFA Managing Director, Knowledge, Innovation & Growth Investment Banking (647) 497-8816 | adam.adamou@europac.ca | #BringTechBack2Bay
the market is pricing in more growth than is being generated by the Index at its current run rate. Market Sentiment
Market sentiment is a measure of the technical indicators of each of the stocks in the Operating Company Index. We use standard technical analysis techniques to measure the sentiment of each stock in the Operating Company Index on a scale from Very Bearish to Very Bullish. Aggregating these values over the entire universe provides us with an average technical indicator for the Operating Company Index:
Sentiment Distribution Very Bearish 0% Bearish 3% Neutral 54% Bullish 39% Very Bullish 4%
Summary of Component Companies 250.00 Figures are for Last Twelve Months (LTM)on a Rolling Basis $273,258 26,569 77,419 326,190 176,362 62,604 8,173 44.01% 5.53% 4.63% VALUATION 2.17 5.45 1.38 18.09 1.90 1 All figures are based on averages,
excluding the high/low outliers.
Avg. Market Cap: Avg. Cash: Avg. Debt: Avg. Enterprise Value: Avg. Revenue: Avg. Gross Profit Avg. Cash Flow: Avg. Gross Margin %: Gross Profit Growth (Run Rate) Cash Flow Margin %
We see a modestly positive skew toward the bullish with 43% of the companies in the Operating Company Index rated as Bullish or Very Bullish against only 3% rated as Bearish or Very Bearish. More than 50% of the companies are rated as Neutral. The aggregate technical indicator for the Operating Company Index as a whole is at +1.90 which is considered to be Neutral to Modestly Bullish.
Market sentiment for the Operating Company Index is in the Neutral to Modestly Bullish category. Operating Company Index Winners and Losers: 2013
Worst Performing Stocks
EV/Revenue (LTM) EV/Gross Profit Gross Margin Multiple Price/Cash Flow: Technical Indicator Notes:
Northstar Healthcare Inc. (TSX: NHC) NTG Clarity Networks Inc. (TSXV: NCI) Sphere 3D Corporation (TSXV:ANY) International Barrier Technology Inc. (TSXV: IBH) Kelso Technologies Inc. (TSXV: KLS)
based on the averages of the individual components and not on the averages of the global numbers. 3 Note that the universe is not static and changes over time. Results may therefore not be comparable over long periods of time, 4 Cash Flow is CGBO before working capital changes.
406.25%
ProSep Inc. (TSX: PRP) Times Three Wireless Inc. (TSXV: TTW) Data Group Ltd. (TSX: DGI) Swisher Hygiene Inc. (SWSH) MicroPlanet Technology Corp. (TSXV: MP)
-70.00%
The Operating Company Index is trading at a trailing GMM of 1.38x. To maintain the 1:1 relationship predicted by our GMM model the market is pricing in gross profit growth of 38% over Adam Adamou CFA Managing Director, Knowledge, Innovation & Growth Investment Banking (647) 497-8816 | adam.adamou@europac.ca | #BringTechBack2Bay
Focus Index
All Data is LTM
Summary of Component Companies 25.00 Figures are for Last Twelve Months (LTM)on a Rolling Basis $101,668 18,312 9,794 92,411 37,957 25,490 3,078 63.69% 18.52% 15.92% VALUATION 2.19 3.92 0.50 15.68 2.00 1 All figures are based on
Companies in Universe:
2-Oct-13
Avg. Market Cap: Avg. Cash: Avg. Debt: Avg. Enterprise Value: Avg. Revenue: Avg. Gross Profit Avg. Cash Flow: Avg. Gross Margin %: Gross Profit Growth (LTM/LFY) Cash Flow Margin %
EV/Revenue (LTM) EV/Gross Profit Gross Margin Multiple Price/Cash Flow: Technical Indicator Notes:
The 25 constituents in the GMM Model Index were selected to balance the size and scope of the Index and include companies ranging in market capitalization from under $10MM to almost $400MM.
Company Name Ticker Last Market Cap LTM Revenue GMM Absolute Software Corporation TSX: ABT $ 6.98 $ 297,941 $ 87,546 0.60 C-Com Satellite Systems Inc. TSXV:CMI $ 1.61 56,976 16,741 1.96 D-Box Technologies Inc. TSX:DBO $ 0.20 32,756 14,971 0.67 The Descartes Systems Group TSX:DSG $ 13.50 847,095 151,033 1.16 Espial Group, Inc. TSX:ESP $ 0.75 14,828 11,364 0.14 EXFO Inc TSX:EXF $ 5.19 313,601 252,422 0.33 Halogen Software Inc. TSX:HGN $ 12.38 268,039 46,876 0.82 IWG Technologies Inc. TSXV:IWG $ 0.24 9,053 6,606 0.34 Microbix Biosystems Inc. TSX:MBX $ 0.15 10,003 7,575 0.52 NTG Clarity Networks Inc. TSXV:NCI $ 0.40 12,502 8,736 0.46 Northstar Healthcare Inc. TSX:NHC $ 1.12 41,263 24,788 0.27 NeuLion Incorporated TSX:NLN $ 0.53 89,568 44,752 0.41 NexJ Systems Inc. TSX:NXJ $ 1.90 40,523 26,787 0.31 Photon Control, Inc. TSXV:PHO $ 0.26 26,102 13,120 0.67 Pethealth Inc. TSX:PTZ $ 1.95 59,789 40,555 0.19 Pure Technologies Ltd. TSX:PUR $ 6.75 344,817 59,102 0.88 QHR Corporation TSXV:QHR $ 1.19 57,064 33,344 0.59 $ 2.77 43,086 36,030 0.25 Redline Communications Group TSX:RDL Sandvine Corporation TSX:SVC $ 2.62 363,818 112,839 0.39 Symbility Solutions Inc. TSXV:SY $ 0.42 86,304 21,080 0.55 Terago Inc. TSX:TGO $ 6.24 71,372 51,084 0.58 Titan Logix Corp. TSXV:TLA $ 1.25 31,267 16,493 0.54 TransGaming Inc. TSXV:TNG $ 0.17 14,092 10,590 0.43 Wanted Technologies CorporatioTSXV:WAN $ 1.16 27,853 7,641 0.34 Webtech Wireless Inc. TSX:WEW $ 0.33 34,806 29,975 0.20
averages, excluding the high/low outliers. 2 Percentages and Multiples are based on the averages of the individual components and not on the averages of the global numbers. 3 Note that the universe is not static and changes over time. Results may therefore not be comparable over long periods of time, 4 Cash Flow is CGBO before working capital changes.
Relative to the Operating Company Index, the GMM Model Index is trading at a similar revenue multiple (2.18x vs. 2.19x). Gross profit growth run rates for the GMM Model Index however are tracking at an annualized rate of 18.52% while average gross margins are at 63.69% vs. 44% respectively. Note that these aggregate statistics reflect only a point in time and they are not adjusted for seasonal or cyclical factors.
The GMM Model Index is specifically constructed with lower GMM companies relative to the Operating Company Index. It DOES NOT contain a fundamental analysis of the businesses or their prospects. Inclusion in the Index does not necessarily constitute a recommendation to buy or to sell the securities of any of these issuers. It simply means that they had low GMM multiples at the end of 2013.
Redline Communications Group (TSX: RDL) NexJ Systems Inc. (TSX: NXJ) Terago Inc. (TSX: TGO) Symbility Solutions Group (TSXV: SY) Espial Group (TSX: ESP)
Adam Adamou CFA Managing Director, Knowledge, Innovation & Growth Investment Banking (647) 497-8816 | adam.adamou@europac.ca | #BringTechBack2Bay
93 private placements closed in 2013 representing 64% of all transactions by quantity during the year. Private placements are generally smaller issues by dollar value with the largest transaction being the ViXS Systems Inc. (TSX: VXS) issue that closed in April for $57.4MM. Rounding out the top five were Redknee Solutions (TSX: RKN April 2, $45MM), Amaya Gaming Group (TSX: AYA June 19, $40MM), Black Diamond Group (TSX: BDI July 3, $40MM) and DHX Media (TSX: DHX October 29, $35MM):
The sectorial breakdown of transactions largely tracks the sector composition of our Operating Company Index: 45% of closed transactions (66 deals) in the Information Technology sector vs. a 41% weighting in the Index, 28% (41 deals) in the Industrials sector vs. a 34% weighting in the Index and 7% (10 deals) in the Consumer Discretionary sector relative to an 8% weighting in the Index. We also saw a nice surge for Healthcare industry financings with 19 deals closed representing 13% of all transactions relative to a 9% weighting in the Index. We saw some new investors making an impact on the KIG sectors this year with Difference Capital Financial (TSX: DCF) active as an announced buyer in four transactions valued at $37MM followed by Pinetree Capital Ltd. (TSX: PNP) active in three deals valued at $9MM.
There were 39 Public Offerings in 2013 with the largest being the $595MM JDS Uniphase (TSX: JDSU) issue closed on August 15, followed by two separate issues by Cogeco Cable (TSX: CCA) for $400MM and $300MM closed on April 14 and May 22 respectively, a Manitoba Telecom (TSX: MBT) issue for $249MM that closed on November 19 and a $200MM issue for TransAlta Renewables (TSX: RNW) that closed on September 25. Of the 10 Mergers & Acquisitions that closed during the year the largest was the sale in August by Geosam Investments Ltd. of General Donlee Canada Inc. (TSX: GDI) to Triumph Aerospace Adam Adamou CFA Managing Director, Knowledge, Innovation & Growth Investment Banking (647) 497-8816 | adam.adamou@europac.ca | #BringTechBack2Bay
Agenda: To approve definitive agreement for acquisition by Motion Industries (Canada) Jan-29-2014 Jan-29-2014 Jan-29-2014 Jan-29-2014 Jan-29-2014 4:30 PM Jan-29-2014 4:30 PM Jan-29-2014 4:44 PM Jan-30-2014 Ex-Div Date: Jan-30-2014 Pay Date: Feb-28-2014 Feb-04-2014 Feb-04-2014 Feb-05-2014 Feb-05-2014 Feb-05-2014 5:30 PM Ag Growth International Inc. (TSX:AFN) HNZ Group Inc. (TSX:HNZ.A) Student Transportation, Inc. (TSX:STB) Wajax Corporation (TSX:WJX) Exco Technologies Limited (TSX:XTC) Exco Technologies Limited (TSX:XTC) Exco Technologies Limited (TSX:XTC) TransAlta Renewables Inc. (TSX:RNW)
Passcode: 7687072 Passcode: 7687072 Live Audio Details & Webcast URL: http://www.snwebcastcenter.com/webcast/sierrawireless/2013q4/ Feb-07-2014 Feb-07-2014 2:00 PM Feb-10-2014 Feb-10-2014 Feb-10-2014 Feb-11-2014 Feb-12-2014 Feb-12-2014 Pay Date: Feb-28-2014 Craig Wireless Systems Ltd (TSXV:CWG) Calian Technologies Ltd. (TSX:CTY) 16th Annual BIO CEO & Investor Conference Novik Inc. (TSXV:NVK) Transition Therapeutics Inc. (TSX:TTH) Mediagrif Interactive Technologies Inc. (TSX:MDF) Cangene Corp. (TSX:CNJ) Enghouse Systems Limited (TSX:ESL) Amount: 0.080 (CAD) Record Date: Feb-14-2014 Annual General Meeting Annual General Meeting Conference Location: The Waldorf Astonia, New York, New York, United States Special/Extraordinary Shareholders Meeting Company Conference Presentation Earnings Release Date Special/Extraordinary Shareholders Meeting Ex-Div Date (Regular)
The information contained in this report represents the view of the author(s) and was developed from sources we believe to be reliable. We do not represent that such information is accurate or complete and it should not be relied on as such. Any opinions expressed herein reflect our judgment at this date and are subject to change. Euro Pacific Canada Inc. and/or employees from time to time may hold shares, options or warrants on any issue included in this report and may buy or sell such securities. This report is not to be construed as an offer to sell or solicitation to buy securities.