The Caseridge Blog will be moving to a real time social networking structure as of today.
The transition of the web from the “static web pages” of the past to the blogs of the present is giving way to the real time web through vehicles such as twitter and social networks such as LinkedIn,. We are adjusting to these new realities by moving our updates to these platforms.
For live daily updates on our research, reviews, reports and late-breaking news we invite you to join the Caseridge TechSys DealBook Network on LinkedIn This is a private group forum for qualified investors only. For live updates that are available to everybody, you may follow us through our Twitter feed at http://twitter.com/caseridge.
Below, we are publishing our final blog post on this forum, appropriately titled, How To Use Twitter.
Twitter is relatively new, and many of you who are looking to explore twitter are struggling to understand just what the “noise” about twitter is about… it frankly doesn’t appear to be very transformational at first glance. It is.
The emergence of twitter marks the birth of the “real time web”, or the next iteration of the internet: Web 3.0. The first version of the web (Web 1.0) consisted of a number of static web pages published in HTML that one would manually visit, read, then go to the next site or search term. Web 2.0 marked the birth of the interactive web, with social networks, blogs, podcasts, video and RSS feeds bringing an interactive dynamic to the web that simply did not exist in the static web pages of Web 1.0. This latest iteration, the twitter inspired Web 3.0 represents a transition to the “real time web” in which one is connected in real time to events, sites, networks and people as they happen or change. When something happens, I almost always hear about it on twitter before it pops up on any web page, blog, radio, broadcast news or newspaper. It is live, real, and continuous – and it takes getting used to. Here’s a few “getting started” suggestions to get you up to speed on how to take advantage of this technology.
First, get a twitter account at http://twitter.com. The process is as simple as typing in an email address and a password. Next, make sure to lock up proprietary words that relate to you or your business (or have your IT people get on it) – such as the name of your company, trademarks and copyrights and other identifiers. Wait too long and you might discover that the name of your company is being used by somebody else for less than savory purposes.
Next, choose to “follow” us by using the “Find People” tab on the twitter site and typing in the word Caseridge (or just go to http://twitter.com/caseridge and choose “Follow”). As a follower of Caseridge on twitter, you will be updated whenever there is a status change or alert that is sent out by us. We follow a number of users in our Caseridge account, including FPTradingDesk, HotWiredStocks, WSJ, Makeitseven, Venture_Capital, TechCrunch, MarketWatch and a number of others, you might want to follow them as well if they are relevant to you or your business.
Now, you should download a few applications to make twitter easier to use. Download and install TweetDeck on your PC (you can find it at www.tweetdeck.com). This is an application that streams real time twitter feeds to your PC. To get the most out of it, you should go to www.stocktwits.com and enter in your twitter username and password. In the portfolio section, enter in the ticker symbols for companies that you care about or that you would like to track. Once done, you should add the Stocktwits Portfolio and Stocktwits Recommended feeds to your TweetDeck. This will provide you with real time information on those companies, as well as real time market and trading information from other people that are interested in those companies.
Now add the TwitScoop Buzzing option to the TwitDeck: this provides you with a graphic representation of what people are talking about worldwide. If you have a Facebook account, add that to your TweetDeck as well. On my TwitDeck, I also have a number of real time searches added, such as Caseridge for example, so that any time Caseridge is mentioned in any conversation, we are informed.
For those with a Blackberry (and I imagine that’s most of you), you should use your Blackberry browser to download Ubertwitter at www.ubertwitter.com/bb/download.php. Ubertwitter is an application that provides real time updates from twitter to your Blackberry. It allows you to post updates to your twitter account, respond to and follow others, run searches, keep on top of emerging trends and to retrieve additional information on topics that are of interest to you.
Here are some practical examples of how to use twitter for those looking for ideas.
If you are an executive at a company, set up a blocked twitter account for your senior team that allows only pre-approved people to track you. With your TwitDeck, Blackberry and Ubertwitter in tow, you can post updates on important meetings in real time as events develop. Post the results of a sales pitch or a list of follow-up tasks, track projects or track due diligence field updates, track financial position and inventory orders - whatever makes sense in your business and with that particular group – in real time. It’s much easier than putting together an email and then forwarding it around and a lot less intrusive. It allows you to track information and conversations or respond to questions as they develop. You will quickly discover, if you are consistent in using it, that your team is better informed and on top of each other’s priorities. You will find as a result that face-to-face meetings can now focus on the key priorities since all parties are up-to-speed on the key recent developments.
Here’s an example sent to me by an analyst friend of mine in New York who covers the retail sector: he tracks the various retail chains in real time using an application named TwitScoop. This application allows a user to pick a series of topics, in this case the major retail chains in the US (Wal-Mart, Costco, Sears, the Gap and so on) and to track their popularity based on the number of times that they are mentioned in various tweets, and to track them in real time as they change. Each of the retailers is tracked and the more popular they are, the larger the font. If the “buzz” on “Wal-Mart” is large and growing, the font will appear bigger than the others and it will also appear to be growing in real time. This would imply that more people are twitting about Wal-Mart and that the rate of change is increasing. If the size of the Costco font begins to grow relative to the others, this implies that more people are tweeting about Costco. A click on the word “Costco” provides a list of the tweets underlying the search: This might lead to a discovery underlying the growing number of people that are talking about it – for good, bad, or in some cases silly reasons. A single tweet stating “I hate Costco” is irrelevant. A million tweets likely means that it has hit the mainstream media. A few thousand tweets that is growing quickly, means that you have a “heads-up” on something that is developing, right now, in real time.
Those are a few examples, there are countless others; the potential is truly unlimited. Just as the emergence of email and the cell phone changed our communication patterns over time, so is the emergence of twitter and Web 3.0. It takes time and some effort to learn the in’s and out’s of a new operating system… but all we are saying, is give a tweet a chance. Send me a tweet @caseridge to let me know what you think.
There has been a pick-up in activity over the year in the acquisition of growing Canadian TechSys companies by larger global companies. Recent examples include Certicom Corp. (TSX:CIC) and just last week an announcement regarding the break-up and sell down of Kaboose Inc. (TSX: KAB) and its assets to the Bounty Group and to Disney Online. It feels as if the Caseridge TechSys mid-market is being hallowed out, but rather than complain about it, we decided to investigate further by running some targeted filters on the Caseridge TechSys database in order to bring to your attention some companies that might be of interest to prospective purchasers over the next year.
Our search began by looking for companies with market capitalizations of between $40MM to $200MM along with Enterprise Values of between $50MM to $250MM. This resulted in a list of 35 companies that met both conditions (69 companies met the market capitalization filter and 35 of those met the Enterprise Value filter as well).
To prune this list down to a smaller and more manageable group, we ran some additional filters isolating those companies that have cash on the balance sheet and that are expected to have a positive cash balance on the books twelve months from now. This reduced the size of the group down to 30 companies.
Digging further, we filtered this list further to focus on those companies that are growing their dollar gross margins at a quarter-over-quarter (annualized) run rate of more than 10%. This is an exceptional growth rate given that we are measuring dollar gross margins in the most recent quarter to the margin in the last twelve months (which includes the last quarter) as the “current growth rate“. In other words, these companies grew their gross profit in real dollar terms by 10% during the worst recession in 20 years!
This brought the list down to just 10 companies. Of those 10 companies, five are rated as “undervalued”, one is rated as “fairly valued” and four are rated as “overvalued” when using our GMM model. Our first inclination was to focus the final list only on those companies that are “undervalued”, as being the most likely takeover candidates. Upon further reflection we decided that it is just as likely for companies that are “overvalued” to sell than it is for companies that are “undervalued“. Our final list is highlighted in the full version of the Caseridge TechSys DealBook along with our GMM target stock prices for these companies. No discussions between Caseridge staff and the company management at any of these companies has taken place regarding their prospects as takeover candidates.
If you have not received the DealBook in your email inbox, please send us a note along with your preferred email address for the distribution, and we will add you to our distribution list.
We hope that you enjoy this weeks’ Caseridge TechSys DealBook.
Strong markets lead to higher demand for new issues in the Canadian equities market, particularly in the small-to-mid capitalization marketplace that is the focus of the Caseridge TechSys Index. We have seen the strong markets. We have yet to see an increase in new issue activity to date, at least in the TechSys sectors. The list below highlights the fact that TechSys new issue activity has been essentially non-existent over the last quarter: the only deal of substance was itself a special case related to the acquisition of the company by a single shareholder.
|
Private Placement Transactions (Last 3 Months) |
|
||
|
Announced Date |
Closed Date |
Target |
Size ($mm) |
|
Mar-18-2009 |
Mar-23-2009 |
Finavera Renewables Inc. (TSXV:FVR) |
0.43 |
|
Feb-27-2009 |
Mar-17-2009 |
Titan Trading Analytics, Inc. (TSXV:TTA) |
0.52 |
|
Feb-27-2009 |
Mar-05-2009 |
Xplore Technologies Corp. (OTCBB:XLRT) |
0.4 |
|
Feb-23-2009 |
Feb-23-2009 |
Genesis Worldwide Inc. (TSX:GWI) |
1.22 |
|
Jan-26-2009 |
Feb-03-2009 |
Timminco Limited (TSX:TIM) |
20.29 |
|
Jan-06-2009 |
Jan-21-2009 |
Active Control Technology, Inc. (TSXV:ACT) |
0.45 |
|
Dec-29-2008 |
Mar-03-2009 |
Zecotek Photonics Inc (TSXV:ZMS) |
0.47 |
We have reason to be optimistic however. For one, the fact that a new-issue window has developed alongside a surge of new issue activity in the mining and materials sectors over the last month is a positive sign that indicates that investors have the ability and the willingness to pile in to what they believe to be “opportunistic” investments. The reality of Canadian institutional investing is that fund managers are more knowledgeable about and more comfortable with the materials sectors than they are with the TechSys sectors: it should not surprise us that they have moved first to the relative comfort of the resource sectors first. This will change as we move forward.
The technology sectors are better positioned to benefit from a normalization of economic activity: they operate with lower operational risk rates, offer tremendous value and for the most part they have weathered the storm quite well. With the rate of change in the business environment increasing; businesses are looking for technology solutions that enable them to deal with, and to benefit from, this accelerating level of change. The technology sectors are also a good hedge against inflation in that they provide efficiency improvements to their customers that allow them to reduce costs. If general prices increase via an inflationary expansion of the money supply as expected, then it is likely that we will see an improvement in technology gross margins as well, This will lead to an expansion in multiples and valuations.
We are preparing now for this opening in the new issue window with two new issues presently “on the go”: a $30 to $50MM initial public offering is tentatively scheduled for the September time frame while a smaller $3 to $5MM private placement is expected to close in May. Our advice to you is this: if you need capital, you should be preparing for it now. We see some light out there and you need to jump into it before somebody hits the dimmer switch.
Caseridge has expanded the TechSys DealBook via the Caseridge TechSys DealBook Network on LinkedIn. This group is designed to provide daily updates, discussions, news alerts and announcements to readers of this report and for those interested in the TechSys sectors in Canada. In the first week since going “live”, over seventy members of our network have joined our Caseridge TechSys group on LinkedIn, creating one of the largest targeted networks of senior level professionals, investors, bankers and analysts in Canada. If you want to stay connected with those that are connected, this is the perfect venue for you.
Check it out and please feel free to join us by clicking on the title above or on this link. The group is a private group that is open to readers of the Caseridge TechSys DealBook (if you receive this report directly via email then you are a pre-approved member of the TechSys DealBook Network). If you are not on our direct distribution list and would like to be, please send us a request via the links above, and once vetted we will bring you in to the fold.
We hope that you enjoy this weeks’ Caseridge TechSys DealBook.
Best,
Caseridge TechSys DealBook March 16, 2009
The number of Twitter “Good News Alerts” doubled in number week over week from 11 positive economic news stories to 22 during the last week. Our sentiment charts indicate that despite the positive market momentum that the improvement in “Bullish” sentiment is coming at the expense of “Neutral” investors rather than the “Bears”. This contrarian indicator may be seen as bullish for our TechSys index. Finally, the average market capitalization in the index increased by nearly 6% last week as enthusiasm returned to the markets, however the average GMM multiple remains near the lows of mid January. With the “average date of the reported financials” now at mid-November, it appears that while gross margins continued to face some pressure, the decline to date has been marginal, while top line revenues have continued to grow at a steady pace.
We hope that you enjoy this weeks’ Caseridge TechSys DealBook. To receive a copy of the full copy of the Caseridge TechSys DealBook in PDF format via email, please send an email to the address below.
Best,
adamou@caseridge.com
416-915-4142
Who is next After UTS Energy?
Less than one month into 2009, my prediction regarding an active year for M&A amongst promising resource plays is ringing true. In an earlier piece just three weeks ago here I referred to 2009 as the “Year of the Billion Dollar Deal”. Well, guess what….should Total succeed in acquiring UTS Energy, the price tag will likely be somewhere near $1 Billion. Total’s initial bid of $630 Million is an obvious lowball – UTS has about $300M in cash and owns 20% of the single largest undeveloped oil sands project in the world. UTS’ partners in the massive Fort Hills project, Petro Canada and Teck Cominco, are responsible for a disproportionate share of Capex, further enhancing the value of UTS shares. The question for investors now is whose next? Let’s examine some possible scenarios.
Oil Sands
Fort Hills Partners – Petro Canada and Teck Cominco
Unless someone were to come around and make a bid for the whole of Petro Canada, there is no reason for the company to divest its 60% stake in the Fort Hills project. The company is well diversified, has a strong balance sheet and committed to the project when oil prices were far lower than current levels. On the other hand, Teck Cominco’s position is far different. The company is over-leveraged, having purchased the remaining 60% stake in Fording Coal Trust at the top of the market and faces falling prices and slack demand for most of its products, save for its relatively minor gold production. Despite its efforts to emulate commodity majors, such as BHP Billiton, the company would likely exit the oil business before entering production, should someone be willing to absorb Teck’s Fort Hills Capex obligations.
Teck’s 20% share would likely be had for about $1B dollars, as Teck stands to gain significant revenues from mining productions, to offset Capex obligations.
Canadian Oil Sands Trust
(COS-UN.TO $18.70)
To me, this seems an unlikely player to be acquired in the current market environment. Recent speculation that they would be next to be bid on doesn’t make a whole lot of sense, given that the Trust still has a fairly strong balance sheet, so a takeover would be expensive. The Trust is clearly reeling, having not sold forward oil hedges at peak prices; a costly mistake given that current oil prices do not cover operating costs, interest expense and monthly distributions (even after they were hacked from 75 to 15 cents per quarter).
For every day that WTI is below $50, Canadian Oil Sands’ financial position deteriorates, so prospective buyers are better off waiting.
OPTI Canada
(OPC.TO $1.60)
Another unlikely candidate, unless Nexen decides to put them out of their misery. Opti has been plagued by delays and is projected to be one of the more expensive SAGD projects, due to its high stem to oil ratio (high natural gas usage). Nexen recently purchased a 15% stake in the Long Lake Joint Venture for $735M – at no premium – which indicates there were no other bidders. The upside to Opti is that production has commenced, however, the company has almost $2B in debt, making loan defaults a very real possibility.
Survival of the company at this stage is a 50/50 bet, so if a takeover were to materialize, it likely wouldn’t offer investors much of a premium.
Baytex Energy Trust (Seal Oil Sands)
(BTE-UN.TO $14.30)
Baytex is an Energy Trust with a significant focus on Heavy Oil, including oil sands. The Trust is well run, with a conservative balance sheet and is small enough to easily be swallowed up by any number of players. Of particular interest could be the Seal Oil Sands project. By no stretch should this resource be compared to the potential scale of the Fort Hills or Long Lake projects, but numerous foreign entities in particular have demonstrated an appetite to purchase smaller oil sands projects, to establish a foothold in the region, gain technical insight and build long-life reserves. Baytex would be an ideal candidate to meet all three objectives and does not have a major shareholder either.
Takeout price would likely be in the range of $3B, using current energy pricing.
Pengrowth and Penn West
Both are strong candidates to divest oil sands assets in 2009. In the case of Pengrowth, its Lindbergh oil sands asset is not material enough to say no to reasonable offers, especially considering the Trust’s debt load and high production decline rate. Penn West has a more material oil sands project in the Peace River Arch, but is in a desperate struggle to shore up its balance sheet, via aggressively cutting distributions and raising equity.
Divesting its oil sands asset, perhaps even at a fire sale price, is the best option.
It is unlikely that a large oil sands player will be acquired in the near term, as the price of oil in the near term is anything but a certainty.
Connacher Oil & Gas
(CLL.TO $.90)
Often mentioned in the same sentence as UTS. In reality, the company is a hodgepodge of assets of little interest to energy majors. Current operations consist of a small oil refinery in Montana, 2000+ Boepd of conventional production, a minority stake in South American producer, Petrolifera Petroleum and the
Great Divide oil sands project. Current enterprise value, including debt, is approximately $700M. Were the company to be acquired, it would be by an entity that was willing to carve up the various pieces of the company and keep what they wanted.A likely target for a $1B acquisition.
Historical Equity Pricing Data supplied by Capital IQ is licensed by FTSE International Limited to publish the FTSE Note that the opinions in this report are solely those of the author. The information in this report is gathered from various information provides that we believe to be reliable. Material errors or omissions are unintentional, and corrections may be forwarded to the author for correction in a subsequent report. This report is intended only for sophisticated and accredited investors, the recommendations made should not be acted upon by investors without proper advice and consultation with their investment advisor. Caseridge is a limited market dealer registered in Ontario.
With tremendous budget deficits looming, the result of huge stimulus spending plans that are being undertaken by various governments in order to protect us from a deflationary-stagnation spiral, we ask in this week’s report – are things really as bad as we’re being told? Or is there something else at play?
· The Caseridge TechSys Index realized its first positive month of returns in the last six;
· The Caseridge TechSys Index is “up” by almost 15% over the last 30 days;
· Average gross profits for companies in the Caseridge TechSys Index have grown by nearly 12% over the last twelve months (to October 2008) vs. a growth rate of only 8.5% for the previous fiscal year. Thanks in part to the relative decline of the Canadian dollar in the last four to six months; we see the growth rate of the TechSys Index remaining good over the course of the current year, having called for a conservative annual growth rate of 5% for 2009 in our annual forecast;
· The current gross profit growth rate of the Caseridge Index is over 15% when we measure the run rate of gross profits based on data from the most recently announced quarter;
· The Caseridge Sentiment Indicator has shown a veritable collapse in “Bearish” sentiment over the last month as more and more shares park themselves into the “Neutral” category, ready perhaps to jump into the “Bullish” bandwagon which for the first time in over nine months has more members than the Bearish clan.
· We are beginning to see an increase in M&A activity, and not only for fantastic companies such as Certicom (which we included in our list of Best Companies for 2009), that are being acquired at decent premiums, but also for companies such as Chalk Media whose future absent an acquisition, was in our opinion, questionable at best.
· We’re also seeing an increased level of interest in the companies in our universe from fund managers and investment bankers. In a recent road show for a prospective IPO candidate that was organized by Caseridge, the level of interest in this pre-IPO technology company surprised and impressed even us. We are going forward to the next steps and hope to have the first Canadian technology IPO in more than a year completed in the next few months.
The above represents a good list of some pretty positive signs from the month of January, yet the news that we hear is almost unanimously negative.
I’m not an expert in group psychology, but I’m going to take a wild guess as to what I believe is causing the news to be skewed to the negative: It is in the best interest of the great number of embedded interests looking to benefit from the tremendous increases in public spending from governments worldwide.
When trillions upon trillions of dollars are about to be “invested” in various projects as part of a global stimulus program, one that is unprecedented in world history (at least in peace time), it can’t help but create a strong incentive for a great number of these interests to play up the negativity, to take every weekly report and announcement as the veritable “end of the world as we know it”. These massive spending and social programs must be sold to the public that is ultimately footing the bill, the middle class, and it doesn’t require a great leap in logic to presume that they are more likely to go along if they are scared out of their wits. The pork is calling, and good news is the enemy of these embedded interests until they’ve had their piece. The size of the spending and the breadth of the spending is in fact so inclusive, that it is difficult to find any embedded interest that is not on side, from the left to the right to the center, to the top and to the bottom. Comfort, is the enemy of all of them, and fear is the friend of all.
I expect that over the next three to six months, with these stimuli and spending programs passed by Congress and various Parliament’s worldwide that the benefits of accentuating the negative and downplaying the positive will pass. Once these packages are signed and the first dollars begin to trickle through the system, the incentive will in fact be to take credit for all of the “good news” that will suddenly be discovered, and to downplay the bad news as being “backward looking”. Perhaps at that point, we can all once again begin to read our newspapers and watch the television news programs without constantly being pounded by those seeking to feed off of the governments’ roasted pork.
Tax Relief Measure, if Passed, Could Lead to Enormous Rally
With all eyes on Washington for a historic Inauguration Week, I felt it would be appropriate to highlight an element of President-Elect Barack Obama’s proposed stimulus package that carries significant importance to energy investors. Before I dive into details, I must confess that I am generally of the view that in times of economic contraction, well-targeted strategies to promote spending are most often more effective than tax cuts, to get the economy moving. With my Keynesian beliefs disclosed, I would like to now speak of a measure that, if enacted, will lay the foundation for a very significant market rally.
Buried amongst the hullabaloo of the various measures to promote economic activity, a surprising gem appears in the works: a House Democratic tax relief measure that would extend the loss carry-back provision for net operating losses to five years (instead of the usual two), thereby allowing companies to recoup sizeable tax windfalls. Should it be included in the final stimulus package, this will have a significant impact on the markets for the following reasons:
•
The past five years represent peak earnings, with earnings on the S&P 500 topping out at $87.50 in 2007. With earnings estimates for the S&P averaging around $50, there will be many companies that will be able to receive billions in taxes paid. This measure will serve as a megabailout for all eligible sectors.•
A significant portion of listed companies are trading as though they are insolvent, or will be shortly. This is not unusual in times of recession, as one never knows exactly how long or how deep the downturn will be. What we do know, is that this downturn will end, as all recessions do and five years of carry-backs will be enough of a stimulus to allay investor concerns in many companies. Think of how many large cap companies that up until recently were very profitable, yet their stock is currently around $5.•
This measure would largely remove the current “death watch” mentality of the markets, where fear and hysteria have gripped investors. Of course, there will still be failures, but the prospect for a more rational market is likely.•
The energy sector would be a huge benefactor. It is not a secret that service costs cannot fall as quickly as the precipitous decline in energy prices, thereby producing losses for fiscal 2009 for many companies. If the measure were to be enacted for fiscal 2008, it is possible that companies that produced accounting losses due to hedging production at below market prices would actually be eligible for tax relief. This would be quite a bonus for investors in the sector, especially in a year of record-breaking prices.• Mergers and acquisition activity would pick up significantly, especially in the energy sector. Well-managed, recently-profitable companies would have an additional tail wind that even if energy prices stay at depressed levels for the next few quarters, eligible companies will be able to bolster balance sheets and have more time to rationalize costs. All this will lead to a more stable environment for sector leaders to execute strategic plans.
•
Lastly, this measure will pump up the stock market. With the death watch mentality removed, many once-proud large caps that are now fallen angels will rise partly on the strength of their five-year earnings history. Financials, retail, mining companies, to a lesser degree, energy issues, will lead the rally. I believe the impact on energy issues won’t be as significant because large cap producers haven’t fallen anywhere near as much as their counterparts in the aforementioned sectors.The vast majority of investors have the bulk of their assets in the stock market and real estate. Typically, both do not recover at the same time and turning housing around is often like steering a tanker (or in this case, The Titanic). The usual levers to revive housing haven’t worked this time around, so efforts to inflate the stock market makes more sense at this juncture. A revival in the stock market is what will save housing.
In terms of small and midcap Canadian energy producers – they will be the benefactors of a resumption of appetite for risk; a normal occurrence in normal markets. Companies positioned to be the biggest winners are Income Trusts and Small Cap resource plays with strong balance sheets.
Steven Ilkay, Caseridge Capital Corp, 100 King St West, Suite 5700
416.728.2176 silkay@caseridge.com
Last week we were on the road with a multi screen content company and their partners and advisors. We introduced these companies to a short list of institutional investors primarily to gauge their interest in sizable new issues given the current market conditions. We held some one-on-one meetings with a group of the key institutional investors and then subsequently participated in a large “Bay Street” luncheon to which bankers and analysts from a broad range of brokerages were also invited. We put a lot of time, effort and planning into these events and the over-all strategy, and simply put, the response was positive and we hope to move forward toward a $20MM to $30MM initial offering soon.< ?xml:namespace prefix = o ns = "urn:schemas-microsoft-com:office:office" />
Is it possible to raise money in this environment? Well, we won’t count our chickens yet however there are a number of lessons here for those considering going to the market. If you are considering a public offering or a private placement, you should have good answers to the following questions:
Do you have momentum and identifiable short-term catalysts? Institutional investors are dealing with losses and redemptions. In some cases the “cash on hand” is ear-marked and put away for the possibility of future redemptions. Even if you have a great company, investors will need to justify their allocation into your company by reducing their precious cash balances or re-balancing their existing portfolio. In order to do so, you need to be able to make a convincing argument. You can do this by having a very plausible answer to the following question: What can or might happen over the next nine months that might lead to a dramatic improvement in your business prospects and share price? This “catalyst” should be identifiable and it should have be highly probable. Better yet it may already be in place. If no catalysts exist, there likely is very little chance of new investors showing an interest.
Why are you going to market now? If you have a great business, strong momentum and identifiable short-term catalysts, then the obvious question from investors is… “…why are you raising money in this market?” Clearly your timing is not great, so you should be prepared to explain to investors why the level of dilution that will be realized through an offering of shares in the present environment makes sense. Survival, unfortunately, is not an adequate answer.
Are you a plausible consolidator or should you be looking to be acquired? This is an important question that few companies are able to answer. Investors will look to back the consolidators with momentum as such. They will also have identifiable catalysts and a strong justification for going to market now. Strong companies with catalysts that are not large enough or broad enough to be considered as consolidation candidates should be looking for an acquisition partner not for a financing. Don’t waste your time looking to raise money from institutional investors when you should be investing your time talking to corporate buyers.
Feel free to contact us if you’d like more information on these strategies. We have some interesting insight given our recent activity.
We hope that you enjoy this years’ Caseridge TechSys DealBook. If you would like to be added to our distribution list to receive the full report, please contact me directly at adamou@caseridge.com.
Caseridge Performance Review and Projection
As an end of the year exercise we have scoured through our database of Caseridge TechSys companies to find some of the best companies of the year along with some outstanding investment or acquisition ideas for the coming new year.
The Caseridge TechSys Index of Canadian listed technology and special situations companies is made up of 241 companies in various industries representing a broad scope of activity in the technology, industrial, manufacturing, health care, software, internet and special situations sectors across Canada. To this list we applied a variety of filters that identified companies that are in good shape and that possess superior prospects for the future. We then narrowed these lists using our proprietary Caseridge GMM multiple as an indicator of relative value.
With the average Caseridge TechSys GMM multiple currently at 0.89, we see companies with GMM values significantly lower than this figure as “undervalued” relative to companies with multiples that are significantly higher than this average. As mentioned, the GMM multiple for the Caseridge TechSys Index is presently at 0.89 which is near historic lows. We believe that there is “expansion potential” for the Index multiple over the course of the next year; we believe that the Index GMM will end 2009 at approximately 1.0, an increase of 12% from current levels. This provides investors and buyers in the companies that we are highlighting with an even greater potential for growth as we believe that these companies have the potential to outperform on an operating level; that the company specific GMM multiples will expand over the year, narrowing the gap between them and the Index multiple; while the market GMM multiple will also be expanding thereby lifting the potential for gain even further.
Our picks are of course based on our models and opinions. Accredited investors should perform their own analysis and conduct their own due diligence prior to making any investment or purchasing decisions. Non-accredited investors should consult with their personal financial planner for advice before making any investment decisions. Please feel free to call us if you require additional information or would like company specific reports or reviews for the companies listed in this report. We have extensively detailed reports available that may be custom crafted to your requirements. We hope that you enjoy this week’s Caseridge TechSys DealBook.
Top Companies of 2008 that have ”Superior Prospects” for 2009
The best predictive indicators of value for small to mid capitalization operating companies are growing gross profits that are combined with stable or growing gross margins. Gross profits reflect the incremental dollar value that is provided by an operating company while gross margins highlight the proportion of incremental value in the finished good that is being provided by the firm. Growing gross profits along with stable or growing gross margins eventually result in higher valuations through growing cash flows and expanding multiples. These last twelve months were difficult, however the five companies below delivered growth in gross profits year-over-year and were rewarded with higher stock prices as a result.
To determine the finalists, we looked for companies with higher stock prices over the last twelve months; that had revenues at the start of the year that were in excess of $5MM; that realized substantial gross profit growth during the year; while maintaining stable or expanding gross margins. From this list we selected the five that we believe have the strongest prospects for the next twelve months by using our proprietary GMM valuation model.
|
Company Name |
% Price Change (2008) |
Gross Profit, 1 Yr Growth % [LTM] |
Gross Margin % [LTM] |
Gross Margin % [LTM - 1] |
GMM and 2009 Stock Prospects |
|
Fortsum Business (TSXV: FRT) |
40.5% |
18.0% |
66.1% |
65.7% |
0.19▲▲ |
|
Olympia Financial (TSXV: OLY) |
10.8% |
33.5% |
87.1% |
86.8% |
0.36▲▲ |
|
Certicom Corp. (TSX: CIC) |
9.49% |
17.1% |
83.1% |
80.1% |
0.35▲▲ |
|
Constellation Software (TSX: CSU) |
2.02% |
29.8% |
62.4% |
62.3% |
0.52▲ |
|
RuggedCom Inc. (TSX: RCM) |
1.37% |
76.1% |
61.0% |
59.7% |
0.52▲ |
|
Prices and data provided by CapitalIQ as at December 12, 2008. |
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Best Stocks for the Investor Who “Wants” Everything!
Bear markets result in anomalies that develop as investors flee the market for the safety of more stable alternatives. The following list highlights some of these anomalies in the TechSys universe.
To generate the list we first ranked the companies by their cash balances as a percentage of their market capitalization. While cash is good – burning through your money is a “no-no” in these markets so we screened the list again for companies that are cash flow positive over their last four reported quarters. We don’t like debt in bad markets, so we screened again for companies that have a positive tangible book value AND total debt that is less than $5MM. Still not satisfied (because the list was still too big) we screened for companies that were growing their revenues AND their gross profits over the last year. Incredibly, we came up with a list of 27companies. Here they are ranked by “cash to market cap” ratio along with our GMM value and ratings:
|
Company Name |
Cash to Market Capitalization Ratio |
Positive Cashflow ($MM) |
Tangible Book Value/Share ($) [Latest Quarter] |
Total Revenues, 1 Yr Growth % [LTM] |
GMM and 2009 Stock Prospects |
|
Advent Wireless Inc. (TSXV:AWI) |
153% |
$ 1.56 |
$ 0.61 |
19.1 |
0.07 ▲▲ |
|
Sierra Wireless Inc. (TSX:SW) |
96% |
$ 36.10 |
$ 8.82 |
53.0 |
0.26 ▲▲ |
|
Mediagrif Interactive (TSX:MDF) |
86% |
$ 3.15 |
$ 1.68 |
- |
0.04 ▲▲ |
|
Bridgewater Systems (TSX:BWC) |
84% |
$ 2.90 |
$ 2.22 |
14.9 |
0.04 ▲▲ |
|
Chartwell Technology Inc. (TSX:CWH) |
78% |
$ 1.88 |
$ 1.32 |
13.4 |
0.16 ▲▲ |
|
Grey Island Systems (TSXV:GIS) |
66% |
$ 1.24 |
$ 0.21 |
41.9 |
0.19 ▲▲ |
|
Xenos Group Inc. (TSX:XNS) |
63% |
$ 1.13 |
$ 0.73 |
6.4 |
0.05 ▲▲ |
|
C-Com Satellite Systems Inc. (TSXV:CMI) |
57% |
$ 1.62 |
$ 0.15 |
6.6 |
0.24 ▲▲ |
|
MOSAID Technologies Inc. (TSX:MSD) |
64% |
$ 9.53 |
$ 3.16 |
- |
0.32 ▲▲ |
|
International Datacasting Corp. (TSX:IDC) |
55% |
$ 1.96 |
$ 0.31 |
24.0 |
0.21 ▲▲ |
|
Miranda Technologies Inc. (TSX:MT) |
50% |
$ 17.90 |
$ 4.75 |
18.0 |
0.24 ▲▲ |
|
Sangoma Technologies (TSXV:STC) |
41% |
$ 2.78 |
$ 0.21 |
27.6 |
0.17 ▲▲ |
|
Fortsum Business Solutions (TSXV:FRT) |
39% |
$ 2.90 |
$ 0.07 |
10.7 |
0.19 ▲▲ |
|
EXFO Electro Optical (TSX:EXF) |
39% |
$ 20.10 |
$ 2.92 |
20.2 |
0.26 ▲▲ |
|
Gennum Corporation (TSX:GND) |
38% |
$ 17.00 |
$ 3.32 |
38.8 |
0.16 ▲▲ |
|
Tecsys Inc. (TSX:TCS) |
33% |
$ 2.60 |
$ 0.67 |
23.8 |
0.20 ▲▲ |
|
Glentel Inc. (TSX:GLN) |
31% |
$ 14.40 |
$ 4.19 |
30.3 |
0.24 ▲▲ |
|
Matrikon Inc. (TSX:MTK) |
30% |
$ 8.56 |
$ 0.87 |
7.8 |
0.19 ▲▲ |
|
Wireless Matrix Corp. (TSX:WRX) |
28% |
$ 0.91 |
$ 0.25 |
28.4 |
0.41 ▲▲ |
|
Hemisphere GPS Inc (TSX:HEM) |
25% |
$ 10.20 |
$ 0.75 |
59.6 |
0.36 ▲▲ |
|
Zedi, Inc. (TSXV:ZED) |
22% |
$ 1.68 |
$ 0.24 |
29.4 |
0.33 ▲▲ |
|
Computer Modelling (TSX:CMG) |
21% |
$ 10.30 |
$ 1.17 |
38.5 |
0.32 ▲▲ |
|
MKS Inc. (TSX:MKX) |
19% |
$ 6.06 |
$ 0.23 |
27.5 |
0.12 ▲▲ |
|
Immunotec Inc. (TSXV:IMM) |
18% |
$ 1.07 |
$ 0.22 |
2.0 |
0.15 ▲▲ |
|
Olympia Financial Group Inc (TSXV:OLY) |
13% |
$ 4.58 |
$ 4.60 |
30.1 |
0.36 ▲▲ |
|
AlarmForce Industries Inc. (TSX:AF) |
9% |
$ 2.32 |
$ 1.23 |
19.3 |
0.29 ▲▲ |
|
CriticalControl Solutions (TSXV:CCZ) |
2% |
$ 3.12 |
$ 0.02 |
6.1 |
0.25 ▲▲ |
|
Prices and data provided by CapitalIQ as at December 12, 2008. |
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Updated Winter Distribution Outlook
With the final days (thankfully) of 2008 coming to a close, I thought I would provide investors an updated outlook on Energy Trust Distributions for this upcoming winter. The outlook is intended as a guide for announced distributions through to the end of winter, as predicting distributions beyond more than one quarter would prove folly in such turbulent times. Only a few trusts declare distributions for more than one month at a time and of course, one, Canadian Oil Sands Trust, pays quarterly.
The final few trading sessions will provide investors plenty to think about regarding should one view a particular trust investment as yet another tax-loss selling opportunity, or as a high-yielding keeper, for times good and bad. Not surprisingly, the outlook for many trusts is for lower monthly distributions and since I issued my initial Winter Distribution Outlook six weeks ago, forecasts for payouts are even lower, given ever-tumbling energy prices. However, one could easily argue that the market has already priced this in, given the
average distribution yield of the coverage group is 21.7%.On a positive note, two Energy Trusts likely will not have to cut distributions at all (Daylight and Vermilion) and it is possible Peyto and Paramount may keep distributions at fall 2007 levels as well. Unfortunately, buying a basket of trusts and letting the cash register ring, simply won’t work in this environment. A few trusts are approaching a crossroads, where their viability and potentially, solvency, could be called into question in the not too distant future, should commodity prices stay near current levels. Even more damaging would be if market perception were to be that $25 oil is right around the corner. This fate has befallen a number of trusts since Flaherty’s Halloween massacre, but so far victims have generally been smaller trusts. This time around could look very different.
One caveat with distribution projections is that one needs to consider that most Trusts have a series of options, including selling off assets, joint ventures, reducing Capex, closing out in the money hedges and such actions could easily alter my outlook.
Distribution Chart
Currently, the financially weakest of the 15 trusts in the coverage universe appears to be Advantage. Historically, payouts have been far too high and cash flows cannot support and payout anywhere near current levels of 12 cents/month would damage an already overleveraged balance sheet. Should the trust remain in its current form and using current energy pricing, a monthly distribution of 2 to 4 cents appears likely.
A handful of trusts appear susceptible to large distribution cuts as well. Canadian Oil Sands Trust, Pengrowth and Penn West are likely candidates to cut distributions one third or more. In the case of COS, the trust’s recent 2009 forecast calls for distributions to remain high to effectively overpay distributions before the 2011 deadline for trust taxability. Unfortunately, the Trust’s assumptions call for WTI to average US $75 in 2009, so it is not hard to see where the Trust may have difficult decisions to make before winter comes to a close.
Pengrowth and Penn West both have significant debt levels and flat to negative drill bit growth. Further, Penn West appears to have far too many exploration-oriented projects to be paying such a high monthly payout, in the current financial climate.
Two trusts that are quite difficult to accurately predict future payouts are Harvest, due to its large asset concentration in refining and Provident, due to its midstream businesses. Both Trusts present an interesting risk/reward scenario. Trusts that appear best positioned to weather the financial storm are Enerplus, ARC, Daylight and Vermilion.
Enerplus has an excellent diversity of assets, ranging from Oil Sands to Bakken Oil to conventional production and a well managed balance sheet. As one of the larger trusts, it also is in a much stronger position than peers such as Penn West or Pengrowth to consolidate the sector, through accretive transactions.
ARC surprised me by slashing its distribution from 24 to 15 cents, but appears to have got its payout down to a manageable level for current energy pricing.
Daylight is a smaller trust that has completed a string of moves that have really strengthened the company’s balance sheet. The company also has excellent hedges in place.
Vermilion has never cut distributions, due to very conservative management. Coupled with an international asset base and large stake in Verenex, which is currently on the block, a distribution at the current level remains likely for the foreseeable future.
In a market of great turmoil, investors seeking companies with solid fundamentals have yet to be rewarded. Great companies share prices have been punished as though a major disappointment had been bestowed upon investors. What is unusual about this market is that most companies share prices have been sent straight to the penalty box, with most issues share prices tightly correlated. Well, this week, we take a quick look at fundamentals, using common valuation multiples.
Sample Group and Considerations
My sample group are the ten midcap energy producers that are liquid enough to be option eligible, herein referred to as the “Big Ten”. I exclude energy trusts from this comparison, to avoid apples to oranges scenario. Constituent list as follows:
Birchcliff Energy Ltd. (TSX:BIR)
Compton Petroleum Corp. (TSX:CMT)
Crew Energy Inc. (TSX:CR)
Galleon Energy Inc. (TSX:GO.A)
Highpine Oil & Gas Limited (TSX:HPX)
NuVista Energy Ltd. (TSX:NVA)
Paramount Resources Ltd. (TSX:POU)
Petrobank Energy & Resources Ltd. (TSX:PBG)
ProEx Energy Ltd. (TSX:PXE)
Tristar Oil & Gas Ltd. (TSX:TOG)
Average production for the Big Ten producers is approximately 20,000 Barrels Oil Equivalent/ Day (Boepd). I purposely avoided common valuation metrics such as multiples of earnings or cash flow, as the last twelve month’s energy prices are almost assuredly going to come higher than the next twelve months and therefore, financial projections come down entirely to a commodity price assumption.
However, in uncertain times, market leadership will come from companies that have low debt levels, as these companies can whether most any storm and have the potential to grow production, should energy prices continue to decline. Companies with debt levels appropriate for $100 oil face the prospect of asset sales to merely stay afloat, or in some cases, receivership.
The table below ranks companies by most debt per share to least. Compton carries the most debt/share by the widest margin; Highpine has no debt and a positive working capital position.
Debt per Share
Compton Petroleum Corp. (TSX:CMT)
$ 1.39 $ 5.86NuVista Energy Ltd. (TSX:NVA)
$ 8.10 $ 4.36Galleon Energy Inc. (TSX:GO.A)
$ 4.20 $ 3.51Crew Energy Inc. (TSX:CR)
$ 5.30 $ 3.25Tristar Oil & Gas Ltd. (TSX:TOG)
$ 12.25 $ 2.98Petrobank Energy & Resources Ltd. (TSX:PBG)
$ 23.85 $ 2.77ProEx Energy Ltd. (TSX:PXE)
$ 11.61 $ 2.77Birchcliff Energy Ltd. (TSX:BIR)
$ 5.70 $ 1.91Paramount Resources Ltd. (TSX:POU)
$ 8.40 $ 0.90Highpine Oil & Gas Limited (TSX:HPX)
$ 5.85 $ (0.07)The future looks bleak for Compton, as the company is carrying approximately ¾ Billion in debt against a mostly Natgas production base of 26,000 Boepd. Highpine has a pristine balance sheet and untouched $225M credit line and Paramount likely has some attractive growth options as well.
Midcaps by Production
Company Name Barrels/Day %Natgas
Birchcliff Energy Ltd. (TSX:BIR) 10,000 65%
ProEx Energy Ltd. (TSX:PXE) 11,122 93%
Crew Energy Inc. (TSX:CR) 11,505 76%
Paramount Resources Ltd. (TSX:POU) 13,206 72%
Galleon Energy Inc. (TSX:GO.A) 17,200 60%
Highpine Oil & Gas Limited (TSX:HPX) 19,715 34%
Tristar Oil & Gas Ltd. (TSX:TOG) 20,553 24%
Compton Petroleum Corp. (TSX:CMT) 26,006 84%
NuVista Energy Ltd. (TSX:NVA) 26,065 71%
Petrobank Energy & Resources Ltd. (TSX:PBG) 30,850 8%
Petrobank is the largest of the group and is growing by leaps and bounds with its Bakken play and Colombian interests.
Valuation – Enterprise Value/Flowing Barrel
Birchcliff Energy Ltd. (TSX:BIR)
$ 5.70 85,526Tristar Oil & Gas Ltd. (TSX:TOG)
$ 12.25 83,307ProEx Energy Ltd. (TSX:PXE)
$ 11.61 75,020Petrobank Energy & Resources Ltd. (TSX:PBG)
$ 23.85 71,776Crew Energy Inc. (TSX:CR)
$ 5.30 52,910Paramount Resources Ltd. (TSX:POU)
$ 8.40 47,713NuVista Energy Ltd. (TSX:NVA)
$ 8.10 37,849Compton Petroleum Corp. (TSX:CMT)
$ 1.39 36,247Galleon Energy Inc. (TSX:GO.A)
$ 4.20 33,335Highpine Oil & Gas Limited (TSX:HPX)
$ 5.85 19,988There is a very wide discrepancy in this chart, where the market is valuing the peer group from a range of $20,000/Flowing Barrel to a high of over $85,000 Per. For some strange reason, the only company in the peer group carrying no debt (Highpine), has the lowest enterprise value per flowing barrel. How long can this dislocation last? Alas, not to worry, as all markets revert to the mean and companies that are outperforming peers will reward their patient and astute investors.
Steven Ilkay, Caseridge Capital Corp, 100 King St West, Suite 5700
416.728.2176 silkay@caseridge.com
I came of age during the “market crash” of 1987. I was in my junior year of the Bachelor of Commerce program at the University of Toronto, living away from home for the first time and pretty well having the time of my life. When the Black Monday crash took place in October of that year, the drop was of great interest to me because it ran counter to what I was learning in school, particularly in my courses on monetary theory. Why would rational people bid up a market only to suddenly decide to sell these same assets on a global scale, all at the same time and at deeply discounted prices? Why were the shares of companies whose shares were being snapped up as “bargains” the day before now be sold at huge discounts on what was essentially no material or new information?
Markets are made up of people that want to make money, why would they all be wrong, at the same time and in the same direction? The conclusion that I came to at that time, thinking in the language of a budding economist, was that there must have been certain outside “externalities” that were responsible for the expansion of valuations beyond an “appropriate” level and that the “crash” was the result of certain other “externalities” that burst this bubble while causing it to also implode to unsustainably low subsequent levels. In common terms, something caused both the expansion and the implosion – and whatever “that” was, it caused people to behave in a rational manner yet in a way that didn’t make sense. As they say in the Bronx: blame the game, not the players!
I entered the work force in 1990, just in time for the recession. As a young investor at an early stage venture capital fund, I saw first-hand the hardships that CEO’s and company owners had to deal with as worldwide demand suffered a blow and particularly so for companies that produced products for retail consumption. Once again the suffering that I was seeing first hand was not caused by “bad management”, but by certain externalities outside of managements’ control. This downturn in the economy led to a buyers market (5X cashflows was our standard valuation metric at the time along with a 30% targeted internal rate of return) that led to some excellent investment opportunities for our fund. We focused on placing investments in companies that were positioned to survive this downturn and we succeeded quite impressively.
By the mid-nineties we were in the middle of a tremendous market run that led to what we believed to be “crazy” valuations, but yet we kept buying. We at first resisted paying the inflated valuations that were being offered up in the market, however there came a point of capitulation where we, and many other investors just “gave up” – in my economic terms certain yet undefined market externalities led us to adjust and to expand our valuation parameters as we were under pressure to put our capital to work and, to put it quite simply, there was relatively “easy” money to be made by “playing the game” than there was by resisting it. Again we behaved rationally in what we at times considered to be an irrational market by adjusting our behavior to suit the facts.
Eventually, this type of behavior led to the technology market stock “crash” of 2001-2003 which was just the latest incarnation of an externality driven boom and bust cycle that now dated back a number of decades. By 2005 I could now see that those companies that survived the earlier “meltdown” were well ahead of the curve toward a sustainable recovery while their valuations lagged their performance - it was only a matter of time before their valuation multiples would once again come to reflect economic reality and there were substantial gains to be made in positioning oneself appropriately. This recovery cycle lasted until the end of 2007, which brings us to the present bust.
Today, as a “forty-something” investment banker with some grey on my thinning hairline it is time that I consolidated my views on the behavior of the capital markets into a single theory that might allow me to make some sense of it all. In order for a single theory to be acceptable to me as a market participant, it must contain a number of elements that I know to be correct based on my experience with corporate management and their decision making process, and with institutional investors and their market behavior.
Broad market failures, whether bubbles or crashes, are the result of system-wide failures in millions of individual decisions made on a global basis by people that have real money at stake in their quest for greater returns. If their quest is leading them in a direction that is not sustainable, it is more likely that it is the game that is flawed and not the millions of people! I believe that these institutionalized market failures result from a flaw in the design of the “game”. My hope is that by understanding the flaws in the game that we can profit from this knowledge at the expense of those that do not. While I believe that the rules should be fixed and that they can be fixed to eliminate these externalities, I do not have confidence in our political establishment to remove them, and therefore they unfortunately will be with us for some time to come.
Supply Side Externalities With Disastrous Results
The bubble-crash cycles that we have lived through for the last forty years are the direct result of the dominance of what is commonly referred to as “supply side” monetary theory that was developed and popularized by the University Of Chicago School Of Economics and their great economist, Milton Friedman. While the Chicago School offered a great deal that is commendable, the Chicago School’s single greatest impact was in the development and dominance of monetary power through a theory that resulted in a greater level of government control of the money supply.
This development has been at the heart of every recession and market boom or crash since it came to become the dominant economic theory in the 1970’s. It was during this period of its maximum prominence as a school of thought that the US government used Chicago school monetarist supply side theory to nationalize and to take control of the money supply. This development has been an unmitigated disaster. Controlling the money supply through a central regulatory body makes no more sense than the establishment of a central body to control the supply of cars in Soviet Russia or the supply of cans of tuna in Communist China. In all cases central planning leads to massive inefficiencies and to a system-wide misallocation of resources.
Money however is more central than cars or tuna – it is everywhere and in everything and it is the mechanism by which information is transmitted between market participants and through which the allocation of all resources are made in a market economy. Get this signaling mechanism wrong, and everything breaks down in a manner that leads to misallocation, misappropriation, bubbles and busts. Place the control of the money supply in the hands of a central body and the shocks never end, rational decision making is constantly at risk of being misallocated as market participants seek to earn excess returns by playing an irrational game rather than by generating real wealth. What’s worse, this entire government controlled market disaster that is the fiat floating currency was sold as a “free market” solution – when the exact opposite is in fact the case. Incredibly, supply side economics and the resulting dominance of monetary theory resulted in the greatest expansion of government power since the establishment of the Soviet Union … and for the most part, we missed it! Talk about an “oh crap” moment!
The key victory for the supply side monetarists came in 1971 when the Nixon administration removed the US dollar from the fixed rate Bretton Woods gold standard of $35 per ounce of gold. This was replaced by a fiat and floating standard that was controlled by the Federal Reserve of the United States as the reserve currency (rather than gold) and with the cooperation of all of the Central Banks of the Western Democracies. Make no mistake; the floating monetary standard resulted in the nationalization of our standard of wealth via a Soviet style pricing mechanism in which a government body determines the quantity of money and the quality of money over time. The gold standard that preceded this change kept currencies stable for hundreds of years at (roughly) $35 per ounce (aside from wartime) and interest rates more or less stable at about 4% annually. In an environment in which money has a stable and predictable value the transparency of the information that is transmitted through the pricing mechanism is pure and unfiltered. While “market crashes” occurred during certain periods in which the gold standard was in place, a closer analysis of those periods shows that the destruction of the value of money preceded the market crashes and that in most cases downward turns in economic activity were the function of either wars, government mandated deflation or reflation, or all of the above.
Under a gold standard, the government does not have control over the money supply for the simple reason that a central body cannot be trusted to maintain the value of our store of wealth! Contrary to popular opinion, a gold standard does not and has not historically meant that a “Fort Knox” deposit of gold is required for each dollar of currency in circulation (any more than a fiat currency requires that every bill must be stored in a bank vault somewhere). What it requires is convertibility as demanded or required. The simple fact that the government stands behind the gold convertibility of the currency eliminates the opportunities for the government to “cheat” – as cheating will be detected by market participants and this will lead to greater requests for the conversion of the currency into gold.
What is important here is the idea that a stable currency leads to an improvement in the pricing mechanism, an improvement in the pricing mechanism leads to greater predictability, greater predictability leads to better decision making, and that better decision making leads to a more stable economic environment and to more efficient markets.
The root of all of the financial turmoil of the past forty years has been the breakdown in the pricing and signaling mechanism that is at the root of the floating currency regime. Since moving from the gold standard in 1971 we have seen cycle after cycle of booms and busts, of double digit inflation and interest rates, of recessions caused by periods of disinflation and deflation and of asset price inflation in stocks, bonds, real estate and consumer prices. Governments’ have gone to great lengths over this period to control not only the money supply, but our perceptions of their manipulation of the money supply since as rational participants we incorporate expectations into our decisions. As market participants started to “get it” in the late 1970’s and 1980’s, we began to demand higher wages to make up for the deterioration in the value of our compensation. At first, governments responded by imposing “wage and price controls” that failed miserably since reality cannot be manipulated by government fiat. Over time however, central bankers began to manage the consumer price index in such a way as to maintain a stable level of apparent prices in this manufactured index so as to fool us into believing that higher prices were actually lower prices. This tomfoolery worked for a while with real wage levels declining which resulted in growing recorded productivity levels and to higher market valuations. Since greater wealth in light of lower wages is not sustainable, this bubble blew up to be replaced by more monetary manipulation that resulted in the formation of asset bubbles in real estate, equities, bonds, and other asset classes as we bought into the notion that we were now living in a “perfect” world economy:
The fact that we now require almost $900 to acquire that same ounce of gold that our ancestors could purchase for less than $35 at any time between 1794 through to 1971 speaks volumes of the regulatory failure that we’ve suffered under the system of centrally managed floating currencies. It has been a complete and utter disaster. Our currency has been depreciated to 1/30th of its 1971 value – how can such a massive devaluation not cause systemic periodic failures? Imagine if the 100M dash in the Olympics had decreased by the same amount over the same period… the same race would now be only 3.3M in length! This single systemic market failure has led to every recession, to every market bubble and to every market crash of our generation – the curse and the burden of the baby boomers. Unfortunately, there is no end in sight.
Our view is that the problems facing the world economies are structural and not temporal in nature; we believe that the solutions that governments and central bankers are offering up are temporal and not structural in nature; we believe that this will result in a spike in the volatility of market returns which is a natural and rational result of this on-going imbalance; we believe, unfortunately, that much of the wealth creation that will follow will be the result of investment perseverance and that these gains will accrue at the expense of others as part of a zero sum gain rather than through the economic growth that we have come to depend on to “lifts all boats”. As a result, this will create an increase in the relative number of “haves” vs. “have-nots”;
which will lead to a greater and growing level of government economic, monetary and tax interference in the real and financial economy; and finally to an extended period of stagnation in the economy.Next week, we will discuss some strategies that investors and CEO’s might use to protect one’s assets and strategies that might be used to position oneself for the potential windfall profits that will accrue to those that play the game with a clear understanding of the rules, as flawed as they might be.
Notwithstanding the late day rally on Friday November 21, last week will stand out as an excellent lesson in how not to time a market. Feeling a little optimistic, for whatever reason, I entered into the small to mid cap Canadian market with some well timed purchases in the shares of companies that I have tracked, followed and discussed for some time. The result? My proverbial ass was kicked. Lesson learned.
I continue to believe that there are significant investment opportunities in the technology and special situations markets, in the energy and energy alternatives areas as well as in commodities and materials sectors. This won’t be easy, and it won’t happen overnight, but I urge you, our readers, to remain optimistic, to take the steps that must be taken, to take the lumps as they are served, and to move forward humble in the reality that certain lessons needed to be learned, and others didn’t… but nevertheless, forward we must march!
Shell-shocked operators and investors alike need to constantly evaluate and re-evaluate plans on how best to survive (and thrive) in difficult markets. Wishful thinking (oil will be 100 bucks next month, etc) won’t get us out of this mess, but we are not powerless. Now, I am not picking on operators, as I don’t envy the challenges faced by a market that has thrown mainstream predictions of $200 and $20 oil at us within just a few months. Below is my top ten list of action items, with the first one a message to regulators.
Reinstate the uptick rule.
For those that aren’t familiar, the uptick rule is a securities trading rule that regulates the short selling of securities. The rule stipulates that when a short sale occurs it must be at a price higher than the immediately preceding sale. The uptick rule would prevent the daily blow downs in share prices in many junior stocks, where the vast majority of trades are at lower prices (and likely often via shorting). The rule was initiated after the stock market crashes of the late 1930’s and was repealed by the SEC and OSC last year. Why, I have no idea. The unending waves of lower prices are rapidly eroding shareholder confidence and causing undue harm to companies in many cases.Stop buying back stock!
Time and again, I see share buybacks from junior explorers, because their stock is “cheap”. However, most such companies carry debt on their balance sheets and in many cases, will need to either access capital markets for an equity offering or increase credit lines in the next 24 months, especially should energy prices stay constant or trend lower. I can’t tell you the number of times I have seen a company in bankruptcy that executed a share buyback in the 12 months preceding. Share buybacks in this environment should be reserved only for large cap producers with pristine balance sheets.Spend within cash flow.
This applies to most e+p’s, although some with little to no debt have far more leeway in this regard. No access to capital markets for 24 months, a high probability of a decrease in credit lines and a downward sloping pricing curve spell trouble.Develop a MAD strategy.
Once energy prices stabilize – at high, low, or medium levels – we will see a significant amount of mergers, acquisitions and divestitures. Question is, is your company ready to either reduce debt, concentrate a play or take advantage of bargains in the marketplace? Call us to discuss how we can help your company take advantage of current market conditions.Close out in the money hedges.
Closing out hedge positions for at times, large one-time gains can supercharge the balance sheet of even smaller producers. Both crude and NG are technically oversold and the fundamental picture for NG is beginning to turn positive, so the near term bottom is either in, or within a few percentage points.Develop a hedging strategy.
This can often serve as the difference between a junior that thrives and one that goes bankrupt, in the current climate. With unprecedented price swings in both crude and natural gas in very short time periods, 2008 has been a year where a producers hedge book should be driving a substantial percentage of profits.Improve operational metrics.
As energy prices plunge, increased focus will return to operational metrics. I recently evaluated a junior explorer where interest costs for the previous period amounted to $30/barrel produced! What might have worked with record high prices, will not fly in a tighter pricing environment. All the more need for companies to consolidate operations, and/or take a realistic approach in evaluating whether their company should be exploring certain types of plays.Develop a 40/5/24 strategy.
Develop an organization that can grow production with $40 WTI, $5 NG (Nymex) for the next 24 months, with no access to equity markets and no increase in credit lines. This isn’t a prediction on energy prices, however, a prudent approach with the economy in early stages of decline. If energy prices decline below this threshold, further rationalization and/or asset combinations will be required. Companies that can succeed within this framework will be first to receive funding once equity markets rebound. Those that cannot adapt, if they survive, will likely be orphaned, or excessively leveraged, creating more unintended consequences (hedging at the wrong time, declines, fire sale divestitures, employee retention issues, etc).Don’t hunker down – it will kill you.
The biggest mistake a junior e+p company can make is to hunker down and go into survival mode. Investors do not buy juniors for stability, rather they want growth and lots of it. For stability, there are an endless number of great large cap names that can likely survive multi-year market slowdowns and even a few trusts as well. This is very much a grow-fast-or-die part of the market. Lack of growth becomes a real slippery slope, with declining margins and operational performance, not to mention challenges in retaining key personnel. Inevitably, in most cases it leads to significant value destruction. If growth under current market constraints is not possible, it is time to develop a MAD strategy. Your shareholders will love you for it.Be ready to strike!
The inevitable return to calm in the capital markets will lead to fantastic opportunities for well-positioned operators. Companies with strong balance sheets, high capital efficiencies and high growth profiles will emerge as sector leaders. Assets will be available for a fraction of the cost spent to acquire the land in some cases. In other cases, many exploration-rich juniors will need to find partners with stronger balance sheets to continue building shareholder value. Lastly, a new group of companies need to be created via combinations to satisfy large fund buying interest, for better times ahead.
Commentary: Some Answers to your Questions
This week we’re going to run through a short “question and answer” session to answer some of the questions that we’ve received and are receiving about the state of the markets and what to expect:
When Will I Be Able To Raise Some Money?
Not for 2 years. There will be exceptions for extraordinary companies with compelling stories, however for the typical company the line-up for an equity raise will be long and trying. For those that would like to try; you should begin your preparations now, and then wait for a window of opportunity to appear.
What Should I Expect In The Markets In The Next Year?
Predicting short terms market movements is a fools game best left to pro traders and their backers. However, the markets are pricing in what appears to be a permanent increase in market risk and volatility, a contraction in the real economy and a deflationary cycle in real prices. Changes in these expectations will likely drive market movements over the next twelve months.
My Stock Is Down By (30%, 40%, 50%, 60%, 70%, etcetera) But We’re Beating our Targets!
Yes, and you’re not alone. If your fundamentals are strong, the dramatic decline in your share price is the result of a decline in the demand for your shares and not related to your performance, per se. Tens of trillions of dollars in investable assets has been lost due to a variety of factors. Less money is now available to be invested, leading to a dramatic decline in “investable dollars”. Economics 101 tells us that a decrease in investable assets leads to a decline in the demand for risky asset classes – and small to mid-cap Canadian equities are considered to be among the riskiest asset classes around. A permanent decline in valuation multiples has resulted, the “old” multiples are irrelevant.
We Have Lots Of Cash And Are Profitable – Why Are You Against Stock Buybacks?
If a friend asked you if it was a good idea to invest a significant amount of their free cash in a private placement, where they would be the only buyer, in which 100% of the money raised would go to buy out existing shareholders, in which future liquidity would be considered highly unlikely, and that would result in the concentration of their assets and a reduction in diversification in their portfolios during one of the worst periods in stock market history… what would you tell them?
You Talk A Lot About Mergers/Acquisitions and Divestitures… Why?
It goes back to the liquidity issues, the decline in investable assets and the decrease in the demand for risk tied in with the dramatic decline in equity share values through the contraction in the valuation multiples. We believe that winners and losers will result, with the “winners” being those that have cash or access to cash and the “losers” being those that don’t. We believe that companies identified as the “consolidators” will outperform in the next year as their cash resources and access to capital reduces their relative risk as investments. Their relative out-performance will reinforce their ability to act as consolidation vehicles creating a feedback loop as they arbitrage their higher multiples to acquire companies at relatively lower valuations. We are still too early in the process for these “consolidators” to have broken out from the pack and the necessary “feedback” loop has not yet developed. This means that you still have a chance to benefit by positioning yourself as a consolidator, or by looking to join up with a consolidator so that you end up on the winning team.
This Isn’t About TechSys, But What Do You Believe Caused This Financial Mess?
I don’t want to get into this because it will end up in a long Adamou Rant and I’m not up for that right now. However, if you want me to get all “macro” on this, then I believe that the cycles of booms and busts that have taken place in the last generation are the direct result of the decoupling of the world monetary system from the gold standard that took place in 1973 under the Nixon administration. This change resulted in the nationalization of world currencies and as with all grand government schemes, they overshoot and undershoot over and over and over again. They then attempt to deal with the fallout from their miscalculations through short term stabilization policies that solve the immediate problems but that end up creating larger longer term problems. We’re in the latest version of this cycle right now.
What Books Are You Reading? Do You Have Some Recommendations For Me?
Gold: The Once and Future Money
by Nathan Lewis, Addison Wiggin
Comment:
“A guide to the history of money and the importance of a stable currency - and how to get back to it! Very readable and non-technical, an excellent guide for beginners and for those that need to be re-introduced to classical economics.”Mobs Messiahs and Markets
by William Bonner and Lila Rajiva
Comment: “An interesting look at human behaviour and the creation of mob mentality in society and how it relates to the markets. It is a difficult and sometimes frustrating read, however the insights that the authors provide are worth it.” We hope that you enjoy this week’s Caseridge TechSys Dealbook.
adamou@caseridge.com
The Obama Effect
Over the coming weeks and months we will spend considerable time here discussing what an Obama administration will mean for various constituents of the energy complex. Because there are numerous factors that comprise an Energy Policy, we will try our best to tackle single issues and analyse their effect, at least until the President-Elect has had the time to articulate enough of his policy agenda. Of course, the initial speculation has been that Obama may be bearish for oil prices and bullish for natural gas, but early indicators already conflict with this view. Let’s take a look at the Natural Gas equation for now, as until we have a handle on what foreign policy will look like under the next cabinet, there is little point in speculation.
For natural gas drillers, 2008 has been one of good and bad news. The good news is that we now know that through horizontal drilling techniques North America has several new mega prolific natural gas basins. This means that US policy makers are now empowered to consider a wide variety of initiatives to tip the scales in favour of clean burning NG versus coal, imported oil and nuclear. The bad news is until large-scale initiatives to increase NG demand are brought on line, we have potentially a large oversupply problem. This is where the initial hype about an Obama administration may be just that, hype. The belief has been that a Democratic choice would undoubtedly be less friendly to big oil than a Texas oilman, or to John McCain, who appeared to favour coal and nuclear over NG. However, the fallout from the financial crisis may limit Obama’s ability to spend America’s way out of recession with large scale megaprojects, which is exactly what is required to bring on additional uses for the fuel.
A prime example is Proposition 10, an initiative shot down last week in California. California Proposition 10, or the California Alternative Fuels Initiative, was one of 12 ballot measures in last week’s election. Two of the measures were alternative energy related and both failed. The measure called for the state issuing $5B in general obligation bonds, primarily to offer rebates to buyers of NG powered vehicles. The funding was intended to be an alternative to diesel heavy trucks and could open up a large market for NG consumption. Prop 10 certainly didn’t suffer from a lack of backing. Infamous oilman Boone Pickens and Aubrey McClendon, founder of Chesapeake Energy (largest NG producer) were the founders of the measure.
Major backers include:
California is a bellwether in passing energy policy, particularly as it relates to policy with stricter environmental standards, which is what makes the vote all the more important. The measure failed by a 3 to 2 margin. Voters seem to be indicating that they are more concerned with the economy, than the environment or dependence on foreign oil.
Meanwhile the world is looking to the same bunglers and thieves that managed to create this mess to get us out through a “coordinated international plan” of G20 central bankers that has decreed that a “coordinated”” solution is to “create” money out of thin air in order to pay the bills on the “bad loans” that were caused by the previous rounds of unmitigated money creation. If this were a cure, then the fact that the Fed created more money out of thin air during the “Greenspan” years than in the entire history of the United States up to that point combined, would have created a utopia of wealth for us all… and Zimbabwe would be the poster child for worldwide prosperity. Instead, we have this: AIG announcing that they have worked through the bailout cash and now need more, the Detroit Three screaming for some cash, any cash, in order to survive, China announcing a $600BB “stimulus” package in an economy that is growing at five to seven times the rate of growth in the United States, interest rates falling to levels so low that it “costs” more money to save than to borrow, and calls for a worldwide change to our financial institutions by third world despots that have somehow figured out the laws of supply and demand in between the cycle of starvation and torture that is common in their realms. Take cover folks, there’s more to come.
The current situation is precarious. We believe that a market recovery is possible and even likely in the short term as a result of these misguided actions simply because easy money seems to always work until it doesn’t, but this recovery will be an illusion, a short term “fix” for an addiction that will reinforce the addiction rather than to eliminate it. Down the road withdrawal will set in, and we will be in an even bigger mess, it’s inevitable. Being small business people, investors, shareholders and managers however, we aren’t in a position to make the rules we can only live by them. That doesn`t mean that you can`t take advantage of the confluence of these factors and circumstances so that you might position your company to take advantage of this irrational mob behaviour that is developing on the macro front. Here’s a few tips and some new services that Caseridge is providing in order to help you through these difficult times:
1. CUT COSTS NOW!
The spike in volatility and uncertainty is creating a tremendous and perhaps once in a generation opportunity for you to reduce your costs, to renegotiate agreements with suppliers, vendors, employees and possibly even customers. You need to prepare and to execute a system-wide Cost Reduction (“CR”) Strategy immediately in order to benefit from the short term price deflation before the inevitable real inflation sets in to increase your costs. A “CR” strategy is not just for companies that are in financial difficulty or trouble – in fact it is likely to be even more successful, for growing, successful companies… your vendors don`t want to lose you! Why should the weak and troubled sisters’ benefit from a structured turnaround and renegotiated lower prices when you have more to offer and your suppliers more to gain from your success?
We have worked with a number of clients over the last several months to review their vendor agreements, leases, contracts and fixed cost relationships in order to identify cost reduction strategies. On this front, Caseridge offers structured CR Implementation Strategies: we are willing and very able to negotiate on your behalf with vendors and suppliers to execute an approved cost reduction strategy that will help you to strengthen your balance sheet and improve your prospects. Frankly it is often more convincing for a supplier to receive a call from a Caseridge Banker as part of a coordinated strategy rather than from a CFO or a CEO when executing on a CR plan. Our compensation model for these strategies is structured primarily as a percentage of the actual cost reductions that are realized by you, our clients: a win-win strategy for all involved. Get these costs down now and look to enter into longer term fixed cost agreements that will protect you from price inflation down the road. A dollar saved is a dollar earned, and the savings are there for the taking… don`t miss the boat on this!
2. PUT A MAD-R STRATEGY IN PLACE:
A successful MAD-R (Mergers, Acquisitions, Divestures & Restructurings) plan will be one of the hallmarks of Canada’s most successful company’s once we get to the other side of this turmoil. There are three groups of companies in this category and we offer services for all three:
a. The Living Dead (“LD”): We believe that perhaps as many as 30% of the companies in the Caseridge TechSys index, as many as 75 companies, will not survive to see the other side of any recovery due to a lack of cash, a failure to realize cost reductions, or a general failure to develop and implement a successful business strategy. If you are burning cash (or expect to in the near future) and you do not have sources of capital readily available then you will likely not survive. That may be a harsh assessment; however there are opportunities for you but they lie in taking action NOW! Caseridge offers financial viability reviews; an honest and perhaps a brutal assessment of your company’s business prospects in the present environment that is particularly useful for proactive Boards that are looking out for the shareholders. Based on this initial review Caseridge is able to offer survival strategies and alternatives to LD’s that may be both drastic and marginal depending on the circumstances. This might give you some more room to find a graceful and perhaps even a profitable exit and maybe even some short term structured financing. We encourage companies that are in this category and particularly their Boards’ to protect their shareholders and their assets. The opportunities will not find you… you must seek them! Your first step to recovery may very likely be a call to us.
b. BUYERS and SELLERS: Of the 70% of the companies in our index that do survive we believe that roughly half of these, or roughly a further 75 companies would benefit tremendously from a targeted Merger/Acquisition strategy. This is the group that we identify as candidates for the Ideal New Issue (on the next page). An acquisition or even the sale of your company to a supplier, customer or competitor with the cash resources to move your plan forward will help to position you tremendously not only to survive but to prosper. Once you gain some traction as a consolidator, or become part of a consolidator should you sell to one, then market dynamics will shift in your favour. Caseridge has access to an extensive database of potential takeover candidates, strategic investors and peer-group analysis models. Our approach is to explore opportunities on a world-wide basis both on our own and in conjunction with some of our partners in Europe, the US and Asia. A broad scope is necessary so that you do not run into the trap of buying the best of a bad lot in a particular local market, and even if your needs are local, comparing prices on a broader scale will assist you with your negotiations. Our model for these activities is a marginal upfront retainer to cover our costs in preparing a broad list of comparables and targets and then a transaction based success fee based on the completion of a successful transaction.
c. The Steady as She Goes’ (“SSG”): SSG companies are doing well and perhaps even prospering on a relative scale despite the current market conditions. These management teams and their Boards are aware of opportunities, have access to capital if required and are comfortable in their business model. Congratulations! The challenge for this group is not to be complacent or over-confident. Some are instituting Buyback strategies in what we believe to be a misguided attempt to shore up their stock prices by reducing their float, liquidity and capital resources. In many cases Boards’ believe that the announcement of a Buyback is an important signaling mechanism – but in this environment it just doesn’t work. Cash is king, pure and simple. Considering how rare it is for a company to announce the successful issuance of shares for cash, announcing that you are giving away your cash and cancelling shares just doesn’t make a lot of sense. We would recommend that company insiders instead purchase the shares on their own account rather than using up precious capital resources to do so on behalf of your shareholders: frankly if shareholders wanted to buy more shares they easily can with a simple call to their broker. That would be a more convincing sign of confidence in your company’s prospects than the “OPM” Buyback approach. Resist the urge.
3. LOOK TO INTERNATIONAL MARKETS AND OPPORTUNITIES
We are finding a marked increase in companies that are based in international markets, particularly in Europe (the UK, Germany, Italy, Spain, the Netherlands and France) and the US as well as Asia looking to the Canadian markets more favorably. This may be as a result of our relative success in dealing with the credit crisis on a national level. It may also be the result of the success that the TSX and the TSXV have had in marketing our exchanges as viable alternatives in the international marketplace. Open up the scope of your search for opportunities, you may find a more willing market out there right now.
We hope that by offering up a wide array of services in addition to our M&A and New Issue services that we will continue to be a preferred supplier of financial and advisory services to Canadian technology and special situations companies. We hope that you enjoy this week’s Caseridge TechSys DealBook!
adamou@caseridge.com
Our charts clearly show that during the month of October that the 50 day trend line for gross profits ended its multi-month contraction and turned the corner toward higher growth rates. We also noticed that the Gross Margin Multiple. a standardized value of the TechSys index is highly correlated to the Gross Margin Growth rate though the movements appear to be more volatile. As one would expect, higher growth rates are indeed related to higher multiples and higher valuations – a relationship that has held remarkably well during this liquidity crunch. Indeed it is good to see that fundamentals sill have a place in financial analysis, however what did change was the degree of the swings in the correlation: in other words; the changes in growth rates (particularly declining gross margin growth rates) resulted in a much greater swings in valuations as a result of the related contraction in market multiples.
So what does this mean? At this point we are optimistic about the next few months going into the new year. Our theory posits that the decline in the Canadian dollar will lead to higher gross margins and to higher gross profit growth rates, factors that combined should lead to higher valuations. We believe that it is possible that with a sustained period of stable and improving growth rates that the valuation chart may turn upward driven by a sizable expansion of multiples. In other words: the last half of the first quarter of 2009 looks very promising.
As many of our readers are aware, in 2006 I joined with a small group of like-minded individuals to establish Evergreen Capital Partners Inc. as a well placed and well positioned institutional boutique brokerage firm. With offices in Calgary and Toronto and a growing team of bankers, sales people, traders and analysts we had a tremendous level of success throughout my tenure, hitting the profitability targets that we had set for 2010 three years early by focusing on our plan, defining our business model, applying appropriate risk mitigation strategies and by developing personal relationships with our clients.
Last week Evergreen announced that it was ceasing operations and that it was being wound down, though the details remain sketchy at this point. I have no knowledge of what has happened to whom, why or how. I had a continuing financial interest in the firm and as far as that is concerned, I am in what may develop to be a long line-up of vendors, suppliers and shareholders that are looking for answers.
Whatever the case, the over-all market is looking just a tiny bit brighter… but our advice (throughout this blog) to “hunker” down still stands! Good times often roll into bad times just as soon as you begin to feel just a little bit too comfortable.
adamou@caseridge.com
416-915-4142
For those of us that are focused on business rather than just on the markets there is some good news for the TechSys sector this week: the dramatic decline in the value of the Canadian dollar vs. the US currency should help to boost gross and operating margins just in time for the calendar year end in December.
Readers of this report should be aware of the value that we place on high gross margins and on gross profit growth rates and both figures are affected greatly by exchange rate movements. The basic Gross Margin Multiple model (”GMM”) that we use at Caseridge holds that higher gross margins lead to an expansion in valuations.
With respect to growth, the GMM model holds that it is the growth rate of gross profits that matters most to valuations of small and medium sized TechSys companies rather than growth in revenues or cash flows.As the Canadian dollar ran up from the $0.80 level to above par over the last two years, gross margins were depressed for companies with a Canadian cost base that sold products into the US. With valuations tied to the quality and growth rates of gross margins under our model, the appreciation in the C$ resulted in a decrease in market multiples. With the sudden decrease in the Canadian dollar back to the mid $0.80 range once again we expect to see this effect begin to unravel giving Canadian small caps a slight boost that we hope is sufficient to overcome decreases related to a slowdown in economic activity.
We track the quarter-over-quarter growth rates of each of the 241 companies in the Caseridge TechSys index and from this we calculate the current growth rate for the group as a whole. As new quarterly results are released the growth rate changes to reflect the most recent results. The “actual” gross profit growth rate changes as the quarterly results stream into our model and as a result it is highly volatile. The 50-day moving average of the gross profit growth rates is more stable reflects the aggregate growth rates as it smoothes out the individual aberrations.
At the end of October 17th, we can see from the Moving Average line that the quarterly growth rates have remained relatively stable over the last five months with a modest downward trend making itself evident over this period. We have postulated in previous commentaries that the September quarter would likely show a reduction in the gross profit growth rate and so far we are bang on with our prediction. At this stage however, with the rapid decline in the value of the Canadian dollar we believe that the December quarter (and calendar year end for many of the companies in our index) will likely see some improved growth rates, perhaps even enough to offset and reduce this slightly negative trend year-to-date. It’s too early, too little and too premature to make any predictions right at this point, however it is enough to make us just a little more
optimistic about the prospects for the TechSys sector going into the first quarter of 2009, where we believe that with just the right mix of circumstances we may very well see the first window of opportunity for new TechSys financings in over a year.We hope that you enjoy this week’s Caseridge TechSys DealBook.
Commentary – Iraq a Larger Factor than OPEC
This weekend’s bombshell announcement that not only has the Bush administration reportedly reached a draft agreement on key security terms of a deal with the Iraqi government, but the deal includes a 2011 timeline for the withdrawal of troops. This is a stunning reversal for an administration that has adamantly resisted an official timeline for troop withdrawals (“We will not cut and run”) and places Bush’s position on Iraq as quite similar to that of Barack Obama.
Terms of the draft deal include key concessions on part of the Bush administration. Aside from the troop withdrawal timeline, Iraqi courts will have the right to prosecute US military personnel and civilians for crimes committed outside their bases and when off duty. Iraq will also have primary jurisdiction over private security contractors, which if ratified, will likely lead to a rapid escalation of violence in areas where private forces comprise a high percentage of the occupation. The agreement still needs to be signed by both sides and approved by the Iraqi government. If implemented, the draft plan calls for US troops withdrawals from Iraqi towns and villages by June 2009 and out of Iraq completely by December 2011. There are out clauses, however, and this agreement is still in draft phase, but identifying troop pullout dates from parts of Iraq that have seen the most fierce battles in as little as 8 months, is a shocking policy reversal. A near term retreat of troops from Iraq before security is established will undoubtedly put energy production at risk and perhaps create another Nigeria, where at any given time shut-in production from terrorist attacks is similar to actual production.
Perhaps the policy reversal is a Machiavellian ploy to solidify McCain support, now that the Bush proposal looks like one crafted by Obama. After all, Bush is a polarizing figure and his largest contribution to the McCain campaign would likely be to toss him a political softball that no doubt McCain will publicly decry. It is the best way to create a real wedge issue that already existed, yet McCain’s Iraqi policy appeared to be a mirror image of the Bush administrations.
Iraq’s oil production is roughly 2M barrels/day. More importantly, almost 80% of production is exported, so any decrease in production due to neglect, lack of investment or terrorism, can have a large impact on global supply. Pipeline bombings and power plant sabotage are commonplace. Production for September is estimated at 2.29M Barrels (per Platts). However, huge production gains are projected into most global petroleum estimates. Official production estimates are 4.5M Boepd in 5 years, rising to 6M Boepd in 10 years. Pre-war peak summer production had risen to 2.5M Boepd.
Prolonged instability in Iraq will have a significant impact on crude prices in the future, if efforts to exploit the nation’s estimated reserves of 115 Billion Barrels proves more difficult than originally estimated. Currently, all of Iraq’s oil sales are collected in an account at the Central Bank of Iraq at the Federal Reserve Bank of New York, as per a UN mandate. The money is then transferred from the CBI to the IraqFinance Ministry for government program spending. However, only a small fraction is spent, leaving a large bounty stockpiling in New York. Iraqi budget surplus for 2009 is estimated to be $79Billion.
With regards to OPEC – at this point, any attempt by OPEC to curtail production will at best result in a (very) short term opportunity to hedge forward production at higher prices. Most OPEC members (and non-members in producing nations) are coming around to the understanding that $70 oil is still very profitable, especially in light of the rising US Dollar and reduced raw materials input prices. Most state controlled energy firms will do nothing to halt production and may actually turn the spigot and increase production, given forward estimates on the US economy. Macroeconomics and forward forecasts are driving energy prices currently and until evidence emerges of at least a few months of a snapback in demand, OPEC is a complete non-factor at this point.