I am starting to get worried.
The Canadian microcap market has been so bad since early 2021.
Investors have endured almost three years of pain.
Earlier-stage companies have struggled to stay afloat in what has been one of the most severe financing droughts of the last fifteen years.
Then, in late 2023, US private equity firms started to acquire companies in our market.
These transactions not only validated that valuations were cheap but also provided a much-needed influx of capital in the sector. The capital that was returned to shareholders got redeployed into other opportunities.
High-quality stocks started to move higher on growing volumes. The market has been slowly coming back to life, providing hope for better days ahead.
What happens now?
Strategic buyers and insiders want in on the bargain-hunting party. If the deals are good for financial buyers (private equity firms), they must be great for strategic buyers!
Let’s look at a few of the most recent acquisition attempts:
Mediavalet (TSX: MVP)
The cloud-based digital asset management platform agreed to a $1.71-a-share acquisition by STG, a US private equity firm. Last July, STG acquired the work management platform Wrike, one of Mediavalet’s significant integration and referral partners. Even though STG is technically a financial buyer, the transaction looks highly strategic for them. The premium offered was 30% over the stock’s last closing price, and the valuation was about 4.5 times annual recurring revenues.
IBEX Technologies (TSX-V: IBT)
The Montreal-based pharmaceutical manufacturer recently agreed to an acquisition by BBI, a strategic buyer, for $1.45 per share. The $38 million consideration, payable in cash, was a 29.5% premium to the stock’s last closing price. The valuation, net of the acquired cash on IBEX’s balance sheet, was close to 13 times TTM EBITDA. IBEX has quietly executed its business plan for several years and handsomely rewarded its shareholders with a 16-bagger from the share price low in August 2019!
Indigo Books and Music (TSX: IDG)
Insiders are also trying to take advantage of the depressed valuations. Indigo board member and majority shareholder Gerald Schwartz is trying to take the book and lifestyle retailer private after a more than 85% share price decline over the last five years. Through entities he controls, Schwartz already owns a little over 60% of the outstanding shares. The premium offered was 52% over the stock’s last closing price, and the $62 million valuation worked out to about 0.07 times TTM revenues of $951 million. Yes, you read that right: 0.07 times revenue, not 0.7.
So what am I worried about?
I’m afraid that public market investors will get the ground cut from under their feet as some of the most undervalued opportunities get acquired for relatively small premiums compared to the share price declines they’ve experienced.
Q4 Inc. was a good example. The stock peaked at $12 per share following its public debut in late 2021. Then, it declined to a low of $2 before creeping back up, only to be acquired for $6.05. A New York-based fund that owned 5% of the shares tried to publicly advocate for turning down the deal but failed.
Suppose you’re a long-term shareholder willing to hold a stock for 10 years regardless of the volatility. Then you get a bear market, the stock drops over 50%, and an opportunistic buyer scoops it up for a 30% premium. Well… say goodbye to your long-term horizon. You just got screwed, thank you very much.
Investing alongside management teams and boards with skin in the game is more important than ever, where their interests align with minority shareholders. You want insiders who know what their company is worth and won’t sell too early.
And, of course, a broad valuation rerating in the microcap sector would help ensure that the premiums offered for acquisitions are actually on top of an already-decent valuation, not a basement-bargain one.
Will acquirers keep indulging? Or will public market investors wake up before it’s too late?
The race is on.
Disclaimer
This publication is for informational purposes only. Nothing produced under the Stocks & Stones brand should be construed as investment advice or recommendations. Mathieu Martin, the author, is employed as a Portfolio Manager with Rivemont Investments. This publication only represents Mathieu Martin’s own opinions and not those of Rivemont. Rivemont may own positions and transact on any securities mentioned in this publication at any time without prior notice. At the time of this writing, the Rivemont MicroCap Fund does not hold positions in the companies mentioned. Always do your own research and consult a professional before making investment decisions.
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