KeyStone’s Stock Talk Podcast – Canadian Small-Cap Stock Sandvine Corp. (SVC:TSX) Receives Another Bid, We Search for Value, Organic Garage Ltd. (OG:TSX-V) is this New Penny Stock a BUY/SELL/HOLD? Small-Cap New Look Vision Group Inc. (BCI:TSX) is Our Star, and Tesla (TSLA:NASDAQ) is our DOG
We have another busy show for you this week. We start off by updating what has become an ongoing bidding war for small-cap networking equipment company Sandvine Corp. (SVC:TSX) – in fact, the company received another bid just this afternoon. We also have a brief chat about our findings from our recent discovery research in Canada and the US – is there any value out there? In our Your Stock, Our Take segment we take a question from a listener about new micro-cap company, Organic Garage Ltd. (OG:TSX-V) an independent, Ontario-based natural and organic grocery chain – is it a BUY at present? Our star of the week is New Look Vision Group Inc. (BCI:TSX), a provider of eye care products and services in Eastern Canada which jumped over 12% this week following an announced acquisition of a rival eyewear firm. Our dog of the week is market darling Tesla (TSLA:NASDAQ), which lost over 18% of its value after Goldman Sachs stated the company’s shares could lose nearly half their value and reiterated its SELL rating on the electric carmaker while cutting its price target to $180, about 49% lower than the stock’s closing price on Monday.
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Now, let’s dig into the show.
I would like to welcome again, myhost, KeyStone’s Senior Equity analyst, father of 1, and a man who is so thrilled his Vancouver Canucks drafted another Swede with their first pick in last week’s NHL entry draft he is pitching the team on a new Swedish reality TV show, believes Ikea should automatically sponsor the team and change their jerseys to the Swedish National uniform, Mr. Aaron Dunn.
Topic 1: Sandvine Corp. (SVC:TSX)
One of KeyStone’s Top Canadian Stock Picks for 2017
Industry: Communications – Software & Hardware
Recommended: December 2014
Recommendation Price: $3.02
Current Price: $4.29 – Stock halted pending news!
What does Sandvine do?
Sandvine Incorporated is a networking equipment company based in Waterloo, Ontario, Canada. Sandvine’s network policy control products are designed to implement broad network policies, ranging from service creation, billing, congestion management, and security.
Why are we discussing the company again today – for those unaware the company has been on our Focus BUY list for a couple of years and recently jumped 22% when it announced it received a bid to be acquired at $3.80 by Vector Capital – a private equity firm. From this point the anti has been upped to $4.15 by competing private equity Francisco Partners, then matched by Vector and just hours ago this offer was bested again by a $4.40 offer from Francisco Partners. It has been a wild ride and it may not be over as Vector Capital now has a 5-day matching period.
The firms have been playing a financial markets game of chicken and neither has blinked.
We believe we are closing in on the end.
Through the process, we have recommended holding the shares as the potential for a competing superior bid has outweighted the potential for no further bids. The stock has added 16% over this period and has pushed our return to 46% not including dividends.
We are pleased with the return overall, but not pleased with the conduct of management during the process.
First-off, the management team and board signed into the original agreement with Vector Capital at $3.80 which in our opinion was low but we can forgive the team to a degree as the company was permitted a go shop period under the deal. It would have been nice to start at a higher point. Management structured the deal so that Sandvine’s CEO, Dave Caputo (Board member), together with members of Sandvine’s senior management team (Don Bowman, Tom Donnelly, Brad Sim and Scott Hamilton (Board member) agreed to exchange an aggregate of 5.1 million shares (representing the majority of their common share holdings) for shares of an affiliate of Scalar Acquireco.
Essentially, they are taking a different deal (not the cash) that the shareholders are to receive. Yet, the company’s Board recommended shareholders vote for the deal.
The management teams reason for taking shares in the Acquireco was to reinforce Sandvine’s senior management team’s full commitment to the Company’s long-term success. Mangement’s loyalty should be to the owners of the business – the shareholders. In this case, they are not aligned with shareholders as their return in terms of their share holdings is the same regardless of what price shareholders receive un the Vector offer. They are not incentivized to work their butts off to get a higher bid. Frankly, in a takeover situation, shareholders could give a rats behind as to the management’s commitment to the company beyond the cash payment for their shares.
Moving on, the original Arrangement Agreement provided for a termination fee of CAD $8.4 million with respect to such a termination during the go-shop period and CAD $16.9 million in certain other circumstances.
Why a company that is in high demand which Sandvine clearly is (note the competing bids) needs to provide a termination fee to the suitor is questionable in my opinion. I understand in certain circumstances it is customary, but in this case are we seriously supposed to believe that Vector would not have entered into the agreement if the termination fee was not offered? They are in the business of acquisitions and factor due diligence costs into daily operations – it is a cost of doing business and the company being taken over should not have to pay for them to conduct their diligence. Sandvine was certainly not starved for capital and should have been in no hurry to sell itself unless a very attractive takeover bid appeared.
All the break fee does at this stage is discourages competing bids and this is irresponsible to shareholders.
Finally, under the original agreement between Vector and Sandvine the termination fee or break fee was not to increase to CDN$16.9 million until the end of the go shop period or 11:59 p.m. (Toronto time) on July 7. 2017. Management amended the deal in its agreement with Vector to match the $4.15 bid on July 6th to increase the break free to CDN$16.9 million immediately.
Again, this is a disappointment as it serves as a deterrent to competing bids.
I would hope the management team of any responsible public company would be taking the same offer as shareholders and be screaming from the tops of every skyscraper in town across the globe that the company was for sale and open to ALL bids with no penalties.
Topic 2 – Current market conditions – we are presently conducting our Sedar and Edgar sweeps and our initial findings;
1) Broadly speaking there is not a great deal of value – stock valuations to cash flow and earnings are relatively high and factor in continued growth. If this growth continues, broad stock indexes are priced ok. If not, there is a real argument for a correction.
2) We are finding select value but we are cautious as some of the value is being uncovered in; a) Cyclical stocks and b) Companies with red flags such as poor investor communications. Orphans – you have to be wary of these situations.
3) We are ok will holding an above average percentage of our portfolio in cash. Why? Part of the cash build up has come from a number of takeovers in the first half of the year including International Road Dynamics (IRD:TSX), Merus Labs (MSL:TSX), and Sandvine (SVC:TSX). Part has come from the lack of new buys due to the lack of value generally in the market.
Happy to wait for good long-term opportunities.
Your Stock Our Take
Recent Listing – Small-Cap Penny Stock
Organic Garage Ltd. (OG:TSX-V)
Market Cap: $12.75 million
OG is an independent, Ontario-based natural and organic grocery chain with 2 stores operating in the Greater Toronto area. Its main business activities are selling natural and organic products to consumers through its retail network of store locations. The company is an expanding specialty retailer of natural and organic groceries. Its focus is on providing high-quality products at affordable prices. The goal is to generate long-term relationships with customers based on a transparent and honest approach by selling only natural and organic groceries that meet OG’s strict ingredient standards and utilizing an efficient and flexible smaller-store format to offer affordable prices in a fun and inviting shopping environment. OG’s core mission statement is to offer healthier options for less.
July 5, 2017, Toronto, Canada: Organic Garage Ltd. is pleased to announce the grand opening of the company’s newest flagship store located at 43 Junction Road in Toronto’s west end.
At least the company is a real business trying to make a go of it. Yes, that may sound like a low bar, but the TSX-Venture is fraught with shell companies with no current investment merit.
Decent balance sheet – $2,620,585 in cash and cash equivalents as at April 30, 2017. Limited debt. We would expect this would change as it takes capital to expand in this business.
For the last quarter ended April 30, 2017, the company had $4.16 million in sales, up slightly from $4.06 million in the previous quarter. Both quarters the company produced losses of ($148,208) and ($45,643) respectively.
The company passes our first hurdle of revenues, but does not make our second criteria of profitability.
From here we can look to the outlook – at this stage the company is not providing any guidance to the market so we do not see a path to profitability laid out.
At this stage, while there is some promise, the company is in a tough market segment which has low margins and we see a good deal of capital needed for expansion. At this stage, we will monitor the company, but would not be buyers.
The company could do a better job communicating its plan to investors.
New Look Vision Group Inc. (BCI:TSX)
New Look is a leading provider of eye care products and services in Eastern Canada. As of April 1, 2017, the Group had three main banners: New Look Eyewear, Vogue Optical, and Greiche & Scaff. The Group’s network consists of 227 corporately-owned eye care stores.
Shares jumped over 12% this week following the announcement on July 4, 2017, that it has entered into a definitive agreement to acquire all of the issued and outstanding shares of The Iris Optical Inc. (Iris). Founded in 1990 by Dr. Francis Jean in Baie-Comeau, Quebec and based in Laval, Quebec, Iris has grown to become a leading optometrist based retail eye care provider across Canada with a network of 150 locations, comprising 53 corporate, 77 jointly owned and 20 franchise locations. The Iris banner is recognized nationally with locations in Quebec (82), British Columbia (36), Alberta (16), Ontario (15) and New Brunswick (1).
Adjusted pro forma consolidated revenues for the same period amounted to approximately $60 million.
The purchase price for the shares of Iris is $120 million on a cash-free and debt-free basis, subject to customary price adjustments. New Look Vision has entered into various financing agreements to finance the acquisition, including: (i) a $38.75 million increase of its senior secured term facility with its bank to $95 million; (ii) an arrangement for a $35 million junior unsecured debt facility and a $20 million equity private placement of 646,400 subscription receipts at a price of $30.94 per subscription receipt with a Quebec-based fund; and (iii) a $30 million concurrent equity private placement of 969,600 subscription receipts at a price of $30.94 per subscription receipt.
The combined entity will have estimated annual revenues exceeding $265 million and a store network in excess of 375 locations reinforcing New Look Vision Group’s position as the largest Canadian retail optical company and the 8th largest in North America. We will be the dominant player in Quebec, the Atlantic Provinces and British Columbia. This should lead to greater efficiencies and lower operating costs in many areas of operations
On, May 11, 2017, New Look Vision Group Inc. Announces Record First Quarter Revenues for 2017.
New Look Vision reported record revenues of $51.0 million and adjusted EBITDA of $7.9 million for the first quarter ended April 1, 2017, representing increases of 14.5% and 8.3% respectively over last year. The increases were mainly due to the net addition of 20 stores in the last twelve months as well as same store sales growth of 1.9% over last year.
Adjusted net earnings attributed to shareholders, defined as net earnings adjusted to remove the impact of acquisition-related costs and equity-based compensation, for the first quarter were $2.4 million (or $0.17 per share) compared to $2.2 million last year (or $0.16 per share).
The deal makes New Look a dominant play in Canada.
Revenues in 2012 were $82 million in 2016 they were $199 million – the company has been a great growth story.
From a valuation perspective, the stock has not been cheap for some time. Prior to this acquisition the company traded at around 40 times earnings and 20 times cash flow – both premium to expensive multiples even for a solid growth stock.
For the past year, the share price had been relatively flat while growth had slowed. Shares jumped this week on the acquisition which will provide growth. The company has taken on significant debt and leveraged its balance sheet to a higher range.
We see the shares as fully valued at present, but the company holds potential for growth 2-5 years forward. We monitor it.
Telsa Inc (TSLA).
Our Dog for this week, quite surprisingly is Telsa Inc (TSLA).
• Everyone knows Telsa, the world’s number 1 maker of electric cars.
• Well the stock has been on a tear since the start of the year but hit a bump in the road last week sending the share price down nearly 20%.
• So what happened?
• Well one issue was that the company missed expectations on deliveries in Q2 with 22,000 vehicles shipped compared to 25,000 in the same quarter last year and analyst consensus of 23,500.
• The company blamed a severe production shortfall of battery packs and said production average 40 percent below demand, until early June.
• Tesla says that the issues have now been resolved and that production is back at full speed.
• But analysts at Goldman Sachs don’t seem convinced.
• Goldman issued a report reducing its 6 month price target to $180 from $190 citing plateauing sales of the company’s existing Model S vehicle and saying that the company will have trouble hitting production targets for the year.
• They have a SELL rating on Telsa with the price target implying a near 50% decline in the company’s stock price.
• I also believe concerns about competition might be weighing on the stock.
• Other car makers are investing heavily in their own electric vehicles.
• Just last week, Volvo announced that it would be converting its production to all electric vehicles by 2019.
• In my personal experience, I was shopping for a car about 9 months ago and I did do some research on electric vehicles.
• At the time at least, the stats on Telsa with respect to range and charge time really blew away any other options.
• So there is a real competitive advantage there but the company is going to be facing more and more competition going forward.
• Telsa over the past year has been anything but a dog.
• Although the stock is down 20% on the week it is still up 45% just since the start of the year.
• But the company continues to burn through cash and has only had a single quarter of profitability in its history.
• That was Q3 of last year, when they squeaked out $80 million in operation profit.
• They are losing about $250 million a quarter right now so it wouldn’t pass our investment criteria.