KeyStone’s Stock Talk Podcast – Cananada’s Active M&A Small-Cap Stock Market – Does it Predict a Market Top?, Building a Cannabis Town – American Green Inc. (OTCMKTS:ERBB)..really?, Pacific Insight Electronics Corp. (PIH:TSX) jumps 76% -Star, and Sleep Country Canada (ZZZ:TSX) – Long-Time Star – Drops 10% – Dog?
We have another busy show for you this week. We start off by looking into what has been a busy year in terms of M&A activity in the Canadian Small-Cap market – 3 stocks from our Focus BUY list and 3 from our Additional Coverage have been bought out year-to-date. We discuss whether this is a sign of an overheated market, why these specific stocks are being bought for big premiums, and if there are further opportunities. In our Your Stock, Our Take segment we take a question from a listener about U.S. penny stock, American Green Inc. (OTCMKTS:ERBB), which has recently announced they are building an entire town in California based on marijuana, interesting – is it a BUY, SELL or HOLD? Our star of the week is Nelson, BC-based Pacific Insight Electronics Corp. (PIH:TSX), an ambient and direct LED light maker for the automotive industry, which jumped 76% this week after it announced the company was to be acquired. Finally, our dog of the week is Sleep Country Canada (ZZZ:TSX), the well-known mattress sell which had been a star performer since its recent “re-IPO”, dropped 10% yesterday on the heels of a mixed Q2 numbers that brought the Sleep Country’s premium valuations into question.
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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, shocked the twittersphere last week by not sending out his first tweet, Mr. Aaron Dunn.
Let’s talk M&A – specifically –
Small-Cap Merger & Acquisition Activity in 2017
What prompted this? – another takeover bid this week for Pacific Insight Electronics Corp. (PIH:TSX) – our Star this week – from our Additional Coverage which received an offer at a 75% premium this week.
Takeovers from our Focus BUY Portfolio
- International Road Dynamics Inc. (IRD:TSX) – 80% gain (recommended at the 2017 Outlook & on my previous appearance on Money Talks)
- Sandvine Corporation (SVC:TSX) – 50% gain (recommended at2016 World Outlook)
- Merus Labs International Inc. (MSL:TSX)
Takeovers from our Focus BUY Portfolio
- IWG Technologies Inc. (IWG:TSX-V)
- Pacific Insight Electronics Corp. (PIH:TSX) which received a takeover offer at a 75% premium this week.
There are a lot of things at play here but three factors I see as influential are – Three factors impacting the M&A activity level;
1) Interest rate hikes spur offers – cash is still cheap to finance acquisitions, but the fear is that could become more expensive if rates continue to move higher. Groups which are looking to make an acquisition may be pushed to do it sooner rather than later. Near-term M&A activity increases in the near-term as a result.
2) The rise of private equity – with its greater popularity a number of funds are flush with cash and on the hunt for acquisition targets. That cash has to find a home. In past cycles we have seen several of our recommendations including Sleep Country and GDI Integrated Facility Services Inc. bought at strong premiums by private equity and taken of the public markets for 5-10 years only to return when their segments are hot – “going public” through an IPO once again. We are seeing this cycle once again – it is interesting.
3) Strong U.S. Equity Markets – 5-years of solid growth and companies are flush with cash. This creates more M&A activity, which isn’t too surprising – in the later innings of a bull market, you typically see more greed than fear.
Following these takeovers, we have been left with a good deal of additional cash – we think this is a good thing in market that is not broadly cheap. We are happy to sit on the cash and deploy it very selectively.
- You can definitely profit from these bids.
- Make sure the bid is a good one before tendering to the offer. If it is not at a fair price, we hold the shares as there can be competing offers – we saw three bids and higher prices for Sandvine this year and held the stock through the offer process.
- Most important takeaway – Never buy a stock just because you believe or have heard it is a takeover target – buy it because it is a great business trading at a cheap to reasonable price. If you buy a great company, the rest including a takeover bids, will take care of themselves. If you buy just for a potential takeover, you may be waiting years, if not decades and if it is not a good business, you are not in a good position.
Your Stock Our Take
We have a question from Sam in Victoria.
American Green Inc. (OTCMKTS:ERBB)
· What is your take on American Green Inc? I read that they are building an entire town in California based on marijuana. Could this be a good move for investors?
· The short answer…our take is that American Green is not an investible company.
· I had to do a double take on the share price and share count.
· It trades at 0.17 cents per share. That’s 1/17th of 1 cent.
· I’m not sure I have ever seen a share price that low.
· I also see a share count of over 13 billion shares…I pretty sure that is the highest share count I have ever seen…its more than Apple and Microsoft combined.
· It’s also on the Pink Sheets which has the lowest disclose requirements of the OTC’s three markets.
· From the OTC’s own website, the Pink Sheets have “no minimum financial standards”….generally we avoid pink sheet companies at all costs.
· You are correct that it has recently been made public that the company is in talks to buy a town in California, presumably with the intention of turning it into some kind of a marijuana tourist destination.
· The idea has some promise I suppose…I don’t know of any other marijuana themed towns so I’m sure if it was done properly it would attract customers.
· But I personally have no confidence that this would be the company to pull it off.
· They are essentially making no money right now…$9K in revenue in the last quarter.
· Last year they reported $370K in revenue and a net loss of $2.7 million…more than $10 million in net losses over the past 3 years.
· They have a little under $200K in cash on the balance sheet and $700K in debt.
· From what I can see, this company has very little in the form of financial resources to turn this idea into a reality.
· I would not touch it.
Sleep Country Canada; symbol is ZZZ and currently trades at about $35 per share.
- The company also pays a dividend and yields just under 2%.
- I’ll admit that it feels a little strange to have this company as a DOG.
- We actually recommended the company way back (I believe 2005/2006) when it was an income trust and it provided an amazing return back then and was eventually acquired and taken private at a big premium.
- The company returned to the public markets with an IPO in July 2015 and has since increased in price by over 130%.
- Obviously we have been following Sleep Country closely since it returned to the market but the issue for us is that the valuation was too high…its pretty much been up around the 30 times earnings mark.
- But the stock is down now almost 15% from its high in early July and dropped nearly 10% just yesterday after the release of its Q2 financial results.
- For the second quarter, revenues increased 10.7% to $133.0 million, same store sales growth was 7.5%, and adjusted earnings per share increased 18.5% to $0.32.
- This might be a little confusing to some investors…why would a highly touted and successful company that just reported double digit revenue and earnings growth decline by almost 10% in a single day.
- The answer is valuation…at KeyStone we talk a lot about valuation risk and this is a good example of that.
- When a company is trading at a high valuation multiple…say 30 times earnings…there is a certain expectation with respect to growth.
- To maintain that high valuation, the company has to continue not just to grow but to meet the market’s expectation of the rate of growth.
- So while Sleep Country’s growth rates for Q2 look good at face value, you are less impressive when viewed alongside side the Q1 results where revenue growth was 16%, same store sales growth was 12% and adjusted earnings per share increased by more than 42%.
- Or the 2016 financial results….when revenues grew 14%, same store sales grew 9.6%, and adjusted earnings were up 36%.
- While the Q2 results were strong, they weren’t strong enough.
- This is a key reason why value growth investors like KeyStone are price sensitive when we buy stocks.
- We prefer situations where the company has better potential to outperform market expectations whereby the valuation can increase and the share price rises both from a high valuation to earnings and higher earnings.
- All this being said, I believe that Sleep Country is an excellent company, the valuation is starting to look better at about 25 times earnings and it’s a story we are watching closely.
Pacific Insight Electronics Corp. (PIH:TSX) – a company that was highlighted in our Breakthrough Small-Cap Report last year.
Pacific Insight designs, develops, and manufacturers electronic products and full service solutions to the automotive, commercial vehicle and specialty markets – primarily for the automotive market the company’s products including LED lighting systems, electronic control modules and wire harnesses. It provides some of the interior lighting for Tesla – LED based ambient and direct lighting.
The stock is up 76% this week.
What drove the gains?
On August 1, 2017, Pacific Insight Electronics Corp announced it would be acquired by Methode Electronics Inc. at a price of CAD$18.50. This represents a premium of 76% based on the closing price Pacific Insight on the TSX on July 31, 2017 and a 79% premium based on Pacific Insight’ s 20-day TSX volume weighted average price ending on July 31, 2017. All outstanding options and warrants will also be acquired.
For holders, we would recommend tendering shares to the offer as we see it as fair. While it is always possible, we do not see a scenario developing with competing bids such as we witnessed with Sandvine Corporation over the past month.
It is a great return and puts the company in place as our Star of the Week.