Investing in small-cap companies can be risky, but rewarding too. They can offer higher growth than their larger peers and even become takeover targets with a juicy premium.
Bigger firms may want to acquire smaller players doing the risky legwork in consolidating their industries or to gain access to new markets or technologies. Takeovers can also occur from company founders looking for an exit strategy, or private equity firms that could be on the prowl for investments.
We asked three fund managers for their top picks among stocks that could be attractive takeover candidates.
Stephen Takacsy, president, chief executive officer, chief investment officer and lead portfolio manager, Lester Asset Management Inc.
His fund: Lester Canadian Equity Fund
The pick: CareRx Corp. (CRRX-T)
52-week range: $3.81 to $5.10 a share
CareRx aims to consolidate pharmacy services for seniors, but could one day be a takeover target too, Mr. Takacsy says. The Toronto-based company, which serves long-term-care and retirement homes, was formerly known as Centric Health Corp. In the United States, “large retail drug chains CVS and Walgreens have acquired stakes in institutional pharmacies [excluding hospitals],” he says. Under chief executive officer David Murphy, appointed in 2018, CareRx has divested unrelated businesses and rebranded. With the recent acquisition of Remedy Holdings Inc., CareRx is now the leader with about 15 per cent of the market, and will benefit from cost synergies in the coming quarters, Mr. Takacsy says. A risk is new government regulations that could impact its business negatively. CareRx shares trades at about 8 times earnings before interest, taxes, depreciation and amortization (EBITDA).
52-week range: 0.08 to 0.245 cents a share
Diamond Estates and Spirits could eventually be acquired by Lassonde Industries Inc. (LAS.A-T), which bought a 20-per-cent stake in the wine producer last year, Mr. Takacsy says. The Niagara-on-the-Lake, Ont.-based firm, which has wineries in Ontario and British Columbia, owns brands such as 20 Bees, Dan Aykroyd Wines and Lakeview Cellars. Quebec-based juice producer Lassonde, which has a wine unit, can help Diamond expand into grocery stores, especially in Ontario, he says. Mr. Takacsy’s fund and other accounts at his firm own 9.9 per cent of Diamond as well as shares in rival Andrew Peller Ltd. (ADW.A-T). Wine has been a fast-growing part of the beverage industry, he says. A slowdown in exports to China hurt past sales, but Diamond has diversified its export market. The big risk is poor weather affecting the grape harvest. His minimum target price with a takeover is 40 cents a share over 24 months.
Bruce Campbell, president and portfolio manager, StoneCastle Investment Management Inc.
His fund: Purpose Canadian Equity Growth Fund
The pick: Protech Home Medical Corp. (PTQ-X)
52-week range: 0.47 cents to $1.48 a share
This U.S. supplier of medical equipment to homes is an industry consolidator that could be a takeover candidate, Mr. Campbell says. Cincinnati, Ohio-based Protech Home Medical sells and rents equipment such as ventilators and machines to treat sleep apnea. U.S.-based AdaptHealth Corp. (AHCO-Q) could potentially be the acquirer because its filing documents to go public this year described possible takeover targets, including a firm resembling Protech without naming it, he says. Protech is a “fairly, fast-growing company” with recurring revenue and yet trades at almost 5 times enterprise value/EBITDA for next year versus 12 times for AdaptHealth, he notes. Risks include the ability to execute its acquisition strategy to unfavourable health care legislation. Protech was known as Patient Home Monitoring Corp. until 2018, when it spun off a unit, which is now Viemed Healthcare Inc.
The pick: Bluma Wellness Inc. (BWEL.U-CN)
52-week range: 0.355 to 0.90 cents a share
Florida-focused medical cannabis operator Bluma Wellness could be acquired by an industry peer wanting to expand into that state, but can’t do so because of limits on licences, Mr. Campbell says. The Toronto-based vertically integrated, licensed medical marijuana company does business as One Plant Florida through dispensaries and an e-commerce home-delivery service. In June, it went public following a reverse takeover. Bluma, which is seeing strong sales momentum, benefits from Florida’s higher number of seniors being prescribed cannabis by their doctors, he says. Its strong management team, with a history in the cannabis sector, is a plus, he adds. Although Bluma is not profitable yet, the biggest risks stem from the challenge in raising capital and any unexpected changes in the highly regulated industry, he says. “It is certainly a more speculative stock now.”
David Barr, president, CEO and portfolio manager, PenderFund Capital Management Ltd.
The fund: Pender Small Cap Opportunities Fund
The pick: Mav Beauty Brands Inc. (MAV-T)
52-week range: $1.78 to $6.37 a share
This personal-care company, which has takeover potential, is also in a historically recession-proof business, Mr. Barr says. Vaughan, Ont.-based Mav Beauty sells hair care and other products under brands such as Marc Anthony and Renpure in North American grocery and drug stores. It was founded by Marc Anthony Venere, who holds a 28-per-cent stake. In February, Mav Beauty executive Tim Bunch succeeded Mr. Venere as president and CEO. This could be a sign that the company is open to selling itself, Mr. Barr says. Mav Beauty is also growing faster than U.S.-based Coty Inc.’s hair business, which was spun out recently, with private equity firm KKR & Co. taking a 60-per-cent stake. MAV has had two consecutive quarters of strong free cash flow helped by better cost controls, he adds. A risk is its debt load, which is coming down. MAV Beauty trades at about 6 times 2021 earnings.
The pick: Prontoforms Corp. (PFM-X)
52-week range: 52 to 98 cents a share
Prontoforms, which allows companies to develop mobile apps for field workers without using coding, has takeover potential, Mr. Barr says. The Ottawa-based firm’s platform allows companies without a software development team to build apps for mobile employees, such as sales teams, to connect with corporate business systems and databases. Consolidation is starting in the no-coding space, particularly in field-service apps, he says. Prontoforms’ U.S. rival GoCanvas was bought by a private equity firm in 2018. Prontoforms’s recurring revenue has had an impressive 28-per-cent compounded annual growth rate from 2013 to 2019, he says. The firm, which is marginally profitable because it invests in growth, is selling directly to clients now instead of through third parties. The risk is management execution in growing its business. Its stock trades at less than 4 times 2021 revenue.