A Quick Look at Canlan Ice Sports (TSX: ICE)

Warning: Canlan (TSX:ICE) trades very infrequently. The company has a market capitalization of $50 million; only 10% of which is considered free float (ie. actively trading). If you are looking for a hot stock pick, do not bother reading further. But if you are interested in process, which I hope you are, this should be a useful post.

A Quick Look at Canlan Ice Sports (TSX: ICE)

Every once in a while, you come across a stock that you immediately like. You read the business description and instantly want to go to your brokerage account to buy. For me, Canlan (TSX: Ice) was one of those stocks. Canlan acquires, operates and develops ice hockey rinks that are mainly in Canada. It’s an easy to understand business which appeals to me. Whenever you come across a company like this, it is important to recognize you have an emotional bias. You can combat emotional biases by sticking to a rational process.

Let’s look at Canlan through the same process that I initially outlined in my post on Mediagrif (TSX: MDF). There are four attributes I look for in an initial view 1) Capable management teams and board, 2) Strong balance sheets, 3) Profitable growth, and 4) An attractive valuation.

Step 1: Is the Management Team capable?

The first thing I look at in determining if a management team is capable is whether management’s interests are aligned with shareholders. An important source of information is the management circular posted on Sedar. In the management circular, you can figure out how much management pays themselves and if there are any significant shareholders.

Pg 4 of 21 of the Canlan Circular has the excerpted paragraph below. We can see that 76% of shares are owned by Bartrac Investments and 16% by a trust.

Pg 3 of 21 of the Canlan circular has the names and principal occupations of the Board of Directors. From this, we can take away that Canlan’s major shareholder has representation on the board. This is a good sign when making the determination whether Canlan’s management is aligned with shareholders.

Pg 7 of 21 of the Canlan circular has the summary compensation company for management. There are a couple things to look for here. The first is excessive use of options and share-based awards. The second is whether total compensation is reasonable. I generally get worried when management of a small company like Canlan (market capitalization of ~$50 million) pays itself more than $500,000 per annum.

After looking at compensation, the next thing to look at is management tenure. Joey St-Aubin became CEO of Canlan in 2009. Prior to being CEO, he spent 11 years at Canlan starting as the general manager of a facility. In total, St-Aubin has been at Canlan for 20 years. This is a good sign. If you see that a new CEO has been brought in from outside the company (ie. an external hire), it can signal that something has gone wrong and the board has been forced to look outside the company for a fresh view.

Summary: In summary, management of Canlan looks capable on an initial view. There is a large shareholder with representation on the board. The executive team does not pay themselves excessively and the CEO is tenured. The next step would be to look at the board/management’s track record in terms of capital allocation, strategy, and execution. This requires a much deeper dive and is more suitable for a second phase of analysis.

Step 2: Is the Balance Sheet Strong?

To assess, the balance sheet, we look at the most recent available quarterly financial statements on Sedar. We can see debt totals $57 million (including financing leases). Cash is $14 million, so debt net of cash is $43 million. Total net debt is not much good to us in a vacuum. We must look at net debt in the context of Canlan’s earning power and the assets used to generate earnings.

The industry consensus is to look at EBITDA relative to net debt as a determinant of debt capacity. We can pull EBITDA right off of Canlan’s income statement (see below). Note that many companies do not have depreciation in the income statement, meaning you need both the income statement (where you find EBIT) and cash flow statement (where you find depreciation and amortization) to calculate EBITDA. Canlan is in the middle of its year so it is usually best practice to look at the last twelve months which we can do by taking 2016 EBITDA and adding EBITDA from the first 9 months of 2017 and subtracting EBITDA from the first 9 mths of 2016. So the calculation is: $12.2M +$7.3M – $6.9M = $12.6M.

A simple calculation gets us to Canlan having 3.4x net debt to EBITDA (net debt of $43M divide by LTM EBITDA of $12.6M). 3.4x net debt to EBITDA is a high ratio. As a general rule, companies with above 3x to 4x net debt to EBITDA are not considered investment grade by the major rating agencies (S&P and Moody’s).

There are two mitigating factors for Canlan: 1) the company is noncyclical; Canadians play hockey in good and bad economic times, and 2) Canlan’s debt has hard assets attached to it (ie. real estate). Banks would generally view this favorably relative to a company who only has intangible assets built up from acquisitions over the years.

Given the mitigating factors, I am willing to say Canlan’s balance sheet while far from ideal is still okay from a potential equity investor standpoint.

Step 3: Can the company grow profitably?

It is important to note here that I mention profitable growth rather than just growth. It is not enough to just grow – with an unlimited amount of money or funding, any company can grow. The key to the growth is that it is profitable.

Generally, for growth to be profitable, the company under analysis must have a competitive advantage. Canlan appears to have scale and associated network effects in that it is the largest operator of hockey leagues. Scale helps leagues in many way. One is finer segmentation of player skills. The more people you have, the easier it is to create leagues of people with similar skill levels. Anyone who has ever participated in recreational sports knows that it is a bummer to play with people way worse or way better than you. Another advantage is scheduling. With more people, you can offer several leagues at different time slots to appeal more people’s scheduling.

It is generally easier to assess profitability before growth. You can assess profitability by looking at a snapshot. Growth generally requires looking at the company over a long period team; meaning statements from several different years.

In terms of profitability, I like to use a shortcut of looking at EBIT relative to invested capital. Company’s tax rates can bounce around and this takes that volatility out of the picture. It also excludes ‘below the operating line’ items that are one time in nature.

We have already calculated Canlan’s EBITDA. The next row down is D&A so we can calculate EBIT by subtracting D&A from EBITDA. Or in numbers: ($12.2M – $7.0M) + ($7.3M – $5.2M) – ($6.9M – $5.2M) = $5.6 million.

In terms of invested capital, we have already calculated net debt of $43M, so all we have to do is add shareholders’ equity of $43M (looks like a type-o, but it’s not – both net debt and s/h equity are both $43M). Total invested capital is $86M ($43M + $43M). It is important to note in a more detailed analysis we may do things like add back impairments in prior years to this amount (Canlan had a $4M impairment in 2015). But this is not necessary at the current stage of analysis.

So based on these numbers, we get to pre-tax return on capital of 6.5% ($5.6M / $86M). This is weak in my opinion.

One possibility I thought of is maybe Canlan is depreciating its buildings too quickly and they actually have a longer useful life. This would mean D&A is too high and the result would be that the EBIT we are looking at should actually be higher. Pg 46 of 62 Canlan’s 2016 annual report has the table below showing that buildings are depreciated over 40 years. I’d also note that Canlan’s gross amount of “Buildings” is $117M and it is recognizing depreciation on buildings of $3.8M which implies a life of 31 years ($117M divide by $3.8M). Based on this, I do not think Canlan is depreciating the buildings too quickly; 30 to 40 years seems like a reasonable estimate of a useful life.

The 6.5% pre-tax return on capital that Canlan earns is indicative of a lack of competitive advantage. There must be something else going on outside of the scale advantages I listed earlier. My view is that it is hard to earn good returns on capital when your competition is publicly subsidized non-profit organizations. Many hockey and other leagues are structured as non-profits. They also get access to government-owned facilities like community centers at a good price. When you own your rinks, it is difficult to make good returns up against this sort of competition.

Step 4: Is the valuation attractive?

There are three metrics that I like to look like to get a quick sense of valuation: P/B, EV/EBITDA, P/E ratio.

For price to book, we already know shareholders’ equity is $43 million. We also need share price and shares outstanding. We can find number of shares outstanding of 13.3 million in note 7 of Canlan’s Q3/17 results (pg 11/18). Canlan’s share price from Google is $3.83. So price to book is ($3.83 * 13.3M) / $43M = 1.2x. As a rule of thumb, if a company trades above 1x P/B, this means that the company’s return on equity is greater than its cost of equity. If you want to know more, Google the search term “justified price to book”. It is odd that Canlan trades above 1x P/B given the poor return on capital it earns.

For EV/EBITDA, we already know net debt is $43M. We can add this to market cap of $51M (share price of $3.83 * shares outstanding of 13.3 million) to get to enterprise value of $94 million. We also know from the balance sheet section that last twelve months EBITDA is $12.6M. Putting the two together EV/EBITDA is 7.5x ($94 million / $12.6 million). In today’s market, you have high quality companies that trade high-teens to low-twenties EV/EBITDA (but note these companies would be earning a much higher return on capital in general which should mean you will pay a higher multiple of current earnings / cash flow).

For P/E, I estimate an adjusted LTM EPS of $0.25. I feel like I have already walked through enough calculations for one post; so I will pass on this one. Email me at qualitysmallcaps@gmail.com if you want more information. This gets us to a P/E ratio of 15x (share price of $3.83 / $0.25). Again relative to the overall market, this seems cheap. But I am do not have a sense if you would say Canlan is cheap relative to other companies that earn a similar low return on capital.

Summary

Management appears to be honest and experienced. Balance sheet is stretched, but within reason given the nature of the company. The return on capital is too low for me to consider Canlan an investment candidate. Valuation looks attractive without taking the low return on capital into account.

Where I could be wrong

It is interesting that the major shareholder of Canlan is a real estate company. It is possible they think there is a higher and better use for the land the arenas that Canlan owns are on. Bartrac is simply collecting a small coupon while they wait for a condo developer to come make them an offer they can’t refuse. This would require doing a whole lot more work on the neighbourhoods’ of the arenas and the developments around them. Not something I have much interest in doing at the current time.

The Company’s website: https://www.icesports.com/

Author Ownership: No TSX: ICE

Read Disclaimer:

This article is for informational purposes only. This article is based on the author’s independent analysis and judgment and does not guarantee the information’s accuracy or completeness. The information contained in this article is subject to change without notice, and the author assumes no responsibility to update the information contained in this article. The information contained within this article should not be construed as offering of investment advice. Those seeking direct investment advice, should consult a qualified, registered, investment professional. This is not a direct or implied solicitation to buy or sell securities. Readers are advised to conduct their own due diligence prior to considering buying or selling any stock.

Qualitysmallcaps.com is not engaged in an investor relations agreement with Canlan Ice Sports nor has it received any compensation from Canlan Ice Sports for the preparation or distribution of this article.

The author may trade shares of Canlan Ice Sports through open market transactions and for investment purposes only.

Mediagrif (TSX:MDF): Does MDF pass the investment checklist?

A problem all investors face is allocation of time. We all only have 24 hrs, even Warren Buffet. In order to help my readers, I have structured my write up on Mediagrif in terms of how I think about optimally allocating time. I do a quick initial view and then I dive into the most pressing issue.

Initial View

There are four attributes I look for in my initial view: 1) Capable management teams, 2) Strong balance sheets, 3) Profitable growth, and 4) An attractive valuation. These attributes are often in conflict with one another. For example, it is easy to find companies with strong balance sheets and profitable growth, but at unattractive valuations. The art of investing requires finding the best possible mix of these attributes. How does Mediagrif stack up?

  • Management team. The CEO of Mediagrif is Claude Roy. Roy’s interests are aligned with shareholders as he owns 24% of shares outstanding. Prior to Mediagrif, Roy founded Logibec, a healthcare IT company. Logibec was bought by OMERS in 2010 for ~C$230 million. Upon becoming CEO at Mediagrif, Roy moved quickly to restructure and align MDF’s cost structure with its revenue base (ie. he laid off a lot of people).
  • Balance sheet. At 30 Sept 2017, MDF had $35 million of debt and $12 million of cash for net debt of $23 million. LTM EBITDA is $25 million meaning MDF is just under 1x net debt to EBITDA. MDF’s debt is held in a revolver and has not been termed out.
  • Profitable growth. Top-line growth has been flattered by acquisitions. Organic growth has been negative for each of the past five years. MDF has very little in the way of tangible capital in the business. However, it does have ~$175 million of intangible assets from prior acquisitions. MDF’s return on capital looks weak when including the intangibles from acquisitions.
  • MDF’s share price is down nearly 50% over the past year. Over the past four years, MDF has averaged about $20 million of free cash flow per year. This represents a ~13% FCF yield on its current market cap of ~$150 million. Earnings per share over the last 12 month EPS has been $0.79 for a p/e ratio of 13x.
    1. It is worth noting that MDF acquired a company called Orckestra in June 2017. Orckestra is currently losing money at an annualized rate of roughly ~$3 million pre-taxes. The LTM EPS of $0.78 only has two months of Orckestra losses. It’s likely EPS would be close to $0.65 if we projected Orckestra losses over a full year (ie. a P/E ratio of 15x). However, MDF says Orckestra will make a positive contribution within the next fiscal year so this may not be necessary.

Summary: 1) CEO has a good track record and owns a bunch of shares, 2) Balance sheet is okay, 3) Growth profile and returns on capital are relatively weak, and 4) Valuation looks attractive.

Next Step in Analysis: Deeper Dive on Growth

As I said above, it is rare  impossible to find a company that perfectly meets all four criteria in today’s market. So is the weak growth a deal breaker? Not necessarily. The stock market often takes recent growth numbers and extrapolates them forward. One of my favorite set-ups is finding a company where the market has assumed that weak recent growth will persist indefinitely into the future. In this situation, if you can correctly forecast that the company will return to growth, you can earn a healthy return. Based on MDF’s valuation, the market definitely appears to be assuming weak growth will persist. So the next step in the analysis is to determine if we think MDF will be able to grow in the future.

Track Record

Some sense of historical track record is necessary in order to predict the past. I find it helpful to look at top-line growth on both an IFRS and organic basis. In this case, IFRS includes revenue growth from acquisitions. The weak organic growth rate is a cause for worry. In my view, gaining confidence that the weak organic growth can be reversed is the key factor in deciding whether or not to invest in MDF.

Growth on a regional basis tells a similar story. The majority of growth has come from Canada which is where the large acquisitions have took place (ie. jobBoom and LesPac). Revenue has been falling in Asia/Europe, which I think is likely due to some sort of structural headwind at the Broker Forum and Power Source Online businesses.

The Business Model

Before we can figure out whether or not Mediagrif can return to growth, we have to know what the business does. I find an easy shortcut is to compare the business in question with a business you already know. For Mediagrif, I think a helpful comparison is Google. We all know what Google does. Google is a website that helps people find information they are searching for. While Google is a ‘general’ search engine, Mediagrif is a collection of search engines focused on specific verticals. Mediagrif also owns a collection of businesses that are more one-off in nature and do not fall within the search engine “bucket”. Within the search engine bucket, there are consumer-focused search engines and B2B focused search engines (if you would like individual business descriptions, please see the appendix):

  • Consumer search engines: LesPAC, jobBoom, Reseau Contact.
  • B2B search engines: Bidnet, ePipeline, governmentbids.com, Merx, Construction bidboard, Global Wine & Spirits, The Broker Forum, Power Source Online, Polygon.
  • “Other businesses”: Market Velocity, Carrus, Intertrade, Orckestra.

The number of businesses MDF owns makes the analysis of growth complicated. Especially given that MDF does not disclose individual revenue numbers for each business. We have to decide what to prioritize. Based on purchase price as well as disclosure around how much revenue the acquisitions added in their initial year, I estimate that the non-search businesses represent about 25% of MDF’s revenue on a going forward run-rate (ie. including Orckestra). I estimate the ‘consumer’ search engine businesses (ie. LesPac, jobBoom and Reseau) represent about 30% of sales and the b2b search engines represent about 45% of sales.

The Revenue Model

Continuing with the Google analogy, we can look at how each of the businesses earn money. There is a striking difference in that nearly all of Google’s revenue comes from advertising whereas nearly all of MDF’s revenue comes from “rights of use”. Within rights of use, Mediagrif includes packages of classified ads on LesPAC and recruitment packages on jobBoom.

Competitive Advantage

Within most software and e-commerce businesses, competitive advantage derives from network effects. Put simply, network effects mean the value of a product or service to a user goes up as more people use the product / service.

Google benefitted from network effects as they allowed Google to refine its search algorithm quicker than anyone else. The more people who use Google, the more information Google collects to make its search service even better. For example, if you search for “Dog Food” and the first site that pops up is pictures of dogs eating food, you will likely a) not click on it, or b) click on it then immediately bounce off of the site. Either way, Google gets valuable data to know that site of dogs eating food should not show up as the first rank when someone searches Dog food. Multiply this by the millions (billions?) of searches on Google each day, and you have a very valuable network effect.

Network effects in Mediagrif’s case are even more straightforward. For jobBoom, if there more jobs available that fit my skills, the site has higher value to me. For Bidnet, if there are more contracts displayed in my area that I should bid on, the higher the value of the site to me. And so on…

But the point here is not to define a network effect, but rather how you should act when you are in a business that is impacted by network effects. When a network effect is in play, the goal should be to build scale as quickly as possible. Once you have built scale, you go about figuring out a way to monetize it.

Mediagrif appears to have took the opposite approach with its businesses. Rather than build scale by offering an unbeatable user proposition, the company appears to charge heavily in hopes that the user base is sticky and will only churn slowly.

One example is LesPAC. LesPAC did not offer free posting of classified ads until March of 2017. This seems crazy given that Kijiji has been offering free classified ads since 2005. Not to even mention craigslist.org…

Another example is jobBoom. jobBoom revenues decreased by $0.7 milllion in FY17 due to price adjustments reflecting “market conditions.” Contrast this to indeed.com (owned by Recruit Holdings in Japan) who grew revenues by 62% in their most recent fiscal year. The key difference is that employers can post jobs for free on indeed. In fact, indeed even crawls websites to find jobs that are not voluntarily posted by employers. Indeed only makes money from employers who choose to pay to increase the visibility of their specific job postings.

Another big group of businesses owned by Mediagrif are the e-tendering businesses that help contractors find jobs to bid on. I would put Bidnet, ePipeline, governmentbids.com, Merx, and Construction Bidboard all in this bucket. Merx is a Canadian offering while the other offerings are focused on the USA. The American offerings have different tiers of service with governmentbids.com being the cheapest. A core component of these sites is an automated web-crawler that scans the websites of local, state and federal governments to find new bids or RFPs that have been released. The higher end offerings combine this with human research related to upcoming projects that have not yet been released (based on forecasts from aggregate budgets). The human researchers will also do things like find out who won similar jobs in the past and at what price to help optimize bidding strategies for their clients.

The automated web-crawler side of the business benefits from network effects similar to Google. The more contractors who use the service, the more data MDF gets to fine tune the web-crawler and make it the best one out there. The human side of the business benefits from scale. It is expensive to field a team of researchers. If you have scale, you can spread the cost of researchers over more users. This makes cost per user lower (or you can hire more researchers and keep cost per user the same but provide a better product). Within Canada, Merx is the largest provider and benefits from scale. However, in the United States, MDF is dwarfed by Deltek/Govwin/Onvia (all of which are owned by Roper). Since Roper is much larger and has more users, it can afford to employ more researchers and provide a better product at the same or lower cost than Mediagrif. There is also another well funded competitor in the space, Bloomberg Government. Not to mention a start-up with venture funding (ie. no need to make money immediately) – govini.com.

So I stopped…

As I mentioned at the start of this post, my strategy to optimize time is to do an initial view and then dig into the most pressing issue. In MDF’s case, the most pressing issue was their growth profile. The work above leads me to believe that MDF does not have any strong competitive advantages in a large portion of their businesses. Without confidence in their competitive advantage, it is difficult to make the forecast that MDF will return to growth. Without a return to growth, it is possible the stock could stay at a cheap/attractive valuation for an extended period of time.

Where I could be wrong

There are a few ways I could be wrong. One way is that the consumer businesses in Quebec could benefit from Quebec being a unique market from a cultural perspective. Mediagrif only needs to be the best in Quebec and does not need to worry about global competitors. My point would be that people in Quebec still use Google and ultimately the best site with the largest network effects will win, but I could be wrong… Another point could be that Mediagrif does not need to grow organically. They generate so much cash that they just need to keep a constant flow of new acquisitions and they will be okay. This business model is not for me personally. It feels unsustainable and a bit too much like Valeant. You also have to ask what type of talent they can attract to the company with this model… Last you could argue what is all this stuff about Google and network effects? Most of MDF’s businesses are much more like eBay as they resemble marketplaces. eBay does not make money on advertising; eBay makes money on their take rate based off of gross merchandise value. My response would be who has been more successful – eBay or Google?

Where else could I be wrong?

Appendix 1: Business Descriptions

Consumer “Search Engine” businesses:

  • LesPAC: a search engine specializing in helping users find pre-owned goods and local services (ie. classified ads)
  • jobBoom: a search engine specializing in helping users find job postings
  • Reseau Contact: a search engine specializing in helping users find other users looking for relationships

B2B “Search Engine” businesses:

  • Bidnet, ePipeline, governmentbids.com, Merx, Construction bidboard: search engines that specialize in helping contractors find relevant jobs to bid for. They also have software solutions for the buyer to streamline the bidding process. The different search engines above focus on different tiers of service (ie. price points) and geographies.
  • Global Wine & Spirits: a search engine helping buyers of wine and spirits find sellers of wine and spirits
  • The Broker Forum: a search engine for distributors and brokers to find other brokers and distributors selling electrical components. Also provides escrow and parts inspection.
  • Power source on-line: a search engine for dealers, resellers and brokers find other dealers, resellers and brokers selling IT and telecom parts. Has a supplier certification program.
  • Polygon: a search engine for buyers (retailers, suppliers, etc.) of gems and jewelry to find sellers.

Other “Search Engine” businesses:

  • Market Velocity: Market Velocity helps electronics manufacturers streamline their aftermarket support to customers by providing trade-in, recycling, and donation solutions.
  • Carrus: Carrus provides software to help auto mechanics and aftermarket parts distributors manage their businesses.
  • Intertrade: Intertrade helps retailers and their suppliers automate the ordering, fulfillment and billing process so that it can occur with minimum human intervention.
  • Advanced Software Concepts: ASC is a software tool to help businesses quickly and efficiently prepare and manage contracts such as RFQs (request for quotes).
  • Orckestra: Orckestra has a software solution to help retailers integrate their brick and mortar and digital solutions.

The Company’s website: http://www.mediagrif.com

Author Ownership: No TSX: MDF

Read Disclaimer:

This article is for informational purposes only. This article is based on the author’s independent analysis and judgment and does not guarantee the information’s accuracy or completeness. The information contained in this article is subject to change without notice, and the author assumes no responsibility to update the information contained in this article. The information contained within this article should not be construed as offering of investment advice. Those seeking direct investment advice, should consult a qualified, registered, investment professional. This is not a direct or implied solicitation to buy or sell securities. Readers are advised to conduct their own due diligence prior to considering buying or selling any stock.

Qualitysmallcaps.com is not engaged in an investor relations agreement with Mediagrif Interactive Technologies nor has it received any compensation from Mediagrif Interactive Technologies for the preparation or distribution of this article.

The author may trade shares of Mediagrif Interactive Technologies through open market transactions and for investment purposes only.