Nortel is toast. So Now What?

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Welcome to the first ever Cantech Roundtable . The Cantech Roundtable is an ongoing series of discussions on technology and the public markets in Canada. Each roundtable will feature industry experts responding to a topic question. The discussion is then moderated by Cantech Letter’s Nick Waddell. Our first three panel members are Adam Adamou of Caseridge Capital, Andrew Wahl of Canadian Business Magazine and Leslie Klein of C-Com Satellite.


Nick Waddell:

“With the delisting of Nortel, there are now only a handful of tech companies in Canada more than one billion dollars in annual sales, Why do you think this is the case and what can be done to improve this

number?

Adam Adamou:

Thank-you for inviting me into this discussion Nick. Excellent topic with a great cast of contributors. My initial reaction to the question is… so what? I ran a quick search of companies across all sectors in Canada and there were 190 that were listed as having their headquarters in Canada and with revenues over a billion dollars (the actual number is actually lower since that number includes both parents and subsidiaries in some cases).

Adam Adamou: To me, the bigger issue is really the fact that most large Canadian  "technology" companies (excluding the best Canadian based company in the world, Research In Motion) are operating in areas in which there are foreign ownership restrictions."

Adam Adamou: To me, the bigger issue is really the fact that most large Canadian "technology" companies (excluding the best Canadian based company in the world, Research In Motion) are operating in areas in which there are foreign ownership restrictions."

Of this total, about 7% were in the technology-telecommunications-healthcare spaces. This number is obviously low, but given the fact that “technology” companies operate at much higher margins, revenues are not a great basis of comparison – high revenue low margin commodities, consumer retail and distribution companies are more likely to achieve greater revenues than are software companies, for example.

To me, the bigger issue is really the fact that most large Canadian
“technology” companies (excluding the best Canadian based company in the world, Research In Motion) are operating in areas in which there are foreign ownership restrictions (Rogers, BCE, Telus) or are in sectors in which there is government procurement benefits (Bombardier, MDS, etcetera).

Andrew Wahl:

For arguments’ sake, here is how Canadian Business defines “Canadian tech” for its Tech 100 list (www.canadianbusiness.com/tech100):

> * headquartered in Canada

> * conducts own meaningful advanced technology R&D

> * develops advanced hardware or software technology of its own for an end market

> * provides advanced IT services or manufactures advanced IT products

> * business model rests on a value proposition of in-house advanced

> technological knowledge and ingenuity

But to Adam’s point, he’s right that getting a billion in annual sales means a Canadian company generally needs some form of protected status‹ monopoly, strategic importance combined with government procurement (see aerospace), foreign ownership restrictions. RIM really is an exceptional situation.

I think that’s lead to the Canadian capital markets generally perceiving the relatively unprotected tech plays as being too risky, or at least viewed with more skepticism, particularly in comparison to the more familiar resource investment opportunities. And without a lot of money flowing in to Canadian tech companies to fund their growth, they are more vulnerable to takeovers (see ATI, Cognos, more recently Tundra Semi). From my conversations with tech companies, it seems to happen at all levels, right down to seed-stage companies.

I would be interested in hearing what others have to say about what, if anything, has to change to encourage more capital, domestic or foreign, to flow into tech. But I do wonder if Canada, given its size, really should expect to have more billion-dollar tech companies. A larger cadre of strong tech companies with $500 million in annual revenue might be a better target. As it is we have just 23 companies with more than $100 million in annual sales, according to our Tech 100.

Leslie Klein:

I agree with Andrew on this one, I am not sure what the significance of having billion dollar plus companies around is. Most companies that populate the world and produce the majority of GDP are small ones like ours.

Adam Adamou:

Just to circle back for a minute, we’re on the same page Andrew. My definition of “technology” focuses on more or less the same sectors but with a screen based on “gross margins” rather than an identifiable research and development program. In my opinion, maintaining gross margins in excess of 40% as revenues approach $500MM – or even as they begin to exceed $100MM, implies that there is something proprietary in the product or technology that cannot be replicated or duplicated elsewhere. Interestingly, by this definition there are only six companies in Canada with revenues exceeding $1BB that would qualify, Rogers, BCE, Telus, RIM, Bell Aliant and Nortel. Which
of those is not like the others…?

Nick Waddell:

Andrew, in your  Canadian Business Blog article of June 22nd you mentioned you attended an invitation-only event in Ottawa, hosted by Industry Minister Tony Clement, which examined the future of the country’s so-called digital economy. One thing that was discussed at the day long conference was “Canada’s global competitiveness and productivity, and the role technology plays in improving both…” Do you feel it is very important to the overall Canadian economy that tech becomes more of a factor or is it OK to simply have an economy that is based largely on natural resources?

Andrew Wahl:

There were a couple of interrelated agendas at that digital economy conference. The high-tech industry (see ITAC, CATA) argues that in order to close Canada’s productivity gap, Canadian businesses need to use IT more, which a number of studies have identified as a problem for the country’s overall competitiveness. So one of the topics of this conference was how to incent greater adoption of IT by Canadian businesses, with the underlying intention that this would help Canadian tech companies. I don’t completely buy that implied connection. But that’s a question of tech consumption, and the more pressing concern is the production of high-tech in Canada.

Andrew Wahl: Every world economy wants to move up the value chain from being an exporter of raw resources and net importer of goods. I don't think it's a question whether it is important that technology becomes more of a factor in the Canadian economy, but how to help make that happen.

Andrew Wahl: Every world economy wants to move up the value chain from being an exporter of raw resources and net importer of goods. I don't think it's a question whether it is important that technology becomes more of a factor in the Canadian economy, but how to help make that happen.

I doubt you would find many to disagree that Canada needs a strong, vibrant technology industry for the future economic prosperity of the country. Natural resources won’t last forever, and those industries need close access to technology to improve their own businesses, and tech companies employ well-educated, high-earning people that keep the economy rolling while being less vulnerable to swings in the economic cycle.

Every world economy wants to move up the value chain from being an exporter of raw resources and net importer of goods.I don’t think it’s a question whether it is important that technology becomes more of a factor in the Canadian economy, but how to help make that happen. And in my research and writing, I don’t see a shortage of smart people or good ideas, but I do see a cultural gap with the U.S. in regards to entrepreneurship, and a lack of risk capital at all levels to support the creation and sustainability of tech businesses.

Leslie Klein:

I do agree with Andrew about lack of entrepreneurship in Canada as compared to the US. We tend to be very conservative and when it comes to investing in technology there is a fear of losing. Some of it may be justified based on some fiascos ala Nortel and JDU, but nothing ventured nothing gained, in my opinion. I also think that we are seeing a generation of young people who are not nearly as driven as their parents were and they seem to be expecting a lot without working for it. This also has a huge dampening effect on trying to find enterprising risk takers who will work hard and are prepared to take a chance. Most of them want guaranteed salaries, as little work a possible (good forbid working after 5PM or on weekends) and are not prepared to take risks. This is not how you build new companies and develop new technologies.

Adam Adamou:

I think that there is a tendency in Canada to assume that the Canadian market for technology or more broadly for “high-margin” companies is the same as it is in the United States and that we need to encourage, promote and incentivize Canadians to create a mini-US here. I don’t accept that. Canada is significantly different from the United States in our technology and growth company sectors, and US solutions will not succeed here.

Having said that, we first need to identify if there is, in fact, a problem. I just ran a quick search on Companies with more than $100MM in revenue in the sectors generally considered to be the high tech sectors (Aerospace and Defense, Electrical Equipment, Research, Development, and Testing Services, Healthcare, Information Technology or Telecommunication Services to compare Canada vs. the US.

In the US, there are 20,330 US listed companies, of which 492 are in the sectors identified above, have revenues of $100MM or more, and gross margins of more than 40%. That’s approximately 2.4% of the total number. In Canada there are 641 Canadian listed companies, of which 20 are in the sectors identified above, have revenues of $100MM or more and gross margins of more than 40%. That’s 3.1% of the total – by this metric Canada is outperforming the US, and I’ve only included companies that are listed on the TSX in the Canadian total!

I think that we need to be realistic about the performance of the Canadian high margin sectors. They’re doing quite well. In my opinion, from a policy perspective the focus should be on opening international markets through free trade, reducing the tax burden on all companies, allowing for more competition in the regulated sectors (which would reduce the “made in Canada” tax on small business), and to create a sector neutral investment environment by eliminating incentives that discriminate against high margin businesses, such as “flow-through” tax credits or resource and energy tax credits. Make it all even across the board and Canadians will do the rest.

Nick Waddell:

Those stats are a bit of a surprise to me, Adam. I think they would be a surprise to many of our readers….

Leslie Klein: I would be in favor of a flat 20% income tax and also a flat corporate tax. It would go a long way to make Canada one of the most desirable places to do business.

Leslie Klein: I would be in favor of a flat 20% income tax and also a flat corporate tax. It would go a long way to make Canada one of the most desirable places to do business.

Leslie Klein:

I would even go further and attract companies into Canada by offering them the opportunity to make money and do not pay any corporate tax for a number of years. The tax systems should also be looked at and I would be in favor of a flat 20% income tax and also a flat corporate tax. It would go a long way to make Canada one of the most desirable places to do business.

Adam Adamou:

Agreed. Let’s remember that we’re looking to attract people with talent and energy here away from other clusters, say Silicon Valley, that are already developed. Why would they come here… certainly not for the weather. They will come if they believe that they will have a competitive advantage, and for Canada that should begin with low tax rates and free trade. We live next to the largest market in the world – we have a tremendous advantage in terms of free trade, a similar culture and language and low transportation costs. Cut taxes to make us significantly more competitive in high margin sectors, and we will explode with talent and clusters of activity across the country. I don’t hold out a lot of hope of this happening unfortunately.

Andrew Wahl:

The idea to eliminate “flow-through” tax credits or resource and energy tax credits was something brought up at the digital economy conference. I think the tech industry wants the opportunity to prove itself on even ground, not be systemically considered insignificant. Government procurement is another bone of contention, because the rules favour large multinationals. This is good for Canadian taxpayer, bad for Canadian economy.

Nick Waddell:

Shifting gears a bit, let’s look at the time and places when Canadian tech has been really flying; in Ottawa in the 80′s and 90′s and in Kitchener-Waterloo in the early 2000′s. Is there something that regional governments were doing well to encourage this condition or was this just an accident? I am sure places like New Brunswick, which is trying to encourage techs investment, would be interested in…What causes these regional flare-ups of tech?

Adam Adamou:

Technology happens in clusters, it’s the nature of the sectors in that you need a critical mass of knowledge, capital and entrepreneurship to create a sustainable high margin business. Governments should focus on making their region attractive to these types of people through a strong education system and a low tax environment. If the people that drive the wealth creation process don’t want to live in your cities or provinces, government pork is only going to act as an incentive for other pigs.

Andrew Wahl:

Waterloo and Ottawa have been built on traditions of R&D and education. Waterloo in particular has a strong intellectual property policy that supports academics also building businesses, but the success of that region goes back to the 1980s. Ottawa has had a pool of smart researchers through NRC, Bell-Northern Research, etc. This stuff doesn’t happen overnight. Strong education, healthy cities, and low taxes will bring more companies and smart people here.

I’ve spoken to some people who think Canadian tech firms will be at risk of takeovers due to lower Canadian dollar and valuations, especially once the economy starts to turn. Are Canadian tech companies vulnerable? And if they do get bought out, wlll the proceeds flow back into regional innovation engines, or just dissipate?

Adam Adamou:

It seems like whether the Canadian dollar is high or low, we are paranoid about the resulting impact on the Canadian tech sector… I think that the purchase of Canadian companies does not hurt the Canadian high margin sectors… making money is never bad for an economy.

Andrew Wahl:

The question is who is making the money and what they do with it next? If some of the money goes to an entrepreneur who then reinvests his/her payout back into other tech firms, either as an angel or by becoming an entrepreneur again, sure, it’s all virtuous. But if it’s going back to institutional investors that would rather just invest in holes in the ground, then watching as scores of tech companies get bought is, in fact, bad for the economy the Canadian tech economy at least. At minimum it’s a loss of business savvy.

I think the tech bubble created a naiveté that investing in tech companies should pay off quickly. They actually take a long time to build, and most venture investors don’t have the patience, or the portfolios to support the longer time horizons. Canadian companies should not expect to live the Silicon Valley dream. And I think too many companies go public before they are ready. More companies need to stay private longer‹and then go public in the U.S. Canadian tech entrepreneurs and their early-stage backers are becoming more savvy to this, I hope.

Adam Adamou:

Andrew, I agree that the tech bubble did create a sense of instant gratification. What we’ve seen over the last ten years however are asset bubbles in the credit markets, real estate, commodities, and energy – and the money and talent have followed the dollars. Canada’s monetary policy is not equipped to address the creation of international asset inflation bubbles of this sort, and so we do what we can as investors, employees and entrepreneurs.

With respect to the public vs. private company issue, I respectfully disagree. In Canada, the venture market is the public equity markets. In Canada we have considerably lower listing and regulatory fees than in the US, and with the CPC programs and the newly implemented SPAC programs, the best route for a company to take in order to improve its chances of being successful in Canada is to access the public markets sooner, rather than later. This speaks to the point that I mentioned earlier about the Canadian and US markets being very different, and this is one of the primary differences. In fact, very few high margin companies in Canada have succeeded without going public early on in their development – including Research in Motion.

As tight as the access to capital is, it is very much easier to raise capital in Canada as a listed company than as a private company. Private equity companies in Canada are attempting to replicate the Silicon Valley venture model in Canada, and that model just doesn’t exist here. Unfortunately, government tax credits have also been focused on this “silicon valley” model that has compounded the problems for Canadian technology companies. As a result, US investors – both institutional, hedge fund and corporate, see through this and come in to buy these listed companies instead.

Leslie Klein:

I agree with Adam. C-COM would not exists today if we did not raise the $5 million it took us to develop the technology..The angel investors (I was one of them) would not have come up with this much money for a technology that was not in existence 12 years ago and it was science fiction at best at that time. Only a true visionary would have seen that what we advocated was possible and is selling today all over the world. Not going public would have not made this possible.

Andrew Wahl:

Adam, Leslie, Nick: do you think Canadian institutional investors have an appetite / knowledge for tech?

Leslie Klein:

In my opinion, no…

Adam Adamou:

I think that there’s a good base of knowledge in the institutional community, but since the so-called “tech bubble” popped, the level of competence in the Canadian financial community, from banking to investment banking, research, trading and portfolio management has declined. The money has been in the “resources”, and this has been accelerated through the presence of flow-through tax credits that have sucked the money dry from non-resource companies. To be blunt, it has been very, very easy to make a lot of money building, financing and selling start-up holes in the ground, regardless of whether there is actually anything in the hole itself. As a result, companies like Leslie’s have suffered from a relatively lower access to capital. Furthermore, as portfolio managers and hedge re-weighted their portfolios to the resource and energy sectors, they have set a much higher bar for technology companies than for unproven holes in the ground.

Sad, but true.

Leslie Klein:

This is also true that most people would take a flier on a hole in the ground rather than buy shares in a technology company like ours that is profitable, has been for 20 quarters, has no debt, has cash in the bank and exports 87% of the products it manufactures world wide. It is hard to convince people to look at us and the stock as a result of this languishes below what the book value of the company is.

Nick Waddell:

But Adam/Leslie are you optimistic that this will change for companies like C-Com Satellite? I mean we have had 6 or 7 years of resources, surely tech is due for another run soon, don’t you think?

Adam Adamou:

Well, I don’t try to time the market, and I don’t believe that things are due. I can only say that of the twenty companies that I identified earlier as being “technology” companies with revenues over $100MM and with gross margins in excess of 40%, the vast majority are undervalued by my calculation. Some will be acquired, others will grow. The bigger problem is really the fact that the Canadian dollar is highly correlated with commodity prices rather than the industrial, financial or technology sectors. We might really benefit from two currencies in Canada!

Leslie Klein:

Time will tell. I have been at this for many years and at least 12 years with C-COM, nine of which as a public company. It will be interesting to see what will it take to get us for example recognized as a well managed well run and profitable company that would translate this into higher share price..

Nick Waddell:

Last question. It seem like, despite the inherent road blocks, that most Canadian techs are not in bad shape, they aren’t saddled with a ton of debt, for instance. If you could wave a magic wand, what would be the one thing you would do to improve conditions for tech in Canada? Eliminate”flow-through” tax credits or resource tax credits? Lower taxes?

Leslie Klein:

Taxes are killing us all not only personally but also corporate wide. If you can offer a corporation a tax incentive, they would hire people (who would pay taxes) and they would be able to compete on a world scale as their overhead would be lower and there would also be more money left for everyone (including the government) to invest and drive the Canadian economy through the roof. Unfortunately this country is run by lawyers and not engineers/businessman who would not spend 10 minutes running the government as they would want to uproot what the lawyers have laid down and as a result they would be shot as those who are in power are short-sighted , hate change not to mention taking

risks and like it this way. Change is not in their vocabulary and taking risks is something fighter pilots do.

Adam Adamou:

I would wave my wand and double the market cap of every Canadian listed company with gross margins » 40%. To do that, I would do what Leslie suggested earlier, reduce corporate taxes dramatically, eliminate government programs that subsidize returns on investment, and institute a flat tax for personal income taxes across the board.

Andrew Wahl:

I’m tempted to write, “beats the hell out of me,” and go enjoy the sunshine. I don’t think it’s good policy to take away an incentive for one industry because it’s not fair to others — just give the other industries the same incentive. So a flow-through tax credit would be good. And lowering taxes (personal, corporate, you name it) is a default editorial stance at Canadian Business magazine. That’s an easy one.

For the long-term, things can be done to create a better breeding ground for tech, but it’s hard to see much happening in the short-term that suddenly turns the tide. Sustaining smaller and mid-sized public tech companies isn’t on the government agenda (heck, they didn’t even toss Nortel a lifeline), it’s an issue for public markets.

So, if I could wave my wand, I would make investors less risk averse, more willing to invest for longer time horizons, and feel guilty about supporting Earth-scarring natural resource industries. (And yes, that was glib.)

It’s been fun, and enlightening. Thanks for the opportunity, Nick.