If you were to sum up the media portrayal of the average tech company’s journey, it’d go something like this: two geeks in a garage create the new “thing” that everyone’s gonna want on their phones or in their homes. They relocate to an office, start scaling up and get bought by Google in a matter of weeks. Ta da!
The reality is a lot more slow-moving, of course, but as investors, it’s the plodders and grinders who often get overlooked, says David Barr, President and a Portfolio Manager at PenderFund Capital, who insists that the next quarter’s results aren’t always the best measure of a company’s success.
“Some people think building a technology business is easy,” says Barr, in conversation with Cantech Letter. “To us, success comes to companies that focus on engaging with their customers and building products and services that meet their needs, the ones with the perseverance to see it through — because it can take years.”
Ottawa-based Espial Group (TSE:ESP) is a case in point. The TV software solutions provider has been building software for telecom and cable companies for a decade, but with their new SaaS platform Elevate, they now look to be hitting their inflection point.
“The cable industry is facing massive disruption from over-the-top (OTT) providers,” says Barr. “Incumbents are struggling to stay ahead and are highly motivated to find a solution to reduce churn and compete with the OTT providers. Espial has been a leader in the space and has won two big contracts in Europe.”
“With Elevate, they’ve found the product the market has been waiting for,” Barr says. “They’ve also partnered with Netflix and made it really easy for small operators to offer Netflix services to their subscribers, which is a huge benefit to small operators that typically do not have access to Netflix.”
Barr notes Espial’s strong balance sheet with no debt and $38 million in cash ($1.06/share), with expectations of being cash flow positive in the second half of 2018. “We view the stock favourably as there is limited downside risk with the cash buffer,” he says. “With the success of SaaS offerings, we believe the company is going to do well in 2018.”
Photon Control (TSXV:PHO) was founded way back in 1988 and has had a number of ups and downs since (including legal disputes during the past couple of years over a non-arms length R&D contract). But Barr says that management and board reshuffles and multiple growth opportunities for the precision measurement company have put Photon Control in a great position to execute.
“The company underwent a transition last year, upgrading governance and internalizing the company’s core IP and R&D team,” says Barr. “This coincides with what we see in the semiconductor industry as a change from a high cyclical consumer product driven industry to a secular growth industry driven by the massive adoption of the IoT.”
Barr points to three growth opportunities, in particular: a robust semiconductor capex cycle that should continue to fuel the majority of the company’s growth; a large runway to grow within its existing semiconductor client base by selling other sensors into the array of manufacturing processes; and, although currently on the back burner, Photon also has greenfield opportunities in other markets to pursue, such as selling optical flow meters to the oil and gas sector.
“The company has $25 million-plus cash on the balance sheet and produces over $7.5 million in cash flow from operations per year,” says Barr. “Given our confidence in the new management team, this cash stock pile will be used prudently for growth and provides the company ample downside protection if the semiconductor cycle were to abruptly change.”
Last but not least is data centre and cloud infrastructure company TeraGo Inc. (TSE:GO), which, like Photon Control, has seen its stock price rise sharply over the past month. Barr says that although the connectivity business has been in decline recently, TeraGo management has taken steps to stabilize the business and leverage their existing 4,000-strong customer base.
“The company has data centres across the country, currently with very low utilization rates of about 40%,” Barr says. “This is both attractive from a growth perspective, as incremental revenue is very high margin, but also makes them very attractive to a strategic buyer. They also own spectrum in Canada. Similar assets have recently been sold in the US for a significant premium. In the tussle for spectrum in Canada, this dramatically increases the value of TeraGo to strategic buyers.”
“Recently, TeraGo’s trading volume has spiked – roughly 20% of shares issued have been traded,” says Barr. “We believe there might be some strategic transactions incubating. Shaw would an ideal acquirer given TeraGo’s national presence. Historically, data centres are acquired at an average of 4x revenue and 13x EBITDA. TeraGo’s valuation looks attractive.”