Westwind says: look again at the dealers
In light of the ongoing sucess of common share offerings, and great results out of Lehman Bros. last night (beat the street by 18%), it probably makes sense that Westwind Partners’ equity research analyst John Grandy is upgrading both Canaccord and GMP this morning. Nice time to be covering small caps as an investment banker, probably better than being a small cap TSX-listed CEO.
Reminds me of the line the Hon. Harve Andre, a former senior federal P.C. Cabinet Minister, used when he entered the home of one of Canada’s best public policy advisors, Harry Near of Earnscliffe Strategy Group, for a cocktail party in the late 1980s: “Why is it better to know Harvey Andre than to be Harve Andre?”
Must be a super time if you’re a great investment banker who knows more than a handful of pre-IPO CEOs. Here is a summary of Mr. Grandy’s research:
“Time to Get Back into Canaccord
The risk to reward for Canaccord has improved over the past two weeks. The share price has depreciated by 18.5% since we initiated our HOLD rating; meanwhile, we have become more confident in our fiscal Q1/08 estimate of $0.54. Investment banking in Canada and the U.K. have been strong for the quarter so far. We are raising our rating from HOLD to BUY.
Canaccord’s share price has depreciated by 18.5% since we initiated a rating of HOLD following a transfer of coverage on May 16, 2007. It has come to the point where we see the sell-off as overdone, and now view the risk to reward profile as suitable to increase our rating to BUY. Since May 16, we have only become more confident in our outlook for Canaccord, particularly in our forecast for the current fiscal first quarter (Q1/F08, ending June 30).
We have seen a pick-up in the amount of financings on the AIM market, which is of key importance to Canaccord for April and May compared with the first quarter of this year. During April and May, ten deals were completed worth a total of $515 MM, comparing favourably with Q4/07 in which six deals closed worth a total of $299 MM. We are looking for $29 MM in revenue from the U.K. division in Q1/F08; if anything, our estimate may be low. Investment banking business in Canada is also strong and leaves us comfortable with our estimate of $60 MM in revenue from this segment in Q1/F08. To date this quarter, Canaccord has completed 97 deals compared with 129 deals last quarter. Lastly, the firm’s market share of block trading for the second quarter to date has been 5.5% — in line with our estimate for the full quarter. These three key metrics result in us being comfortable in our estimates for revenue of $216.0 MM and $0.54 in EPS.
The valuation for Canaccord is now more attractive, trading at a price to earnings ratio of 10.6x our 2007 calendar estimate; meanwhile, its North American peers trade at an average of 13.5x and GMP Capital Trust at 14.7x (after we apply a 35% tax rate). With a total potential return of 27.7%, we are upgrading our rating for Canaccord Capital from a HOLD to a BUY with a $26.00 target price. We recommend that investors in GMP Capital Trust now consider switching into Canaccord stock.
Limited Upside From Here Unless Markets Surprise Us
GMP Capital Trust (GMP:TSX) has proven itself to be a superb creator of value to its shareholders. Since its IPO on December 9, 2003, the company has delivered a compound annual return of 51%. The company has a well-established track record for producing an exceptional return on equity consistently. However, the company is heavily levered to the overall health of the Canadian stock market.
Efforts at diversification into wealth management and private equity management are in their early stages, and will not be able to offset a potential decline in the core business. We consider GMP to be fully valued today; therefore we are reinitiating coverage with a HOLD [upgraded from a SELL].
We have increased our valuation on GMP, mainly due to stronger then expected Canadian capital markets. However, we still consider GMP to be fully valued based on our expectations that:
– Over time, GMP’s market share will be trimmed back from the current 12%–13% level to 10%, which history has shown to be the highest sustainable market share for a Canadian stockbroker;
– Trading commissions will remain on a long-term downward trend;
-Equity underwriting in Canada will experience some softness this year and in 2008, relative to a robust market in 2006;
– The M&A practice will continue to successful development, although with volatile revenue;
– The wealth management business and EdgeStone will continue to grow, but remain a small part of the overall business;
– GMP will convert back into a fully taxable Canadian corporation in 2011 and will resume paying taxes at a 35% effective rate.
We have introduced a DCF methodology, which we base our $22.00 target price upon. Additionally, using the price to earnings ratio as a secondary measure, the implied ratio based on our target price is 14.1x (using on a 35% tax rate on 2007 earnings), which is slightly higher than its North American peers at 13.5x.
GMP remains highly levered to the Canadian capital markets. We believe that while these markets will remain strong, they are also at their peak; we do not expect further significant growth. Therefore, we do not see a large potential upside in the unit price. Catalysts that could lead us to change our view are: successful development of the U.K. business, rapid growth in the wealth management business, and potential acquisitions that could lead to synergies. In the meantime, we rate GMP Capital as a HOLD with a $22.00 target price. We recommend that GMP unitholders now consider switching into Canaccord Capital (CCI-T: BUY, $26.00 target).”
Mr. Grandy didn’t discuss the wisdom of Canaccord basing their Canadian software and services analyst in California, but perhaps that was part of the attraction for him in the name.
The brand “torque” that comes from merely as a result of an independent investment bank going public can’t be underestimated. Perhaps Cormark Securities and Orion Securities, to name but two viable candidates, should reconsider the strategy of the private route?