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Canada has long been known for its natural-resource stocks. But in recent years, breakthroughs in Internet technology have replaced prospects for gold as sources of the hottest tips coming out of the Canadian marketplace. Nonetheless, high-flying technology stocks are still relatively exotic bets for many of the traditionally conservative investors in Canadian markets, and the pool of capital in Canada just isn't big enough for companies with global aspirations.
For many Canadian Net companies, going south is the only way they can get the capital and recognition they need to emerge as market leaders. For American investors, many of these unheralded companies represent an opportunity for a bargain -- but only until they hit the U.S. market. Even many of the big Canadian brokerages are just beginning to assign analysts to follow the fast-growing Internet sector full-time.
Yorkton Securities Inc. is one of the few Canadian brokerages that has focused on Internet stocks that have been emerging in Canada. Business Week Online's Hugh Filman recently spoke to Mark Maybank, until last week Yorkton's senior analyst covering software, the Internet, and e-commerce.
Maybank has left Yorkton to become executive vice-president at itemus Inc., a company that will concentrate on incubating new Canadian technology companies. He says that while U.S. investors are beginning to tap the Internet and technology resources coming out of Canada, there's still room for savvy American market players looking to find good stock picks. Here are edited excerpts from their conversation:
Q: How are Canadian Internet stocks doing on the whole?
A: On the whole, there's a lot of good Canadian companies that list in the U.S., and some that go straight to the U.S. Part of that is, there's a gap in the Canadian financial and social fabric to retain those businesses. There are larger pools of liquidity in the U.S., with better exchange and regulatory environments. One obvious one would be Delano Technology (DTEC-Nasdaq), a Canadian-based company that went straight to Nasdaq.
Q: Are there Canadian companies that are not reaching their potential because they're not in the U.S. or because Americans really don't know them?
A: I would say there's definitely an awareness issue. There are some Canadian Internet companies, like Chapters Online (COL-Toronto Stock Exchange), which is a spin-off from Chapters [bookstores]. They're
trying to be the Amazon of Canada. They've done a lot of things that are great, but all their presence is in Canada. So they're an example of a company that will have difficulty going to the U.S. because 100% of their
revenues are Canadian-based, and U.S. investors will look at it and say, "There's no U.S. angle here -- where's the world-class potential?" It could be a phenomenally well-run business, but it has limited geographical
expansion capabilities.
Another example of that would be Versus Technologies (V-TSE). They have the E*Trade Canada franchise and also have a large institutional electronic-trading network. Again, Canada focus and Canadian-based revenues. It's tough to break into the U.S. market due to regulatory issues and critical-mass issues. So there's another company that will tend to remain more Canadian than others.
Q: What are some of the other Canadian stocks that have potential in the U.S.?
A: You can take a look at some of Canada's core competencies. One is Internet or technology security: how to authenticate the user, encrypt the data, and provide a secure environment for online information exchange and transaction processing. Canada has been blessed, because U.S. encryption-export restrictions [have helped] in creating a number of world-class companies, such as Certicom (CIC-TSE), Diversinet
(DVNT-Nasdaq), and Entrust (Technologies, ENTU-Nasdaq) -- all Canadian-based companies, all operating in the security space. Those companies are reasonably hot but also have tremendous market opportunities in front of them, particularly in the burgeoning wireless space.
Another company, called BCE Emergis (IMF-TSE), is in the process of doing a large U.S. awareness campaign and financing and listing on Nasdaq. Emergis has benefited already from the increased profile of just initiating that phase. Another company, Mortice Kern Systems (MKX-TSE), has world-class technology that's receiving very little attention in Canada and the U.S., but their Web content-management product is world-class.
Q: Are these stocks and others stocks like them undervalued compared with what American companies are doing in the U.S. markets?
A: I would say that they are definitely undervalued relative to their U.S. peers. And again, it comes down to less liquidity in the Canadian marketplace and no attention from an international standpoint. As Certicom has rolled into the U.S. and expanded their U.S. awareness and presence, their share price has risen in the last 15 months from about C$10 to C$200.
Q: Are there other hot Internet stocks that are coming out of Canada?
A: Canada has a lot of great competencies in the network and network-enabling space, some great wireless technologies. Research in Motion (RIM-TSE) is a Canadian company that is slightly less Internet and more wireless. There are some great core competencies in the financial-services space: 724 Solutions (SVN-TSE), which does wireless financial-services
applications, being a brilliant example of that. The Canadian banking system is dominated by five big banks that have huge international reach and very large economies of scale and, as such, provide great incubation and validation vehicles for the technologies. So there's a kind of speed-to-market
that Canada has in the financial-services space.
Also coming out of Canada, you see great insights from a development side and from a Web integration-services standpoint. And you see an increasingly large amount of deal flow from the U.S. being channeled into Canada because of the quality of the talent and the price differential. You can basically get dollar-for-dollar equivalents with a 45% exchange rate [US$1 to C$1.45], so
you can get a significant cost reduction by outsourcing or relocating some of your R&D or development efforts in Canada.
Q: It seems like a lot of the companies you're talking about basically have an edge in technology and market potential. That's it?
A: There needs to be strong competitive positioning. In an investment, they don't necessarily have to be No. 1 in a space. They could be a close No. 2. A close No. 2 is not a bad spot to be in, because you can learn from the mistakes of the leader. And when they stumble, you can catapult past them.
Q: Are any of the companies we're talking about close seconds?
A: Certicom would fall in as a close second. They obviously trail behind RSA and VeriSign in the security space -- but not by that much. And they have some proprietary technology that is going to give them an edge in some new markets, like the PDA market and the wireless market.
Q: Is there a concern that a company with a bigger name and a U.S. address will emulate some of these technologies and just take over the market?
A: In a number of cases, the valuation gap between U.S. companies and Canadian companies is justified. That's because Canadians have been historically good at coming up with good ideas and engineering good technologies, but they have not been very proficient at marketing, business
development, and building strategic partnerships and alliances. Nor have they been great from a financial-engineering standpoint.
It comes down to: Can they compete on a global basis? Do they have the same market potential? Do they have a strong and capable management team? And do they have strong competitive positioning -- No. 1 or No. 2? If the answer is yes, then often Canadian companies can be a better investment, particularly
before U.S. awareness comes in, because the stocks typically receive a tremendous valuation then.
Copyright 2000, by The McGraw-Hill Companies Inc. All rights reserved.
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