Can you have too much “Cancon” in your TSX IPO?

Mark McQueen

As Bay Street investment bankers closed the books on the Real Matters IPO roadshow, it was clear that many good decisions were made along the way.  How else can one summarize a deal that was reportedly “seven times oversubscribed?”

Depending on how you take the recent Globe and Mail coverage, some might be fretting that the “demand [for the Real Matters offering] was overwhelmingly Canadian.”  As the story goes, unlike Kinaxis (another TSX-only IPO), 85% of the institutional interest in the Real Matters order book came from “conservative” Canadian investors.  Kinaxis (KXS:TSX) sold half of its deal to U.S. buyers, we are told (likely by someone in that particular syndicate), after hitting far more cities than merely Boston and New York on that 2014 IPO roadshow.  Apparently, the overwhelming Canadian institutional interest in Real Matters might somehow be a bad thing.

I think it’s the opposite.

When a deal is hot, allocations are usually done based upon which institutional investors are most important to the trading desks of the IPO’s lead underwriters.  Given the massive daily trading volumes of hedge funds, they get the first pick of any sought-after offering, even if these firms never saw the roadshow presentation.

By avoiding the traditional error of placing IPO stock into the hands of U.S. hedge funds, for example, Real Matters is doing its best to limit the likelihood that a huge amount of its offering will be flipped on the morning of its first trading day.  For more than 15 years, 30-40% of the daily trade on the TSX is undertaken by U.S.-based institutional investors.  Our local market is well-known for trading a plethora of resource shares, for example, and folks have made lots of money over the years on a host of high quality, publicly-traded tech co’s.  And yet, most Canadian-based companies aren’t widely-held by U.S. institutions.

And there’s a good reason for that: whether we like it or not, the vast majority of Canadian public securities are micro-caps in the eyes of U.S. investors.  A U.S. investor already has 18,622 locally-listed small cap names to choose from (of which 310 companies have a larger market cap than Real Matters).  That’s ignoring the 1,947 midcaps and 592 large caps (>US$9.5B market cap) — all of which are substantially larger from a market cap perspective; with more liquidity.

It’s been ever thus.

More than 20 years ago, Open Text (OTC:TSX) did a NASDAQ-only IPO, against the advice of local i-banking firms.  When the research coverage and trading attention failed to materialize, the company listed on the TSX two years later when then-CEO Tom Jenkins discovered just how small a fish the company was in the big U.S. pond.  To this day, critical mass still matters.  That’s one of the things that likely attracted Canadian investors to Jason Smith’s latest offering: a billion dollar valuation is actually not small cap land in Canada, and the positive EBITDA profile matters to those investors that liked the Real Matters’ tech angle, but would otherwise worry about cash burn at the garden-variety innovation deal.

As compared to Real Matters, Kinaxis’ revenue was less than 25% of Real Matters’ at the time of its 2014 IPO, and KXS had negative shareholders’ equity as well.  Perhaps that’s why they needed a longer roadshow.  If Canadian institutions are truly more conservative, you can imagine why they piled into the Real Matters offering given the company’s critical mass and relatively stronger balance sheet.

I’m all for broad distribution, and a nine-dealer IPO syndicate was a smart move on the part of Real Matters Board of Directors.  The commission fee pie doesn’t change whether you engage five underwriters or nine.  Canadian syndicates are traditionally too small in my mind.  The U.S. market does a far better job of spreading the wealth; it makes for a more healthy ecosystem.

By focussing on its own bank clients (such as BMO, BoA and Wells Fargo) as well as a couple of independent dealers for its IPO syndicate, Real Matters kept true to its word to Bay Street over the past number of years.  More friends is better from the Issuer’s standpoint, with increased research coverage and more Institutional Sales Desks to follow the story over the coming quarters.

On the heels of a blow-out offering — how else would you describe a book that was 7x over-subscribed, with retail fills as small as 10%? — the mood will be good when the company starts trading later this week.  As for those who are whining to journalists about the Real Matters roadshow destination choices or the apparent lack of U.S. demand, you can safely assume those folks are i) either on the outside of the syndicate, looking in, or, ii) jealous that they didn’t break into the syndicate’s top line (along with BMO, Infor and Bank of America Merrill Lynch), and doing all they can to make management pay for the apparent slight.

Pay no attention to the inside baseball.  The company appears to have made all of the right choices.

MRM

(disclosure; our Wellington Financial Fund III owns equity securities in RM, and I personally bought some shares via the IPO)


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