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We undervalue our tech stocks – and pay the price

Gennum and RuggedCom the latest losses in Canada’s incredibly shrinking tech sector

From Tuesday's Globe and Mail

18:59 EST Monday, January 30, 2012

Canadian investors are losing their technology stocks one by one, and they have only themselves to blame.

In the past eight days, two more TSX-listed technology companies have been picked off by acquirers. Gennum Corp. and RuggedCom Inc. have both agreed to be sold in friendly deals. When the sales close, two of the top 20 tech stocks in Canada by market capitalization will vanish.

The striking part of each deal is the premium. Siemens AG is paying a 142-per-cent markup to where RuggedCom was trading before it was put into play. Semtech Corp. is paying 125 per cent more than where Gennum was trading.

That means that industry buyers are seeing a lot more value in Canadian tech stocks such as RuggedCom and Gennum than are Canadian investors. It’s not a new phenomenon.

Microsemi Corp. last year agreed to pay a 67-per-cent premium for Zarlink Semiconductor Inc. In 2009, Integrated Device Technology Inc. paid almost double the market price for Tundra Semiconductor Corp.

There’s always a control premium in any acquisition. But prices this far above the market price suggest investors are not even close to pinning the right value on these tech companies, and buyers are swooping in to take advantage. To give some idea of how undervalued these companies are by the market, the average markup on acquisitions of Canadian targets in all industries over the past 12 months was 36 per cent.

RuggedCom wasn’t looking for a buyer when it got the initial hostile offer from Belden Inc. that started the sale process that eventually resulted in the deal with Siemens. But RuggedCom was coming off a few rough months that had sent its stock down from the $20 range to the $15 range. Belden pounced, offering $22 a share. Belden saw that “the market didn’t reflect the value,” RuggedCom chairman Peter Crombie said.

RuggedCom never intended to sell, but didn’t have any choice. The company put itself on the market, and drummed up a $33 a share bid from Siemens. That’s a credit to RuggedCom’s board, but it has to be bittersweet.

“We were building a business we thought could grow to a significant size,” Mr. Crombie said. “We were not put into play voluntarily.”

The problem becomes a vicious cycle. There are so few tech companies left in Canada that those that do trade in the country don’t get a lot of attention from investors and analysts, so valuations can languish. As peers disappear, the problem worsens.

At this rate, there will be precious few technology companies of any size left on Canada’s main stock market in a few years. Canada isn’t producing independent technology companies at even close to the pace needed to replace the losses.

Since the beginning of 2011 there has been exactly one tech IPO of any significant size. That was the debut of Nexj Systems, now ranked the 25th-largest tech stock in Canada by market cap.

Certainly, it’s not a one-way street into Canada to buy up tech companies. There are plenty of Canadian companies that are acquisitive, swallowing rivals here at home and abroad. Stars such as Open Text Corp., SXC Health Solutions and Constellation Software are all growing and rewarding shareholders.

If shareholders want to keep them, they will have to pay up. Stocks don’t come much better than Constellation, which has provided shareholders almost a double in the past two years, and pays a healthy dividend. Yet it trades at a scant price-earnings multiple of 12, very low for a company that builds earnings at the rate of 35 per cent a year that Constellation puts up.

As the past week has shown, if investors don’t place a value on Canadian technology stocks, acquirers will.

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