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Expert Interview with Tom Astle, Head of Investment Strategy at Difference Capital

Written on July 19th, 2013

smallcappower – Financial Post (July 19, 2013) – We are pleased to feature this exclusive interview with Tom Astle, Head of Research, Difference Capital, a Toronto, Canada based Merchant Bank.

In this exclusive, Mr. Astle talks about his approach to finding high potential technology companies for investment. Furthermore, he talks about the major sectors within the broad technology sector that could do well in the near future. He also shares his insights about the stock markets in general and his investment outlook.

Q: Can you tell us about Difference Capital and your role there?

A: Sure. So Difference Capital is a publicly listed tech-focused merchant bank. We’re mainly focused on private investments, and we do some, what we call private investments in public companies as well. And the company’s been around about a year, founded by a few people, including Mike Wekerle who was the founder of GMP. And I joined about five, six months ago along with a few others, and my role is basically looking at the investment opportunities that come in the door, finding some of those investments and then the whole investment due diligence process and making a recommendation.

Q: So what are some of the key characteristics of technology companies that Difference Capital would look to invest in?

A: So we’re focused on non-resource growth. Right now our primary focus is tech and some media and maybe a bit of healthcare. But those are the three big sectors we’re focused on. We just went out and raised a fair bit of money in an offering. Being publicly listed, we’re able to do that. And right now we are targeting later stage, mostly private, technology companies. And you might say, why private versus public? I’ve been an analyst covering public companies for years and the Canadian universe of public tech companies is pretty limited as you may know. And I found out the private universe is actually much more interesting. There’s much better quantity. And there’s better quality I think in some cases, and a lot of the value appreciation now in small companies is when they are private. For example, an extreme example would be Facebook where all the value creation was when it was private. And then when it went public, was basically at the peak of its most recent valuation. So we, as a public vehicle, give investors an opportunity to get into that– the private value accretion stage. So that’s one of the criterias. We tend to look for private, although we’ll do early stage publics as well. We look for basically companies that are I.P. rich – intellectual property rich. We think that’s a key competitive differentiator. We are not looking for look for start-up companies, so companies have to have some revenue. They have to have customers we can call to verify what their products, are competitive. We are looking for visibility to about at least $10 million in revenue and positive EBITDA. And then we like management teams that are well invested along with us and business models that are somewhat proven out.

Q: So that actually answers some of the next question, but could you elaborate a little more on your approach and methodology of picking high quality stocks that can become tomorrow’s potential winners?

A: Yeah, absolutely. So been doing this for years and the key thing in the tech and media space, is what drives a competitive advantage? So that’s partially why we look for companies that are very rich in intellectual property. That’s obviously a big source of competitive advantage. But there’s other things to look for as well, like recurring revenue. That’s a nice positive. A lot of companies are moving to what’s called a cloud or SaaS models that have often-recurring revenue you can count on every year, that gives it some stability. We also look very closely at what stage they’re at in a product cycle. Product cycles start out early. If you’re too early, it can be very painful. If you’re too late, it’s all over. So you have to find that mid spot in the product cycle. And we look for things like visibility for growth, third party verification of their technology. So it’s all those together.

Q: So in general, what is your overall outlook for capital markets in the next 12 to 18 months?

A: Well, in the sectors we’re focused on, we’re very excited. We think that the Canadian market in particular is feeling a lot of pain right now as the commodity super cycle kind is slowing down, and then investors are trying to get some exposure in what we call the non-resource areas. And there’s a real scarcity value I think of companies in that space. And so we’re quite positive on the tech or in media, healthcare and cleantech and the industrial growth space. So that’s where we’re focused in the sector market call. I don’t think I’m really qualified to make an overall market call, but generally pretty positive on those sectors.

Q: Considering the broader economic uncertainty, do you see continued growth in the tech sector over the next two to three years?

A: Yeah, I mean, I think if you looked at what’s going on in terms of all the product cycles that are happening in tech in particular, it’s a pretty exciting time. I was an analyst through the tech bubble a decade ago and was driven by just one product cycle, the wired Internet. As we go forward here we’re looking at a lot of the product cycles that are very exciting, and they will drive a lot disruptive [?] opportunities going forward.

Q: So do you believe that investors have much of a risk-appetite for smaller market cap companies currently?

A: That’s coming around. The last three or four years have been very challenging for small cap companies. There’s been a lot of consolidation at the institutional investor level that– the funds have gotten so large, they have trouble looking at smaller names. I think smaller cap definition probably has moved up. It probably starts at $200 million versus $50 million a few years ago. So there’s a bit of a challenge there. But I think coming back to my earlier comment that the market is very hungry for getting more exposure to non-resource growth, I think that will drive some scarcity value. So I’m more of positive on the smaller cap space in the non-resource growth area.

Q: So what technology sector should investors be watching now?

A: So I think of four or five major trends that we like to have exposure to- and these are mega trends in these product cycles I was talking about. So one is particularly mobile. Anything mobile is still growing very rapidly. Mobile Internet is– you know, it’s in our pocket now, still growing internationally, so I think there’s going to be lots of opportunity there. Overlay that with the whole move to cloud computing. So when you have a device in someone’s pocket that connects you to a very powerful cloud computing environment, you can do a lot of things and we’re seeing all kinds of examples of that. Then related to that is the whole big data trend. So discovering that with that kind of mobile and cloud environment, you can collect lots of data and that data has a lot of value when it gets to a certain size. And then social commerce is currently taking off. Valuations are probably a bit of a head scratcher in that space, but it’s another mega trend you got to be aware of. And then the last thing that we’re probably a bit more unique on focusing on is content. Content in general has gone up lots in value now that we have all these different ways of distributing it. It’s not just TV and print. It’s not only your pocket, it’s on your P.C., it’s on your tablet. So those are the five major areas that we focus heavily on in the technology content space.

Q: And finally, can you share some of your favourite companies with our investor audience and elaborate on why you like them?

A: Well, I’ll do a little self-promoting. First of all, I think that Difference Capital (DCF.V) is quite interesting. We give investors exposure to some of the upcoming private companies in Canada and some in the U.S. So I think that’s obviously one that we’re self-interested in mentioning. But beyond that, other public companies that I’ve tracked in the past and still think are very promising outlooks would be companies like Redknee (RKN.T), which is a SaaS based billing software for wireless operators. Another company, which sounds similar, but it’s Redline (RDL.T). They’re just an emerging small cap name with some neat wireless technologies. And then there’s the names like Descartes (DSG.T), which continues to do very well. I also watch a small company called CounterPath (CCV.T), I think they have an interesting plan. And full disclosure, we also own a few public companies like Amaya (AYA.V) , GuesLogix (GXI.T) and a company called CRAiLAR (CL.V). So we obviously like those ones as well.

Q: Great. Thanks very much for taking the time to give our investor audience some of your great insights.

A: My pleasure.

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