$1.1B Q9 Networks deal another reminder that Canadian markets don't get tech

News item: BCE and partners to acquire Q9 Networks for $1.1 billion (Hat Tip: Globe & Mail)

If you’re a Canadian mutual fund portfolio manager, the name Q9 Networks will ring a bell; or perhaps not. Back in April 2004, you probably passed on its IPO at $8.50. Back then, Q9 served its customers from two data centres located in Toronto and Calgary, with plans to build a second facility in Toronto; that site would have been completed by the late summer 2004, providing new room for revenue growth on the back of the IPO. Internet infrastructure wasn’t entirely a household name back then, but what Q9 did should have resonated with the various PMs:

Maintaining a reliable and high performance Internet operation requires a significant investment in facilities, personnel, equipment and networks. With an increasing number of organizations depending upon the Internet for critical business functions, there is a growing trend to outsource Internet infrastructure, allowing organizations to focus on their core competencies, reduce costs and reduce the time required to bring their products and services to market.

It’s not as though they were promising to turn cat manure into energy with a speculative technology.

Despite the broad underwriting syndicate of CIBC, TD, BMO, RBC and BNS, Q9 could only raise $32.385 million at a valuation of about $138 million (pre stock option impact). Why did you pass on the deal? Perhaps you bought 180 Connect instead, or one of the other less-robust techie offerings that year. Or maybe RIM, which would have rewarded you for years, in fact.

From 2001 until the IPO, Q9 revenue and customer figures had risen each and every quarter. Important customers at the time included ADP, BMO Nesbitt Burns, Cadillac Fairview, dbrs, Fairmont, the Globe and Mail, The Toronto Star, RBC, Stikeman Elliott…. From a pedigree standpoint, VC and PE shareholders included JLA III Venture Fund, VenGrowth (remember the LSIF industry…the one the Ontario Liberals set out to kill?), Scotia Merchant Capital (JLA LP), e-Scotia, OMERS (JLA LP) and TD Capital Canadian Private Equity Partners (TD Bank was a JLA LP, too). As a group, they’d invested $109.6 million to launch the company and they weren’t seeking much of a premium (at 25%) to what they already had in; and they were staying in the deal, unlike those early Facebook investors. Not to mention there was $42 million of cash and short term investments on the balance sheet; you don’t see that every day in the tech world.

The net operating loss had been pared from a high of $13 million/year in 2003 to an annual run rate of $5.2 million during Q1 2004 — strong evidence of the scalability of the business concept. On an EBITDA basis, things were positive to the tune of $455k in the quarter right before the IPO.

Think back to 2004: it was clear the Interet wasn’t going away, and that large institutions weren’t going to want to manage their own data centres if someone else could do it for them in a safe and reliable fashion. And that they couldn’t erase the data they’d saved so far. Perhaps it was too infrastructurey for people’s liking, but for any defensive stock market players, that should have been an appeal.

At the time, I recall the tug-of-war between the investors and IPO Underwriters over the deal pricing. Q9 CEO Osama Arafat had done a stellar job with the business, and everyone on the roadshow should have appreciated that Mr. Arafat would have been just as comfortable heading up a tank batallion in battle as a successful tech story: those people are hard to find in any market.

Not that any of it mattered, as a $40 million IPO book target didn’t get filled. Wisely, management and the investors went ahead with the smaller $32.4 million deal. Sometimes, it is true that any deal is a good deal.

And look what happened. Management executed on the plan they laid out on the IPO roadshow, and private equity shop ABRY Partners bought the company in a takeover bid in August 2008 for $17.05/share ($361 million). Prior to the bid, the stock was trading at $13.02; up from the IPO, but clearly not appropriately valued by retail and institutional investors alike.

Less than four years later, financed largely through free cash flow and new bank debt, Q9 now has 11 Canadian data centres and is worth $1.1 billion (or $54.63/Q9 share assuming no new shares had to be issued for equity during the ABRY period) to BCE, Madison Dearborn Partners, Providence Equity Partners and Ontario Teachers’ Pension Plan.

Had the public markets appropriately valued Q9 back in 2008, perhaps the takeover bid wouldn’t have happened. And the robust cash flow and supportive lenders/advsiors at TD Bank, TD Securities and elsewhere would’ve financed Q9’s growth just the same.

Those retail investors and mutual fund PMs would be getting $54.63/share today, a 543% premium to the IPO price, instead of the $17.05/share they received 45 months ago. Tech can work as an investment: it requires great management, capital, a defensible position and patience.

But it can work out very well indeed.

MRM