TSX/LSE merger sheer madness for small caps

According to my morning paper, Canadian large cap CEOs and their Bay Street lawyers love the idea of the TSX merging with the London Stock Exchange. Got it. But the vast majority of folks in the Canadian capital markets don’t fit that profile. If you are a small cap company without a tinge of rocks or black gold associated with your story, the idea is sheer madness.

According to Kevin Cowan, TSX Markets President, the announced deal “brings exciting possibilities for Toronto Stock Exchange and TSX Venture Exchange”. I definitely agree that the possibilities are exciting for TSX shareholders, and that is appropriately the primary concern of the TSX’s Board of Directors, but no one in the real world of capital-raising can buy the spin of some market-watchers about this deal being “good for Canada”.

The daily trading market share of the TSX versus Pure versus electronic trading platforms is irrelevant to a Canadian based/listed software company with $70 million of annual revenue. TSX shareholders have reason to be concerned about cost compression and other changes in the industry, but that’s what can happen when you invest in a utility. There will always be investment risk that some smart gal/guy will find an angle to chip away at your dominance. That’s usually referred to as the free market at work, even when you’re protected by a regulatory moat.

This is exactly what’s happening to the mobile divisions of Rogers, Telus and Bell right now, for example. It’s also what the satellite radio stations did to over-the-air radio. Or what cable did to rabbit ears; or satellite TV to cable. On and on go the examples.

But the capital market hub is different than radio frequencies or buggy whips. Our economy lives and dies by the ability of entrepreneurs to effectively access capital. Companies raise funds to grow their businesses, which invariably involves job creation and demonstrable economic benefits for the overall economy. In essence, it’s why we are no longer an agrarian society.

There’s nothing about a merger of the LSE and TSX that will make it easier for the vast majority of Canadian companies to raise capital.

Here is how it works for every TSX-listed small cap company (think Absolute Software with $70 million of revenue, profitable, and a market cap. of $175 million) when they try to raise capital; in this case imagine a $25 million raise given the market cap. The firm hires the appropriate investment bank — one that suits their needs; more than likely one that already provides research coverage on the name (such as GMP or Versant Partners). A company of that size has 5 analysts actively promoting the story (one of whom works for a bank-owned dealer). The institutional sales desk calls portfolio managers to set up the roadshow meetings. They start with Toronto and Montreal firms like CI and AGF, and, if pressed, call accounts in Boston and New York.

In Boston, they might get a meeting with Fidelity, but that is just as likely to be covered from their Montreal office; Wellington Management Co. and the other 800 pound gorillas can’t be bothered. Pioneer and Constitution Research might make time for you.

New York meetings will entirely involve hedge funds who play small caps, but at best there will be four or five in total. The guys in Denver (Janus) don’t have time for a firm that small, nor do the big California-based funds.

As for Zurich or Paris or Munich, you’ll likely be skunked. Unless you want a charity meeting or a break from a newborn baby at home, it isn’t worth the plane fare.

So, this it the thing. If you couldn’t get a meeting with a large Zurich or Munich-based institution yesterday, what is it about the LSE/TSX merger that is going to change that?

The LSE itself isn’t even a great place for their own small caps, as we witnessed with the predictable demise of their microcap AIM exchange (see indicative prior post “Whatever became of the AIM?” Oct 3-07).

For the S&P/TSX 60 firms, it will likely be neutral. They get all the attention they need as it is, and would have no trouble cross-listing on the LSE without the merger. They might even be winners out of this, just as law firm Ogilvy Renault LLP stands to benefit given their announced merger with Norton Rose. But as BMO found when they listed on the NYSE in the 90s, the bank’s profile in the USA didn’t change a snick.

On the current TSX “Composite Index”, there are 244 companies. The market cap. of #244 is $435 million. Five or six years ago, #300 on the TSX 300 Composite had a market cap. of about $250 million. With over 2,500 listed companies on the TSX and TSXV, you can appreciate why about 90% of Canada’s publicly traded firms fall into the category of small cap.

Throw these names into bed with the LSE’s 1,400 listed companies, and the AIM’s additional 3,000 illiquid “quoted” stories, and you definitely have a bigger exchange.

But what you don’t have is better access to capital for 90% of Canada’s capital markets. I wish it were different.

MRM