Blair Driscoll, CEO and director of Toronto-based FAX Capital Corp., which went public in November, sees big opportunities in small-capitalization companies.
Small-caps, Driscoll notes, didn’t benefit from the longest bull market in history to the same extent as their larger peers. Instead, institutional investors and asset managers pumped the lion’s share of available capital into large public companies over the past decade.
That bull market is now over, with the S&P/TSX composite index having plummeted by about 25% from its high on Feb. 20. But watching smaller companies miss out on the rates of growth experienced by large-caps over the past 10 years led Driscoll to a “light bulb” moment: “There are some really great companies that can grow very fast in [the small-cap] space, and we need to attack this market.”
FAX is ready to attack. The investment holding company, which trades on the Toronto Stock Exchange, plans to invest primarily in Canadian small businesses — mostly public companies, but also on the private side.
“Identifying these opportunities is extremely exciting,” Driscoll says. “Our ultimate goal at FAX is to identify a business that can grow from a $150- million market capitalization to $2 billion or $3 billion over time.”
And there’s no shortage of small-caps for FAX to choose from. “If you look at the Canadian marketplace, there are about 2,300 publicly listed companies. Over 91% of those companies have a market cap below $1.5 billion,” Driscoll says. “Essentially, our whole market is small-caps.”
FAX plans to have a concentrated portfolio of 10 to 15 companies: 60%-80% publicly traded companies and 20%-40% privately held. Companies with market caps in the $100 million-$500 million range fall squarely within FAX’s “strike zone,” Driscoll says.
FAX’s investment mandate is flexible: the firm can invest in equity, debt and convertible debt of companies. “This gives us an opportunity to be more creative when getting involved with smaller businesses that need capital,” Driscoll says.
Driscoll acknowledges that other vehicles, such as small-cap mutual funds, ETFs and private equity funds, invest in the small-cap market. But one advantage FAX has, he says, is a permanent capital base of $190 million.
“We are a long-term vehicle and we’re allocating capital into companies with a very long-term view of five-, 10-, 15- [and] 20-year horizons,” Driscoll says. “When we invest in a business, it’s stable capital, it’s long-term capital, and there’s no risk of it going away.”
Unlike a mutual fund, FAX doesn’t offer daily redemptions, which allows the firm to invest in stocks that are less liquid than a small-cap fund, Driscoll says. And FAX’s permanent capital base means FAX can stay invested in companies for the long haul and weather adverse conditions.
“We can take advantage of volatility in the markets, which I think is crucial when you’re looking at smaller companies that tend to be more volatile,” Driscoll says.
There’s been no shortage of market volatility lately, and FAX has taken advantage. On March 16, the firm announced it had deployed approximately 15% of its total cash resources in a number of public investments. A statement from FAX indicated that management was “encouraged by the increasingly attractive opportunities this recent market sell-off has provided to accumulate shares of target companies at lower prices.”
The potentially wild ride of investing in small-caps isn’t for everyone, says Driscoll, who notes that the risk parameters of investing in, say, a Big Five bank are much different from investing in a Canadian company with a market cap of $150 million.
“To me, investing in the small- and micro-cap market is not something you dabble in. It’s a market you need to be fully dedicated to,” Driscoll says. “You need to intimately understand the fundamentals of these businesses and be able to separate the high-quality companies from the low-quality companies.”
FAX takes a patient, long-term approach to investing in these companies. “If we’re able to build a very strong portfolio with great companies and, most important, stay the course, our shareholders will do very well,” Driscoll says.
Driscoll learned the value of staying the course while working in the investment department of Toronto-based asset manager Sentry Investments Corp. (Toronto-based CI Financial Corp. bought Sentry from the Driscoll family in 2017.)
“Even though we [at Sentry] had some of the structural difficulties of being an open-ended mutual fund, we tried very hard to think long-term and allocate capital with a long-term bias,” Driscoll says. “A lot of the fundamentals I espouse here at FAX were some of the things I learned and developed working alongside some of the great portfolio managers we had at Sentry.”
While at Sentry, Driscoll gained first-hand experience in how businesses operate. “Not a lot of people get the opportunity to operate a business,” he says. “You get a lot of respect for how businesses work, and a lot of respect for making long-term decisions and building a strong culture.”
That knowledge, Driscoll says, can be invaluable when building relationships with the management at small companies.
“When we talk to management teams and business owners of companies we’re looking to invest in, I understand the struggles that they go through when it comes to making decisions, allocating capital and trying to take a long-term view — but ultimately facing market participants who have a very short-term view,” Driscoll says.
FAX is sector-agnostic, although the company avoids investing in speculative business models, such as energy and mining companies. Outside of those industries, anything is fair game.
“We can look at any business, from health care to discretionary, staple and industrial,” Driscoll says. “If you look at the Canadian small- and micro-cap space, there [are] a lot of different types of businesses and different types of end-market exposures.”
With public companies, FAX looks for a minimum 5% ownership stake, which, Driscoll says, gives FAX a voice in the company: “We want to partner with these companies and grow with them over a very long period, so we want to make sure that we’re a significant enough part of their story.”
With private companies, the minimum ownership stake would have to be higher — around 30%, Driscoll says. One of the reasons FAX wants to allocate a smaller portion of its portfolio to private companies, he says, is because there’s “no more illiquidity premium in the private markets.”
According to Boston-based Bain & Co. Inc.’s Global Private Equity Report 2020, last year marked the first time 10-year returns in the public markets matched those for private equity.
“This is why we pivot more toward focusing on the public side,” Driscoll says. “If I can find a great public company that tends to trade at the same multiple, has the same growth characteristics, has less leverage and has liquidity, that, to me, is an attractive opportunity.”
It’s the challenge of finding those great opportunities that keeps Driscoll, a father of four boys, engaged in the investment business.
“For me, it’s a business that’s never easy,” he says. “It’s always interesting. There’s always something going on that keeps you on your toes.”