What you need to know: • Over the past two months, there have been seven takeouts of Canadian small/mid-caps. We think this demonstrates the major disconnect between fundamentals and valuation in the market today which financial and strategic buyers are taking advantage of. • We outline six common characteristics of the acquisitions in order to create a framework for finding the next one and provide a list of stocks that meet the criteria. What’s Going On Here? Over the past two months, we have seen seven takeouts of Canadian small/mid-caps at significant premiums. This includes HS GovTech Solutions (HS:CSE), H2O Innovation (HEO:TSX), Neighbourly Pharmacy (NBLY:TSX), OpSens Inc. (OPS:TSX), Spark Power Group (SPG:TSX), Logistec Corporation (LGT.B:TSX), and Playmaker Capital (PMKR:TSXV). We believe this points to the major disconnect between fundamentals and valuation for small-cap Canadian equities which private equity firms and strategic buyers are taking advantage of. How Do We Find the Next One? Looking at the seven acquisitions that occurred in the Canadian small/mid-cap space over the last few months, we have identified a few common characteristics as outlined below. 1) Poor Stock Performance – On average, the acquired companies were down 27% compared to their last peak seen in 2021/2022. Most firms have improved fundamentals over that period while rising interest rates and multiple compression led to the stock price decline. We expect this to be a leading indicator as financial and strategic buyers look for discounts to normalized multiples. 2) Cheap vs. U.S. & International Peers – As seen across most Canadian equities, stocks trade at significant discounts compared to their U.S. and international peers. For example, H2O Innovation was taken out at ~15x 2024E EBITDA compared to U.S. peer Evoqua Water which was taken out for 25x earlier this year. This is a function of liquidity and lack of institutional capital in Canadian small/mid-caps, providing opportunities for acquirors to buy assets for less than their intrinsic value. 3) Profitable – Five of the seven acquired companies were profitable with the unprofitable two being on a solid path forward. HS GovTech was running small losses ($580K EBITDA loss last quarter) and OpSens was marketing the launch of a highly-important new product, yet its legacy business was profitable. 4) Solid Growth & Tailwinds – On average, the acquired companies grew 42% YoY over the LTM and were expected to grow 19% in 2024. 5) Market Cap Over $100M – Six of the seven acquired firms were taken out at a valuation over $100M. We note that the $100M-$500M range could be the sweet-spot given that micro-caps are not on the radar for most buyers (too small for multi-billion-dollar funds) and large-caps are out-of-reach given current interest rates and financial conditions. 6) Private Equity Friendly – Five of the seven companies were acquired by private equity firms, with OpSens and Playmaker being the outliers. Therefore, we should look for characteristics in small-caps that would fit into a private equity portfolio such as predictable revenue, clean balance sheet, profitability, etc.