Canaccord Capital Inc. is well positioned to continue its growth, but it won’t come easy. The changing and increasingly competitive environment in which the firm operates presents significant challenges — such as globalization, technological advances, and regulatory shifts and burdens — that it will have to cope with.

The Vancouver-based brokerage, which went public in 2004, is ahead of the curve in the global small-cap investment-banking niche, but other companies are likely to pursue this profitable area. And although Canaccord is also ahead of many competitors in offering a strong array of global investment ideas to Canadian retail investors who increasingly want to diversify abroad, competition is expected to increase in that niche as well.

At the same time, regulatory changes in the U.S. and Britain will facilitate electronic trading, which could reduce trading volumes for brokerages.

Canaccord’s main strategy is twofold, says Mark Maybank, who was appointed chief operating officer in Toronto in August 2006.

First, in capital markets, the firm is already leveraging its new presence in the U.S. — it acquired Boston-based Adams Harkness Financial Group Inc. in January 2006 — to offer corporate clients more expertise and the opportunity to list in the U.S., Britain (where it already has a strong presence) and Canada.

Second, in the retail brokerage business, Canaccord is increasing communications between analysts and retail brokers to disseminate its investment ideas.

There is also a smaller private-client line of business.

Canaccord’s earnings before unusual or non-recurring items were $67.4 million in the first nine months of fiscal 2007 (April 2006 to December), vs $49.8 million for the same period the year prior; revenue was $540.5 million, up from $376.3 million. Operating cash flow after changes in non-cash working capital was $18.3 million, vs negative $60.5 million. There was no long-term debt at Dec. 31.

The 47.8 million outstanding shares — which trade on the Toronto Stock Exchange and the London Stock Exchange’s Alternative Investment Market — were trading at $18 at the beginning of February. That’s well up from the initial public offering price of $10, although down from a spike of more than $27 a share in the spring of 2006 — when many underwriters benefited from the gold frenzy.

Management and directors own 30% of Canaccord’s shares; employees own another 20%.

Investors view Canaccord’s expertise to be in resources, but this should change as recognition of its knowledge in other sectors increases, Maybank says. Although mining and metals accounted for 42% and energy for 21% of Canaccord’s capital markets revenue during the first nine months of fiscal 2007, he considers his firm’s exposure to resources to be less than that of many Canadian competitors because of its expertise in technology, life sciences, consumer, real estate and industrials. These sectors accounted for 51% of the company’s transactions during the period.

Here’s a look at Canaccord’s three main businesses in more detail:

> Capital Markets. This line of business had a revenue of $319.6 million in the first nine months of fiscal 2007, up 50% from $213.4 million a year earlier. Net income before taxes was $82 million, up 22% from $67.2 million.

The Adams Harkness deal, worth about $26 million, was small but critically important in providing access to the huge U.S. market for companies listed on Canadian markets and the AIM, says Maybank. Canaccord can now offer clients both listings and experts in Canada, the U.S. and Britain. For example, a recent deal with a Canadian company involved an analyst in New York, a banker in Toronto and a dual listing on the TSX and the AIM. (Dual listings give companies better liquidity and higher prices for their stock.)

Canaccord is also expanding its global energy expertise by opening an office in Houston. To emphasize the U.S. connection, the company’s capital markets activities have been rebranded as Canaccord Adams Inc.

Already, there has been a significant impact on revenue in terms of geography. In the first nine months of fiscal 2007, 30% of revenue was raised from non-Canadian operations (primarily in the U.S. and Britain), vs only 22% a year earlier.

Canaccord was the lead underwriter in 173 Canadian equity offerings of more than $1.5 million in 2006 and participated in another 333 — the most of any dealer in both cases — earning $45.5 billion in total underwriting proceeds. It was seventh, in terms of proceeds ($4.8 billion), for deals in which it was the lead underwriter, largely attributable to its focus on small- and mid-cap companies.

@page_break@On the AIM in 2001-05, Can-accord ranked sixth in proceeds raised by new issues (£332.8 million), and first for the average price performance of those issues, at 185.7%. This is Canaccord’s niche: it targets companies with market caps of less than US$2 billion.

Canaccord views itself as No. 1 globally, in terms of its focus on growth companies, and as a leader, in terms of global reach. Canaccord’s 50 research analysts cover more than 550 small- and mid-cap companies in seven sectors.

Firms with more global reach in their research include RBC Dominion Securities Inc. and BMO Nesbitt Burns Inc. , both based in Toronto, and New York-based Jefferies Group Inc.

But keeping Canaccord’s strong position isn’t going to be easy as competition heats up, both in Canada and globally. Seven of the 10 top merger and acquisition advisors on the investment-banking side — in terms of value of deals — in Canada last year were non-Canadian, Maybank notes. There are also lots of foreign investment dealers entering or increasing their presence in the Canadian market.

One example is New York-based Lehman Brothers Inc. , with its announcement in May 2006 that it is opening offices in Toronto and Calgary. Maybank says UBS AG and Credit Suisse Group, both of Switzerland, and New York-based Goldman Sachs Group Inc. are also increasing their activities in Canada.

To keep itself on the leading edge, Canaccord plans to take its Canadian real estate research expertise and apply it to Britain first and then to the U.S. Similarly, it will take the consumer products expertise it acquired with the Adams Harkness acquisition and apply it to Canada and Britain. Canaccord also plans to expand its coverage of life sciences in the U.S. and Britain; this is a small sector in Canada.

The firm’s philosophy is to increase expertise in sectors at a time when these sectors aren’t performing so well, so the firm can be ready at the time when the sectors do take off, Maybank says. For example, Canaccord is currently really strong in technology, a sector the firm believes will perform well in the next two years.

Increased electronic trading is another challenge, but although Canaccord is concerned about the potential impact, it’s somewhat insulated from this because it deals with smaller companies that are often not very liquid. This makes the role of a brokerage firm more important in this arena.

> Retail Brokerage. This arm of the company had revenue of $196.7 million in the first nine months of fiscal 2007, a 34% increase from the same period a year earlier. Net income before taxes was up 29%, to $50 million.

Growth in this division has been strong and steady. Assets under administration were $14.3 billion as of May 31, 2006, up 72% from two years earlier. With the drop in oil prices last summer and the resulting dampening of energy-stock prices, Canaccord’s AUA dropped to $13.8 billion as of Sept. 30 but was back up to $14.1 billion by Dec. 31.

Even though Maybank is pleased with the growth in AUA, he believes Canaccord has not leveraged its international investment ideas and opportunities as much as it could have. With the elimination of foreign-content rules for RRSPs, globalization of portfolios is a key trend, he notes.

For instance, Canadians bought $72.5 billion in foreign securities from Jan. 1 through Nov. 30, 2006, according to Statistics Canada, surpassing the previous high of $62.9 billion in all of 2000.

Canaccord provides Credit Suisse research to its advisors for ideas in the sectors Canaccord doesn’t cover. It also offers two sets of portfolio programs, which, Maybank says, have been helpful in attracting advisors. The six Independence-branded portfolios, launched in 2001, are managed in-house and had $696 million in AUA as of Dec. 31.

Canaccord’s top-tier wealth-management service, the Alliance Program, was launched early last year. The program allows investors to choose a combination of managers — there are 10 from which to choose, including Canaccord itself — to create six similar portfolios. Although the program had early success, it still has less than $100 million in AUA.

Canaccord’s strategy, besides leveraging its investment ideas for retail clients, is to continue to update the quality of its investment advisors and client service, as well as increase its advisors’ awareness of the international investment ideas it is generating.

The increase in AUA has been achieved with virtually no increase in the number of advisors, which has remained around 430. Instead, the company has substantially increased the size of the average advisor’s book to more than $32 million from $21 million in 2004 by weeding out 10%-15% of low producers each year and replacing them with motivated high producers. Canaccord also offers a flat 50% payout of revenue generated for advisors and a generous employee stock-ownership plan.

The market for advisors is currently very hot. Canaccord has had to increase its hiring incentives this year, but it isn’t paying the 150% of an advisor’s previous annual revenue that some other firms have been rumoured to be offering.

> Private-Client Operations. Canaccord’s private-client hiring incentives in the first nine months of fiscal 2007 were $4.7 million vs $2.9 million the year prior, but, Maybank says, this mostly reflects the bigger books acquired.

Converting capital-markets relationships to private-client relationships to the extent possible is another area in which Canaccord has not done as well as it might have, adds Maybank, but the firm is working on this.

Canaccord prides itself on its excellent private-client service, including the quality of its back- and front-office technologies. The company has state-of-the-art technologies and will continue to upgrade, says Maybank.

The Big Six banks have problems in this area, as they are saddled with old systems and can’t afford to upgrade unless bank mergers are allowed. If mergers are eventually allowed, that will have a huge impact on the industry as blocks of business will be sold off in order to meet the competition guidelines that are expected to be put in place.

Being in a position to pick up business in the event of bank mergers is one of the reasons Canaccord went public.

However, says Maybank, there aren’t many acquisition possibilities on the Canadian landscape right now. IE