Canada on Sale

Since the recession of 2008, companies and investors based in the United States have been increasingly focused on Canada when considering acquisition targets. Over the past few years, we have seen more US buyers in the small and mid-sized market as the Canadian dollar declines and a strengthening US economy bolsters confidence among executives south of the border. With buyers potentially shifting their focus away from ...
Canada on Sale
Chris Hutchinson, EY
Since the recession of 2008, companies and investors based in the United States have been increasingly focused on Canada when considering acquisition targets. Over the past few years, we have seen more US buyers in the small and mid-sized market as the Canadian dollar declines and a strengthening US economy bolsters confidence among executives south of the border. With buyers potentially shifting their focus away from resource-based companies, we expect this trend of snapping up middle-market companies to continue over the next year.

The mid-sized M&A market has been dramatically impacted by the fall of the Canadian dollar, which has plummeted from almost 95 cents per US dollar in January 2014 to less than 80 cents for much of 2015. Canadian companies that have cost inputs or revenue in American dollars may experience short-term effects (such as currency gains and losses), but there are also more long-term consequences that must be considered.

> US PURCHASING POWER
The declining Canadian dollar has presented the opportunity for buyers in the United States to purchase Canadian middle-market businesses for a smaller US dollar investment when compared to prices that existed less than a year ago. On the other hand, this will also mean that certain smaller Canadian businesses will now fall below the radar of US buyers with minimum target thresholds.

From the Canadian perspective, companies looking south of the border for acquisition targets will now need to write a larger cheque to expand into the US market. While Canadian buyers will require more initial capital to enter into the market, there’s an upside to owning a US business. Those who invest more on the purchase of a US business can take advantage of a healthy cash flow stream in US currency and may be able to naturally hedge their existing business — not that this should be the primary reason for US acquisitions.

> FOREX CONSIDERATIONS
Accounting practices for foreign exchange in the private-company space hasn’t always been consistent from business to business. In recent years, foreign exchange gains and losses between Canadian and US dollars didn’t have a significant impact on a company’s earnings before interest, taxes, depreciation and amortization (EBITDA). The difference between the Canadian and US dollar was minimal and the rate stayed relatively static. Today, a significant debate has resurfaced among vendors and purchasers on how to normalize foreign exchange gains and losses, and each buyer and seller will need to consider their own circumstances.

The way that foreign exchange gains and losses appear on an income statement doesn’t always reflect the whole story of how foreign exchange can affect a business. It’s important for all parties involved to be transparent around these issues in order to minimize the risk of delays to due diligence and deal negotiations.

Buyers may simplify the foreign exchange issue by normalizing earnings to a current or projected exchange rate (using constant currency analysis). Depending on the company’s position in the marketplace, they may or may not be able to pass on foreign exchange fluctuations to their customers. Recasting the company’s results based on currency alone may not provide an accurate view of the earnings under a constant currency assumption. Companies that execute on hedging strategies can mitigate some of the impact that exposure to foreign currency can present; however, many mid-market companies aren’t sophisticated in hedging strategies within their organizations.

Any buyer or seller venturing into an M&A deal should have a good grasp of the risks that are associated with foreign exchange, as well as actual impacts on projected and historical EBITDA. By taking exchange rates into consideration, you can remove one of the uncertainties associated with businesses that aren’t purely dealing in Canadian dollars. With increased middle-market momentum, and the decline of the Canadian dollar, foreign exchange is once again a key consideration in many transactions.

Chris Hutchinson is a VP of EY’s private mid-market practice. Follow him on Twitter @Chutchinson_.