Foreign investment into Canada is likely to stay strong due to a number of factors, say Canadian corporate lawyers
Canadian companies should expect more inbound investment M&A activity, in particular from the US, where they have a currency advantage, strong balance sheets and private equity sitting on piles of dry powder, says Emmanuel Pressman, a Toronto partner and Co-chair of the Corporate Department at Osler, Hoskin & Harcourt LLP. “There’s a lot of money that still needs to be put to work.”
John Leopold, a senior partner at Stikeman Elliott LLP in Montréal and Co-chair of the firm’s Mergers & Acquisitions Group, says when you look at overall M&A activity in Canada, “the market is very robust with the highest volume of deals we have seen since 2007. Foreign buyers have been a big part of this uptick in activity. While the US continues to be the primary source of cross-border deals, not surprisingly, there is also a healthy level of activity from Europe as well as scattered deal flow from Asia.”
Indeed, the UK is an active hub of activity for investors engaging in or exploring M&A opportunities in Canada. “As much as we in North America get so centred on New York being a financial centre, we need to remember London is a tremendous financial centre,” says Cameron Belsher, an M&A partner in the Business Law Group at McCarthy Tétrault LLP in Vancouver. “It’s an aggregator of funds from Europe, but more importantly, it’s an aggregator of funds from the Middle East, whose funds are immense, from private enterprise and also from state-sponsored funds.”
Still, when talking trends, the US appears to be top of mind.
Leopold says an important trend is the increasing role of US private-equity funds in Canadian middle-market deals. He says there has been a material increase in the number of Canadian middle-market deals involving US private-equity funds because pricing in Canada for deals in this space is generally less expensive than equivalent deals in the US market.
The definition of what constitutes “middle market” is somewhat fluid and has changed since the recession. “Middle market is in the eye of the beholder,” says Leopold. “If you asked me in 2007, I would have said middle-market deals were in the range of $250 to $500 million whereas today that number would be closer to $50 to $200 million.”
Another quickly growing trend is M&A deals between baby boomers looking to exit their companies and US private equity with money ready to deploy, says Belsher. “These are small deals that don’t move on the radar and don’t make front-page news.” Primarily, the sellers are owner-managed companies with an enterprise value in the range between $25 and $50 million. Often, the small US private-equity shops buying them manage in the $300–$400 million range, says Belsher, who currently has a number of these types of deals underway.
“It’s all about private-equity funds that have been formed with fund managers sitting on a few hundred million dollars’ worth of equity ready to invest. They need to find bite-sized pieces to invest in to build a portfolio,” Belsher says. “With the current state of the Canadian dollar against the US dollar, and a plethora of privately owned Canadian businesses with succession issues, these US funds are increasingly looking northward and investing to Canada.”
Private-equity and inbound investment activity is being fuelled by a combination of dry powder, strong credit markets and low interest rates, with several prevalent themes present, says Pressman. “These include private-equity exit strategies including sponsor-to-sponsor deals where one fund’s exit is another fund’s investment strategy. Sales to strategic buyers and IPOs have been traditional exit strategies for private equity. In volatile markets, sponsor deals are often faster to execute and finance. In current markets, we’re seeing more interest in strategic sales.”
Pressman says in the energy and resources commodity sector, in particular, private equity is allocating its capital in mid-market transactions. “Where there’s very low or limited organic growth opportunities, M&A is often a strategy or a strategic imperative for companies that are trying to build scale and grow their businesses. All of which, with the Canadian dollar priced where it is relative to the US dollar, creates potential opportunities for US private equity to capitalize on.”
Mark Eade is a partner in the Calgary office of Norton Rose Fulbright Canada LLP whose corporate finance and M&A practice is largely confined to the energy sector. In 2014, “we saw a lot of private equity coming in as major buyers of oil and gas companies, yet it’s more oriented toward companies that are growth-oriented,” he says.
This interest is coming from private equity in Canada, as well as US and North American pension funds, says Eade, with some interest from next-tier Chinese buyers, as opposed to state-owned Chinese companies. “My expectation is this interest will probably continue as those teams take advantage of low valuations and large pools of money available to them.”
Jeff Barnes, a partner in the Toronto office of Borden Ladner Gervais LLP, says, “there seems to be a lot of cash available, looking for equity-type returns and going into various types of funds and avoiding low debt returns, especially at the retail and pension fund levels. Borrowing costs for good credits are still pretty low, even if credit requirements may be going up.”
According to Barnes, developments in M&A will depend on the assessment by buyers and sellers of the possibility of competing bids, which he thinks will be lower than normal, except for crown jewels. There may also be regulatory issues under competition or foreign investment laws because there may be market pressure to sell significant assets. “An increase in activity would create a desire for higher break fees if buyers become more active. Sellers now should, if there is a potential regulatory issue, be looking for better reverse break fees, because the sale is likely the last opportunity in the same time frame.”
As a further thought in regard to timing, “especially from now to the federal election, I could see resistance to foreign acquisitions, especially but not exclusively for sovereign-owned entities, of important assets like oil sands and technology-based companies,” he adds.
“One cannot predict how politically sensitive or politically charged any given M&A situation may or may not be,” says Pressman. “Canada does not have a lot of global dominant players and as a consequence, our politicians can be protective of national treasures, strategic assets as they have been referred to in the past, so no one can say it’s a rubber stamp or predictable, this really isn’t the case.”
Although there’s a lot of money available for M&A, equity funds and strategic buyers are being very disciplined as to the deployment of that capital, says Eade. “We think there’s a lot of money available to invest in North America in the energy sector, but that it may take a little while to see a lot of this kind of activity happen, even compared to last year. We’re seeing companies, even those with secure cost of capital and leverage profiles, waiting for the bid/ask to narrow for the acquisition of assets of potentially distressed companies or a full buyout of the companies themselves.”
What’s driving this “is there’s some thought in that world that the bottom in terms of pricing of commodities might not be here yet, but I can speak from my own experience that we’re seeing them out there kicking the tires in terms of entering into negotiations with oil and gas companies.”
In looking at challenging M&A trends, Leopold says, “it is a very difficult market to be a buyer given the pricing on deals, which has become quite expensive, some would say frothy, especially for the high-quality deals. The converse of this trend is it is a great time to be a seller and we are seeing that reality reflected in a number of our clients who are actively pursuing a sales process for their business.
“In a very competitive deal environment that is seller friendly, sellers have become more and more demanding on deal terms. For example, we see some deals where sellers will only provide limited recourse, or in some cases, no indemnification for breaches of the agreement, terms we haven’t seen since 2007.” Leopold says to bridge the gap between what buyers and sellers are prepared to accept, “we are seeing representation and warranty insurance, which has been prevalent in the US for some time, as a vehicle that is slowly creeping into the Canadian market.
“I can tell you in my entire 30-plus-year career, while I’ve looked at representation and warranty insurance for clients on many occasions; I actually had never done a rep/warranty deal up until six months ago. I’ve now done eight deals with rep and warranty insurance for buyers in the last six months, which illustrates how important this phenomenon has become in Canada.”