Ten noteworthy trends that will have an impact on the Canadian mergers and acquisitions landscape in 2009 are:
1) Cash is King
We expect that debt will remain expensive and lenders gun-shy in the wake of the global credit freeze. Purchasers who have access to cash reserves, with less need for third-party financing to complete an acquisition, will have a significant advantage over those buyers that have traditionally relied on leverage. Strategic buyers who have hoarded cash in recent months will have an opportunity in 2009 to make acquisitions at discounted prices. We expect significantly higher equity components in any private equity-backed deals in 2009.
2) Share-for-Share Deals Will Increase
With a new focus on preserving cash stockpiles, strategic investors will be quick to offer share consideration in public transactions. However, the refinancing of existing target debt will continue to be challenging and the financial position of the purchaser, including its relationship with long-term lenders and ability to issue new debt, will be key.
3) Distressed M&A Will Abound
Insolvencies and restructurings will increase as businesses struggle with weaker financial results and an inability to renew existing credit facilities. Distressed companies will face a decision between being acquired by an opportunistic buyer or bankruptcy. We may see insolvencies within those industries hardest hit by the financial downturn, including suppliers to the automotive and oil and gas industries. We also expect consolidation among real estate investment trusts (REITs), as real property market values continue to fall and cost-effective financing for new and existing properties continues to be hard to come by.
4) Focus on Deal Terms and Commitment Letters
In this cautious deal environment, buyers and sellers have a renewed focus on deal certainty and will carefully negotiate ‘material adverse change’ and ‘specific performance’ provisions. The recent BCE decision of the Canadian Supreme Court arguably provides Canadian directors with greater scope to exercise discretion and negotiate deal protection provisions than their American counterparts, as long as they are satisfied they are acting in the best interests of the corporation. With uncertainty in the credit markets, buyers will continue to push for financing outs. Sellers will look for security from buyers to ensure closing, particularly where buyers are outside the jurisdiction. There will similarly be renewed conflict over commitment letters as purchasers pressure lenders to provide firm, comprehensive financing commitments with fewer outs, while lenders remain highly cautious about the state of debt capital markets.
5) Income Trust M&A
One major factor that should affect M&A activity in Canada in 2009 is changes to tax laws affecting income trusts. With almost 200 income trusts in Canada having an aggregate capitalisation of more than C$125bn, income trusts are a significant part of the Canadian capital markets. As a result of changes announced by the federal government in 2006, income trusts will start paying the equivalent of full corporate tax in 2011. The loss of favourable tax treatment and corresponding decline in market value have made income trusts attractive targets for acquisition by US private equity funds and strategic buyers.
6) Focus on Alberta
The lower price of oil will lead to bargain hunting as cash-rich companies take the opportunity to pursue consolidation. Similarly, over-leveraged companies with reduced cash flows will be forced to sell themselves to survive the downturn. We will continue to see significant acquisitions of existing energy trusts by domestic and foreign acquirers in response to the 2006 changes to the taxation of income trusts.
7) Weakened Loonie Will Lead to Acquisitions of Canadian Targets
The precipitous drop in the value of the Canadian dollar will once again make Canadian public companies attractive acquisition candidates for international buyers.
8) Continuing Shareholder Activism
Hedge funds have become active in influencing corporate policy, engaging in proxy battles and even initiating takeover bids in an effort to put issuers in play. Activist hedge funds often acquire large positions in issuers undertaking fundamental change transactions to establish a blocking position. Pressure on hedge funds to find liquidity will intensify this trend. We expect to see many potential acquirers negotiating simultaneously with both target boards and key securityholders.
9) Contentious Environment
An increasingly contentious deal environment has led to a wealth of new Canadian legal guidance on issues such as the enforceability of standstill agreements, the utility of shareholders rights plans, the timing of disclosure obligations and the scope of the oppression remedy. The recent decision of the Ontario Securities Commission in HudBay has led to new guidance on the ability of Toronto Stock Exchange-listed acquirors to issue shares as purchase consideration without shareholder consent. We expect the battles, and resulting judicial and administrative decisions, to continue.
10) Reforming the Foreign Investment and competition Review Processes
On 6 February 2009 the Canadian government introduced a bill before Parliament to implement certain provisions of the federal budget, including far-reaching amendments to both the Competition Act and Investment Canada Act. The bill proposes to align the merger notification process under the Competition Act more closely with the merger review process in the US. The bill would also increase the threshold before which an investment may be subject to mandatory review, as well as introduce a national security test, under the Investment Canada Act.
Conclusions
Despite the current market uncertainty and limited availability of financing, Canadian transactions continue to be announced and successfully close. Further consolidation and distressed M&A opportunities, combined with the relative weakness of the Canadian dollar, will provide well-positioned international buyers with the chance to make a significant Canadian acquisition in 2009.