A lower loonie still goes a long way

For the second straight year, outbound deals take top billing in our Special Report on M&A. But don’t be deceived: domestic action has been steady, too
By Jim Middlemiss

While there are many ways to evaluate this year’s mergers and acquisitions activity as the calendar draws to a close, it’s hard not to declare 2016 as a year for building Canadian power abroad. The source of that pronouncement: outbound merger activity that has eclipsed all previous records, according to deal-tracking research firm Mergermarket.

Final totals have yet to be tallied, but we do know that Canadian companies spent more than US$136.5 billion on 214 deals to buy foreign companies through Sept. 30 alone—a massive volume that already surpasses the US$134.2 billion spent on outbound deals for the entire 2015 calendar year.

In fact, the US$136.5 billion already spent is the highest total outbound activity on record for any year since Mergermarket started tracking such figures in 2001.

“It’s a record for us, up over 21%,” from last year’s Q1-Q3 figures, says Tom Cane, managing editor, Americas at Mergermarket. “There has been a lot of outbound activity.”

This massive wave actually builds on a trend in outbound momentum that has been emerging for several years. A few mega deals also helped, including Enbridge Inc.’s (TSX:ENB) whopping $37-billion purchase of Houston-based Spectra Energy Corp., the largest deal in 2016 and also the one that Listed has chosen as its 2016 Deal of the Year (see “Better a buyer than a builder be?”).

At the same time, in terms of analysis, the outbound story overwhelms what actually has been a consistently healthy year for M&A activity—whether you’re looking at overall totals, inbound deals or domestic transactions, large and small. This review, and the data that follow, dive into each of those areas. But first, we’ll start with the rest of the outbound story.

Good for Canada

Emmanuel Pressman, a mergers and acquisitions lawyer and chair of the corporate law department at Osler, Hoskin & Harcourt LLP, says the “massive, billion-dollar foreign outbound deals are creating global champions based in Canada. It’s good for the Canadian domestic economy and it’s good for Canada’s global positioning.”

It’s also a far cry from 10 years ago, when we saw a wave of inbound merger activity that took out a number of Canadian mining icons, including Alcan, Falconbridge and Inco. The discussion then focused on the hollowing out of Canada and the loss of head offices. “That has gone 180 degrees, when you look at the data,” says Mike Boyd, head of global mergers and acquisitions at CIBC. “Canadian companies are very much the acquirers.”

Indeed, if you look at our list of the year’s top 10 Canadian-led deals (see accompanying chart), seven involve Canadian companies buying foreign operations. Only two deals, BCE’s $3.9-billion acquisition of Manitoba Telecom and the Potash-Agrium merger, pegged at a value of $24 billion, are pure domestic transactions. The other remaining deal in the top 10, Waste Connections Inc.’s (TSX:WCN) $3.9-billion purchase of Progressive Waste Solutions Inc., is technically an inbound deal. But because it was structured as an “inversion” and the newly forged entity is based in Canada, it is included in our top 10.

Top 10 Canadian-led deals in 2106. Click to enlarge

In terms of active buyers, Canadian pension plans continued to rack up foreign acquisitions. However, it’s also true that a greater array of Canadian companies reached beyond our borders looking for opportunities to expand their business in a slow-growth economy.

Also noteworthy is the broad-based nature of the industries involved. While the scales for the top deals were tilted toward the energy, mining and utilities sector, they included deals in industrials and chemicals, transportation, financial, consumer and real estate.

Diversity was an overall theme for the year, observes Shlomi Feiner, an M&A lawyer at Blake, Cassels & Graydon in Toronto. The sectors featuring buyers have “really become more diverse.”

Nonetheless, when it came to outbound activity, Feiner adds, energy infrastructure and the power sector led the charge.

Topping the chart, as noted, is Enbridge’s all-share acquisition of Spectra in September. That deal will create a North American energy infrastructure powerhouse in terms of pipelines and storage. It’s the largest foreign purchase ever by a Canadian company.

TransCanada Corp. (TSX:TRP) put the Keystone XL debacle behind it last spring by purchasing Texas-based Columbia Pipeline Group Inc. for $19 billion. The addition created another pipeline giant, operating more than 90,000 kilometres of pipelines and supplying more than 25% of the natural gas consumed daily in North America.

Fortis Inc. (TSX:FTS) also found opportunity in the U.S., paying $15.8 billion for ITC Holdings Inc., which operates transmission lines in the Midwest. The deal makes the combined entity the 13th-largest North American utility, and builds on Fortis’s earlier U.S. acquisitions.

Feiner says these energy and power deals are “significant transactions. I think it’s commendable that we have companies here who are able to flex their muscles down south.”

Add Alimentation Couche-Tard Inc. (TSX:ATD.B) to that list. Canada’s biggest convenience store operator built upon its sizable, existing retail presence in the U.S. by pulling off a blockbuster $5.5-billion purchase of gas station chain CST Brands Inc., the company’s largest acquisition in history. That deals expands Couche-Tard’s reach into Texas as well as eastern Canada.

CIBC (TSX:CM) also found its long sought-after U.S.-based wealth management platform, paying $4.9 billion for PrivateBancorp Inc., allowing it to expand its commercial and private banking business south of the border.

However, it wasn’t simply the U.S. that attracted Canadian interest. Canadian organizations were busy cutting deals to acquire companies around the globe.

Brookfield Energy Partners LLP bought the Colombia government’s stake of Isagen SA, which operates the country’s largest hydropower plant, in a deal worth $2.8 billion.

A consortium that also involved Brookfield, in this case Brookfield Infrastructure Partners LP (TSX:BIP.UN), bought a 90% stake in Nova Transportadora do Sudeste, the gas pipeline unit of Petrobras in Brazil. The price tag rang in at $6.5 billion. Other notable offshore consortia purchases: Ontario Teachers’ Pension Plan, OMERS and Borealis teaming up to buy the London City Airport for $3.8 billion; and the Canada Pension Plan Investment Board, Brookfield Asset Management Group (TSX:BAM.A) and the British Columbia Investment Management Corp. joining forces to buy Asciano, an Australian rail and port operator for $12.7 billion.

Interestingly, all of these foreign deals come at a time when the Canadian dollar is trading lower than it did a few years ago. So what’s driving the outbound activity?

Boyd attributes it in part to Canada’s sterling stock market, which has been a leader in returns for much of 2016, compared with other markets. “Canadian companies are trading at premium valuations to U.S. companies,” Boyd observes. That gives Canadian companies an advantage when doing accretive deals.

Add in the fact that investment funds and shareholders are willing to back deals and it makes for opportunistic expansion times.

Another driving factor behind the offshore expansion is flat economic growth at home, combined with limited growth opportunities in a mature Canadian market. Cam Belsher, who heads the M&A group at law firm McCarthy Tétrault LLP, says these factors are forcing Canadian companies to look abroad to find sustainable growth opportunities. “Canadian companies aren’t afraid to build and grow outside our borders,” but he adds that they like to stick to what they know best, resources.

Other deals that flew under the radar, but are instrumental to building Canadian champions, include Fairfax Financial Holdings Ltd.’s (TSX:FFH) various acquisitions in 2016. In October, the company bought American International Group’s insurance operations in Argentina, Chile, Colombia, Uruguay, Venezuela and Turkey for $US240 million and entered into an agreement to acquire certain assets and renewal rights with respect to the portfolio of local business written by AIG Europe in Bulgaria, Czech Republic, Hungary, Poland, Romania and Slovakia. That built on earlier deals to buy Zurich Insurance Co. Ltd.’s South African and Botswana operations and a deal acquiring an 80% stake in an Indonesian insurer.

Inbound action keeps pace

All of the above is not to say that inbound M&A, often a key driver for local law firms and investment banks, has gone away. But there haven’t been as many big-ticket deals as there were a few years ago during the golden era of inflated oilsands, energy-sector and mining deals.

Nonetheless, by the end of the third quarter, Mergermarket had tallied 176 deals worth US$18.3 billion, a slight increase of 3% over the same period last year.

Lowes Companies Inc. topped the list of foreign buyers, with its US$2.3-billion deal for Rona Inc., while U.S. healthcare giant McKesson Corp. paid US$2.2 billion to buy drugstore operator Rexall.

There was also what could be one of the last major tax inversion deals when, as noted above, Canada’s Progressive Waste Solutions agreed to a $3.9-billion reverse merger deal with Texas-based competitor Waste Connections. The deal made the combined entity North America’s third-largest waste management firm. However, it almost didn’t happen. The deal hit political headwinds last spring after the announcement, but before closing. That’s when the U.S. government rewrote the tax inversion rules, in response to a proposed US$150-billion tax inversion merger between Pfizer and Allergan. That prompted more discussions with nervous Progressive and Waste Connection shareholders, but the deal eventually passed muster. Waste Connection shareholders got 70% of the combined entity and Progressive shareholders 30%, but its head office is in Canada.

Experts say inbound activity was weighed down by a couple of factors, one being the previously mentioned high valuation of Canadian companies. The other was the general malaise affecting world economies. “I think there is a lot of uncertainty,” says Vincent Mercier, an M&A lawyer at Davies Ward Phillips & Vineberg LLP. He notes that the volume of deals is “down significantly both globally and in Canada,” though deal values remain buoyant.

Also weighing on the markets were both the Brexit vote in the United Kingdom and the U.S. election, which culminated with the selection of Donald Trump as the next U.S. president. That has cast further uncertainty over U.S. policy towards trade, and will likely weigh down fourth-quarter merger activity.

“My crystal ball is telling me there is still a lot of global uncertainty,” Mercier says. “Until that clears up, there is going to be choppy M&A markets.” He says there is “some pent up M&A demand” because of the election, but the choice of Trump could dampen that while investors figure out what’s next.

Elections aside, Pressman says “the markets are ripe for a glut of inbound cross-border activity, especially if Canada’s market slows and the U.S. gains steam. He notes the low-interest-rate environment, widely available credit, a rebounding commodities market and a low Canadian dollar make Canada an attractive destination for foreign capital.

Domestic deals mostly strategic

Domestically, Canada’s M&A numbers held up in 2016. There were 439 deals in the first eight months of the year worth US$67.3 billion, on par with last year’s value, which was considered a banner year. By October, the market was on pace to equal if not surpass last year’s total of US$80.6 billion. Yet, overall the number of deals was trending down.

While eye-popping multi-billion-dollar domestic deals were sparse, they existed nonetheless. In addition to the Potash and BCE deals, for example, Corus Entertainment Inc. (TSX:CJR.B) paid $1.9 billion to buy specialty channels from Shaw Communications Inc. (TSX:SJR.B).

In mid-October, Constellation Brands Inc. sold its Canadian wine business to the Ontario Teachers’ Pension Plan for $1 billion, which includes the Wine Rack retailer and brands such as Jackson-Triggs. Teachers knew the business from its early days as a private company as Vincor International, which went public in 1996. In 2006, Constellation acquired Vincor for $1.5 billion.

Dealmakers in the legal community say that, domestically, the forces driving M&A deals were strategic acquisitions.

By the end of the third quarter, the industrial and chemicals sector led the pack with 62 deals worth US$20.5 billion, aided by the mega Potash deal. That was followed by energy, mining and utilities, with 103 deals worth US$17.4 billion. The latter, of course, is normally Canada’s top sector, but it failed to record any deals in the top five domestically, and the overall value through September was down 56% over last year. One thing that could have held back deals in the mining and oil and gas sectors was an uptick of commodity prices in the spring. Belsher says that allowed some junior and intermediate companies to tap the money wells. “They got a lifeline and it took some consolidation pressures off.”

Mid-market movers

Big deals tell only part of the year’s M&A story, of course. In fact, it’s comparatively smaller deals in the mid-market where the volumes really add up. “That’s where the vast majority of deals are getting done,” notes Feiner. Most deals in Canada are under US$500 million, he says. “That’s what keeps the lights on. It’s across a wide array of sectors.”

Much of the spending on mid-market deals involves domestic companies looking to expand and make strategic acquisitions or consolidate their sectors. However, private equity firms are also at work, looking to bulk up their portfolios.

McCarthy Tétrault’s Belsher says there were a number of interesting “bolt-on” acquisitions and tuck-in deals last year that will help the acquiring companies grow moving forward. For example, Loblaw Cos. Ltd. (TSX:L) paid $170 million to acquire Kelowna-based healthcare technology company QHR Corp., which focuses on electronic medical records. Loblaw called it a “natural complement” to its business of providing pharmacy and health and wellness solutions for patients and providers nationally. QHR is expected to operate as a distinct business within the Shoppers Drug Mart division.

Belsher says the deal was notable because successful Canadian technology companies are often sold south of the border.

The shape of the economy also created opportunities for buyers. Cara Operations Ltd. (TSX:CARA) took advantage of a flagging economy in the West, to acquire majority ownership of Original Joe’s Franchise Group Inc., for $93 million. It operates 99 full-service restaurants in Canada and the U.S.

In terms of private equity, both buyouts and exits were trending down by 37% and 57% respectively at the third-quarter mark. However, lawyers say that’s not from lack of interest. Pressman says “private equity is behind a lot of transactions.”

It’s a very competitive buyer’s market, he says, noting there is a “lot of money competing for deals. You’ve got a massive amount of dollars in pension funds, private equity, SPACs (special purpose acquisition corporations) and on the balance sheet of strategics, and they are all chasing the same deals. We have more clients participating in auctions than I have seen in a very long time.”

SPACS are a little-known factor in Canadian M&A, being a relatively new investment vehicle. However, they are starting to gain traction. In November, Acasta Enterprises (TSX:AEF.A), which raised $402 million in 2015, announced a SPAC triactor with three qualifying transactions of private companies worth more than $800 million. They include a US$270 million to purchase Stellwagen Finance Co., $390 million to purchase Apollo Health & Beauty Care Partnership and $135 million to acquire JemPak Corp. Earlier in the year, another former SPAC, Infor Acquisition Corp., aborted its qualifying transaction right before closure, nixing a merger with ECN Capital (TSX:ECN), a commercial finance company itself hived off from Element Financial Corp., now Element Fleet Management Corp. (TSX:EFN), in 2016.

Large Canadian pension plans continue to play a role in domestic M&A activity, but as Davies’ Mercier points out, “Canada has become almost too small for the amount of assets they have to invest.”

Some of the deals in 2016 were notable for the way in which they were achieved by overcoming regulatory hurdles. Take BCE’s deal to buy Manitoba Telecom. In order to get that through regulatory hoops, BCE said on the same day it announced the deal that it would sell one-third of MTS’s wireless subscribers and one-third of its dealers, taking regulatory risk out of the merger equation, and lessening the likelihood of rejection. Couche-Tard did the same when it said it would sell a number of service stations to Canada’s Parkland Fuel Corp. to eliminate concerns that would likely arise from the competition regulator. Pressman notes it’s best to “address regulatory risk head on.”

As well, all eyes in the Canadian M&A world were on a very tiny deal, Idaho-based Hecla Mining Co.’s hostile bid for Dolly Varden Silver Corp. (TSX-V:DV), a Vancouver-based company in which Hecla owns a 15.7% stake. Mercier says the deal was important because “it was the first hostile bid since the new [takeover] rules were adopted.” Dolly Varden responded to the unsolicited offer by announcing a $6-million private placement. Hecla challenged that move at the B.C. and Ontario securities commissions but lost. Hecla later withdrew its bid, noting the planned dilutive private placement “effectively acts as a poison pill, raising the cost of acquiring Dolly Varden by more than 50%.”

As for what’s next, a lot will depend on where interest rates and the economy are headed, as well as the agenda of new U.S. president Trump, who criticized trade deals during the election, but vowed to focus on job creation.

Boyd was optimistic when interviewed prior to the election when Hillary Clinton was leading, noting that if she won he expected it would be “business as usual.” He warned, however, that “all bets are off ” if Trump prevailed. “We are all going to have to wait, watch and see what he will do.” Markets are now in that waiting game.

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