Fundamental truths

The foreign exchange (FX) gap is certainly something to consider for U.S companies contemplating a Canadian target company, but let’s put it in perspective.

For mergers and acquisitions (M&A), the fundamentals still apply: consider the quality of the acquisition target, its brand, market position, intellectual property, customer base and more. Acquirers will also want to analyze how the target’s location fits in with their existing business and whether there are other possible synergies between the two.

Obviously, FX rates can affect valuation; Canadian companies appear relatively cheap to U.S. buyers right now, while potential U.S. acquisitions look expensive to those north of the border. Buyers can gain a deeper perspective through sensitivity analysis (modelling), looking at how foreign currency movements affect the target company as a whole.

This might sound straightforward, but it can be complex. Acquirers will want to look at targets that have robust financial reporting and management systems, because determining the real effects of FX on a company calls for examining issues in isolation.

For example, a Canadian business with a high percentage of U.S. customers might have seen revenue climb over the past year as the U.S. dollar’s relative value rose. The challenge is to determine how much of that jump was driven by FX shifts and how much by other forces, such as increases in sales volume, changes in pricing or a new product mix. Isolating all of these factors is no easy task, but it’s worth the effort.

Perform such an exercise on the cost side, as well as on the revenue side. Are some costs influenced by foreign exchange? Do changes in costs mitigate changes in revenue? Only by dissecting a target company’s income statement can a buyer understand its exposure to FX.