While Canada’s economy regained some momentum in the first half of 2019 after stalling in late 2018, concerns over the future linger. Global economic weaknesses, worries about the likelihood of a US economic slowdown and ongoing geopolitical and trade tensions may not have stopped overall growth, but they’re inspiring a little more caution.
The first half of 2019 saw a drop in Canadian mergers and acquisition activity compared to the previous six months. Despite this decline, there remains a robust underlying level of M&A activity.
The outlook looks promising for a healthy deals market. With abundant capital, corporations, private equity firms, pension funds and other investors continue to look for the right deals to achieve scale, boost growth or gain a competitive advantage.
Overview of Canadian transaction activity for the first half of 2019
- Aggregate deal value and deal volume down
- Average deal value up slightly
- Retail deal volumes up amid decline for technology sector
Aggregate deal value and deal volume down
Overall Canadian deal volume fell by about 5% in the first six months of 2019 when comparing activity to the latter half of 2018.
As a percentage of total transactions, domestic deals declined from 41% to 38% when comparing the first half of 2019 to the preceding six months. Inbound deals rose from 22% to 23%, while the number of outbound transactions was stable at 36%. Corporate deals accounted for 71% of transactions in the first half of 2019, compared to 29% for private equity. This split was virtually unchanged from the previous six-month period (73% versus 27%).
Average deal value up slightly
Overall deal value of US$73 billion showed an 11% decline from US$82 billion in the second half of 2018. Average deal value in Canada fell slightly, from US$192 million to US$184 million.
The largest transaction in the first half of 2019 was Newmont Mining Corp.’s US$10-billion deal to buy Vancouver-based Goldcorp Inc.
Private equity firms and pension plans were responsible for six of the 14 mega deals (deals greater than US$1 billion). Notable private equity transactions included Brookfield Asset Management Inc.’s leveraged buyout of Oaktree Capital Group and Onex Corp.’s acquisition of WestJet.
Corporate transactions, including the Newmont-Goldcorp deal, accounted for another eight mega deals in the first half of 2019.
Retail deal volumes up amid decline for technology sector
Technology deal volume fell by 4% compared to the second half of 2018.
One segment with a notable drop was financial technology, in which deal volume was down by 20% over the second half of 2018. After several quarters of feverish activity, we suspect the drop may simply be a pause as companies focus on absorbing and integrating their fintech acquisitions.
The retail segment saw a noteworthy increase in activity, with deal volumes rising to 53 transactions in the first six months of 2019 from 33 in the second half of 2018. The retail activity could be a sign of buyers snapping up troubled or distressed assets, or it may simply be the result of buyers with strong risk appetites placing educated bets.
“While high-quality deals are still coming to market, there are also a number of targets with characteristics that merit a closer look under the hood.”
Taking more time
One notable trend in the current environment is the fact that, where competitive dynamics permit, buyers are often taking a more measured pace to the deal. Particularly in cases where issues surface during the deal, buyers are taking more time to work through them. In prior periods, when transaction volumes were higher and it was perhaps more of a sellers’ market, buyers would have had less leverage to force such delays.
- A more robust due diligence
- Probing deeper into technology acquisitions
- A rising focus on cybersecurity risks
A more robust due diligence
For a variety of reasons, we’re seeing buyers put more time into the due diligence process in an effort to ensure strategic fit, uncover potential issues and justify the purchase price. Strong valuations and the complexities created by ongoing geopolitical and trade tensions mean buyers need to be very certain that the bid price is justified.
Due diligence is also taking longer in part because of the nature of what’s available in the market. Many high-quality businesses were sold—often quickly—in the competitive M&A market market of the last few years. While that remains the case as high-quality deals are still coming to market and sparking pre-emptive bids, there are also a number of targets with characteristics that merit a closer look under the hood. For example, if part of the target’s business isn’t performing well, buyers are more likely to push to see the next month’s trading or undertake additional commercial or operational due diligence to confirm that the drivers of poor performance are temporary or have been addressed.
Probing deeper into technology acquisitions
As traditional companies acquire technology businesses and assets to drive new revenue streams or increase efficiency, the need for more rigorous due diligence has grown. The technology may be often unfamiliar to buyers, which means they need more time to fully understand what they’re buying.
Buyers are right to invest the time and effort into evaluating the technology they’re acquiring. They need to know whether it will integrate with their business and deliver the anticipated benefits and if it will be possible to modify, scale and evolve the technology as the company grows and changes. Buyers also need to confirm that the technology they’re looking at will endure and make sure it’s not likely to fall behind alternative or emerging technology solutions.
Buyers have several options for exploring potential technology acquisitions. Some corporate buyers are establishing in-house innovation groups that focus on identifying promising technology targets. Companies are also taking minority positions or setting up joint ventures or partnerships to look into whether a particular technology or business will be a truly good fit before pursuing a full acquisition.
Another reason buyers are spending more time on technology-related due diligence is to identify and avoid potential intellectual property problems or patent infringements. A small technology start-up might fly under a patent holder’s radar, but once a larger player with deeper pockets acquires that company and its technology, an intellectual property matter can quickly become a major legal, reputational and financial headache.
A rising focus on cybersecurity risks
Cybersecurity risks are another increasing focus of deal due diligence. Acquirers want to make sure a target has properly protected its assets, including customer, supplier and employee data, to sustain deal value. Buyers should also look at whether the transaction will make them subject to additional compliance obligations, such as the EU General Data Protection Regulation.
Many target companies require significant investment to bring their cybersecurity capabilities to an acceptable level. This is true even for technology targets, which may be start-up or emerging companies where putting strong cybersecurity measures in place hasn’t been a priority. Strong cyber due diligence can identify key shortcomings in a target’s cybersecurity practices and critical cyber vulnerabilities. It can also help determine the costs and time required to address these issues so they can be priced into the deal.
Besides future cybersecurity risk, buyers need to think about the possibility that there may have been prior, but still undisclosed, cyber breaches at the target that could leave acquirers facing costly future litigation and issues with customer, supplier and employee relationships. Since it can take months to discover such a breach, identifying and managing cybersecurity risks can be very challenging.
In response to these cyber-related risks, we’re seeing buyers digging deeper into these issues during due diligence. Many are seeking stronger cyber-related representations, warranties and indemnities from sellers and are taking out cyber security insurance.
Effective integration planning is often key in mergers, especially since a significant portion of deal value in such situations tends to come from the synergies from combining services like information systems and technology, finance and human resource functions. If the target’s cyber protections aren’t where they need to be, acquirers will want to keep the other company’s systems separate until they’ve made the necessary remedies. This could take significant time and delay the realization of synergies and anticipated deal value.
Despite the dip in Canadian deal activity between the first half of 2019 and the last six months of 2018, the overall long-term trends we’ve observed in the market over the past several years continue to hold true. There remains an abundance of capital in search of the right deal, and buyers continue to have plenty of interesting targets to pursue. The additional due diligence we’re seeing buyers carry out is a positive signal of financial prudence, strategic thinking and careful risk management.
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