In the first half of 2018, according to a report by PWC Canada, mergers and acquisitions (“M&A”) activity in Canada hit $93 billion. This is largely attributable to increased activity in the cannabis, technology, real estate and energy sectors. This trend is likely to continue for the rest of the year despite the current climate of uncertainty surrounding the impact of the United States – Mexico – Canada Agreement (“USMCA”). In this post I will discuss five trends and developments in Canadian and cross-border capital markets and M&A and why they are significant. They are:
- Growth and importance of strategic vs. financial buyers
- Prevalence of mid-market deals
- Growth of inbound vs. outbound transactions
- Technology and cannabis sectors are driving transactions
- Tighter control around Fairness Opinions
The Growth and Importance of Strategic vs. Financial Buyers
A notable trend in Canada last year which was characterized by resurgent M&A activity, was the dominance of strategic buyers. Improved market conditions prompted private equity funds to exit their investments rather than acquiring new targets. As a result, strategic buyers re-emerged as dominant buy-side players in Canadian M&A, while private equity funds tended to be on the sell-side of the equation.
Mid-Market Deals Dominate
In Canada, the M&A landscape is dominated by mid-market deals (i.e. transactions valued at less than $500 million). Last year was no different. According to a variety of surveys, about 80 percent of public M&A deals were valued at less than $100 million. In fact, Canadian public M&A transactions with a deal value of $1 billion are a rare commodity, with just a handful occurring in any given year. In 2017, according to a number of deal surveys, only 3 percent of Canadian public M&A transactions exceeded that value.
Growth of Inbound/Outbound Deal Activity
Cross-border M&A activity accelerated in 2017 improved from 2016, notwithstanding that the Canadian market showed a decline in total deal value over the same period. The decline in total deal value was largely driven by fewer “mega-deals” of $1 billion or more. For the first time in years, outbound deals to the U.S. and elsewhere from Canada decreased. In contrast, inbound M&A deals to Canada increased substantially on a year-over-year basis. A major factor that will both positively and negatively drive the cross-border M&A landscape in the near future is the potential impacts of USMCA. The protectionist stance of the current U.S. administration is creating a degree of market uncertainty in terms of U.S. investment in Canada and elsewhere. At the same time, acquirors outside of North America might find investment in Canada preferable to the U.S. until the current uncertainty over trade and tariffs is resolved.
Technology and Cannabis Are Driving Transactions
The technology and cannabis sectors are two areas of the Canadian economy that have been ripe for M&A and capital markets activity recently. This could create challenges for issuers in other sectors that have fallen out of favour with investors recently, including junior mining.
On the technology front, fintech and blockchain technology have accounted for a substantial portion of recent capital raising and M&A activity. Cryptocurrency and related blockchain technologies dominated a lot of press attention in 2017 especially in view of the extreme volatility in the value of Bitcoin. In June 2018, the Canadian Securities Administrators published CSA Staff Notice 46-308 Securities Law Implications for Offerings of Tokens (the “CSA Notice”) providing guidance on token offerings. The CSA Notice indicates that whether a token is a “security” for regulatory purposes will be determined in accordance with established case law concerning “investment contracts”. The existence of an investment contract is determined by whether an offering involves: (i) the investment of money; (ii) in a common enterprise; (iii) with an expectation of profit; (iv) to come significantly from the efforts of others. The CSA will consider the technical elements, as well as the economic realities, as a whole with an emphasis on substance over form in determining whether a token offering involves a “security”. The CSA Notice provides a number of useful examples of situations where an offering of tokens involves a security. In addition, the CSA Notice indicates that token offerings that involve multiple steps that are staged over time can engage securities laws.
Cannabis companies in Canada are in a frenzy of activity as legalization of recreational use approaches. Some public cannabis operators have experienced extreme growth in market capitalization over a very short period of time. For example, Canopy Growth Corporation, one of the largest medical producers, has seen its market capitalization grow from $17 million to $10.15 billion in the space of four years.
There is, however, a market imbalance related to cross-border cannabis activity. Some states in the U.S. have legalized recreational cannabis, but it remains a criminal activity both federally and in several states. The lack of clarity in the U.S. resulted in the TSX refusing to list recreational cannabis companies with a U.S. connection. This might create an opportunity for domestic Canadian cannabis issuers in terms of a competitive advantage in raising capital in the domestic market.
Recent initiatives of the U.S. border protection agency regarding questioning of Canadian residents crossing the U.S. border concerning their cannabis investments and involvement has been given media attention lately. It is, however, interesting to note that Constellation Brands (one of the world’s largest liquor conglomerates based in the United States) recently made a strategic equity investment in Canopy Growth Corporation valued at $4 billion. This is a clear indication of the interest that foreign money is now showing in the Canadian cannabis market. In addition, recent M&A deals, including the deal between Aurora Cannabis and Cannimed Therapeutics, may also indicate a trend towards consolidation as the Canadian cannabis market continues to mature.
Tighter Control Around Fairness Opinions
Fairness opinions are a common feature of Canadian M&A deals. Although not always legally required, virtually all public M&A transactions include a fairness opinion authored by one or more investment banks retained to advise the target board or an independent committee. The purpose of the fairness opinion is to demonstrate that the target board has completed a reasoned analysis to make a recommendation to securityholders concerning an M&A transaction. Historically, it has been common Canadian practice for financial advisors to be paid a “success fee” for providing a fairness opinion, a copy of which is typically appended to the bid circular or proxy statement sent to securityholders. Typically a fairness opinion contains the advisor’s conclusion as to fairness but does not provide the detail concerning the underlying analysis supporting the conclusion. As a result of this practice, recent developments have cast doubt on whether this model is appropriate and in the best interests of informing securityholders. These can be summarized as follows:
- In 2014, an Ontario Court, in approving a plan of arrangement involving Champion Iron Mines, was highly critical of a fairness opinion. The Court said the opinion was devoid of any “number crunching” and lacking in sufficient substance to inform securityholders as to whether the transaction was fair.
- In 2016, the Yukon Court of Appeal, in a matter involving InterOil Corporation, called into question the value of a fairness opinion with a “success fee” component.
Following these decisions, the Canadian securities regulators, in the context of “material conflict of interest transactions” issued a Staff Notice providing the following guidance for companies and investment banks on fairness opinions:
- The compensation arrangements for the provider of the fairness opinion should be disclosed to securityholders, including whether the advisor is being paid a success fee or a fixed fee;
- A special committee of directors should thoroughly review the opinion and not blindly accept the assumptions and methodologies used; and
- Securityholders should be provided with a summary of the methodology, information and analysis (not merely a narrative description) underlying the opinion sufficient to enable securityholders to understand its basis.
Companies that are the subject of an M&A transaction that involves court or regulatory oversight need to ensure that any fairness opinion delivered is properly reviewed, analyzed and disclosed in order to withstand scrutiny and potential attack by transaction dissidents.