While the volume of big ticket M&A transactions appears to be on the rise as we enter the third quarter of 2008, it is unlikely that we will see the same number of deals as in prior years. However, certain segments of the Canadian M&A market are enjoying robust levels of activity. For example, international buyers, such as sovereign wealth funds (SWFs), have been very active in pursuing Canadian companies and assets and making significant equity investments. We have advised on a number of these transactions and our experience strongly suggests that this trend will continue.
As has often been the case in the past, U.S. buyers have been active in the Canadian M&A market over the last six months but we are also seeing strong activity levels from overseas purchasers. The Canadian resource sector continues to attract a large amount of international investment as have the financial services and real estate sectors. In addition, overseas purchasers, including SWFs, are actively pursuing significant opportunities in a variety of other industries such as Canadian telecom, technology, pharmaceuticals, life sciences and media/entertainment.
Strategic buyers and sovereign wealth funds
Not only has the current M&A market become more international, but the mix of strategic and financial buyers has also shifted. Given the downturn in the global credit markets, private equity investors and other financial purchasers have seen their access to credit diminish. This, in turn, has made it more difficult for these types of investors to apply the degree of leverage they require to achieve their targeted returns. Accordingly, strategic purchasers such as SWFs who can fund transactions out of cash flow, off of their own balance sheets, or with their own securities, are much more competitive in the current environment.
Sovereign wealth funds (SWFs) have also become increasingly active in the international M&A market. SWFs are typically formed to invest the sovereign wealth of a nation or state. Given the dramatic increase in oil prices, SWFs in the Middle East currently have very significant amounts of capital to invest. As the Middle East and South East Asian regions do not generate enough attractive opportunities to absorb all of this capital, some SWFs have adopted a global perspective and have been prominent in many high-profile international transactions over the last few months. Examples include significant investments in Merrill Lynch, Citigroup, Ferrari, Sony and Cirque du Soleil, and the acquisition of Barneys New York, Doncasters, Northrock and Prime West.
Many SWFs and some strategic buyers are seeking some exposure to the North American markets, and view assets in some sectors, such as financial services and real estate, as being currently well-priced. However, there is a perception among some international players that the United States is not as welcoming of foreign investment as other jurisdictions, and that perception may be deterring investment in the U.S. by some overseas investors. We believe that Canada can expect to see increased levels of foreign investment for this reason.
Long-term investment horizon and criteria
Having advised a number of international enterprises in connection with Canadian acquisitions, we have observed that overseas strategic purchasers and SWFs often have a longer term investment horizon as compared to traditional private equity purchasers, and are not as focused on an exit transaction in the first three to five years following an acquisition. Further, as international purchasers usually do not have to lever the transaction to the same degree as traditional private equity purchasers, their requirement to generate significant earnings growth over the near term is not as pronounced.
Instead, international purchasers are often attracted to long-lived assets, access to technological innovation, prominent brand names, strong management teams and North American distribution channels. Further, SWFs that have accumulated capital as a result of hydrocarbon resources in their home jurisdiction are also looking for diversification away from the oil & gas sector. Hospitality, automotive, aerospace, health care, financial services, media and entertainment are but a few of the sectors that have attracted significant SWF investment.
Despite the fact that SWFs have significant pools of capital to invest, they will not overpay for assets. The international deal teams with whom we have worked are very experienced, sophisticated and highly disciplined. Like all investors, they are focused on value. Simply stated, these types of purchasers will not transact unless the deal meets their investment criteria. International purchasers are quite prepared to walk away from a transaction if satisfactory terms cannot be reached or conditions satisfied, and there is not the same level of anxiety in connection with a broken deal that can exist among North American parties.
Regulation of foreign investments
Although Canada’s regulatory regime regarding foreign investment is undergoing some changes, we believe Canada continues to enjoy a reputation as a country that welcomes foreign investment. Guidelines have been published regarding the application of tests under the Investment Canada Act for investments by SWFs, and the federal government recently blocked the sale of certain Canadian geospatial assets to U.S.-based Alliant TechSystems Inc. Nonetheless, the Canadian government has confirmed its policy objective of ensuring that Canada is a preferred destination for both domestic and foreign investment. In June, the Competition Policy Review Panel released its report containing a number of important recommendations to improve the competitiveness and economic performance of the Canadian economy. The Panel clearly supports continued foreign investment.
Advising international purchasers
International purchasers, such as SWFs, are wise to engage experienced deal counsel to help them navigate Canada’s Competition Act and Investment Canada Act. In addition, purchasers in certain sectors such as banking, telecom, transportation, media and uranium production will also have to be mindful of sector-specific legislation such as the Bank Act (Canada), the Broadcasting Act (Canada) and Telecommunications Act (Canada). Purchasers should also obtain Canadian taxation advice early in the process. Co-ordination of that advice with the corporate and securities analysis is an important element in ensuring that the transaction is structured in an efficient manner.
In our experience, many international purchasers (especially those that have undertaken transactions subject to U.S. or U.K. law) will generally be familiar with the principles that underlie many of the Canadian laws applicable to an acquisition transaction. However, some elements of Canadian corporate and securities law -- such as the availability of plans of arrangement to effect an acquisition, the need for resident directors and our employment laws -- are unique in some respects. Counsel advising international clients should take the time at the outset of a transaction to highlight these differences.
We have also found that cultural and legal differences are rarely an impediment to completing a successful acquisition in Canada. While we have noticed that international strategic buyers and SWFs appear to prefer negotiated transactions, which enhances access to the target management team and permits a deeper due diligence investigation, there is no reticence to going hostile in appropriate circumstances.
There is also a tendency for the executives of some international buyers, especially at the SWFs, to expect significant, direct peer-to-peer interaction with the leadership of the target company. Canadian counsel should advise their clients at the outset about the role of intermediaries and the board of directors of a target in a significant corporate transaction, especially in circumstances where an “independent” or “special” committee of the board has been established.
We expect that international strategic purchasers and SWFs will be increasingly active participants in the Canadian M&A market. There are excellent investment opportunities in this country combined with a regulatory framework that welcomes inbound investment. Further, there should be more Canadian visibility in the international community as SWFs and other foreign investors set up shop in North America and Canadian financial intermediaries travel further afield to promote investment opportunities in this country. It will be very interesting to see to what extent international buyers pursue opportunities in the income trust sector, as these types of vehicles appear to satisfy a number of the investment criteria that international strategic investors and SWFs have enumerated as being important to them.