Innovation in a Downturn

Talk about a change in tone and in tune. Just a short time ago, Canadian M&A overall was still fairly strong, as was inbound investment from multiple countries, and the downturn in oil and gas and base metals — well, who would have thought prices would drop so low. Then, of course, we began to be battered by a combination of a sinking loonie, tight credit markets, as well as macro world events that have sent equity markets on a roller coaster ride.

It’s rather a case of try to forget the naysayers, let’s look for the optimists. That’s because it’s not that there aren’t deals; there’s new approaches and very different types of deals than a year or two ago. And, quite possibly, light in the tunnel ahead.

Grant Zawalsky, a securities and M&A partner with Burnet, Duckworth & Palmer LLP in Calgary, says from his vantage point in Western Canada, “in 2016 the reality is a lot of the traditional buyers, even companies who have a good cost of capital, are market darlings and can raise money right now, are very leery just because this is a very deep downturn in commodity prices that we probably haven’t seen since the 1980s.”

On the other hand, a lot of the companies who would like to sell, he says, just don’t have positive cash flow, so unless the seller has some very unique assets, and the buyer has the financial strength, and patience, to take a longer-term view, the deal isn’t getting done.

Still, Zawalsky is seeing several trends in merger and acquisition activity as buyers and sellers seek to capitalize on opportunities to find value.

He says, for example, Suncor Energy’s acquisition of Canadian Oil Sands to consolidate their interest in Syncrude, or Murphy Energy Corporation undertaking a joint venture with Athabasca Oil Corporation to develop Athabasca’s properties in a low-commodity price cycle. Or, ARC Financial Corp. undertaking a going-private transaction with Boulder Energy Ltd., “a very interesting trend with these very low prices,” says Zawalsky, “providing an opportunity for private equity to come in what people think is the bottom of the cycle.”

Vince Mercier, an M&A partner with Davies Ward Phillips & Vineberg LLP in Toronto, says there’s a lot of what he calls “unhappy busy” in the commodities sector. “This equates to ‘we have to issue equity at prices we don’t like, we’ve got to sell assets to fix our balance sheet, rather than ‘I’m trying to grow the company.’ It’s about restructuring the balance sheet and defensive M&A.”

Which leads to a disconnect as to what the assets are really worth. Are they being priced based on the market now, or when the cycle inevitably changes and oil and gas and base metals are once again an attractive investment?

Simon Romano, a partner with Stikeman Elliott LLP, says, “when you’re talking about something like oil and gas or base metals acquisitions, pricing expectations may not be the same at all; on the one hand, you’ve got purchasers looking to get the deal of a lifetime and, on the other side, vendors are saying, ‘hey it’s temporary, the market for our assets is going to come back and you should pay me a price that reflects the fact that in two years we’ll all forget this ever happened.’”

In comparison, in the non-resource sector, says Romano, if you have cash, or don’t have to borrow too much, companies can take advantage of some fantastic opportunities, especially if the targets are the exporting businesses providing goods or services from Canada, paying their workforce in Canadian dollars and receiving US dollars. 

Alternatives to high-yield market

Organic company growth is very difficult to get these days in a weak economy, so the predominant theme is growth through strategic M&A according to Mercier. “However, financing markets are really tight, with spreads in the high-yield debt market increasing significantly since the beginning of 2016. Depending on who you talk to, some will say the high-yield market is effectively closed, so companies are looking for alternatives to the high-yield market.”

This has led to a difficult deal-making environment, with some deals being abandoned due to lack of financing and some deals having to be re-priced because of more expensive financing terms. On smaller private-equity deals, says Mercier, private-equity firms have chosen to equity finance them, with the goal of refinancing with debt once the credit markets recover. 

On larger deals, Mercier says purchasers have had to be creative in replacing high-yield debt. US private-equity firm Apollo, in its bid to acquire ADT, financed a portion of the purchase price with preferred stock. In Canada, “Corus recently pulled its proposed high-yield debt offering to finance a portion of its Shaw Media acquisition, choosing to wait for improved credit markets and using temporary bridge financing instead.”

In another M&A development, Mercier says there’s much more anti-trust enforcement. A number of deals in the US, including the proposed acquisition of Time Warner Cable by Comcast Corporation, have failed due to this scrutiny. As a result, there’s a trend to agree on an anti-trust strategy upfront that involves agreeing, during negotiations, on potential divestitures to address these issues, as was the case in the Anheuser-Busch/SABMiller merger.

SPACs

Then there’s the debate of what effect – short and long term – that special-purpose acquisition corporation (SPAC) offerings will have on M&A activity in Canada. The first Canadian SPAC was completed in 2015, although the TSX adopted SPAC rules in 2008.

“I’m not saying SPACs, which are new to Canada, are easy deals,” says Stikeman’s Romano, who leads the Stikeman firm team that raised more than one billion dollars in capital in five SPACs last year. “The fact that money is hard to come by and IPOs, which were robust as heck until last August, have all but disappeared, creates opportunities for SPACs that may not have existed a year ago.”

Companies who in the past may have opted to go public, he says, are now “taking a second look and saying ‘maybe this is the way to do our M&A,’ as taking away some of the competition for deal flow can help get a transaction done.”

Mercier says one of the challenges with SPACs is “certainty is king for the seller in a M&A transaction, so having to go back to shareholders has the potential to make the SPAC a less-attractive buyer compared to a strategic or private-equity firm with a firm financing.” However, Mercier says SPACs are potential buyers of assets, and the more buyers the better, if you are a seller, so in that sense it’s a good development.

CCAA and merger combinations

As to what lies ahead for Western Canada, Zawalsky says, “there’s a belief in the City [Calgary] that we may see some CCAAs, although we haven’t seen much of that yet, which is surprising given how depressed commodity prices have been.”

In the 1980s and ’90s, also a time of depressed oil and gas prices, Zawalsky says the economy spurred some creative CCAA solutions, so a company could move forward, in which creditor arrangements were mixed with mergers, such as Dome Petroleum’s acquisition by Amoco. “We haven’t seen any of those types of arrangements yet,” says Zawalsky, “but we think we might, depending on commodity prices.”

Another macro event affecting M&A is the dramatic upcoming change in the Canadian hostile take-over bid rules. At press time, the new regime was scheduled to take effect on May 9, 2016. According to Romano, the new rules will make hostile take-over bids harder to do, which may reduce investor gains from M&A opportunities. For example, financing costs for hostile bidders borrowing cash will go up, as will their transaction expenses. So there will likely be a greater push towards friendly deals.