Worries for Another Day

Are the NAFTA talks chilling M&A activity? Not at all, according to deal lawyers, who say acquirers are taking advantage of plentiful liquidity and a tax-cut windfall
THE NORTH AMERICAN Free Trade Agreement has been a key economic driver for Canada and the entire North American continent. US President Donald Trump, however, is calling it “the worst trade deal ever made” and threatening to tear it up. Is this just bluster, or do we, as Canadians, need to take it seriously? The question isn’t as simple as it seems. The comments, for one, have not dampened an M&A market that can only be described as frothy. Many M&A lawyers say they’re too busy getting deals done to spend time speculating on how things might settle out.

But at the same time, some lawyers admits that, in the event of a worst-case scenario, the outlook for many Canadian companies would likely be harsh. “If NAFTA gets torn up and is not replaced, there’s going to be an impact,” says Brian Graves, a partner at Fasken Martineau DuMoulin LLP with a focus on M&A. “Given the amount of trade Canada has with the US, it’s an enormous proportion of our international trade and it just cuts across so many industries.”

Melanie Shishler, a partner at Davies Ward Phillips & Vineberg LLP who also practises M&A, puts it this way: “In general, any kind of uncertainty, including uncertainty around NAFTA can be expected to create some headwinds.” The US is by far Canada’s largest trading partner, so even if a Canadian company isn’t directly affected by NAFTA, it likely trades with others that are.

But at the same time, down in the trenches of M&A, the impact of NAFTA uncertainty on deal activity seems minimal. Equity values are soaring, cash is plentiful and investors are upbeat. For many M&A practitioners, these are good times. Indeed, says Graves, deal flow in 2017 was “largely unaffected” by President Trump’s NAFTA comments.

According to data from Thomson Reuters, activity in the first nine months of 2017 (the most recent figures available) reached their highest level since the financial crisis, with transaction value rising to $209.7 billion, up 17 per cent from the prior year, helped by a strong economy and rising confidence. “From my perspective in the areas that I work in, [M&A players] aren’t really giving a whole lot of thought about NAFTA,” says Alicia Quesnel, a partner at Burnet, Duckworth & Palmer LLP.

Based in Calgary, Quesnel focuses on the Energy sector, where she’s involved primarily in M&A for large and mid-size companies. Despite languishing crude prices, the sector continues to be active as companies look to diversify and take advantage of historically low prices. “You know, NAFTA is interesting,” she says, but the Energy sector has much more immediate concerns, such as the price of oil. “With the oil industry you’re talking about global markets and commodity prices. That’s the big determinant for how much you’re going to get paid for your product. Some of our biggest issues are pipeline constraints and how do you get to markets that are more lucrative. If we can’t get our product to market, [that’s a problem].”

That’s a common perspective in resource sectors where prices are set globally, and especially in mining where Canadian companies are leading competitors, operating around the world. When your customers are in places like Europe and Asia, why get over-concerned with what’s happening in the US? “Clearly, uncertainty about NAFTA could be detrimental [to M&A] but of course it depends on the industry you’re in,” says
Jeremy Fraiberg, a partner at Osler, Hoskin & Harcourt LLP and co-chair of the firm’s M&A group.

Jonathan Feldman, a partner at Goodmans LLP, says his firm’s M&A practice was the busiest it’s ever been for much of last year, and that looks set to continue, despite the dark clouds over Washington. Clients are wary of the situation, but as long as it’s unresolved they have no choice but to react to real and existing factors. “I think tax reform [in the US] is supercharging confidence, and if you look at it in the US, deal-making is off the charts,” he says. “M&A activity is as robust as it’s ever been, and it’s mega-deals — they’re doing huge deals right now. The M&A market in the US has been on fire.”

Part of the reason the environment in Canada is so buoyant is that the optimistic mood is spilling over from the US. “The Canadian economy is doing really well,” says Davies’ Shishler. Companies have fixed their balance sheets, there’s a lot of liquidity, the banks are willing to lend. These macroeconomic factors helped propel the M&A market in 2017 and “when you reach out to investment bankers, there’s a great deal of optimism around what 2018 will look like.”

Cameron Belsher, a partner at McCarthy Tétrault LLP and head of the firm’s M&A group, says his clients are putting their NAFTA concerns to one side. There’s “an overwhelming feeling from our clients of business as usual right now,” he says. “You have to think about [the future of the trade agreement] — it’s going to be a factor, but right now there’s so many other factors lined up for robust M&A activity [and that’s] overweighing NAFTA considerations.”

Belsher identifies three of them. One is the low Canadian dollar. Another is interest rates, which are close to historic lows. And the third is the emergence of private-equity funds sitting on vast piles of capital and looking for a place to put it. “The M&A market is as robust as I’ve seen it since 2006,” he says. “We are talking across the board.”

“From our clients we don’t hear a lot of fear about NAFTA,” says Belsher. Like everybody else, they’re in the dark about how the negotiations will play out, but they’re not sitting around waiting for clarity. From their perspective, it’s a factor in their thinking, but for the time being it’s less important than the immediate drivers of the economy. “People are focused on the availability of capital; there’s a lot of liquidity in the market so it’s time to build, it’s time to grow.”

Many of the deals he’s worked on involve businesses started by baby boomers who, as they enter their 60s and 70s, are looking to sell up. They’ve spent their lives building their companies and now they want to enjoy the benefits. These are strong businesses with good valuations, and private-equity funds are enthusiastic buyers — it’s a “perfect storm,” he says.

Not everybody is feeling euphoric, though. Auto parts manufacturers, for example, would experience significant disruption if NAFTA was torn up, with Canadian players potentially subjected to penalties for their US exports. Lumber producers would be similarly disrupted, as would pulp and paper companies. Those sectors are in the eye of the storm.

“What I see is that there is considerable uncertainty associated with industries where there is a very significant component of trade with the US that’s front and centre addressed in NAFTA,” says
Fred Pletcher, a partner at Borden Ladner Gervais LLP. “So, if you’re a Canadian auto parts manufacturer or a contributor to the auto supply chain, yeah, it’s more difficult these days” to find an acquirer.

The stumbling block for a potential buyer is figuring out value for the target asset. If NAFTA stays in place, that’s a relatively simple calculation, but if NAFTA goes away or gets renegotiated, what does the price become? Until we know the outcome, pricing is a challenge. Some buyers in industries that would be affected by changes to NAFTA are taking a wait-and-see approach, says Pletcher, who chairs his firm’s national mining group.

That said, deals are still happening, and equity investors, for the time being, don’t seem particularly rattled. Shares in Canadian auto parts makers have risen strongly over the past 18 months, with some approaching record highs. Shares in forest companies are also benefitting from an updraft. Practitioners in the area say one of the few areas where uncertainty is showing through is in some M&A agreements that now include clauses that require the purchaser to be compensated in the event, say, the US walks away from NAFTA.

Perhaps the real issue is that uncertainty around trade deal is so great that players simply don’t know how, or whether, to act. Over the past year, the Trump administration has made a variety of statements about its intentions on NAFTA, ranging from, “It’s a bad agreement that must be torn up” to, more recently, “Let’s renegotiate the pact.” Some observers speculate that even the White House isn’t clear on what it wants.

One theory making the rounds, according to a lawyer who asked not to be named, is that the old Canada-US Free Trade Agreement that existed prior to NAFTA was never actually terminated. Instead it was simply left dormant. Should NAFTA be thrown out, this line of thinking goes, the old Free Trade deal would automatically come back into force. And since it was similar to NAFTA, there would be minimal disruption for Canadian companies.

But this just adds to the speculation. The bottom line is that there are a great many ways this issue could be resolved, and given the complexity of NAFTA itself, each potential outcome would impact companies differently. That’s a whole lot to think about for any potential participant in an M&A deal. Some observers wonder if they’re simply tuning it out. “I think people are sort of saying, we can only control what we can control,” says Goodman’s Feldman. “People are doing deals in spite of the uncertainty.”