Recent Development in Corporate Mid-Market

Despite the confusion in global markets in Q2 2011, Canada's middle market was busier than ever. According to a PwC report, the sector – defined as encompassing deals in the US$100-million to US$1-billion range – saw 71 deals worth US$23 billion during the quarter.

The report, entitled Deals Quarterly: Q2:2011, cites transactions such as Gildan Activewear's $350-million acquisition of Gold Toe Moertz LCC; Lassonde Industries' $390-million acquisition of Clement Pappas & Co.; and Centric Health's $224-million acquisition of Lifemark Health.

"Across all market segments, acquisitions were largely horizontal, pursued by buyers seeking to deploy excess cash and capitalize on access to cheap deal financing against a backdrop of weak organic growth," the report states. "We did not observe a high level of activity driven by vertical integration or operational diversification strategies."

Especially notable in the middle market was an increase in subordinated or mezzanine financing for private equity deals. Cassels Brock & Blackwell LLP's Private Equity Team's publication, M&A in Canada: A 2011 Mid-Year Review, notes that there has been a "re-emergence" of more highly-leveraged and cash flow transactions. Sponsor-based financing is also gaining credibility.

"While fund-raising still appears to be a challenge in the current environment, the overall pace of private equity financings, including leveraged financings, appears to be on the rise," the group states.

Significant PE transactions in Q2 included mid-market fund Novacap's acquisition of Idaho Pacific Holding, Inc., a subsidiary of Otter Tail Corporation that specializes in manufacturing dehydrated potato products; and the $25-million investment by Penfund, a Canadian private equity concern that provides junior capital to mid-market companies, in Hopkins Manufacturing Corporation, which makes branded products for the automotive aftermarket.

Mid-market PE real estate transactions included Primaris Retail REIT's announcement that it would acquire five Canadian shopping centres worth $584 million. The key driver of the robust activity in the real estate sector, according to the report, is "an intense thirst for yield by institutional and retail investors." They in turn are driven by low interest rates and the phasing out of income trusts.

Looking to the future, the report's authors expect "cautious optimism" through 2011 and 2012 with Canada faring better than many other developed nations in a period of macro instability.

Key predictions in the report are that buyer-seller expectation gaps will slow markets; that steady deal volume will continue in select sectors, with the Western provinces particularly active; and that the election of a federal Conservative majority government in Q2 will be a "game changer" for Canadian M&A activity, with the telecom, media, agriculture and oil sands sectors becoming increasingly "foreign investor friendly."

The report also predicts the emergence of foreign asset investment trusts such as Eagle Energy Trust and Parallel Energy Trust, structures that are excepted from income trusts legislation because their earnings are from foreign assets whose profits flow to Canada. According to PwC, the structures are best employed by capital intensive companies with income producing foreign assets in the $100–$400 million valuation range; predictable distributable annual cash flow in the $15-$35 million range; and a reputable management team that can grow unit value and distributions.

Osler, Hoskin & Harcourt LLP's mid-market group, which defines mid-market as deals up to $250 million, has predicted that this market will drive Canadian M&A activity through 2011 as it did in 2010, when almost 90 per cent of announced Canadian transactions were mid-market deals. Many of the trends observed in 2010, the group adds, will continue. These trends include mid-market acquisitions in the natural resources, technology and real estate sectors, the prevalence of cross-border transactions, and foreign acquisitions by Canadian mid-market companies capitalizing on the relative strength of the Canadian economy.