Canada’s unique “bought deal” structures, like Milestone’s Apartment REIT’s recent upsized $165 million offering, have retained their attractiveness despite the vagaries of current economic and market conditions.
“When you’re talking bought deals, you’re talking about the magic sauce of Canada’s capital markets,” says Stephen Pincus of Goodmans LLP in Toronto, who represented Milestone. “Historically, bought deals still get done even after the IPO windows close.”
It was only in the darkest days of the financial crisis that it was tough to arrange bought deals.
“Even then, bought deals recovered very quickly,” Pincus says. “They seem to be a very robust form of financing that remains available through the ups and downs in the market.”
One reason for bought deals’ popularity is that they represent a very efficient way of raising capital that, with limited exceptions for large, seasoned issuers, has no parallel in the US.
“Billions of dollars have been raised since the bought deal phenomenon developed here in the eighties,” Pincus says.
But why are banks eager to get in on these transactions more or less regardless of economic conditions?
“Partly because the underwriters are getting commissions on transactions that involves very good companies with track records, and also because the deals feature relatively easy execution, as opposed to IPOs that involve months of work,” Pincus says.
Indeed, minimized execution risk and short transactional time frame are the hallmarks of bought deals.
“Both the quick turnover and the fact that underwriters assume the marketing risk on announcement of the deal gives issuers significant flexibility in executing a growth or monetization strategy,” Pincus says. “It’s really an application of the short form prospectus system we have in Canada, a process that is not available elsewhere.”
Bought deals are particularly useful to entities like REITS and high-dividend companies that pay out a substantial portion of their cash flow yet need funds to advance growth or monetization strategies.
“Bought deals allow such companies to go to the market in real time to fund acquisitions, work capital or debt repayment,” Pincus says. “That makes life much easier for them because acquisitions are much more difficult to do if you have to go to the market and raise the financing after the transaction is announced – plus there are no costly road shows like the ones that usually accompany marketed offerings.”
Generally speaking, the underwriters commit before the issuer even files the prospectus, and closing usually occurs within two or three weeks. Apart from total market collapse or material change, there are few exit routes from the commitment.
“These deals are done at a fixed price, so the underwriters assume all of the pricing risks after they make the commitment,” says Jim Reid of Davies Ward Phillips & Vineberg LLP in Toronto. “That’s very appealing to issuers.”
The bought deal market is also a hugely competitive one.
“Issuers have leverage in this segment of the market,” Reid says.
Originally set at $100 million, Milestone’s offering was upsized by 65 per cent ($181 million if the over-allotment option is exercised in full). Using a shelf prospectus, the bought deal was completed little more than a week after its announcement.
To be sure, Milestone is no newcomer to the process. It owns 72 multifamily residential properties in the US, did its IPO on the Toronto Stock Exchange in 2013 as the first ever non-US entity to qualify as a US REIT, and has completed five bought deals since going public.
Since the IPO, Milestone has acquired more than $1 billion in assets and its capitalization has grown from $500 million to $1.2 billion.
So why doesn’t a bought deal market exist in the US?
The answer lies in the fact that underwriting banks don’t want to be holding their positions for an extended period of time.
“Canadian regulators are more willing to move quickly and allow these deals to close than their US counterparts,” says Shawn McReynolds, Reid’s partner at Davies. “That’s part of the banks’ risk analysis.”
As it turns out, bought deals were the brainchild of a risk-taking outlier, Gordon Capital, which back in the eighties was a buccaneering, independent Toronto investment house
“By taking up offerings with no marketing risk to the issuer, Gordon Capital found its way to a huge competitive advantage, and eventually everyone had to play the game,” says McReynolds. “But there weren’t any such outliers in the US, where there was more regulatory risk in doing these deals and they could not be done as expeditiously as they could under the Canadian system.”