New foreign investment rules will lead to strategically timed takeovers

Recent changes to the methodology for calculating net benefit review thresholds under the Investment Canada Act could add some strategic wrinkles to foreign takeover tactics.

“There’s definitely room for manoeuvring in public bids, both in the planning stages and in deciding when to make the ICA filing,” says Michelle Lally of Osler, Hoskin & Harcourt LLP in Toronto. “These rules could also create a first-to-file advantage in auction scenarios.”

The new regulations, announced in late March and effective as of April 24, will on their face raise the threshold for government reviews under the ICA to $800 million in 2017, $1 billion in 2019, and indexed thereafter. But comparing these numbers to the previous $369-million threshold is indeed an “apples and oranges” exercise.

The old thresholds used the takeover target’s “book value,” which is readily ascertained from financial statements. The new thresholds use “enterprise value” in the hope that it will attach a more current market value to the target. Enterprise value, which is in constant flux, is calculated by determining the company’s market capitalization, adding long-term liabilities to be assumed by the acquirer, then subtracting operating liabilities and cash.

What’s important from a strategic perspective, however, is that, for the purposes of the ICA, enterprise value is calculated as of the date of the ICA filing. “Because enterprise value is effectively linked to the share price of a company, we could have situations where share fluctuations change the ICA status in the sense that the target might meet the net benefit threshold at one point in time but not at another,” says Omar Wakil of Torys LLP in Toronto.

Because enterprise value is frozen at the date of the ICA filing – but only for the bidder filing – potential acquirers’ reviewability status could differ. “The ICA process is now more than ever a material risk factor for consideration, and could certainly affect the valuation of targets,” says Subrata Bhattacharjee of Borden Ladner Gervais LLP in Toronto.

Auction scenarios are perhaps most likely to be affected, particularly where multiple foreign bidders are stalking the same Canadian target.

“Where the announcement of a first bid has the effect of increasing the target’s share price, it may result in an uneven playing field amongst foreign bidders,” Lally explains. “While the first bidder would not be subject to ICA review, if there is a significant time gap in between bids such that enterprise value has increased as a result of the first offer, the subsequent bidders may be subject to ICA review if the enterprise value threshold is exceeded.”

In addition, if the bidding price goes up beyond the threshold, bidders who upgrade their offer beyond the threshold will still maintain the exempt status proffered by their original below-the threshold bid.

It’s not, however, as if day-to-day fluctuations in share price will be determinative of the outcome. “Enterprise value is calculated using a market cap based on the last 20 days of the month preceding the month of the ICA filing, so an April filing would look to the end of February,” Wakil says.

Whatever their degree of impact, these consequences were not unforeseen. “Various stakeholders, including the Canadian Bar Association and our firm, thoroughly discussed the implications of using enterprise value as a standard with policymakers at Industry Canada,” Lally says. “The government knew that there could be instances in which there might not be a level playing field, but decided that the consequences were not that significant.”

That being said, it’s important to remember that the foreign review changes were implemented by regulation, not legislation. “Regulations are a lot easier to change than legislation, and these could change,” Wakil says. “But at this point the government has done their best to put forward a workable scheme, and we won’t know how it’s working out until we have at least a couple of years’ experience.”