Shareholder activism could play larger role in deals in the future.
When Canadian Prime Minister Stephen Harper’s government rejected Anglo-Australian mining company BHP Billiton’s $39 billion takeover bid for fertilizer maker PotashCorp in late 2010, it sent a message to foreign investors worldwide: as countries seek to reestablish themselves amid the European debt crisis and the world economic slowdown, higher levels of scrutiny would be placed on M&A transactions involving major Canadian companies.
Reuters reported that Harper reemphasized that point in February, explaining in an interview that hostile takeovers of key Canadian businesses – especially those that have critical technologies the government has invested in – could be blocked under the Investment Canada Act because such transactions would not be ‘of net benefit to Canada.’ Of course, determining the types of ‘net benefit’ the government is likely to approve of is just one of the challenges facing companies that want to enter the Canadian M&A market in 2012.
MergerMarket reports that cross-border M&A activity involving Canadian firms decreased in 2011. The number of inbound and outbound transactions dropped to 454 deals worth $94.1 billion (C$94 billion), down from 501 deals worth $112.5 billion in 2010. Even with the decrease, observers are expecting a small uptick in M&A in the coming year. They say Canada has enjoyed budget surpluses over the last decade that make it a great place to do business, and its ample supply of natural resources, minerals, oil and precious metals attracts strong interest from foreign investors. In fact, 65 percent of all Canadian M&A deals were made in the energy, mining and utilities sectors in 2011, according to MergerMarket.
‘The atmosphere for M&A in Canada has remained much more positive than in the US because of the nature of the companies in Canada,’ says Geoff Belsher, a partner at Blake Cassels & Graydon who believes demand for natural resources and minerals from developing countries and Asia will fuel a significant amount of Canadian M&A activity this year. ‘If you take a look at the 50 largest M&A transactions in Canada last year, 74 percent of them were in oil, gas or mining. That’s huge, and that’s because Canada’s resource sector is so important.’
Canadian market obstacles
There are many regulatory and compliance issues that can affect foreign M&A deals in Canada. The following are just some of the issues companies looking to expand into the country need to prepare for so their deals won’t be blocked.
Investment Canada Act: This provision has been on the books for years. Government must approve all major foreign takeovers to ensure they are ‘of net benefit’ to the nation. The law recently received more attention when Canadian Chamber of Commerce president Perrin Beatty complained that unless the term ‘of net benefit to Canada’ is clarified, the rule could act as a deterrent to foreign investment.
‘What we have today is terminology that’s quite vague. It’s very much open to interpretation,’ Beatty told Reuters in February. ‘An investor doesn’t want to be embarrassed by making a bid that ends up being turned down. If there’s too much uncertainty, investors will take their investment elsewhere.’
While the majority of foreign takeover deals are approved, recent statements by Harper that he would like to see BlackBerry maker Research In Motion ‘continue to grow as a Canadian company’ have prompted concerns that protectionism might be on the rise. Investors must now calculate the risk of government rejection as in the case of Potash.
Douglas Watt, an associate director for the Conference Board of Canada, says concerns may be unwarranted because ‘most provincial governments have policies in place that ensure the decisions made are in the best interests of the country.’ He believes the policy has been, and will continue to be, interpreted fairly. ‘You have to have a strong government that is open to global trade and global investment, but also with the interests of the country and the province [in mind], so it’s a balanced approach,’ Watt says.
Operating rules and added costs: Doing business in Canada will differ in some ways from what investors may be used to in the US and elsewhere. ‘You can’t just come in, buy a business and think you are going to repatriate all the intellectual property back to the US and lay off all the employees without costs,’ says Belsher. He explains that because Canada closely monitors its unemployment situation, there may be additional costs to lay off workers. Corporate officers often have lengthy and expensive compensation agreements if they are fired, making some deals less appealing.
There are also French language requirements in Canada, so most products and services must be offered in English and French, and pricing must be labeled in both languages as well. This could add further costs.
Government enforcement of ‘undertakings’: ‘Very often in large acquisitions the federal government seeks undertakings, which generally deal with maintaining plants here in Canada, maintaining or increasing employment and making capital investments,’ says Richard Clark, a partner at Stikeman Elliott.
Clark says the government is going to step up enforcement of these types of agreements, so it is important companies know what undertakings are in the agreement before the merger. He notes that last year US Steel was forced into a settlement over its dispute to close two facilities after its approval to buy Canadian steel maker Stelco. US Steel’s argument that it could close the plants due to the worldwide economic slowdown in 2008 was rejected by regulators. The government has increased enforcement of these agreements, particularly when they involve employment. ‘Be aware of the undertakings built into a deal because you will be held to them,’ Clark warns.
Shareholder activism: The growing litigiousness of M&A transactions has led to more large shareholders trying to use governance proposals as leverage in M&A deals. ‘We are clearly seeing activist shareholders that will oppose transactions likely for the benefit of squeezing more money out of an acquirer, says Belsher. ‘That’s a trend that’s coming to Canada from the US. These are very short-term investors looking at making a very quick return in profit, but possibly at the cost of delaying transactions and making them more difficult.’
Shareholder activism can take many forms, such as attempting to place someone on the board in an attempt to influence company polices or push for a breakup of the company later. Such actions increase the costs of M&A deals, but could also illuminate governance issues that ought to be resolved before the acquisition.
‘Going into the coming proxy season we are seeing an increased interest by activist US shareholders regarding the boards of Canadian companies,’ Belsher says. ‘That may actually be a precursor to M&A – they may attempt to take toeholds to attempt to change the board of directors, start to agitate for change on boards now and it may have an effect on an M&A transaction in one or two years.’
Ownership restrictions: Depending on the industry and nature of the business, you must be very clear about any ownership restrictions imposed by the government. There are sectors, such as financial institutions, airlines, the uranium industry and broadcasting, where there are limits on foreign ownership. ‘In effect, you couldn’t acquire 100 percent of certain companies – you may have to acquire a lesser percentage or form a joint venture with a Canadian partner, which is often done,’ says Clark.
Financing: Even though Canada has some of the strongest banks in the world, the financing of mergers and acquisitions has not been a priority. Much of the financing for these deals comes from US lenders and US private equity firms. ‘If you are acquiring up here, don’t necessarily think you are going to be able to finance it locally,’ says Clark. Having the right financing for a deal, however, will definitely be critical in winning approval from regulators.
Governance trends in M&A deals
Geoff Belsher, a partner at Blake Cassels & Graydon, says certain governance trends are emerging in Canadian M&A, particularly when they relate to friendly transactions between companies of similar size, rather than hostile takeovers:
Open talks about chair, CEO and board composition: Discussions about the composition of the board and who is going to become the chairman and CEO are coming up more often. ‘You will have conversations about those three items because the significant shareholders of the target company will become significant shareholders of the ongoing entity, and usually the board of the target wants to make sure there is some continued representation on the board,’ explains Belsher.
Independent second fairness opinions: More boards are obtaining a second completely independent fairness opinion separate from their usual financial adviser. From 2008 to 2010, the number of companies choosing this option has been increasing; they now represent about a quarter of the transactions. ‘Boards, in a litigious environment, are being extra careful regarding conflicts with everyone –including possible conflicts with their lead financial adviser,’ says Belsher.
The establishment of independent committees: More boards are setting up independent committees to insure the integrity of negotiations during the merger. ‘It is done to fulfill the fiduciary duties of the board,’ says Belsher. ‘It is another evidentiary fact to prove that the board correctly met its fiduciary duty to be diligent and free of conflicts.’
Belsher adds that in 75 percent of the cases where it wasn’t required to set up one of these committees, a special committee was still set up, and in 80 percent of those cases, it was a completely independent special committee.
Pie chart 1: Canadian M&A transactions by industry
Mining 44%
Oil & gas/energy 30%
Industrial/utilities 12%
Financial services 6%
Real estate 4%
Technology & communications
2%
Consumer 2%
Source: Blake Cassels & Graydon
Canadian M&A transactions by size
More than C$5 billion 4%
C$1 billion to C$5 billion 18%
C$500 million to C$1 billion 18%
C$250 million to C$500 million 30%
Under C$250 million 30%
Source: Blake Cassels & Graydon
