Leading the Canadian M&A Revival

Just as Canada’s athletes outdid themselves at the Winter Olympics, so too might the country’s M&A deal makers with a record-breaking year in 2010. Part of the reason for this optimism is the 150 or so investment trusts that have not yet converted to public companies, which they are expected to do before January 2011 when the tax treatment that made such a model favorable will be withdrawn.

‘There will be a great deal of change over the next nine to 10 months,’ says Glenn Keeling, partner at Laurel Hill Advisory Group in Toronto. ‘Most conversions from income trusts to publicly traded companies are expected to be relatively smooth, but there is going to be a lot of action within the sector.’ And Keeling predicts some of this action will be contentious.

Many of the deals that took place in 2009 were at the lower end of the market and, with one or two exceptions, there were few of the blockbuster deals that had come to dominate the M&A landscape until the start of the credit crisis in 2008 (see Financial advisers to Canadian M&A, opposite). One significant change is that private equity has largely retreated from the M&A playing field. Another reason for the drop-off in top-end deals is the pension funds, which are often the instigators of M&A activity. The economic crisis hit them badly, forcing them to concentrate on other issues and be less activist. The relative scarcity of financing and the forced sidelining of some major players have pushed deal activity into the mid-market space. The top end may see something of a comeback in 2010 but the market will likely be driven by the mid-caps, according to David Salmon Market issues of Laurel Hill.

‘We are seeing a lot of unsolicited deals, but these are generally at the smaller end of the market,’ he comments. ‘The companies people are going after are extremely small; on the eastern side of the country, most of what we are seeing is deal sizes from $10 million to $100 million or $150 million.’ Mark Adkins and Michael Gans, partners at Blake Cassels & Graydon, recently put together a list of issues facing the M&A market this year. They include:

• Income trust extinction: with more than 150 trusts still listed on the Toronto Stock Exchange, pension funds and strategic buyers will be looking to take advantage and pick up the best remaining trusts.
• Use of poison pills: while many companies have removed existing pills in recent years, it’s possible boards will ask shareholders to support the implementation of new rights plans in the event of a hostile takeover that may be at a sub-standard price. Recent court activity may make this easier.
• Shareholder activism: institutional shareholders have been showing an increasing willingness to voice their displeasure with management, boards and corporate policy. We can expect to see proxy contests continue, and a renewed push for improved governance standards. Potential acquirers will need to negotiate simultaneously with both the board of a target and its key security holders.
• More hostile deals: depressed valuations resulting from the financial crisis created the strongest buyers’ market in decades. Despite signs of recovery, the gap between buyer and seller expectations will lead to further unsolicited, opportunistic bids for public companies. The new supplementary information request process under the Competition Act has timing implications for bids that raise competition issues and will need to be considered carefully in strategic planning.
• Increased middle-market activity: mid-market deals will continue, while more aggressive transactions requiring significant financing will have difficulty finding traction until credit conditions improve.

The simple reality is that shareholders are now far more likely to get involved and speak with their vote. Although many deals may be basically good, there are certain constituents who may be opposed to them for their own reasons. In the past you could simply overlook these shareholders, but that is no longer the case; this is being seen in the lower approval ratings board members are getting on election day. With a high likelihood of hostile activity and the concerned shareholder demographic changing, it is more vital than ever to adopt a policy of year-round engagement with shareholders.