The Canadian economy has remained relatively stable amidst the continuing global economic uncertainty, bolstered by a robust commodities sector and a stable banking system.
Canadian M&A volume has tracked the moderate levels experienced globally, with 2,523 deals valued at C$216 billion ($207 billion) in 2011 and the first quarter of 2012 (compared with 2,757 deals valued at C$204 billion over the prior-year periods). On the buyout front, there were 274 Canadian transactions in 2011, with a value of C$32 billion (an increase from 146 deals valued at C$29 billion in 2010). This trend has generally continued in the first quarter of 2012, with 56 buyouts, valued at C$1.7 billion (an increase of 14% but a notable decrease of 65% from the same period in 2011).
Looking ahead, we see a number of trends that will continue to shape the Canadian private equity landscape:
Moderate leveraged buyout volume. With sponsors and lenders remaining cautious, given the tepid U.S. recovery and volatility in Europe, moderate Canadian LBO volume is expected to continue. Nevertheless, some general partners will take advantage of existing committed capital (perhaps motivated by pending expiries of capital deployment periods), the stability of Canadian banks and continued availability of financing for incremental portfolio company acquisitions. Sponsors are likely to continue to look for attractive targets in the middle market, which remains the core of LBO deal activity in Canada.
Canadian pension plans to remain active. Driven in part by greater independence in governance models and a desire to diversify asset classes, Canada's public pension plans have proved to be top-tier international dealmakers and have been involved in some of the largest global M&A transactions. These plans are expected to continue active PE investment strategies -- both in Canada and abroad -- having represented over 33% of all Canadian LBO dollar volume in 2011 and in the first quarter of 2012. In addition to direct investments, co-investment deal volume should also remain strong, providing both attractive deal opportunities for pension plans and needed capital to GPs for larger transactions.
LBO deal terms. Although increasingly common in the U.S., go-shop provisions have not found favor in Canada, as evidenced in the Blakes Canadian Public M&A Deal Study, Third Annual Edition Winter 2010/2011, which identified one transaction out of 50 with a go-shop. This reluctance can be traced to fewer public-to-private LBOs than the U.S., skepticism about their effectiveness in maximizing shareholder value and the lack of a "Revlon" duty. Separately, two reverse break fee constructs have found use in Canada, a "pure option" reverse break fee that allows a buyer to walk away by paying a negotiated fee to the target and a reverse break fee for financing failure (with corresponding specific performance available where the lenders are willing and able to lend). Lenders and buyers continue to successfully resist a target's ability to enforce lending arrangements. Nervousness about financing risk has led a number of private transactions to follow a sign-and-close model that eliminates risk to buyers and sellers by pushing the signing of a purchase-and-sale agreement and a committed credit facility to a single date.
Potential new income trust exit opportunities. The government's 2008 tax policy shift, which effectively eliminated the tax advantages of Canadian business income trusts by taxing trust earnings similarly to corporations, didn't impact trusts that derive income from non-Canadian sources. This provided exit opportunities for sponsors that are evaluating taking their non-Canadian businesses, particularly those with stable cash flow, public as one of a new generation of cross-border income trusts. Although the first such "second generation" trusts have been energy-focused, there is generally no restriction on the types of businesses that may use this model, provided they are not Canadian.
Importance of foreign investment reviews. The Canadian government agency responsible for most inbound foreign investment -- the Investment Review Division of Industry Canada -- continues to be at the forefront of public policy debate. In light of the IRD's increased scrutiny of transactions, success will be increasingly dependent on developing effective government, media and key stakeholder-relations strategies early in the deal process.
With stability in its economy and financial system, Canada will continue to be an attractive M&A marketplace for GPs to put their capital to work, especially in middle-market buyouts.
Jamie S. Koumanakos and Michael Gans are partners at Blake, Cassels & Graydon LLP, based in Toronto.