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January 19, 2015
M&A AND CAPITAL STRUCTURE STRATEGY OUTLOOK 2015, PART I

Global M&A: Bigger May not Be Better, But It Is Certainly More Popular

In 2015 both Canadian and global M&A markets witnessed a trend towards larger transactions, with Canadian funding sources prominent amongst both arenas (the Caisse de depot’s participation in the $8 billion PetSmart deal being a case in point).

In Canada, total deal volume rose 40% to CAD$245.7 billion whilst deal volume in the CAD$1+ billion category rose 108% to $150.1 billion. Tax played a significant role, with the private equity owners of Burger stepping up to pay CAD$ 14.6 billion for Tim Hortons in a so-called tax inversion deal.

Globally, US and European M&A topped $2 trillion. Almost 100 transactions were worth $5 billion or more. The four largest deals were:

  • Comcast buying Time Warner Cable: $71 billion
  • AT&T buying satellite TV operator DirecTV for $67 B
  • Allergan buying Actavis for $66 B
  • Kinder Morgan’s purchase of Kinder Morgan Energy partners for $59 B

Interestingly these deals come with seemingly endless regulatory approvals: Time Warner was announced in February and has yet to close.

Energy and resources continued to drive M&A momentum in 2014, though the recent collapse in the price of commodities such as oil and iron ore presages what may prove to be a more temperate climate in the resources sector (at the minimum lower commodity prices will slash the enterprise values of targets). Some prominent energy and resources deals included Encana’s $7.1 billion purchase of Athlon Energy of Texas, Apollo Global snagging Encana’s Bighorn Assets for $1.9 billion and Yamana and Agnico Eagle teaming to spend CAD$3.9 billion to purchase Osisko Mining.

Large scale and over-arching ambition also comes with risks. Very significantly the quantum of withdrawn global deals also soared: $662B versus $285B in 2013.

National Security: The New M&A Protectionism In Canada

Under previous governments Canada had attempted to protect national champions in many sectors through the application of a review process on foreign investment. These rules were scrapped, but of late a much murkier, national-security driven review process has emerged to have an impact on critical sectors such as telecommunications and energy. For example the proposed deals for both Wind Mobile and MTS Allstream were killed by Ottawa on undefined security grounds.

A substantial number of these reviews are being conducted in the Prime Minister’s Office (PMO); we also understand that in a number of cases potential bidders have sought unofficial pre-clearance and have been warned off.  It can therefore be argued that the value of reaching out to Ottawa in advance of a possible bid has never been higher.

In our view this implies a new approach to potentially sensitive deals:

  • think through the potential national security implications of a potential transaction and, as appropriate,  develop a quiet communications strategy with the PMO and/or relevant government departments
  • develop and articulate strategies to address potential concerns of various interested constituencies in advance of announcing any bid
  • as appropriate, consider governance structures to reassure the PMO. Examples could include board subcommittees populated with demonstrably independent Canadian directors (drawn from the “great and the good”) capable of providing oversight of,  and control over,  sensitive matters

Activism – Bigger, More Forceful And Able To Effect Change

A theme we have written a great deal about is the strategic import of the rising scale and ambition of activist investors (please see, for example, our blog posts of 15 December 2014 and 3 October 2014).

The largest activist fund, Mr William Ackman’s Pershing Square Capital, now commands a war chest of $18 billion. Having undertaken an IPO a substantial portion of this now constitutes permanent capital. Moreover Pershing Square has defeated a truly establishment Canadian board (Canadian Pacific) and (in the view of some) created a new model for activism whereby it partners with a strategic acquirer (Valeant/Allergan).  Few companies are truly off limits for activist funds.

Within this context the suggestion that talking to activists better than fighting them appears to be growingly popular. Activists are increasingly arriving with well-researched, thoroughly documented analyses of companies; in many instances they have also enlisted the support of experienced industry executives. Engaging in a constructive dialogue allows companies to at least understand these analyses in a measured way whilst avoiding the first rush of abuse (and even vitriol) that historically accompanied the classic activist approach.

In Canada the number of formal proxy contests is well down from 2012 peak and the number of situations wherein boards and activists arrive at some form of agreement is growing. In Canada, situations where measures proposed for a shareholder vote and are subsequently withdrawn topped 40% for the second year running (source: SEDAR).

Another activist-driven trend increasingly imported from the US is – and this statement is subject to several caveats –  appraisal litigation. An activist unhappy with a purchase price may exercise dissent rights and demand that a court value a business. Approaching 20% of public deals in the US now experience some variant of this. The risk of appraisal litigation renders fairness opinions a much trickier matter.

On the other hand, appraisal litigation is not without risks in Canada.  Paulson & Co launched a dissenting action against Total’s takeover of Deer Creek, arguing that the latter had been undervalued. An Alberta court ruled that the stock market was a better judge of value than any appraisal and left Paulson with no net gain. Canada typically sees agreed deals structured as plans of arrangement – under these situations courts have historically tended to favour the company rather than dissenting shareholders.  Whether this will remain true is another matter.