A decade after a flurry of corporate takeovers spurred worries that deep-pocketed foreign giants would turn Canada into a branch-plant economy, precisely the opposite story is playing out across North American markets.
Canadian companies are bulking up to global scale through a spate of bold mergers and acquisitions. This week, Potash Corp. of Saskatchewan Inc. and Agrium Inc. of Calgary announced that they are joining forces to create the world's largest crop-nutrient company. A few days before, Enbridge Inc. of Calgary unveiled a U.S. deal that will result in North America's biggest energy infrastructure firm. And just a couple of weeks prior to that, Quebec-based Alimentation Couche-Tard Inc. completed a super-sized U.S. acquisition of its own to become the continent's No. 1 operator of convenience stores.
The outburst of deal making over the past month follows a year in which the value of Canadian direct investment abroad surged to its highest level ever. Flush with cash but faced with sluggish growth prospects at home, domestic companies are eager to find new ways to expand their sales and profits. Many are taking advantage of accommodating markets to buy foreign assets and add unprecedented heft.
Corporate Canada's appetite for growth has its risks, especially in a stock market that seems fully valued. However, it's a logical reaction to two global trends – agonizingly slow economic growth coupled with record-low interest rates.
Companies in many countries have responded to those twin factors by doing what comes naturally. They've used cheap money to take over rivals, thus boosting the acquirer's revenue despite the slow-growth environment.
The international urge to merge boosted global mergers and acquisitions activity to a record $5-trillion (U.S.) in 2015, according to analysts at JPMorgan Chase. "As corporations seek external growth, businesses are increasingly turning to cross-border transactions," they note in a report published early this year.
But the Canadian passion for foreign deal making is unusual even in a world where everyone is playing much the same game. In a Deloitte survey this year, Canadian executives topped the globe in terms of their level of interest in doing outbound M&A.
Canada already leads in terms of doing deals in the crucial U.S. market. According to law firm Paul Weiss, Canadian companies and funds have completed more than $93-billion in U.S. mergers and acquisitions over the past 12 months, putting them ahead of both German and Chinese acquirers.
It's a remarkable outburst of activity. And it all stands in stark contrast to the dark days of 2006.
The great hollowing out
The takeover frenzy of a decade ago was driven in large part by the rise of China. As companies scrambled to fill the Asian giant's seemingly bottomless appetite for raw materials, Canadian miners and steel makers became some of the world's hottest assets.
The selling of the Canadian economy inflamed public concern in 2006, when a cavalcade of Canadian corporate icons – Dofasco, Inco, Falconbridge and Fairmont Hotels (the former CP Hotels) – disappeared into the arms of foreigners within the span of 12 months. The blitz continued in 2007 with foreign takeovers of Alcan and Stelco.
When the dust had cleared, roughly $300-billion (Canadian) worth of corporate assets had slipped into foreign hands and some historically important sectors had lost their Canadian champions. In Sudbury, for instance, where two homegrown companies, Inco and Falconbridge, had long dominated global nickel production, the new bosses were either Brazilian or Swiss following Vale SA's $19-billion takeover of Inco and Xstrata's $18-billion acquisition of Falconbridge.
This all fed the narrative that Corporate Canada was being "hollowed out" by foreign acquirers, putting at risk jobs, factories, head offices and national pride. In the spring of 2007, Prime Minister Stephen Harper appointed a panel of corporate leaders, headed by former BCE Inc. chief executive officer Lynton (Red) Wilson, to look at ways of making Canada more competitive in a globalized economy. A year later, the panel published 65 recommendations – many of them aimed at making Canada even more open to both inbound and outbound foreign investment.
Those recommendations remain only partly implemented, but as legislators have continued to wrestle with the issue, the facts on the ground have shifted. Foreign acquirers continue to make Canadian acquisitions at a decent clip, but Canadian companies themselves are aggressively prowling for big foreign deals.
"We got conditioned over a number of years to think that the typical mega-transaction consisted of a foreigner buying a Canadian company," says Ed Giacomelli, managing director at Crosbie & Co., an investment bank in Toronto. "But that's just not the case any more. In many industries, from electrical utilities to financial services, Canadian companies are developing sophisticated M&A strategies to expand their scale and diversify their revenue streams."
Despite all the concern in years past about a hollowing out of the Canadian economy, this is not exactly a new trend, Mr. Giacomelli notes. Canadian companies have in fact been consistent buyers of foreign enterprises for more than a decade.
"I like to call it the Canadian M&A paradox," says Montreal lawyer Robert Yalden, co-chair of the mergers and acquisitions practice at Osler. "A lot of folks involved in public policy debates worry that Canada is getting the short end of the stick or losing more than its fair share of head offices. But year after year, Canadian companies are making acquisitions abroad at a pace and dollar volume that consistently surpasses the inbound activity."
What is remarkable is the size of the current deals. Enbridge's $37-billion (Canadian) deal for Spectra Energy, Canadian Imperial Bank of Commerce's $4.9-billion takeover of Chicago-based PrivateBancorp Inc. and Fortis Inc.'s $6.9-billion (U.S.) purchase of ITC Holdings Corp., the largest independent pure-play electricity transmission company in the United States, are just some of the jumbo transactions that have gone down this year.
Big deals
Swipe or tap to see some of Canada's major shoppers
Cash-rich Canadian companies
Corporate Canada's sudden eagerness for big deals appears to reflect forces that have hit here with particular impact. One such factor is the collapse in commodity prices, according to economist Jim Stanford, an adviser to the Unifor labour union and a professor at McMaster University.
"Canadian business leaders have been forced to consider a more ambitious role for themselves in the world beyond just extracting and exporting," Prof. Stanford says.
It's notable, he argues, that few of the recent acquisitions involve resource extraction companies. Instead, the most aggressive acquirers are in heavily regulated Canadian industries, such as banking, pipelines and utilities.
Those companies may be attempting to flee a restrictive regulatory environment, says Jack Mintz, a fellow at the University of Calgary's School of Public Policy. Slow approvals in Canada for pipelines, liquefied natural gas terminals and a host of other infrastructure projects are chasing money out of the country, he argues.
"There are a whole bunch of areas where getting things done in Canada is difficult," he says. "People are now taking their money abroad, where it's easier to do things."
In other cases, the issue may simply be market saturation, notes Mark Jamrozinski, Canadian managing partner for M&A at consultants Deloitte LLP in Toronto. A small number of Canadian banks, insurers and power utilities already dominate their respective sectors of the domestic economy, leaving them with few obvious ways to generate organic growth in an economy that's only trudging ahead.
"When you're struggling to generate growth internally, you have to go out and buy it," he says.
Many Canadian companies have the financial means to shop for just about anything they want, according to Walid Hejazi, an associate professor of international business at the University of Toronto's Rotman School of Management.
"When you look at the amount of cash in corporate bank accounts, Canada's cash level is the highest in the G7 when measured in terms of GDP," Prof. Hejazi says. "Basically, we're cash rich. The economy has a lot of money looking for places to go."
In addition, there's a big pent-up demand for deals because of Canada's discouraging attitude toward foreign takeovers, he argues. Public policy, shaped by the hollowing-out narrative, has presented a stony face to potential foreign acquirers for years.
In 2010, Ottawa rejected a hostile bid by Anglo-Australian mining giant BHP Billiton for Potash Corp. Then in 2012, when a Chinese state oil company acquired Calgary-based Nexen Inc., Prime Minister Harper drew a line in the sand, warning that future attempts by state-owned enterprises to invest in the oil patch would be allowed only under exceptional circumstances.
"Many Canadian companies that would have merged with large foreign companies over the past five years probably didn't because of the signals the government was sending that such deals weren't welcome," Prof. Hejazi says.
Now, the vicious downturn in commodity prices is adding to the pressure on companies to combine forces. "Whenever you have a downturn, you tend to see sectors consolidate," he says.
That certainly seems to apply in cases such as the fertilizer merger. Both Agrium and Potash confront a market where prices for their key products are in steep decline and it's vital to wring out costs. The two businesses say their tie-up will result in $500-million a year in savings.
"We are in a low-growth environment and companies are looking for cost reductions," explains Mr. Mintz of the University of Calgary. "One of the ways you do that is through a merger or consolidation that can generate synergies."
Those synergies often cross borders. Even the Potash-Agrium merger – a made-in-Canada affair focused initially on stripping out costs – has an international dimension. Jochen Tilk, the Potash Corp. boss, and Chuck Magro, CEO of Agrium, emphasized this week that the combined company will offer a bigger platform for doing more global acquisitions and marketing.
The fact that more Canadian companies are going global is a good thing, according to Craig Alexander, vice-president and chief economist at the Conference Board of Canada.
"Canadian companies that focus exclusively on Canada are focusing on 3 per cent of the world's economic opportunities," he points out. "Canadian companies can't afford to just limit themselves to the Canadian market."
And right now, buying in the U.S. makes sense for Canadian companies looking for opportunity. The U.S. is growing faster that most of the rest of the world and it's this country's closest trading partner, Mr. Alexander says.
"The bottom line is that the U.S. economy is growing, it has a lot of opportunity and it's a natural destination for Canadian business," he says.
Is the price right?
But are Canadian companies paying too much? If there's one caveat about the recent wave of outbound deal making, it has to do with valuation.
Pursuing takeovers toward the latter stages of a long-in-the-tooth economic recovery, when stock markets are already trading at generous multiples after an epic bull run, is usually not a recipe for finding value. That's especially true when acquirers pay lush takeover premiums for their targets.
Recent deals have featured some very generous premiums. Halifax-based Emera Inc., for instance, paid 48 per cent more than the prevailing prices when it acquired Teco Energy, a Florida power utility, last year for $6.5-billion. Fortis bought ITC Holdings in February at a price 33 per cent above where the U.S. utility had been trading, while TransCanada purchased Columbia Pipeline in March at a premium of 32 per cent.
Bay Street sources acknowledge the skepticism about rich premiums, but point out that companies can often choose to employ their stock, rather than cash, as the takeover currency. Some recent high-profile transactions, such as Enbridge-Spectra and Agrium-Potash, have been all-share transactions. Even in a worst-case scenario, such mergers involve nothing more dire than two companies swapping equally inflated stocks for one another.
When it comes to cash deals, the great equalizer is today's low interest rates. The market's willingness to provide financing for mega-deals at historically low rates can make even premium prices attractive to the right buyer – which is to say, a buyer who doesn't want to miss out on important consolidation opportunities and doesn't mind leveraging up the corporate balance sheet.
"These are big, industry-changing deals we're talking about," one investment banker says. "In many cases, you know you're not going to see another target like this any time soon. A CEO has to decide: Are you involved in where your sector is going next or aren't you?"
History suggests caution. Only about 25 per cent of mergers add significant value, while another 25 per cent turn out to be essentially break-even transactions, Mr. Jamrozinski of Deloitte estimates. The remaining half of mergers actually destroy value.
The flurry of takeovers in Canada back in 2006 underline the dangers. Vale, which acquired nickel giant Inco, has seen its stock plunge in recent years, in part because of slumping nickel prices. U.S. Steel, which took over Stelco, put the unit into creditor protection in 2014 as the entire steel industry continued to struggle with dismal prices.
The biggest winners from the current takeover frenzy will be companies that focus on what happens after the deal, Mr. Jamrozinski says. "M&A is hard to do. From our experience, where companies have been successful and created value, the key is often the discipline and approach they use post-merger rather than the price they paid going in."
Still, despite all the risks involved, he thinks the recent outburst of M&A is positive for Corporate Canada, a sign of more executives taking a long-term viewpoint. "This is a good story for Canada," he says. "There are far more companies out there thinking about where they want to be in 2020 or 2025 and pondering the strategies and technology they need to get there."
Illustration by John Sopinski / Source: freedesignfile.com