The deals are back.
After a slow start to 2010, the market for mergers is rolling, with conditions that remind bankers of the golden years of the mid-2000s. The underpinnings for recovery began to line up in summer, after the European sovereign debt scare faded, with cheap and plentiful financing and signs of an improving economy.
All it needed was a spark. It came in August, when BHP Billiton Ltd. launched an almost $40-billion hostile bid for Potash Corp. of Saskatchewan, a proposed transaction that dwarfed anything seen in years.
It was, as one banker put it, the most important deal in Canada since the downturn, even though it was never consummated. The proposal was eventually scotched by the government, in a move that still reverberates with policy implications for deal makers. Still, the mere announcement of a transaction that big, funded with a huge lending commitment, marked a full-on revival of the deal market. For those mulling whether markets were right to launch a transaction, the BHP bid was a giant green light.
“It all really came together with dramatic effect in the summer when we saw the BHP bid for Potash. At that point the whole transaction side of the business got moving,” said Geoff Belsher, head of investment banking at CIBC.
In all, even without the Potash transaction, 2010 mergers and acquisitions totalled $177-billion (U.S.), according to Thomson Reuters, up from $146-billion in 2009. Resources dominated, but there were also large transactions in sectors such as media, infrastructure and banking. Two months into 2011, there are more big deals on the table, including TMX Group Inc.’s plan to combine with London Stock Exchange PLC, and numerous resource deals.
“It’s become an all-systems-go market,” said Tom Milroy, chief executive officer of BMO Nesbitt Burns Inc., which was the busiest adviser on merger deals measured by dollar value in 2010, and the biggest underwriter of stock sales. In addition to the favourable conditions, he said: “There is pent-up demand for deals. A lot of people had been on the sidelines for some time.”
The resurgence coincided with fading concerns about a global double-dip recession, and a realization that while the world economy wasn’t great, it wasn’t likely to fall off another cliff. There was enough stability to start planning for growth. And that means buying.
“There were relatively good values in the market and people were feeling more optimistic about the economic outlook,” said Jack Curtin, CEO of the Canadian arm of Goldman Sachs Group Inc., which was the No. 2 adviser on mergers in Canada last year. “Some of the acquirers wanted to be sure they were on the bus for the rebound.”
But if conditions now resemble the golden years like 2005, when mergers were surging and markets were supportive, some worry about a repeat of the excess that followed those years – and which tipped into the financial crisis.
Already terms on loans are getting much easier, leading Gerry Schwartz, head of buyout firm Onex Corp., to marvel in late 2010 at the remarkable turnaround. He said he was being pitched ideas that many thought had largely disappeared in the wake of the crisis, such as payment-in-kind bonds, where the borrower can pay interest by issuing more debt – the corporate version of a negative amortization mortgage.
“Covenants are getting looser south of the border in the loan market,” said Doug Guzman, head of global investment banking at RBC Dominion Securities Inc. “The pricing isn’t as crazy as it was pre-crisis, but it has come a really long way back.”
On top of that, there remain concerns about mounting government debts and stability in Africa and the Middle East.
“It would be a mistake to overlook the potential risk introduced by factors such as the developments in the Middle East and the overall fiscal debt burdens,” said Pat Meneley, head of investment banking at TD Securities.
Still, the market looks sane so far. Companies have lots of cash, which reduces their need to borrow.
The debt-heavy private-equity mega-buyouts that marked 2007 have yet to return to Canada. Fancy derivative structures such as collateralized loan obligations, which created demand for loans and fed buyout activity, are for the most part still dead and buried.
For the most part, bidding wars such as those that drove up prices for companies such as Inco and Alcan Inc. are absent. There are lots of targets to go around, and executives are leery of overpaying.
“It’s very risky,” said Egizio Bianchini, co-head of mining banking at BMO. “The companies are figuring that out.”
Coupled with that, arbitrageurs, the money managers who buy up shares of target companies and try to force a higher price, are keeping a much lower profile. During the boom years, they had huge influence but were hit hard in the crisis. Some closed up shop. Those that remain are chastened.
“They are not as greedy as they used to be,” said Wes Hall, CEO of Kingsdale Shareholder Services, which helps companies in takeovers deal with their shareholders. “Before it was ‘cash is king, cash is king.’ Now they’re not looking for the additional 30-per-cent premium to the offer price.”
So for the moment, it’s a goldilocks deal economy.
Canadian companies are feeling confident, buoyed by the country’s strong economic performance and currency. Buyers are increasingly looking abroad and finding targets like Chrysler Financial, snapped up by Toronto-Dominion Bank, and U.S. bank holding company Marshall & Ilsley Corp., purchased by Bank of Montreal.
Where will the deals be in 2011? Again, it will be resources. Bankers flag base metals such as copper and bulk commodities such as potash as continuing hot spots, with gold miners also likely to continue to buy up choice assets.
There’s also likely to be more coming in financial services, some deal makers said. Banks are more free to acquire as the capital handcuffs put on by regulators have come off and there are signs the brokerage industry is likely to consolidate, something that started last year when Canaccord Financial Inc. bought Genuity Capital Markets to become a bigger player in the securities business.
Asset managers are likely to be targets, said Gary Girvan, a partner at McCarthy Tétrault LLP who specializes in mergers and acquisitions. Bank of Nova Scotia spent $2.3-billion to purchase mutual fund company DundeeWealth Inc. in a deal cut in November, and other banks may look to acquire asset managers because it’s a low capital business with nice fee income.
“The banks have more confidence now in looking around, saying, ‘How do we grow our business in Canada?’” Mr. Girvan said.
For companies that want to do business, there are investors eager to finance them, especially if there’s a regular payout in it for yield-starved backers.
That’s led to the creation of whole new asset classes in Canada, including a high yield bond market that produced $3.8-billion of issuance. For years, bankers have talked about a high yield bond market, but in 2010 it really happened. There are predictions from banks that issuance could top $5-billion this year.
There’s also a wider market for bonds issued by public-private partnerships. Loans to help governments build hospitals and other public buildings were once the preserve of insurance companies. But since a bond deal for McGill University Health Centre last year showed that a wider range of investors, including mutual funds, would be interested, the market has boomed, said Greg Woynarksi, global co-head of credit capital markets and fixed income at Scotia Capital Inc., the lead underwriter on the McGill deal.
“It’s not a small thing that two new asset classes were created in Canada last year.”