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SNC-Lavalin project Highway 407 in OntarioHandout (SNC-Lavalin)
SNC-Lavalin project Highway 407 in OntarioHandout (SNC-Lavalin)

Pension funds head for the off-ramp Add to ...

The rapid pace of deal making that has kept Canada's pension plans busy in the past two years is expected to slow in 2011 as the market heats up, industry players say.

Managers of the country's largest pension funds have the luxury of being countercyclical investors, thanks to their long-term outlooks. They can snap up deals in slow markets and sit on the sidelines when things speed up. This year, with covenant-light loans, high leverage and deal-hungry strategic bidders returning to the market, pension fund executives say prudence will be the name of the game.

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"I think it's going to be a very, very active M&A year, but I think we'll be less involved," said Mark Wiseman, executive vice-president of investments at Canada Pension Plan Investment Board (CPPIB).

"We've already seen ourselves not just outbid by a little bit, but substantially outbid on deals on several occasions in the last few months," he added. "I wouldn't say markets are exceedingly frothy today, but boy they're sure starting to have the signs of it."

The funds have taken advantage of a high dollar and downturn-reduced prices to earn a global reputation in recent years for astute transactions. CPPIB, for example, has recently played a role in some of the world's biggest private-equity deals, including the takeovers of Tomkins PLC and IMS Health Inc.

In fact, with all of their deal making in the U.K. last year, Canadian pension plans actually managed to inject some spice into Britain's "hollowing out" debate. In addition to CPPIB's investment in Britain's storied Tomkins conglomerate, the Ontario Teachers' Pension Plan paid $625-million for Camelot Group Ltd., operator of the U.K. national lottery, and Teachers' teamed up with Borealis Infrastructure (part of the Ontario Municipal Employees Retirement System) in the winning $3.4-billion bid for the rights to run High Speed One, Britain's only high-speed rail line.

But the funds have become best known for their prowess in the infrastructure space, with deals such as CPPIB's $3.4-billion acquisition of Australian toll-road operator Intoll and Alberta Investment Management Corp.'s $850-million (U.S.) purchase of a 50-per-cent stake in a Chilean highway.

Infrastructure and private equity will continue to have allure in the year ahead, but Leo de Bever, chief executive of Aimco, sees worrying signs in the private equity space. "It's almost as if 2007 and 2008 didn't happen in that the pricing is pretty aggressive and the leverage is pretty aggressive," he said.

And Jim Leech, the CEO of Teachers, said that with a flood of buyers now looking to emerging markets where Teachers has already established a presence - such as Brazil, Chile and Turkey - he might become a seller in some sought-after locales. He can picture a tsunami of money headed for emerging economies, some of which are too small to absorb it, resulting in rapid price appreciation or a bubble.

"Particularly if it's a whole bunch of unsophisticated people running into those markets, as neophytes can cause dislocation," he said. "So that could even cause someone such as ourselves who has been there for some time to actually look to sell into that opportunity."

Nevertheless, Mr. Leech said he expects a growing proportion of the deals Canadian funds do will be in emerging markets, as the pension plans and others respond to the high growth rates in those regions.

When it comes to global deal-making, Mr. Leech sounded another note of caution, pointing to the revolution in Egypt as a serious reminder of how quickly things move in "this new world."

"A risk that you never would have thought of yesterday all of a sudden is staring you in the face today," he said. "It makes you pause and consider all of the risk factors and where they are intertwined. It's kind of like playing whack-a-mole - you hit a risk factor over here and it pops up someplace else you never thought of."

None of that is to say that Canadian pension funds will be out of the game entirely this year. Far from it: Smart investors can always find opportunities.

In many ways the funds will stick to their knitting, however, with nearly all still hunting for infrastructure deals and, in some cases, private equity.

Mr. Leech, for example, will be watching for opportunities in the U.S. where he expects debt-burdened states and municipalities will have to unload non-core assets.

Michael Nobrega, the chief executive of OMERS, will be busier than most as he has been tasked with deploying about $20-billion into private investments in the next five years, as the fund decreases the proportion of its asset mix that's allocated to stocks and bonds.

"We're always on the lookout for good assets, whether in good times or bad times," he said. OMERS will formally open its New York office in March, and is searching for partners to team up with on big deals.

Why big deals? "For big assets, north of $3-billion, you might see two or three competitors. Below $1-billion, you might see 10, 15 bidders." That means your chances are better to land a mega-deal as a consortium, rather than as a lone player in the smaller deals.

Mr. Nobrega said Omers intends to be active in infrastructure, private equity and real estate.

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MOVING INTO THE BIG LEAGUES

Canadian pension plans' confidence on the M&A stage has reached the point where they now feel comfortable syndicating big deals after landing them.

The ability to parcel off pieces of a target after the fact means the plans can do deals faster, and bid higher. It also prevents the last-minute upsets that can occur when players within a bidding consortium squabble over an element of a deal.

"In the interest of speed, people will grab an asset or negotiate an asset and they will have an informal agreement saying 'If you get it roughly in this range, we'll be there to take a piece of it after you get it,'" said Leo de Bever, chief executive officer of the Alberta Investment Management Corp.

In this way they avoid the delays that inevitably occur when three or four partners are trying to negotiate a deal. "The danger of a coalition falling apart at 11:59 when you're trying to get a deal done is pretty high," Mr. de Bever said.

But with syndication, "you control all the pieces and you don't have to worry about somebody else not being able to think or move as fast as you do," he added.

When AIMCo went after a 50-per-cent stake in Autopista Central (a 61-kilometre six-lane Chilean highway) last year, Mr. de Bever obtained board approval to spend more than AIMCo was ideally comfortable with. "So we may be syndicating a piece of that, to bring that down to a more normal level," he said.

Mark Wiseman, executive vice-president of investments at Canada Pension Plan Investment Board, said syndication is something CPPIB has been trying out over the past year and a half, particularly in infrastructure deals.

"Now that we have experience with it, we basically have protocol under which we'll syndicate," he said. "It's not about making money on the syndication, so we will syndicate on the same basis on which we transact."

That means that smaller institutions can take a piece of a deal on the same terms struck by CPPIB. For its part, CPPIB wins by gaining the flexibility to do larger deals, confident it can decrease its risks after the fact (though there's always the risk it won't be able to pull off the syndication).

"In infrastructure scale is incredibly important," Mr. Wiseman said. "But some of the deals are so big that they're almost on the edge of what we would be comfortable doing."

As a result, CPPIB syndicated a portion of its Macquarie Communications Infrastructure Group deal, for instance, and it is in the process of syndicating a portion of its investment in the highway group 407 International Inc.

CPPIB picked up two separate stakes in the 407 last year. It obtained a 30 per cent stake in the Toronto toll road when it acquired Intoll Group, and it paid $894-million for an additional 10 per cent interest from Ferrovial.

"We will syndicate down a portion of that to other like-minded institutional investors," said Mr. Wiseman.

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