Crosbie & Company Canadian Mergers & Acquisitions Report for Q1 2020

Strong First Quarter may be the Last Hurrah…for a While

In the first quarter of 2020, the Canadian M&A market continued to perform strongly, with 797 announced acquisitions worth an aggregate value of $47.1B.  However, as the quarter came to a close, the global COVID-19 pandemic began to take hold resulting in the shut down of many businesses, border closings, and an interruption of much M&A activity both within and outside Canada.  As a result, Q2 will almost certainly look quite different, with significant uncertainty for the subsequent quarters.

Accordingly, we are going to depart from our typical quarterly report format and first provide some perspectives on what we see happening in the markets at the time of writing, as well as some thoughts on the implications for M&A activity in future quarters.  Then, following that discussion, we will provide data and analysis of M&A activity in Q1/2020.

COVID-19 has Pushed Us Abruptly into a New Phase of the M&A Market 

We have been very active over the past number of weeks having discussions with various constituents in the M&A markets, including capital providers (banks, debt funds, specialty lenders and private equity groups), advisors (lawyers, accountants and investment bankers), clients, business owners and corporate buyers.  The comments below are informed by those conversations.

What is Happening with Existing Sale Processes?

The bottom line is that, for a variety of reasons we will get into, M&A activity has slowed to a trickle.  While deals were still closing in the U.S. in early April, the shutdown in Canada seemed to arrive earlier.  What we are seeing can be summarized as follows:

• Deals preparing to go to market – for most deals at this stage, the ‘pause’ button has already been hit.  A handful of special situations may move forward where the impacts on the business are not significant.
• Deals already in the market – again many deals are being put on hold, particularly where there are material business impacts.  A few are forging ahead but with timelines generally being extended given general issues that have yet to be resolved.  Eventually most of these deals will need to address the buyers’ requirement for face-to-face management meetings, plant tours and other critical due diligence matters that cannot be completed while observing travel restrictions and social distancing procedures.
• Deals that are in exclusivity – some of these deals are moving forward but many are also going on hold as purchasers assess the company-specific impact of the pandemic.  We suspect that many deals will either be repriced or pulled altogether.  Buyers might get gun shy and sellers may be reluctant to be tied up in exclusivity for extended periods of time.  Transactions that continue to move forward will be those involving businesses less directly impacted, and/or involving strategic or synergistic buyers that have the capability to close with little or no third part financing.

Across all of these transaction phases, there are a number of fairly fundamental issues that will need to be addressed and navigated to get deals across the line.  These include: 

• Business uncertainties.  Buyers don’t like uncertainty.  But many businesses face a range of “unknowns”, some of which will be very hard to assess in the near term.  These all manifest themselves in the assessment of future cash flows, and how to forecast them with confidence.
• Valuation.  Aside from what earnings can be expected going forward (i.e. our point above), what multiple or discount rate should be used?  Valuation is being reassessed in the public markets (which may impact private company valuations) and the verdict is not yet in. 
• Financing.  For the moment, most of the financing markets relevant to private company M&A are also on pause.  This includes the banks’ willingness to extend credit to new borrowers.  We are at least a few weeks away from understanding how private financing markets will respond.
• Due diligence challenges.  While much due diligence can be done remotely, there is no substitute for face-to-face meetings and plant tours.  Closing most deals without those ingredients will be challenging.  Is there a short-term workaround?     

What is the Mid-term Outlook for M&A Markets?

The world today is swimming in predictions.  However, despite the somewhat bleak near-term outlook for M&A, history has taught us that “this too shall pass”.  We are probably in for a few quarters with much lower overall M&A activity, but this should be followed by a strong rebound in transaction levels.  A key catalyst for this rebound is seeing some of the near-term impediments we have described above resolve themselves.  A return of financing markets and hopefully growth will also help support M&A activity.  

Key drivers of M&A activity we expect to see once markets reopen will likely include the following: 

• Deals that went on pause.  The relaxation of current social distancing restrictions should allow some of the deals that were put on pause to resume.  
• We expect many deals to involve businesses that were significantly impacted and need to sell.  Some of these will be full-on distressed situations but others will be the so-called “walking wounded” – those that need to do something but won’t be quite as rushed.  
• Companies with impaired balance sheets.  Many companies will need fresh capital.  M&A will be a serious alternative for some of these companies. 
• Consolidation within many industries will likely accelerate.  Stronger players will lead that charge.
• Opportunistic bids for public companies with depressed share prices and broad shareholder bases (i.e. no controlling shareholder or group of shareholders).
• Private equity will be chomping at the bit to take advantage of potential buying opportunities at a ‘discount’ to previous valuation levels. Once private equity groups move past their initial focus on their existing portfolios, they will turn their attention to new opportunities.
• Succession will emerge as a stronger driver than it has been.  Many owners will decide, in the wake of COVID-19, that they need to get out.

However, having said all this, M&A deals do have long lead times; typically, 6 to 12 months.  This means that we are unlikely to see a return to more robust activity levels for a few quarters at least.

Overview

• Deal activity increased slightly in the first quarter of 2020 with 797 announced transactions and an aggregate deal value of $47.1B
• The value of all non mega-deals declined to $13.3B, the lowest amount in the last six years
• Cross-border M&A activity remained strong with 309 announced acquisitions
  • Aggregate cross-border deal value was $26.3B

Mega-Deals 

• There were 6 mega-deals announced in the first quarter of 2020 with an aggregate value of $33.8B, the fewest number of mega-deals in a quarter in the last 6 years
• The largest acquisition this quarter was the $12.0B acquisition of Terra Forma Power by Brookfield Renewable Partners
• The second largest transaction was Bombardier Inc.’s sale of its train division to Alstom SA, as the company seeks to deleverage its balance sheet and focus on its corporate jet business

Industry Sector Activity

• Real Estate was the most active sector this quarter with 107 announced deals valued at $10.6B, exceeding the 100-transaction threshold for the 7th consecutive quarter
• The Industrials sector remained robust with 103 transactions valued at $12.3B
• The Precious Metals sector also experienced strong activity in the first quarter with 93 announced acquisitions as gold prices returned to recent highs

Breakdown by Transaction Size

• 94% of transaction activity in the quarter was from mid-market transactions below $250M (for transactions with disclosed values)
• There were 301 mid-market transactions valued at $6.9B or approximately 15% of total M&A value 
• Mega-deal activity declined in the first quarter of 2020, with only 6 announced transactions valued at $33.8B

Domestic Versus Foreign M&A

• For the 10th consecutive quarter, more than 500 Canadian companies were acquired, with 515 announced acquisitions in Q1 2020
• Canadian companies continued to be highly acquisitive, making 638 acquisitions both domestically and abroad in the first quarter
• Foreign acquisitions of Canadian companies declined to the lowest level since Q1 2015

Cross-Border Deals

• Outbound cross-border activity remained robust while inbound cross-border activity declined by 30% 
• Cross-border deals represented 39% of total activity and 56% of total deal value
• As a percentage of total cross-border activity, Canada/US transactions represented 58% of activity and 69% of aggregate deal value

Target by Province

• Ontario remains the most active province this quarter with 182 deals valued at $3.2B
• British Columbia was also active in the first quarter with 127 deals valued at $1.0B
• Alberta had the largest aggregate deal value of $5.3B, comprised of 57 transactions