Nature And Scope Of Canada's M&A Boom
Canada is in the midst of an M&A boom, with growth in transaction value significantly outpacing robust growth in the United States and worldwide. During 2005, the dollar value of announced Canadian deals increased by nearly 85 percent over 2004 levels, compared with growth of 33 percent in the United States and 38 percent worldwide. In the first half of 2006, the growth of Canadian M&A activity was even more dramatic: 784 deals with an aggregate value of U.S.$93.5 billion - nearly triple the value of announced deals for the same period in 2005, compared to U.S. growth of 23 per cent and worldwide growth of 44 percent. The growth in M&A activity in Canada, the United States and worldwide over these periods is the result of increasing transactional value; the number of transactions has remained relatively stable.1
Driving the growth of Canadian M&A activity are several important factors, some global and some unique to Canada. One key factor is the confluence of Canada's significant resource-based economy with high commodity and materials prices. Other factors have been the overall strength of Canada's economy during the last four years, with relatively low interest rates and inflation; Canada's openness to foreign investment; availability of funding from private equity firms and hedge funds; and the attractiveness of Canada to U.S. acquirors, given the country's familiarity and physical proximity.
The resources sector has seen the most visible frenzy of M&A activity, including the competing multibillion dollar proposals to acquire Inco and Falconbridge involving Xstrata, Phelps Dodge, Teck Cominco and CVRD. Significant oil and gas transactions have included China National Petroleum Corporation's acquisition of Canadian-owned and -listed Petro-Kazakhstan and Kinder Morgan's acquisition of Terasen. There have also been several significant transactions involving non-resources companies with a strong North American or global platform, including AMD's proposed acquisition of ATI, TUI's acquisition of CP Ships, Arcelor's acquisition of Dofasco, Kingdom Hotel International and Colony Capital's acquisition of Fairmont Hotels and Constellation's acquisition of Vincor. A significant majority of the recent large and high-profile transactions have involved U.S. and other foreign acquirors.
In this article we highlight several significant trends and strategic considerations relevant to U.S. and other foreign entities seeking to participate in Canadian M&A transactions.
Hostile Deals And Defensive Tactics
Prevalence of Hostile Deals
The Canadian market has recently experienced a significant number of tender offers (referred to as 'takeover bids' in Canada) made on an unsolicited or hostile basis. In the 12 months ended June 30, 2006, more than a dozen hostile takeover bids were launched, including some of the largest and most high-profile transactions such as Xstrata's bid for Falconbridge, Teck Cominco's bid for Inco and Barrick's acquisition of Placer Dome.
However, hostile transactions entail significant completion risk for the initiating party. According to statistics for Canadian hostile bids made between January 1, 1998 and July 31, 2006, a change of control transaction took place in 82 percent of cases, but the hostile bidder was successful in only half of those cases. In the other half of those cases, the successful acquiror was a 'white knight' supported by the target company. It has been relatively rare for the target company to remain independent once a hostile bid has been launched.2
Hostile deals benefit from a favorable regulatory environment that makes it easier to complete a hostile takeover bid in Canada than in the United States. Generally, in the face of a hostile bid a Canadian target cannot 'just say no' without allowing shareholders to consider the offer. Structural defenses that may be available in the United States, such as staggered boards and special anti-takeover provisions in incorporating documents and by-laws, are generally ineffective under Canadian corporate law. In addition, share buy-backs are not permitted under Canadian law unless they are offered to all shareholders on an equal basis.
Under Delaware law, boards generally have greater latitude to engage in defensive measures to counter unwanted takeover proposals, and the Revlon duty to obtain the best price is triggered only if the target board has initiated a change of control transaction or is seeking alternatives to a hostile transaction. However, when the Revlon duties are engaged, a board's conduct will be subject to a heightened standard of reasonableness review. In contrast, Canadian companies are considered to 'always be for sale.' Canadian corporate law has been interpreted to require directors to seek out value-maximizing alternatives for shareholders in any potential change of control context, even when not initiated by the company; however, Canadian courts have declined to adopt the U.S. concept of enhanced scrutiny of board actions.
In Canada, regulation of defensive tactics has in practice primarily been a matter for securities regulators rather than the courts. Canadian securities regulators have adopted a National Policy regarding takeovers that seeks to encourage open and unrestricted auctions to maximize target company shareholder value and choice between competing alternatives.
One of the most common forms of defensive measures in Canada is a shareholder rights plan, or 'poison pill.' As in the United States, a poison pill is intended to protect against creeping takeovers and bids not supported by a target's board. Poison pills may be put in place in advance when no bids are pending, but subsequent shareholder approval is necessary in accordance with stock exchange requirements. They may also be put in place in the face of an actual bid in order to buy time. In Canada, a poison pill is not a semi- permanent showstopper as it may be in the United States, but is generally permitted only to buy a relatively short period of time for the target to conduct a reasonable search for, or to develop, value-maximizing alternatives.
As a result, it is a matter of 'when, not if' the pill will be struck down - a balance between allowing the target board a reasonable opportunity to search for or develop value-maximizing alternatives and ensuring that shareholders are not deprived of an opportunity to decide whether to accept the bid. Canadian securities regulators will generally take action to terminate a poison pill once it has served this purpose, often after a period of 45 days following the initial bid. Against this backdrop, it is not uncommon, as in the case of Barrick's bid for Placer Dome, for a target to agree to voluntarily terminate its poison pill after a specified period in exchange for the hostile bidder's commensurate extension of the expiry date of its offer.
In an interesting recent decision involving Xstrata's unsolicited takeover bid for Falconbridge, the Ontario Securities Commission temporarily upheld Falconbridge's poison pill. The Commission concluded that the poison pill was actually protecting Falconbridge shareholders by preventing Xstrata from increasing its then almost 20 percent ownership of Falconbridge to a blocking position that could frustrate competing bids (i.e., Inco's bid). Consistent with prior decisions, however, the poison pill was permitted to remain in place only for a specified limited period to give competing bidders additional time to advance their bids. This decision effectively signals that a target board may have more latitude to adopt and maintain defenses when one of the bidders has a significant ownership position that could block other bidders and leave shareholders without any offer.
Influence Of Private Equity And Hedge Funds
U.S. and other foreign private equity groups and hedge funds are becoming increasingly active in Canada. This activity has resulted both in direct acquisitions of Canadian public companies and minority investors exerting pressure on management to seek a sale or other value-maximizing transaction (or to seek improved terms for such transactions).
Carl Icahn's partial bid for Fairmont Hotels at the end of 2005 is a prime example of this type of shareholder activism. It was widely speculated that the bid was designed to put Fairmont into play to solicit a higher offer or other strategic alternative. Icahn stated that Fairmont and its shareholders would benefit if Fairmont was acquired by a larger hotel operator that could more effectively take advantage of economies of scale. Fairmont was ultimately purchased by Kingdom Hotels International and Colony Capital at a price materially higher than Icahn's offer.
Other examples of shareholder activism in favor of a sale or other strategic alternative include the sale of Geac Computer to Golden Gate Capital following agitation by Crescendo Partners; Paulson & Co.'s proxy battle for control of Algoma Steel; and KKR's decision to increase its offer for Masonite in response to agitation by hedge fund shareholders.
Income funds and other income securities issuers (which own underlying operating businesses and pay out substantially all of their available cash flow to investors on a tax-efficient basis) have become a major component of Canadian capital markets in almost all industry sectors, including oil and gas, real estate, power/pipeline assets and specialty businesses. There are now over 250 income fund issuers with aggregate market capitalization of more than C$200 billion, representing over 10 percent of the total market capitalization of the Toronto Stock Exchange. Given the significant size and maturity of the sector, income funds will likely become increasingly significant participants in M&A transactions both as acquirors and targets.
Income fund structures are sufficiently flexible to permit significant merger and acquisition activity. Given attractive income fund multiples due to their tax structure efficiencies and market demand, income fund bidders may be able to deliver higher values to sellers. Large mergers and acquisitions are often financed by the issuance of new income securities to the securityholders of the target or to the public and by the vendor's retaining an interest in the combined business, in addition to senior debt. Subscription receipt offerings allow an acquiror to raise funds before (but conditional on the completion of) an acquisition. However, as a practical matter, acquisitions by existing income funds must be accretive to their distributable cash. In addition, in negotiated 'friendly' transactions, the amount of break fees that an income fund may be willing to pay may be constrained, given that the fund pays most of its cash flow to unitholders.
There have been several major income fund M&A transactions within the last year. In one of the largest income fund M&A transactions to date, Penn West Energy Trust completed its C$3.5 billion merger with Petrofund Energy Trust on June 30, 2006. At the end of 2005, successful hostile bids were launched by Livingston International Income Fund for PBB Global Logistics Income Fund and by Agrium for Royster-Clark (an issuer of income deposit securities). As these two transactions demonstrated, a hostile acquisition of an income fund or income securities issuer is more complex than a hostile bid for a corporation, particularly when the acquiror is seeking to achieve a tax-free roll-over transaction for unitholders.
1 The statistics shown in the first paragraph are based on the value of announced transactions and other data compiled by Thomson Financial.
2 These figures are based on statistics compiled by a leading Canadian investment bank as of July 31, 2006.
Michael Amm is a Partner in the Canadian corporate group of Torys LLP. He practices a broad range of corporate, commercial and securities law, with an emphasis on cross-border mergers and acquisitions (both public and private) and corporate finance, including income trusts. Michael practiced in the firm's New York office from 2000 to 2003. Richard Willoughby is a Partner in the U.S. corporate group of Torys LLP and co-head of the M&A practice. His M&A experience includes advising on leveraged buyout transactions, private acquisitions and divestitures (often in an auction context), joint ventures and tender offers, with an emphasis on cross-border transactions.