Angela Blake says deals will be easier for those who can use a single bank for financing
After a solid start to merger and acquisition activity at the beginning of the year, the deal landscape in Canada has changed rapidly since, with concerns over a global recession now top of mind for companies and investors. But Bennett Jones partner Angela Blake says that a rebound is "entirely possible" once buyers and sellers have learned to navigate the new terrain.
In many ways, Blake says, "we're in a similar situation to where we were at the beginning of the COVID-19 pandemic," when dealmakers had to figure out a pathway through a lockdown and other restrictions.
"In hindsight, the learning curve was short-lived, and it was not long before we were back to a very active M&A market."
The recent Bennett Jones Spring 2022 Economic Outlook was released in June and looked at two scenarios for Canada's economy for 2023 and into 2024.
In the optimistic scenario, the Canadian and U.S. economies manage a soft landing. In the pessimistic scenario, the U.S. economy experiences a mild recession in 2023 that Canada narrowly escapes. Both scenarios require the tightening of monetary policy, albeit more aggressively in the pessimistic scenario.
Among the factors that fed into a downturn for M&A is Russia's invasion of Ukraine, COVID-19 shutdowns in China and inflation rates near 40-year highs, leading to fast-rising interest rates.
Overall, M&A deal volume in Canada was down in the second quarter of 2022 to $93.8 billion, from $96.2 billion in Q1. While Q2 was the fourth quarter in a row with overall volume above $90 billion (Q4 2021 was over $120 billion), April to June 2022 saw slightly reduced volume each month.
Still, the Canadian mid-market continued to be robust, Blake says. Deals between $20 million and $500 million totalled $12.9 billion in Q2, while the first quarter saw deals in this range total $12.5 billion.
"It's definitely not as frothy as it was this time last year, but it still is very, very busy, and last year was exceptional," says Blake. "For deals under $100 million and in a position to be done with a single bank's financing, there's still plenty of activity out there."
More significant transactions, those that rely on financing from more than one source, might be "a little tougher" to complete because of the current uncertainty. "But smaller deals, like those $500 million and under, could be easier, and we're still seeing interest there."
Interest rates going forward will play a key role as central banks around the world tighten monetary policy at an accelerated pace to respond to rapidly rising inflation. The U.S. Federal Reserve increased its benchmark interest rate by 75 basis points on June 15, the largest increase since 1994, and is predicted to bring in another 75 basis-points hike later in July.
The Bank of Canada raised its interest rate by a whole percentage point during Q2, and another full percentage point, in one go, in mid-July.
Rising interest rates could constrain financing alternatives and temper M&A, at least in the short term. A blog post written by Blake and colleagues John Piasta and Matthew Hunt says, "there is currently tremendous transaction uncertainty for larger deals requiring syndicated debt financing or access to the high yield debt markets." However, this is not the case "for acquisition financing involving traditional bank single lender facilities with established relationships."
The blog adds: "The pace at which lenders adapt to increasing rates, and the timing of when interest rates may ultimately stabilize, are also likely to affect the speed at which M&A transactions are completed. In addition, buyers will be challenged to evaluate cost of capital and rates of return where debt is a significant component of the purchase price."
By contrast, strategic acquirers with adequate reserves and private equity funds with access to cash are less likely to be impacted.
One of the impediments to getting deals done, Blake says, is the gap in value expectations between buyers and sellers as stock prices and valuations have dropped. "It's like the housing market, where sellers see the high prices of the last few years, and they don't want to adjust to the new market and may choose to sit on the sidelines, hoping prices will rise again.
On the other hand, eager buyers may be willing to pay something closer to what the seller is looking for but might say, "Okay, but I want to do a deep dive into your business and see how comfortable I am," Blake notes. Or both sides could agree to a solution like earnouts (where the target company is paid more after the deal is closed if certain profit and operational metrics are met).
This is where a potential buyer or seller's legal team can help ascertain and mitigate risk in deals where "creative solutions" are employed, Blake says.
M&A in the energy and mining sectors is likely to be most impacted by the current geopolitical and economic landscape. "Opinions are divided about the extent to which the Ukraine war will impact oil supply, with some suggesting supply may outstrip demand and others believing Russia may turn off the taps in response to sanctions."
Still, there are deals to be made, says Blake. She notes that at the Prospectors & Developers Association of Canada's (PDAC) annual convention in June, some larger producers spoke about acquiring more strategic positions in "critical" minerals, like lithium, as the race to supply the electric vehicle market continues. Consolidation in the sector, scarcity of strong gold projects and the mining industry's interplay with China were also notable themes discussed at PDAC.
One fallout of the current volatility in commodity prices is that it could become difficult for buyers and sellers to value assets and agree on a purchase price, making completing deals harder. On the other hand, strategic acquisitions by companies that have done well despite cooling commodity prices and have ample capital likely won't be as affected.
There is optimism that a return to stability will encourage transactions, Blake says. Overall, however, M&A in Q3 will likely be between parties that believe they can achieve long-term value, competitive strength or business synergies.
The "one beauty" of M&A work, says Blake is that there will always be sectors that are strong when others are not, "so there will always be deals to be done."
