"Canadian economy the envy of the world"
- CBS News
"This decade belongs to Canada"
TORONTO, Dec. 29 /CNW/ - As the global financial storm subsides,
Canada's economy is commanding unaccustomed attention and some
new-found respect. A solid regulatory system and strong demand for
Canadian resources and commodities have kept the country in the
business headlines for all the right reasons. In the M&A sector, there
is every indication that the rebound experienced in 2010 will continue
in 2011, as market players continue to adjust and adapt. We believe
that each of the trends identified below will play a part in shaping
the market - whether it's creative methods of financing, more realistic
valuation methods, adjustment to deal terms or regulatory developments
in the areas of foreign investment, taxation and securities law.
1 Investment Canada: Business as usual for foreign investors in 2011
What a difference a year and one transaction can make. In 2010, the
Government of Canada's decision that BHP Billiton's proposed US$38.6
billion unsolicited bid for PotashCorp was not in Canada's national
interest effectively ended the bid and generated considerable
international attention. As a consequence of the Potash transaction,
the Government of Canada has indicated that it will conduct a review of
the entire Investment Canada Act.
In spite of the publicity generated by the Potash case, we believe that
the situation was an anomaly rarely to be repeated. Canada remains open
for business and in 2011 it will be business as usual for most foreign
acquisitions of control of Canadian businesses. This belief would be in
line with the current federal Government's stated position on foreign
investment in Canada. The reality is that only two acquisitions have
been rejected by the Government in over 20 years.
Foreign investment review thresholds continue to rise. At the beginning
of 2010, we anticipated the Government would implement the proposed
higher thresholds for review and approval of foreign acquisitions of
control of Canadian businesses in bi-annual stages to C$1.0 billion in
2015, based on "enterprise value" of the business. Currently the review
and approval test is C$299 million based on book value of assets,
subject to certain exceptions. We would anticipate that in the near
term (particularly in light of the Government's proposal to review the
entire Act) the review threshold will be increased in the normal course
by annual cost of living indexing to approximately C$310 million. In
addition, as we reported last year, the lower review thresholds of C$5
million have been repealed for the sensitive sectors of financial
services, transportation services and uranium mining, leaving only
cultural businesses subject to the C$5 million asset threshold for
direct acquisitions of control and special review by Heritage Canada.
2 Canadian poison pills gain strength: Just saying no may be getting easier
Canadian regulators have opened new room for debate in one area of
Canadian securities law that had long been considered settled - the
role of poison pills in defending against a hostile take-over bid. In
contrast to Delaware practice, Canadian shareholder rights plans have
traditionally been strictly limited to the single purpose of helping
the board "buy time" to seek out improved or alternative offers. Once
that purpose has been served, Canadian securities commissions would
routinely "cease trade" poison pills, sending whatever offer was on the
table to a shareholder vote. It was widely accepted that, under such
conditions, a "just say no" defence was dead in the water in Canada.
This position was consistent with National Policy 62-202, which clearly
states that the main objective of take-over bid regulation is to
protect the bona fide interests of the shareholders of the target.
In two recent decisions, however, the Alberta Securities Commission
(Pulse Data) and the Ontario Securities Commission (Neo Material)
refused to cease trade shareholder rights plans, even where the
target's board had not solicited other bids. In both decisions, the
Commissions acknowledged the fact that poison pills had been strongly
endorsed by the shareholders and, in the latter decision, that tough
economic times and the possibility of coercive bids might justify
keeping the pill in place. In Neo Material, the OSC also placed
considerable reliance on the reasoning of the Supreme Court of Canada
in the BCE decision that the board of directors duty is to the
corporation as such, rather than specifically to the shareholders.
The Neo decision was recently considered by the Ontario Securities
Commission in the Baffinland Iron Mines Corporation decision. In
Baffinland, the OSC issued an order cease.trading the shareholder
rights plan on the basis that the rights plan had provided a sufficient
time for the Baffinland board to obtain a competing offer from
ArcelorMittal SA and that the plan had accomplished the objective of
stimulating an auction by obtaining a competing offer. The Baffinland
board recently approved a new rights plan and the transaction is
3 The commodities sector: No end in sight to foreign demand
Continuing demand by foreign investors for Canadian natural resources is
almost a certainty in 2011. The most prominent recent example was BHP
Billiton's abortive bid for PotashCorp. A key development is that this
sector is seeing more creative and strategic-based structuring for
effecting transactions, not just conventional going-private
transactions and take-overs. Alternative transaction structures in the
mining sector, for example, include acquirors taking toe-hold positions
in a target, coupled with a joint venture arrangement to provide for
offtake, supply or other strategic agreements. Another well publicized
creative structure occurred in the acquisition of a 51% stake in
TSX-listed Uranium One by Russia's ARMZ, which included an asset
"vend-in" by ARMZ involving that company's stake in two Kazakh uranium
4 Financing and valuation: Techniques for bridging the gaps
Notwithstanding increasing confidence in the Canadian economy,
acquisition financing is still not always easy to arrange and residual
economic uncertainty continues to produce many real or perceived value
differences between buyers and sellers. We anticipate the continued use
of various techniques for bridging gaps in financing and/or valuations.
These include earnouts, seller financing (typically secured and
subordinated), seller rollover equity and the seller receiving buyer
stock (often accompanied by mutual "puts" and "calls", to ensure an
ultimate takeout). Other more creative techniques - all of which have
been used in the Canadian marketplace - include:
Structured equity whereby the seller receives equity which provides a
back-end payment tied to a hurdle rate of return. if the buyer achieves
such target over a period of time (usually three to five years), the
seller participates in any upside.
"Loan to own" strategies or a creeping takeover in distressed situations
where a potential buyer makes a secured loan to a troubled target
(possibly accompanied by warrants) and in the event of default, the
secured lender is in a very strong position in any insolvency
proceeding to "foreclose" on the target and own all or a significant
portion of the equity.
Contingent value rights ("CVRs") which are a form of transferable,
earn-out security sometimes used as partial acquisition currency in the
purchase of a public company. For example, CVRs have been used to
guarantee the value of buyer's stock for a period after closing.
Standby equity distribution agreements ("SEDAs") have recently provided
increased flexibility to issuers in raising financing in Canada. SEDAs
provide that one or more investors contractually agree to purchase,
upon demand of the issuer, unissued shares of (smaller) publicly-traded
companies in one or more tranches at a small discount from market
(usually 5% or less) over a period of time (usually two years, with
right to renew for a year or two).
For a more comprehensive consideration of earnouts and other bridging
techniques please see the publication "M&A Trends and Opportunities in
a Downmarket" by Richard Clark, presented at the Canadian Institute's
National Summit on Private Equity in September 2010.
5 Hedge funds, pension funds and other pools of capital
As always, the adage "follow the money" applies. Hedge funds, pension
funds and other pools of capital have increasingly been taking active
positions in public companies or participating in Companies' Creditors
Arrangement Act ("CCAA") or other distressed transactions. Sovereign
Wealth Funds ("SWFs"), State-Owned Enterprises ("SOEs") and hedge funds
have also been active in the natural resource and oil and gas
industries, both in Canada and abroad. In addition to Canadian pension
funds, another emerging source of investment is coming from U.S. state
pension funds that are creating new independent firms - such as the
South Carolina Retirement System Investment Commission - to oversee
their funds' private equity holdings (similar to the direct investment
funds created by two of Canada's biggest pension plans, the Ontario
Teachers' Pension Plan and the Canada Pension Plan Investment Board).
We believe that the Canadian M&A market will see increasing volumes of
direct investment in 2011 by large pools of capital that have not
traditionally participated in such transactions. The key message here
is that this market is prepared to go where the cash is - whether it's
with private equity firms, hedge fund investors, pension fund
investment vehicles or otherwise.
6 Growth of a domestic high-yield debt market: A positive result of low interest rates
Credit markets are starting to open up; the taps are flowing again. 2011
will see greater transactional leverage in Canadian mergers and
acquisitions. As we move into 2011, the emergence of a high-yield debt
market in Canada is a strongly positive development for Canadian M&A.
Commencing in 2009, a Canadian market began to develop, as issuers
including Russel Metals accessed the highyield market in Canada to
raise the funds for potential acquisitions, among other things. In
2010, companies such as North American Energy Partners, Videotron and
Corus Entertainment continued to issue Canadian dollar-denominated,
non-investment grade debt as investors hungered for higher yields.
Income trusts, which have been the principal Canadian issuers of
high-yield debt, will likely retain their taste for high-yield debt as
they restructure as corporations, providing new impetus to the
high-yield market in the corporate sector. In the Canadian M&A market,
certain transactions, such as the acquisition by RTL-Robinson
Enterprises Ltd. of Westcan Bulk Transport Ltd., have already
successfully used a high-yield debt issue as a financing mechanism.
Over the coming year, as the domestic high-yield market continues to
develop, we expect that high-yield debt will increasingly factor into
M&A transactions, especially if, as expected, interest rates remain at
7 Going with the (cash) flow in valuations
In order to obtain more deal certainty on value, several Canadian
institutional investors have begun to favour a multiple of "free cash
flow" to value target companies in certain industries. Previously,
potential acquirors had typically relied on some variation on the
target's multiple of earnings - in which the earnings figure may be
derived from net income, from "EBIT" (earnings before interest and
taxes) or from "EBITDA" (earnings before interest, taxes, depreciation
The progression from net income to EBIT and EBITDA can be seen as an
attempt to climb higher on the income statement to get a number closer
to cash flow. We are now seeing the free cash flow ("FCF") method used
with increasing frequency as an alternative way to achieve a valuation
that reflects cash flow. FCF is generally defined as follows:
FCF = [Net Income] + [Depreciation and Amortization] - [Changes
in Working Capital] - [Capital Expenditures]
As this suggests, there are two fundamental differences between FCF and
an alternative such as net income when it comes to valuation. First,
the net income approach uses depreciation, while FCF measures the last
fiscal period's net capital purchases, such that capital spending is in
current dollars (although a disadvantage is that capital investment is
discretionary and can be sporadic). A second difference is that FCF
deducts increases in net working capital, while the net income method
FCF is basically the cash flow available for distribution to all holders
of security, including equity holders, debt holders, preferred
stockholders and convertible equity holders. It represents the cash
that an entity is able to generate after expending the funds required
to maintain and expand its asset base, thereby allowing the company to
pursue opportunities that enhance shareholder value. Some investors,
concerned that income can be clouded by accounting practices, believe
that cash flow is much harder to obscure and that FCF gives them a much
clearer view of the ability to generate cash (and thus profits).
8 Income tax: Recent developments generally positive for M&A
As the economy continues to improve and cross-border M&A activity
increases, a number of recent amendments to the Income Tax Act (Canada)
and some longstanding structures and techniques will have even a
The repeal of withholding tax on most cross-border interest payments
should continue to facilitate accessing the most favourable sources of
acquisition debt financing outside of Canada.
The repeal of the infamous "Section 116" compliance and withholding
regime on cross-border equity dispositions (except where the equity
effectively constitutes a real property interest) will facilitate the
sale by foreign investors currently holding the shares of Canadian
companies and encourage new foreign investors contemplating an exit
strategy which is devoid of most administrative hurdles.
As purchase prices increase, the use of "exchangeable shares" may become
more prevalent, in order to provide a rollover for capital gains
purposes for Canadian shareholders of a Canadian target where the
consideration includes, in whole or in part, stock of a foreign
Recent administrative rulings appear to have softened the harsh impact
on Unlimited Liability Companies (ULCs) of the anti-hybrid rules
contained in the 5th Protocol to the Canada-U.S. Tax Convention, which
had negatively impacted the payment of dividends and return of capital,
among others, to the U.S. ULCs have been used as tax-flowthrough
vehicles (so called check-thebox) for U.S. tax purposes in many
9 Structuring investments in M&A transactions: Bilateral investment treaties
As a global leader in mining, resource and energy finance, Canada and
its investors are increasingly recognizing the importance of bilateral
investment treaties ("BITs"). BITs permit investors to seek monetary
damages from foreign governments that violate their treaty obligations,
as do the investment chapters of many free trade agreements, including
Chapter 11 of NAFTA. The private, investor-state dispute mechanism
typically allows foreign investors to bring claims for damages before
independent arbitral tribunals in the event that foreign governments
take harmful actions that violate BIT obligations, including those that
prohibit discriminatory or unfair treatment or expropriation without
In structuring investments and M&A transactions we have traditionally
been highly conscious of the implications of tax treaties and possible
claims by indigenous peoples, but it is becoming equally important that
investment into less stable countries are structured through a country
that has a BIT with the host country (in conjunction with a favourable
bilateral tax treaty). In light of this, we anticipate that the
Canadian government will continue to work toward the implementation of
BITs in order to preserve Canada's leadership role in global mining and
In August 2010, Canada's federal government announced a C$130 million
settlement of a Chapter 11 NA FTA claim by AbitibiBowater Inc. arising
out of the expropriation by the Government of Newfoundland & Labrador
of certain water and timber leases held by Abitibi in that province.
This is just a reminder of the importance of bilateral investment
treaties not only in Canada, but also in making investments in other
countries around the world.
10 Infrastructure: One of the hottest M&A tickets for 2011
Infrastructure has been one of the most robust trends throughout 2010 as
pension funds and large private equity groups acquire
infrastructure-focused companies and infrastructure assets. Examples
include CPP Investment Board's October 2010 investment of C$894 million
for a 10% stake in Ontario's Highway 407 Express Toll Route (ETR), soon
to be supplemented with the additional 30% of 407 ETR that CPPIB will
acquire as a result of its purchase of Intoll, an Australian company,
for approximately C$3.6 billion. In 2011, we expect to see continued
growth in acquisition and joint venture activity relating to
transportation and energy infrastructure projects, including
co‑generation, nuclear and hydro. In our view, infrastructure-related
M&A activity will remain a major theme in 2011, as stimulus spending
continues and governments increasingly look to public-private
partnerships (PP) to bridge the gap between scarce public funds and
public infrastructure needs - an important example being the recently
concluded deal between Infrastructure Ontario and Windsor Essex
Mobility Group to develop and maintain the C$1.6 billion Windsor-Essex
Parkway. This was the first civil infrastructure PP in Ontario and also
the largest PP in value in the province to date.
11 Deal terms in Canada and the U.S.: Similarities and differences
In 2011, we will see a continuation of themes that have emerged over the
past two years, namely back to basics with cautious buyers; the return
of more controlled auctions and the reemergence of more strategic
buyers (as distinct from financial buyers); the return of traditional
bank financing (highly negotiated positive and negative covenants - no
In Canadian M&A, we are seeing a continuing influence of U.S. practices,
although there continue to be a number of marked differences within the
North American marketplace for negotiated M&A transactions. The recent
ABA 2010 Canadian Private Target Mergers & Acquisitions Deal Points
Study published by the M&A Committee highlights some of the
similarities and differences (compared to the ABA 2009 U.S. Private
Canadian transactions appeared to involve far fewer earnouts than U.S.
transactions (29% in U.S. versus 3% in Canada).
The concept of a Material Adverse Effect (MAE), as a defined qualifier
of representations and warranties and/or conditions of closing was
defined in fewer purchase agreements in Canada than the U.S. (92% in
U.S. versus 73% in Canada).
The general survival period for representations and warranties was
longer in Canada than in the U.S. (75% of Canadian deals specify 24
months or less, as compared to 88% in the U.S.).
"Baskets" (threshold or deductible for claims) as a percentage of
transaction value totalled 69% for Canadian transactions for a basket
of 1% of total value or less (U.S., 89%).
More interestingly, the cap on indemnity claims was the "purchase price"
in 45% of the Canadian transactions (U.S., 5%) with only 17% of the
Canadian transactions having a cap of 15% or less of purchase price
Only 26% of Canadian transactions had an escrow or holdback component
(U.S. figure not given; previous studies suggest that the figure in the
U.S. is more than double that in Canada).
Finally, in Canada, provisions relating to sandbagging are found less
frequently than they are in the U.S. (31% vs. 47%), and, surprisingly
to us, where they are found in Canadian agreements they are much more
likely - by 21% to 10% - to be antisandbagging than pro-sandbagging
(the reverse being the case in the U.S., where anti-sandbagging
provisions were found 8% of the time vs. 39% of the time for
prosandbagging provisions). Pro-sandbagging provisions are express
statements that the buyer can seek indemnification for breach of
warranties, notwithstanding knowledge of breach. Anti-sandbagging
clauses can be dangerous for a buyer since, if not properly qualified,
they invite the "you knew" defence for almost every claim.
We would also note that due to the existing volatility in the Canadian
capital markets and the continuing disparities in valuations, investors
in Canadian companies are increasingly using dual-track (IPO and M&A)
exit structures to effect liquidity. See Curtis Cusinato's article "M&A
transaction or IPO: Why not pursue both?", in Stikeman Elliott's M&A
Update, April 2010, available at www.stikeman.com or via the firm's
securities law blog, www.canadiansecuritieslaw.com.
All in all, we expect a good year for M&A activity in Canada.
Our Work in 2010
PotashCorp in its defence of BHP Billiton's US$38.6B unsolicited
Ontario Teachers' Pension Plan in connection with BCE's C$3.2B
acquisition of CTVglobemedia from Teachers', The Woodbridge Company
Limited and Torstar Corporation, and the related C$200M acquisition by
Woodbridge of the Globe & Mail assets from CTVglobemedia.
Dundee Corporation, the controlling shareholder of DundeeWealth Inc., in
connection with the C$2.3B offer by The Bank of Nova Scotia to acquire
the 82% interest in DundeeWealth the Bank did not own.
Canada Pension Plan Investment Board in its C$894M acquisition of a 10%
stake in the 407 Express Toll Route from majority owner Cintra
Infraestructuras S.A.U, and as Canadian counsel in its C$3.6B
acquisition of Sydney-based Intoll Group.
Van Houtte on its C$915M sale to Green Mountain Coffee Roasters by an
affiliate of Littlejohn & Co., LLC.
Anatolia Minerals Development Limited in a C$2B merger of equals with
Avoca Resources Limited.
ING Summit Industrial Fund LP in its C$2B sale by its limited partners
to a joint venture company formed by KingSett Capital Inc. and Alberta
Investment Management Corp.
JSC Atomredmetzoloto (ARMZ) in the C$1.2B acquisition of Mantra
Resources Limited (and concurrent option agreement with Uranium One
Inc.) and its C$1.6B acquisition of a 51% interest in Uranium One Inc.
JSW Energy Limited in its C$422M bid to acquire all the shares of CIC
XM Canada in its C$520M merger with Sirius Canada Inc.
Birch Hill Equity Partners in its C$425M sale of Atria Networks LP to
Rogers Communications Inc.
Baffinland Iron Mines Corporation in the C$492M friendly take-over bid
by ArcelorMittal SA
Tata Steel Global Holding Pte. in its C$300M acquisition of an 80% stake
in a direct shipping ore project located in Canada owned by New
Millennium Capital Corp.
TPG Capital as Canadian counsel in connection with its proposed C$850M
acquisition of the property information business of MacDonald,
Dettwiler and Associates Ltd.
ALSTOM S.A as Canadian counsel in the C$2.29B joint acquisition with
Schneider Electric of the transmission and distribution businesses of
Areva T&D and the C$217.5M indirect acquisition of ALSTOM Hydro Canada
Simmons Pet Food, Inc., in its C$239M acquisition of Menu Foods Limited.
Lihir Gold Limited as Canadian counsel in its C$9.5B sale to Newcrest
Intel Corp. as Canadian counsel in its US$7.68B acquisition of McAfee
The financial advisor to Kinross Gold Corp. in its US$7.1B acquisition
of Red Back Mining Inc.
About Stikeman Elliott
Stikeman Elliott LLP is one of Canada's leading business law firms, with
offices in Toronto, Montreal, Ottawa, Calgary and Vancouver as well as
in London, New York and Sydney. The firm is recognized as a Canadian
leader in each of its core practice areas - corporate finance, M&A,
corporate-commercial law, banking, structured finance, real estate,
tax, insolvency, competition/ antitrust, employment and business
litigation - and is regularly retained by domestic and international
companies in a wide range of industries including financial services,
insurance, technology, telecommunication, transportation,
manufacturing, mining, energy, insurance, infrastructure and retail.
This document was prepared by Richard E. Clark and Curtis A. Cusinato,
senior corporate partners at Stikeman Elliott and Chairs of the
M&A/Private Equity Practice Group
SOURCE Stikeman Elliott LLP
For further information: For further information:
please contact your Stikeman Elliott representative or the authors:
Richard E. Clark
Curtis A. Cusinato