Merger and acquisition activity in Canada likely to pick up 2021: Torys report

If you can see beyond the gloom of living under a cloud of Covid-19 for almost a year, the outlook for M&A activity in 2021 is optimistic, says a new report by Torys LLP.

“Equity markets have shown strength and significant capital raising capacity, debt capital is readily available at low interest rates, and well-funded buyers are increasingly active,” says the report. “Altogether, these indicators suggest a positive M&A environment for the year ahead.”

“There’s no question that the pandemic had a considerable impact on M&A activity last year,” says Torys partner John Emanoilidis. “Some very good businesses experienced unprecedented shocks, and many companies went into survival mode.” The result was that a lot of M&A activity was put on hold.

But since the latter part of the year, M&A market sentiment has picked up considerably, he says. “Dealmakers have adjusted quite quickly to the new normal of doing deals virtually. And we ended up the year with the volume of deals roughly on par with 2019.”

While strategic players will play an essential role in M&A in 2021, Emanoilidis says private equity and pension funds will be well-positioned with enough cash to take advantage of the post-pandemic opportunities.

Canadian public M&A activity in 2020 was remarkably robust, the report says, surpassing 2019’s level by the number of deals, 93 in 2020 compared with 88 the previous year. While aggregate transaction values were considerably lower relative to 2019, “the aggregate deal value made an impressive recovery from start-of-year record low values to reach an aggregate of $45 billion in 2020.” (That compares with $99 billion in 2019.)

"While there are certainly headwinds," says Emanoilidis, "there are many reasons to be optimistic, and I think the feeling is that the worst is behind us.”

Lawyers involved in M&A transactions will likely have to go into their “toolbox” of potential solutions in dealing with any valuation gaps between buyers and sellers that come in a pandemic or post-pandemic environment, Emanoilidis says. These tools would mitigate risks perceived by one side or the other and involve remedies such as earnouts or contingent value rights, based on whether specified milestones or thresholds achieved in the future.

As well, he says these milestones wouldn’t necessarily have to be tied to traditional metrics such as revenue or profits, but could be “something different, like returning to some normalized working capital levels.” More transactions involving stock, rather than cash, and more caps and collars, could also be used to deal with price volatility in uncertain times.

Future agreements will likely clarify the terms under which a buyer can walk away from a deal due to an event like COVID-19. Clauses that deal with material adverse events will more likely include provisions that specifically deal with pandemics, as lawyers try to ensure that their clients are protected, Emanoilidis says.

Emanoilidis notes that as the pandemic continues to batter specific industries — particularly retail, travel, hospitality, and entertainment— some businesses in these segments have become distressed and subject to increased pressure leading to insolvency. While not something these companies would prefer under such circumstances, they may become targets for strategic purchases, which would otherwise not be possible.

“Some of these companies would likely not survive without an M&A solution,” Emanoilidis says, especially as government support programs eventually fall away.

Strategic buyers looking to acquire competitors’ assets in these ailing industries may find they can advance these deals and withstand any regulatory challenge from Canada’s Competition Bureau under the “failing firm defence.”

Under this defence, competition regulators may conclude that a merger transaction would not substantially lessen competition because the target firm would have otherwise exited the market in the absence of the merger. The Competition Bureau has accepted this approach in the past.

The report says inbound and outbound M&A activity will continue to be significant in 2021. Emanoilidis points out that foreign acquisition of Canadian targets declined in 2020. Still they remain at historically high levels, indicating Canada is still a favoured destination for M&A. As for Canadian companies, the Torys report says that they continue to look abroad for transactions, despite the decline in 2020. (Outbound capital was just over half the overall value recorded for 2019.)

One factor that will mark 2021, and consistent with what other countries are doing, is the Canadian government’s announcement that it will scrutinize foreign investments in Canadian businesses related to public health or involved in the supply of critical goods and services to Canadians. It also reiterated it would pay particular attention to state-owned or state-influenced investors.

A recent example of this is the Canadian government’s rejection of Shandong Gold’s proposed acquisition of TMAC Resources and its arctic gold mining project on national security grounds. It is the first time the government has blocked an investment in the Canadian mining sector by a Chinese company under the Investment Canada Act. The report says that foreign state-owned investors from China and certain other countries should expect more prolonged and more difficult reviews in the near term.

It isn’t just Canada adopting these restrictions. For example, the French government recently indicated it would nix a transaction under which Canada’s Couche-Tard would buy French supermarket chain Carrefour for more than $20 billion.

The deal would have created the world’s fourth-biggest supermarket chain based on 2019 sales, after Walmart, Lidl owner Schwarz Group and Kroger. But French finance minister Bruno Le Maire said he would block the Carrefour deal if pressed on the grounds of food security.

The Torys report says those interested in pursuing foreign transactions should “consider engaging counsel early in the transaction planning process to appropriately assess the risks and seek to manage them effectively in a proactive manner.”

However, as 2021 progresses, the report concludes the roll-out of vaccines along with extensive monetary and fiscal stimulus by governments in Canada and around the world are expected to set the stage for the recovery and rebuilding effort to come.

“Reduced pandemic-related market volatility and access to robust equity and credit markets should provide the confidence and fuel to ensure that well-funded buyers will be able to advance their strategic agendas and pursue opportunities involving distressed businesses. All of this points to an optimistic outlook for dealmakers in the year ahead.”