Opportunity for M&A in Canadian retail likely to increase as we gain more clarity on Covid-19

As retailers have both floundered and flourished in a Covid-19 world, merger and acquisition activity in the sector will likely increase within the next year, especially if there is more certainty around how the pandemic is progressing, says Norton Rose partner Troy Ungerman.

“For those companies that have been able to withstand the economic shock of the pandemic, this could be an enormous opportunity to grow further through M&A,” says Toronto-based Ungerman. He has handled some key retail-related transactions, including Canadian Tire’s 2018 purchase of high-performance athletic and work gear brand Helly Hansen.

Ungerman acknowledges there has been a definite decline in M&A activity in the retail sector, but he sees that changing in 2021. “I’m a deal junkie, I like to see deals happen, so perhaps I am just optimistic, but I see more clarity on where we are heading regarding the pandemic, and I see activity picking up, especially on the private equity side.”

He notes that some retail businesses — leisurewear and gym equipment, for example — have increased sales or at least held their own through the pandemic. But others, which may have been languishing before Covid-19, have fallen on hard times. Reitmans, Aldo, Tristan, Lole, and David’s Tea are just a few of the Canadian retailers that have filed for creditor protection so that they can restructure. They join big U.S. names like J.C. Penney and Brooks Brothers.

At the same time, he says the pandemic has also forced retails to think about how to better prepare themselves for the “new economy,” one in which e-commerce and supply chain and distribution channels will become even more factors in success.

To that end, technologies that can help retailers conduct their e-commerce more efficiently will become critical, Ungerman says, even for those retailers who have a strong brick-and-mortar presence. “So, a bolt-on tech company acquisition that can help overnight catapult the online presence of a retailer is a good example of the type of M&A we might see in this sector.”

For example, a retailer could have an in-house e-commerce platform that was perhaps good enough pre-pandemic but can’t meet current online demands. A technology acquisition could help solve that problem, Ungerman says. Likewise, investing in artificial intelligence or data mining could help retailers understand who is looking at their websites and what they want.

Along with bolt-on acquisitions that will help existing business, Ungerman says there is potential for the “winners” in retail — those who have managed to be stable or even flourish during the pandemic — to take an interest in those have not fared as well. Valuations for these businesses will likely be lower than before the pandemic, he says, though the potential for greater risk must offset the lower cost of making the deal.

Ungerman, who has worked on both sides of the M&A equation but more typically represents buyers, says strategic retail buyers might emerge. However, a more likely scenario is for private equity and pension funds to start putting the capital they have been sitting on to work.

These non-strategic buyers have the “dry powder” to make deals at potentially lower valuations than before the pandemic, Ungerman says. Still, they need to do their due diligence to see if the targets, even if bought more cheaply than before the pandemic, can “get to the next level” within their investment timeline (typically three to five years) for monetizing the asset.

With the pandemic hitting some retailers particularly hard, the potential to buy a retail asset within a bankruptcy and insolvency process becomes more of a reality, Ungerman says. It might be an opportunity for a motivated buyer to acquire an asset that has been cleansed of its debt obligations under the bankruptcy process. It could also potentially be done more quickly than “traditional M&A,” he says. The riskier environment caused by Covid-19 means more due diligence is needed, and there are increased delays with the process that goes along with that due diligence, such as travel and on-site visits.

However, buying out of the bankruptcy process has its challenges. For example, Ungerman says potential buyers are often reluctant to make a “stalking horse” bid, which means they lose exclusivity in negotiating as other potential buyers can join the process.

“These processes can cost a lot of money to engage in extensive diligence only to be knocked out at the end of the process by someone else.” Ungerman also advises keeping emotions in check to avoid overpaying for those buyers that get into these situations, especially with the continuing fallout from Covid-19.

While a lawyer involved in M&A transactions typically does not get involved in issues such as valuing a business — that is the role of the investment banker — Ungerman says the lawyer’s importance comes in “papering the best deal possible.” That means identifying the risks, quantifying those risks, explaining the client’s risks, and negotiating to reduce those risks. Negotiated terms could mean a purchase price adjustment, an “out” clause, or an earnout agreement where the seller gets a payout if it hits specific metrics within a certain period after the deal closes.

“Ultimately, the client makes a ‘go or no-go decision,’ but a good lawyer should be able to help compartmentalize those risks.”

Like in many parts of the economy, the downturn in retail is unique because it is “incident driven, not really financially driven,” and he hopes that the sector is “not broken but changed.”

He also believes humans are malleable, and things that we thought are forever changed — like choosing to wearing leisurewear over suits or shopping online versus at a physical store. “But then we go back to our old selves.”