A Year in Deals:
Highlights of 2010
Release date: Feb.16, 2011
Host: Vanessa Iarocci
Guest: Kristian Knibutat
Running time: 19:75 minutes
In this episode of Strategy Talks, PwC's Vanessa Iarocci, vice-president of the Deals practice interviews Kristian Knibutat, national Deals leader. They discuss how and why Canadian deal activity closed 2010 at a five-year high, and also offer forecasting insight into the year ahead.
Announcer: Welcome to Strategy Talks, the business podcast series by PricewaterhouseCoopers Canada. Hosted by Helen Mallovy Hicks, National Leader of PwC’s Valuations, Forensics & Disputes Practice, and Calum Semple, an Operations and Consulting Partner. This interview series, featuring new topics and guests every episode, is designed to valuable insight into some of today’s hottest issues affecting your business.
Vanessa: In 2010 Canadian Deal volumes posted a 30% gain over 2009 and closed the year at a 5-year high. What lies ahead for 2011?
My name is Vanessa Iarocci and I am guest hosting Strategy Talks. Joining me today to talk about PwC’s latest Deal Annual is Kristian Knibutat, national Deals leader.
Kristian: Thanks Vanessa.
Vanessa: So we recently released a round-up of 2010 M&A activity and our perspectives on 2011. Perhaps before we get into the outlook can you shed some light on just what kind of year 2010 was from a Deals perspective?
Kristian: Sure, I’d be happy to.
It was a very strong year for Canadian M&A even after you take into consideration that one of the largest deals, the BHP Potash deal, didn’t proceed. We tracked over 3,000 transactions which was a 5-year high - even when you consider the peak in 2007 - amounting to over $155B which was a 30% gain over 2009. So certainly a very impressive year overall, when you look at the comparison as well as the overall level of deal activity; but still, on a dollar value basis below the peak of 2007, which was about $243B. And when you do a benchmark to global level of deal activity the numbers and dollar values were 25% higher than prior years which outpaced global comparisons.
Vanessa: So Canada outpaced the global trend. That’s phenomenal. But why are dollar volumes still well off the peak?
Kristian: Well, we’re still seeing some caution in the larger deals, so the $1B+ segment of the M&A Deal market. So when you look at megadeals - what we would put in that sort of billion dollar plus range - there were 31 of those, which was up significantly from 2009, about double, but still well off the peak, which happened in 2007 where we had 58 of them. As well, when you get into the really large transactions in the $10B+ range that characterized the boom that we had in ’06 and ’07, there weren’t any of those types of transactions at all. And that makes a big difference.
Vanessa: Basically, it sounds like we’re seeing a lot of deals including megadeals, but they’re simply just not super-sized.
Kristian: That’s right. The largest deal in the Canadian market last year was the Kinross Gold deal which was about $6.7B; and the takeover of Redback Mining. If you look to 2006 for comparison you would’ve seen two transactions that would’ve been the $20B+ range which would’ve included the Falconbridge, Xstrata and the Inco Valley transaction. In 2007, we saw the $40B+ Rio Tinto / Alcan merger, so both of those significantly higher than the Kinross deal.
And the ability to get those kind of deals done is really dependent upon the ability to leverage. You need to be able to tap the markets for debt, in order to be able to do that. And when we look at the level of ability to borrow for loans for M&A we’re still in a situation where the ratios of leverage were sort of sitting in the 5-6 times range, which is more in line with where they would’ve been in ’04/’05, and still well below the level that they were at in ‘07/’06 at the peak where they would’ve been sort of 7-10. So that inability to leverage the deals means you can’t get the deal size to be as big or go after as large transactions.
Vanessa: Interesting. So who exactly was doing all of this buying and selling last year in Canada?
Kristian: Well not surprisingly, when you think about Canada, a lot of the deal activity was in the energy and materials sectors, and financial also came on very strong in the last quarter in particular - and I’ll talk about that in a minute. So those three sectors really made up 60% of the overall level of activity.
I referred to the financial sector in the last quarter. There were some changes to the rules for Basel III recommendations on capital reserves and as a result of that banks were able to look at the amount of capital that they needed to retain, free some of that up, and really go aggressively at the market. So in the last quarter of the year we saw Canadian banks do $13B worth of transactions. So a very strong finish to the year for the banking sector, the financial sector.
When we look at sort of who’s doing the deals from a segment perspective, 92% of the deal activity was with corporates and only about 8% of the activity was with private equity.
Vanessa: Only 8%. That’s surprising because I’ve heard so much about large PE deals, especially towards the end of the year and our report highlights that CPP, Onex – the acquisition that they made of Tomkins – was actually the largest PE deal globally of the year. So what’s going on exactly in the PE sphere?
Kristian: Well we certainly did see some large transactions in that space, but it was concentrated in a few players and sort of, as you’ve noted, CPPIB, Onex, Teachers’, and OMERS were involved in deals representing probably about 70% of all of the PE volume. So we’re still only looking at it, when you take into consideration of all the M&A deal activity, sitting at that 8% level.
I think the other thing that’s of interest is when you really step back and look at the PE sector, and we talked a little bit earlier about leverage, which is a key element of them being able to do deals – outside the pension funds to a degree – a lot of the deal activity were in exits. So were they were divesting of investment companies that they had... actually it was about 66% of the activity, which is quite high if you go back in to pre-crisis levels that would’ve been more in line with the 30% range; so more than double the amount of activity in the exits for private equity.
We really saw 2010 as a year where private equity were looking to, one, probably cash out for deals that were coming close to the end of a life of the investment that they had – which typically runs in that kind of 5-year range - and rebalancing out their portfolios.
Vanessa: Interesting. So to sum it up, 2010 was a very good year but for a select few. How do you see 2011 shaping up? More of the same, or will a deal rally be broader?
Kristian: Well, we’re looking for an outstanding year in deal making. And we do see it being much broader. So it’s going to be across a number of segments. And there’s a number of reasons for that. When you start to look at a macro level, there’s more than three trillion dollars (and that’s a “t” – trillion) in cash reserves in corporates globally. We’ve got private equity firms that are holding another $500B. And those numbers would be mirrored in Canada, so we would have a lot cash and corporate balance sheets and a lot of money sitting in private equity in Canada. And that doesn’t take into account the trillions of dollars that are going to be in state-owned enterprises, sovereign wealth funds, that are also looking to deploy their capital and get a good return on that. We’ve also got an ability, now that the debt markets are starting to ease up a little bit and as the outlook for economies around the world is more positive that there’s a freeing up of the ability to get access to debt financing.
There’s trillions more there that will be available to finance M&A deal activity, and I think when you look at Canada specifically, we’ve got the added benefit of a well-capitalized financial system, again, supports the ability to borrow from that perspective. We’ve got a strong dollar, which gives us purchasing power around the globe, which should help in terms of making acquisitions more attractive from a Canadian perspective. And we’ve got leadership in a number of sectors that we’re going to drive. We talked about the strength in our banking sector and the significant increase in overall level of deal activity in the last quarter last year. And that’s just sort of one example of where we believe Canadian companies will be very strong in the M&A market.
So when you look at all of those foundational factors that are going to allow for an opportunity for a great deal market, and you start to look at organic growth rates which, well the economies are starting to improve, it’s sluggish and the expectations are that it’s going to take a while. Companies are looking for growth; are really going to be looking very closely at deals as one way to get higher levels of growth for their businesses.
Vanessa: Clearly it sounds like there’s a strong demand for deals. But demand is only one side of the equation. What about supply? Where do you see that going in 2011?
Kristian: As I said, I think part of the reason that we expect it’s going to be an outstanding year is the fundamentals are improving on the supply side as well. So you need to have two parties to the transaction. You need to have that willing seller, and sellers aren’t going to be attracted to a market unless they believe that they can get a good price, otherwise they’ll sit on the sidelines and wait. And what we did see in 2010, particularly towards the end was that multiples for the deals were starting to expand. And as multiples expand it means that the sellers are going to look at that and have a view that it’s going to be more attractive for them to consider selling their businesses into the market. So certainly when we look at another indicator of that is the average deal size, and when we looked at the average deal size in the Canadian marketplace, it was up 27%. So that certainly supports the fact that there’s being more paid, or higher values being paid, for the businesses that are in the market. We expect that’s going to encourage sellers to come in to the market; there’s going to be more available to buy as well as the demand side of there being players out there that are looking to buy.
Vanessa: Fabulous. So it definitely sounds like there’s going to be more of an equilibrium in the market, but do you have any specific expectations about M&A for 2011?
Kristian: We certainly do. We would say there’s sort of four key expectations that we have. The first is that deals capital is going to be more plentiful, as we’ve sort of talked about that a little bit. When we look at the broader markets in Canada, both pricing and non-pricing conditions are certainly strong. When we look at Canadian bank deal lending, there was a comment made in the senior loan officer survey that the Bank of Canada does that pointed to support for a net increase of demand for credit, where reference was made to the fact that the increase in demand was largely driven by corporate borrowers mainly related to activity in mergers and acquisitions. And interestingly enough this is the first time we’ve seen reference to this kind of reference in this survey post-crisis period though. So we certainly see that as boding well for the ability for companies to be out there borrowing for deal activity.
Vanessa: So Kristian, the private lending market looks to be more hospitable for M&A but what about the Canadian public debt markets?
Kristian: That’s a very interesting question, Vanessa. I think there’s been some changes there in the Canadian public debt markets just recently and we’ve certainly got a low rate environment so there’s a strong appetite for yield out there. So to the extent that there’s debt product that’s brought in to the market it’s certainly getting taken up.
In the Canadian market we haven’t had a strong dead issuance market in what we call non-investment grade, so higher yield type of debt. And last year there was almost $3.5B that was raised in the high yield debt markets. And we expect that that sets a good tone for what the future’s going to be and we expect to continue to see that to be a vehicle.
I think the other thing that’s certainly of interest is – given the profile and prominence of Canada right now from an economic perspective in the global market – we expect that there’s a lot of foreign investors that are looking to Canada that really want to have some exposure to the Canadian space and high yield debt with corporates gives them that kind of an opportunity to participate in the Canadian marketplace as well. We think that’s one of the other things that’s driving the strong Canadian public debt market.
Vanessa: Back to first principles. As leverage becomes more plentiful, buyers should be able to access debt to complete deals and perhaps even to offer up higher purchase multiples, would bode well for the deal market, I think.
Kristian: I couldn’t have said it better myself.
Vanessa: What is the next expected trend?
Kristian: The next trend is something we’ve certainly been talking about for some time. We expect Canadians to begin looking past the U.S. borders to do deals. Sort of consistent with what we’ve seen as the long-term trend is in the Canadian deal market. Canadians really haven’t ventured much past the U.S. border. When we look at 2010 about 86% of the deal activity involved a Canadian company with another company in North America, sitting on the other side of the table.
We did see, however, in the last half of 2010, select Canadians sort of testing the water so to speak , making deal activity, or entering in to deal activity, outside of Canada. And we observe Canadian transactions in nearly every continent during the last quarter of 2010.
One of the key themes here is that as companies look for inorganic growth and you look at North American marketplaces as going to be more sluggish for that kind of growth, you really do need to start to look to some of the emerging markets if you are going to expect to have higher levels of growth. And that’s going to drive companies, we believe, to start to look beyond the North American marketplace. If you combine that with the strong dollar that we have, which gives us more purchasing power for doing transactions, and the expertise that Canadians have in some key sectors, I think Canada has a lot to offer as a good partner as well in the deal space.
So all of those, I think, are going to come together to set a good foundation for Canadian companies and businesses to look beyond North America for deal activity.
Vanessa: Well that’s certainly a new and very interesting development in the Canadian deals market. But will increased cross-border activity of this sort impact deal structure?
Kristian: We think it will change deal structure, or add I guess, to the tools that are involved in doing a deal. So, create more flexibility and options.
Certainly there’s been a lot of focus from a regulatory perspective. I think there’s a heightened level of concern out there particularly politically around acquisitions of foreign investors into domestic markets. And that sort of level of heightened activity causes deal makers to step back and be a little more creative. We expect that we’re going to see more activity in joint ventures, taking a minority position in deals. We saw a little bit of that in the Canadian marketplace last year. And really looking at what the overall objectives of doing a transaction are. Sometimes that’s access to know-how through an enhanced partnering relationship, or it could be access to supply, and whether that’s commodities in particular. Those types of things we expect are going to start to flavour the deal market a bit, and then we’ll see more joint venture and minority interest types of transactions.
Vanessa: Makes sense. Well it sounds like you’ve opined on where we will be doing deals and how, but are there specific sectors you anticipate will be especially busy through 2011?
Kristian: I think - not surprisingly for anybody following the Canadian market – strong energy and mining deals, we expect to continue. Commodity prices remain strong. We’ve talked about the growth in the emerging markets. They’re going to continue to need the raw materials to fuel that growth. So we expect to continue to see that sector – or those two sectors really – continue at the pace that they’ve had. When we get beyond that, certainly financial institution space is one that we expect to see more activity in. We saw some towards the end of last year; we expect to see that continue into the new year. I think it’s going to be hard for Canadian financial institutions to pass up some of the good deals that are out there. Maybe a little more focused in the U.S. market right now as they build their North American platforms out. We also expect to see activity in healthcare, infrastructure, agribusiness, and food, and as I said, banking.
Vanessa: Interesting, Kristian. Unfortunately, our time is too short today to discuss each of these sectors, but can our listeners refer to your report for more sector-specific information?
Kristian: Sure. Our report can be downloaded. It’s referred to as Deals Annual; by visiting pwc.com/ca/quarterlydeals.
Vanessa: Thank you for taking the time to discuss your perspectives with us, Kristian. I am looking forward to an outstanding year of deal making.
This concludes this episode of Strategy Talks. Thank you for listening. We hope you’ll join us again soon for another episode. To download or subscribe to this podcast series, or to find more information, please visit pwc.com/ca/strategytalks. The information in this podcast is provided with the understanding that the authors and publishers are not herein engaged in rendering legal accounting, tax, or other professional advice or services. The audience should discuss with professional advisors how the information may apply to their specific situation. Copyright 2011, PricewaterhouseCoopers LLP. All rights reserved. PricewaterhouseCoopers refers to PricewaterhouseCoopers LLP, an Ontario Limited Liability Partnership, or, as the context requires, the PricewaterhouseCoopers global network, or other member firms of the network, each of which is a separate and independent legal entity.
Announcer: This concludes this episode of strategy talks. Thank you for listening. We hope you will join us again soon for another episode. To download or to subscribe to this podcast series, or to find more information, please visit pwc.com/ca/strategytalks. The information in this podcast is provided with the understanding that the authors and publishers are not here and engaged in rendering legal accounting, tax or other professional advice or services. The audience should discuss with professional advisors how the information may apply to their specific situation. Copyright 2009 PricewaterhouseCoopers LLP. All rights reserved. PricewaterhouseCoopers refers to PricewaterhouseCoopers LLP, an Ontario Limited liability partnership or as the context requires, the PricewaterhouseCoopers global network or other member firms of the network, each is which a separate and independent legal entity.