M&A year in review and 2019 outlook

Despite the ups and downs of trade negotiations and market uncertainty in the final months of the year, Canada saw a strong market for mergers and acquisitions in 2018. Helped by abundant capital and a growing economy with low unemployment, aggregate deal value was up 20% over 2017, and the volume of transactions rose by 8% (2,395 deals in 2018 versus 2,222 the year before).

With Canada embarking on major legal change with the legalization of recreational cannabis in October 2018, it’s no surprise the healthcare industry was among the top sectors for deal activity in 2018. In May 2018, Aurora Cannabis Inc. announced its plan to acquire MedReleaf Corp. for US$2.1 billion. Other big deals in 2018 included Constellation Brands Inc.’s US$4 billion investment in Canopy Growth Corp. and a move by Altria Group Inc. later in the year to invest US$1.8 billion in Cronos Group Inc. Overall, deal volume in the health care sector rose by 87% over 2017.

The financial services industry also saw a significant rise in deal volume (up 31% over 2017), followed by the technology sector (up 29%). The two biggest technology deals were Blackberry Ltd.’s acquisition of Cylance Inc. for US$1.4 billion and Motorola Solutions Inc.’s purchase of Avigilon Corp., a Vancouver-based maker of surveillance systems, for US$1 billion.

One notable trend was the increase in deals valued at more than US$1 billion in 2018. There were 45 such deals last year, up from 32 in 2017. Much of the mega-deal activity reflects both domestic and outbound transactions involving Canadian pension funds in areas like real estate, private equity and infrastructure. One company, Brookfield (including its subsidiaries), was a player in five of the 45 mega deals. In the largest Canadian deal of the year, an investor group led by Brookfield Business Partners LP acquired Johnson Controls International’s power solution business for US$13.2 billion.

Outbound deal activity was strong despite questions for much of the year about the fate of the North American Free Trade Agreement (NAFTA), negotiations and concerns about tariffs and protectionism. Canadian companies showed an appetite for businesses based in both the United States and elsewhere in the world, which drove a 17% increase in outbound transactions in 2018 (as compared to a 4% rise in domestic deals).

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What’s on the M&A horizon for 2019?

With another year of strong domestic and outbound M&A activity behind us, what’s ahead for 2019?

According to our 22nd Global CEO survey, Canadian CEOs are less optimistic about the global economy and their prospects for growth. Faced with a challenging operating environment, and as concerns around protectionism and trade loom, they’re looking inward for growth, citing organic growth (84%) and operational efficiencies (88%) as key drivers. But interest in M&A is also on the rise, with 59% of Canadian CEOs planning on new M&A to drive their revenue growth in the next 12 months, up from 44% in 2018—and compared to only 37% of global respondents in 2019.

Despite a potential slowdown in economic growth, we expect the abundance of capital accessible to investors to continue to support M&A activity. Here’s a look at some of the trends likely to have an impact on the deals landscape this year.

Deal drivers

PwC Canada's Deals Leader, David Planques, provides an outlook on M&A activity. 

Tech disruption

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Cannabis legalization

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Tech talk

Technology has long been a disruptive force in M&A, driving significant deal activity and even changing the deal process itself, introducing technology like artificial intelligence and analytics into the way deals are done. This year will be no different. In today’s cash-rich market with emerging and disruptive entrants in almost all industries, companies are using M&A, and notably technology focused deals, to create or sustain competitive advantages.

In 2018, 53% of Canadian deals were considered cross-sector (i.e. acquirers purchasing outside of their sectors), and 20% of those cross-sector deals were acquisitions of tech companies—a trend we’ve seen gradually increase and expect to see continue in 2019.

Within the tech sector, we believe companies focused on data security, which is an ever-growing issue in light of recent high-profile cyber security breaches, will be at top of the list of M&A candidates. Financial technology companies (fintechs), especially those with proven business models that could attract the interest of more established counterparts like banks and insurance companies, will also be targets for M&A activity.

Corporate venture investments will continue to be another trend in 2019. In the fourth quarter of 2018, corporate venture capital investment in Canadian tech start-ups accounted for 42% of venture deal volume, up from just 17% at the end of 2016, according to our analysis of CB Insights data. The increased corporate involvement in venture investing shows that a growing number of companies are looking at tech as a competitive differentiator, and also underscores the strength of the Canadian tech ecosystem. But it also raises the question of whether it’s best to build, invest or acquire when it comes to corporate innovation strategy.

Technology is also affecting how deals are done, whether as a factor in assessing a target company’s growth potential or as a support to the deals process itself. Artificial intelligence (AI) and data analytics are at the forefront in the near future. Machine learning can help process and analyze far bigger data sets—much of it unstructured—that dealmakers may use to assess a potential target and find additional value creation opportunities. Those that embrace these advances will be in the best position to find an edge in a highly competitive deal environment.

Protectionism and trade

After a roller-coaster year of trade negotiations, Canada has entered 2019 with an unratified United States–Mexico–Canada Agreement (USMCA). Despite concerns from some sectors, particularly the dairy and generic drug industries, about changes included in the deal, the announcement of USMCA has generally served to reduce business worries about the effects of a failure to renegotiate NAFTA and helped improve market sentiment.

But the possibility of global trade disruption remains a concern for businesses. Chief among them is US-China trade relations, which could pose a threat to companies involved in the supply chain of exports to China. But it could also create opportunities for companies involved in the supply chain of North American products that compete with Chinese imports. Ongoing tariffs applied to Canadian steel and aluminum exports to the United States—as well as Canada’s countermeasures—are negatively affecting industries that use those materials as inputs and are raising the prospects of others, such as metal recyclers.

From an M&A perspective, despite concerns over protectionism, Canadian outbound deal volume to the United States rose 16% in 2018 compared to the previous year. Canada-US outbound deals accounted for 60% of all Canadian global outbound deals, a number which has held steady over the last few years. 

But when asked to identify the most attractive foreign markets for investment, Canadian CEOs are expressing more uncertainty. While the United States is still the most important market for Canadians’ growth prospects, with 60% of respondents saying so, it’s a sharp fall from 88% last year. In fact, with the exception of Mexico, interest in the top markets Canadian CEOs consider most important to growth (i.e. United Kingdom, Germany, China and Australia) has stayed flat or dropped year over year. We’ll watch to see whether this sentiment tapers outbound deal volume in 2019.

 

Changing demographics and consumer preferences

In 2019 and beyond, trends like longer lifespans and strong consumer preferences will create opportunities for companies to explore new products and offerings and increase their market share. This will lead many organizations to rethink their business strategy and some to transact through acquisitions or divestitures.

The trends will play out in many ways. For example, shifting demographics will likely increase deal flow in the private markets, particularly as aging baby boomers look to sell and transfer business ownership. From a sector perspective, real estate and seniors’ housing are good examples of areas where we see continued opportunities, especially in North America, where the population is aging and lifespans are increasing. We expect these sectors will see major growth over the next few years amid market consolidation and new investments aimed at meeting population demand.

With demand for government-funded programs rising quickly, government payers will find themselves forced to respond with a changing mix of public and private services. A major focus of the changing mix is healthcare, which is evolving not only because of aging demographics but also because of shifts in the way consumers view and manage their health. Young adults, for example, are focusing more on consumer health and wellness and want to better understand and manage their health through digital channels. This is creating new opportunities for industry convergence as companies in other sectors, such as consumer goods, retail and technology, move into health and wellness services to boost their position and competitiveness.

Other industries experiencing rapid shifts include the automotive and broader transportation sectors, which have been busy making deals to tap into trends like car-sharing, autonomous driving, digitization and urbanization. While companies can try to enter those new markets from the ground up, acquisitions can be the most practical way of capitalizing on the opportunities.

Economic uncertainty

While many economic indicators were strong in 2018, a few signs—notably the volatility in the equity markets—had some observers predicting a slowdown in economic growth in 2019 or 2020.

How could this impact deals activity? To get a sense, it’s important to look at the corporate borrowing environment after a succession of interest rate increases in recent years. Companies borrowed heavily during the years of cheap debt and looser lending standards following the 2008 financial crisis, with many issuing low-rated investment-grade bonds (BBB and Baa). Those with BBB and Baa bonds may struggle when it comes time to refinance or find themselves downgraded if the economy stumbles.

Between November 2018 and early January 2019, the high-yield bond market went 40 days without a high-yield bond sale. According to Dealogic, this is the longest stretch without a high-yield bond sale since 1995, when they started collecting the data. The high-yield issuance slowdown in late 2018 could be the first indicator that the era of lighter lending standards has come to an end. A slowdown in the high-yield bond market could negatively impact overall economic growth as this is the market where growing companies typically go to finance acquisitions and capital expenditures.  

A potential implication of the slowdown in the high-yield debt markets could drive a trend in deleveraging. For example, companies could turn to divestitures by carving out assets they’ve acquired during the years of cheap credit and/or other non-core assets. For companies with capital to spend, that means there could be good buying opportunities in 2019.

And even for those finding themselves in a challenging position, there are more options to deal with their situation than in the past. Specialty services to help with deleveraging have evolved in recent years as we see more debt-for-equity swaps and other creative transactions to manage leverage. What’s more, the number of institutional investors and funds that focus on special situation investing has increased significantly; this gives companies more options to find financing for non-traditional situations. Even if economic growth were to slow, we would expect there would continue to be significant M&A opportunities and an abundance of capital to pursue them.

Cannabis at the crossroads

With recreational cannabis now legal in Canada and medical cannabis rapidly expanding internationally, 2019 will be a pivotal year for cannabis companies to show investors a return on the wave of capital provided to the sector over the past few years. Cannabis indices have fallen from their 2018 peaks, which has typically been attributed to supply shortages and provincial distribution constraints, but many opportunities remain for cannabis businesses to successfully compete and create shareholder value.

In Canada, the wave of consolidation has started as more players enter into partnerships and reach agreements with companies to secure a piece of the nascent market. Recent deals by adjacent entrants (such as Constellation Brands Inc.’s investment in Canopy Growth Corp. and Altria Group Inc.’s deal with Cronos Group Inc.) will likely further drive deal activity into 2019 as more licensed producers (LPs) look to partner with big tobacco, alcohol and beverage, consumer packaged goods and pharmaceutical companies that are seeking to enter the cannabis market.

For LPs already in the market, competition is going to intensify. As recreational sales generate consumer data, market winners will be those with the agility to adapt their business models and create products, brands and value propositions that are attractive to consumers (versus the “hypothetical” consumer brand strategies developed by LPs pre-legalization in the absence of robust retail point-of-sale data).

Amid the market fervour and a rapidly changing environment, dealmakers and investors should look for companies with a multi-phased strategy that’s designed to win within the short-term market realities of limited distribution and inadequate supply but able to pivot to a future where cannabis is an oversupplied commodity and where value-added products, combined with traditional consumer brand strategies, will decide market winners. For cannabis producers, it’s important to remember that with investors now expecting LPs to execute their investment theses and more than 130 LPs approved by Health Canada, copycat strategies won’t be sufficient.

International markets will offer attractive opportunities for industry operators. In the United States, the passage of the Agriculture Improvement Act of 2018 will let hemp cultivation flourish and likely drive a multibillion-dollar industry for hemp-derived products. With signals that federal decriminalization could happen by 2020, US investments are becoming attractive for Canadian companies looking to benefit from their industry expertise and global leadership position to gain a first-mover advantage in one of the largest consumer markets globally.

Several large LPs are already investing south of the border through a variety of strategies designed to comply with exchange listing requirements. Momentum has also picked up in the other direction as many US companies are listing on Canadian stock exchanges to access growth capital. In other regions of the world, the movement to legalize medical cannabis is accelerating. The United Kingdom, for example, has announced the implementation of a medical cannabis framework. Given that medical cannabis can serve as the precursor to a recreational framework in many jurisdictions, we expect the legalization wave to accelerate in the coming years. For example, New Zealand recently announced a 2020 referendum on legalizing recreational cannabis.

For dealmakers and investors, we expect 2019 will bring many buying opportunities. While not all will succeed, cannabis companies are in a phase of rapid expansion, both domestically and internationally, with Canadian LPs positioned as the industry’s current global leaders. To maintain this momentum, the next wave of deal-making must aim to grow our existing cannabis companies and create a platform to capitalize on new market opportunities as they emerge.

Contact us

David Planques

Partner, National Deals and One Analytics Leader, PwC Canada

Tel: +1 416 815 5275

Richard Pay

Partner, Transaction Services Leader, PwC Canada

Tel: +1 416 941 8357

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