By David Planques
Deal volume dipped in the first half of 2018, but it remains at a healthy level, setting a positive tone for the remainder of 2018 where activity is unlikely to slow down significantly given the strong underlying market dynamics including the amount of dry powder available.
Two mega deals drove overall deal value skyward for a combined $15B of deal value this quarter.
Drilling into the current data, there are some important observations for dealmakers in Canada:
Canadian companies, private equity and pension funds are taking a larger share of US cross-border deals. Outbound deals from Canada into the US rose by 8% in the first six months of 2018 compared to the same period last year. Since 2014, we’ve seen a trend of strong US outbound deal growth, as Canadian dealmakers continue to look south for growth opportunities in the world’s premiere high-growth market.
However, Canada-US trade talks remain in flux and inbound deals from the US are down slightly from a year ago. Despite this dip, they remain well above volumes from 2014 to 2016, which may signal that despite the NAFTA and trade rhetoric, cross-border M&A between Canada and the US will remain active.
Canadian dealmakers are also increasingly looking outside of North America for deals. International non-US outbound deals have seen steady growth from 2016 (277 deals for the full year), 2017 (303 deals for the full year), and already 161 deals so far this year. While the drivers for this trend are diverse, the most active industries were notably real estate, telecom, and healthcare.
The growth in international outbound deals is a strong message that Canadian businesses are performing well and continue to pursue growth. Going forward, we expect continuing growth in international outbound deals, as corporate Canada looks to diversify away from continued trade uncertainty, a strong US dollar, and as private equity (in particular pension funds) continue to invest overseas in new platforms and add-ons.
M&A in the Canadian healthcare industry saw strong growth in both deal value (up 233% over last year) and volume (up 48%). This stands in contrast to most other sectors, with the exception of energy and real estate, which continue to be strong.
The strength is due to the considerable impact of M&A in the cannabis subsector, which saw 48 deals since the start of 2018, for a total disclosed value of $5.2B. Interestingly, most of this activity occurred January through March, but we’re currently seeing another spike in activity and value, in anticipation of adult-use recreational legalization in Canada on October 17, 2018.
As most market analysts predicted, the Bank of Canada (BoC) has started on a program of slowly raising its trend-setting overnight lending rate. At the time of writing, bond markets are currently pricing in 25bps hikes for the BoC’s September and December meetings—a rate that is more than we’ve seen over the past several years, but likely negligible in terms of its impact on both valuations and capital-raising efforts in the near future. Or to look at it another way: rates are rising, but are still low from a historical perspective.
Given the continued attractiveness of the current credit climate, it may make sense for dealmakers to complete acquisitions sooner rather than later, and lock in long-term debt while the forward curve remains relatively flat. While financing costs have gone up marginally, lower spreads and covenant-light deals continue to make using leverage to finance acquisitions an attractive option.
With current fragmentation in the Canadian cannabis industry, it’s not surprising that cannabis companies who are flush with cash and have access to relatively cheap capital (due to strong equity valuations) are on a buying spree. These companies are seeking economies of scale, expanding their patient base, securing consumer-centric products and brands, entering new markets or acquiring protected distribution channels.
In Ontario, unconfirmed reports that the new Conservative government will allow legal cannabis to be sold in private stores will likely draw more players into the cannabis retail space and drive licensed producers (LPs) to make acquisitions to strengthen their retail capabilities in the province. And while adjacent industries (e.g., alcohol) have been relatively slow to enter the cannabis industry, this news may expedite their entry as it offers something they have never had access to in Ontario—retail sales.
After October 17, we expect the landscape to shift toward three main activities:
1. Continued consolidation of the LP landscape within the country, as growers continue to mature their adult-use businesses.
2. A “culling” of the space as expected oversupply takes its toll and forces undercapitalized players into bankruptcy (which may be an opportunity for well-capitalized companies to acquire prime assets).
3. Increased focus on international M&A, as LPs look to fuel further growth by tapping emerging foreign medical markets.
From a broader perspective, we expect M&A to continue to be strong in the cannabis sector, with a number of aggressive players and ample capital flow driving growth by acquisition strategies.
New trade tariffs have impacted an array of industries as China, the US, Canada, Mexico, the European Union, Japan, and others introduce tariffs on a wide range of goods. What effect will this have on Canadian companies? It’s still too early to say.
The current trade tariffs are affecting only about 3% of Canadian exports and by themselves these tariffs are not likely to have a significant impact on the Canadian economy. The demand for steel and aluminum imports should not decline significantly, given the lack of capacity in the US, and will likely be reflected mostly in higher prices to US producers. The impact of tariffs put in place by Canada will likely have a small upward impact on consumer prices, and Canadian producers that have to use US steel (due to it special characteristics) may see a significant impact on their bottom line.
Tariffs may also affect the “competitiveness calculation” for certain Canadian businesses in the global M&A market. Changes to sourcing, demand and supply chains, and other business areas driven by changes in tariffs will likely impact business performance and, as a result, valuations and M&A activity. For dealmakers, it’s vital to review the imports/exports and supply chain of targets to identify potential market opportunities and cost increases. While the effects of these tariffs may not be felt for several months, their impact should be considered when analyzing the synergies and value of a potential acquisition target.
The biggest impact of these tariffs is the uncertainty they create at the prospect of a trade conflict. Should this uncertainty continue, we are likely to see a movement of investment from Canada to the US, especially in capital intensive industries that just received a large effective tax reduction in the US.
High valuations for companies will likely keep overall M&A strong in the months ahead, especially given the healthy amount of capital available to corporations and private equity funds. The pace of deals may depend in part on supply, as acquisition targets have been limited in some sectors. That could change though as large companies re-evaluate their portfolios and consider divesting operations that don’t align with their core strategic priorities.
From a big-picture perspective, there continues to be plenty of activity in Canadian M&A. For more on the current deals landscape by industry, please visit our Deals Industry Insights page.