Canada: Trends in Infrastructure M&A

Copyright 2011, Blake, Cassels & Graydon LLP

Originally published in Blakes Bulletin on Mergers & Acquisitions/Infrastructure, January 2011

The Canadian public-private partnership (PPP) market began in earnest in British Columbia in the early part of the last decade and has continued to grow and thrive throughout Canada in the last several years. This growth can be attributed both to the need to replace aging infrastructure – including roads, bridges, hospitals, correctional facilities and schools – and to the corresponding entrance into the Canadian marketplace of a pool of private-sector participants eager to deploy their capital in exchange for the stable, long-term revenue stream offered by Canadian PPP deals.

As the earlier PPP deals have now matured and a consistent stream of new PPP deals continue to appear in the pipeline, a robust secondary market has emerged for Canadian PPP deals in which some of the initial private-sector participants are divesting all or a portion of their equity interests to other private-sector investors. Several factors are driving interest in the secondary market in Canada, including:

  • the ability of the original investors to crystallize an appreciation in the value of their equity interests;
  • the needs of some original investors to liquidate their interests due to the scheduled end of the investment funds that hold such interests;
  • the desire of developers to redeploy their capital in new projects in Canada and elsewhere;
  • the international reputation of Canada as a stable and transparent marketplace; and
  • substantial demand from specialized infrastructure private equity funds, life insurance companies and pension funds seeking stable yields well in excess of what can be achieved in the current bond market.

Recent notable deals in the secondary PPP market include the acquisitions by CPP Investment Board of separate 10% and 30% stakes in Ontario's Highway 407 Express Toll Road; the sale by Macquarie Essential Assets Partnership of its equity interests in the Sea-to- Sky Highway Improvement Project and the Edmonton Ring Road/Anthony Henday Drive Project to a consortium led by Fiera Axium, a Montreal-based infrastructure fund; and the acquisition of stakes in British Columbia's Kicking Horse Canyon Project and another segment of the Edmonton Ring Road/Anthony Henday Drive Project by a U.K.-based HSBC infrastructure fund.

The purpose of this bulletin is to provide some insight into some of the key features of Canadian secondary market PPP deals and how they differ from conventional merger and acquisition transactions.

Auctions Are A Staple

The interests being bought and sold in the secondary PPP market can be of significant size and value, and the participants in secondary market transactions are sophisticated and experienced dealmakers. These factors, coupled with a healthy demand for such interests, will almost always auger in favour of the seller engaging in a controlled sale auction process instead of bargaining exclusively with a single interested buyer. As a result, the usual dynamics in auction processes will come into play, and bidders may need to negotiate more cautiously, and bid more aggressively, than would otherwise be the case. In addition, the sellers in such transactions will need to be cognizant of the increased need to conduct the auction in a fair and transparent manner and to consider the special confidentiality issues that arise when dealing with multiple parties and their professional advisors.

Return Of The Club Deal

In more sizable secondary market transactions, bidders will frequently assemble clubs or consortia to enable them to participate in auctions they would otherwise be unable to participate in or to place a more competitive bid than they would be able to place independently. This gives rise to numerous structural and governance issues – for example, the type of business vehicle to be used, how key decisions of the business vehicle will be made, and how and when income will be distributed – which will need to be considered by the consortium members.

Structural considerations will be of particular importance when a consortium consists of both taxable and tax-exempt entities (such as pension funds).

Sophisticated professional advice will be critical in these circumstances to ensure that the acquisition vehicle and the consortium structure are both commercially and tax efficient.

THE NEIGHBOUR PRINCIPLE

As vibrant as the infrastructure market is, the infrastructure community can be a small place – its participants know and frequently partner with one another in a variety of transactions, and there is considerable homogeneity amongst sellers and buyers in auctions of infrastructure assets. This gives rise to an interesting dynamic in infrastructure auctions whereby the need to negotiate aggressively must be weighed against the need to be perceived as behaving in a fair and commercial manner. This dynamic is not typically present in a traditional auction attended by rival strategic or financial buyers.

"COVENANT LITE" AGREEMENTS

For all the reasons described above leading to the development of a robust secondary PPP market, the terms and conditions contained in an acquisition agreement for Canadian infrastructure assets are significantly more seller-friendly than would be the case in a typical private company merger and acquisition transaction. Frequently, a seller of infrastructure assets will seek to limit its representations and warranties to its ownership of the project vehicle and/or its holding company, and will not offer any meaningful representations and warranties relating to the concession agreement or the subcontracts with its construction or operation partners. The seller will also typically seek to cap its liability under the acquisition agreement at a comparatively small percentage of the purchase price and to further limit its liability by contractually restricting how and when the buyer may make indemnity claims.

THE IMPORTANCE OF DUE DILIGENCE

The need to conduct a comprehensive due diligence process is significantly increased in infrastructure M&A transactions due to the limited contractual assurances and remedies that will be available from a seller of such assets and due to the complex and extensive suite of procurement, project and financing documents that form the basis of every PPP deal. It will be critical for each bidder to gain a comprehensive understanding of those documents in order to properly assess the stability of the revenue stream generated by the project and how readily the project can be financially re-engineered – for example, through a future refinancing of the project's debt facilities – so as to improve that revenue stream. Key issues for bidders will include:

  • the categories of events under the project documents that will entitle the governmental authority to reduce or suspend payments – for example, failures to maintain the infrastructure asset to a particular, defined standard or to make the asset available for use – as well as those events which may lead to termination and the compensation payable in those events;
  • the allocation of risks to be borne by the governmental authority and by the private-sector partner in relation to the project;
  • the passdown of risks by the private-sector partner to its subcontractors, and whether there are any gaps in such passdown that will leave the private-sector partner with stranded risk; and
  • where the project is not yet completed, the process and approvals required to complete the project and the nature of the penalties that can be assessed for a failure to complete the project within the contemplated timeline.

Additionally, each bidder will need to understand the restrictions imposed by the relevant governmental authority as to the persons who are qualified to operate or own interests in the project and what consents are required from the governmental authority and other parties (for example, the project's financiers or subcontractors) to ensure that the buyer is able to acquire an interest in the project and that the buyer's investment is relatively liquid and not hampered by unduly onerous transfer restrictions.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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