Copyright 2012, Blake, Cassels & Graydon LLP
Originally published in Blakes Bulletin on Mergers and Acquisitions, January 2012
With 2011 now closed, we can reflect on a turbulent 12 months characterized by international political gridlock, sovereign debt concerns, tepid growth and economic uncertainty. Canada's sound financial sector and relative fiscal restraint have helped it weather an otherwise volatile period. As Canada's solid economic performance attracts international attention and Canadian companies look beyond the border for investment opportunities, there is no better time to discuss the M&A trends we see unfolding in 2012.
M&A MARKET RECOVERY WILL BE GRADUAL AND REFLECT ECONOMIC AND POLITICAL DEVELOPMENTS
Although M&A activity in Canada remains relatively robust as compared to the rest of the world, geopolitical and macroeconomic uncertainty had an impact on M&A results in 2011. The number of deals over C$1‑billion decreased marginally, with 33 such deals valued at C$87.3-billion in aggregate announced in 2011, as compared to 37 deals valued at C$118.5-billion in aggregate announced in 2010. Of note, the year's highest-profile announced transactions included the C$7.3-billion acquisition of Equinox Minerals by Barrick Gold; the pending C$3.8-billion acquisition of TMX Group by Maple Group; the C$8.6-billion acquisition from Bank of America of MBNA Canada's credit card business by TD Bank; and the pending C$1.32-billion joint acquisition by BCE and Rogers Communications of a majority stake in Maple Leaf Sports and Entertainment (owner of the Toronto Maple Leafs and Toronto Raptors) from Ontario Teachers' Pension Plan.
Facing uncertainty in Europe and a looming U.S. election in late 2012, we believe many M&A participants will remain cautious until additional comfort regarding the political and financial future is available. There are, however, reasons to be optimistic that Canadian M&A activity will rise in 2012. Mid-market transactions, which by virtue of their size are resistant to decreasing leverage ratios, once again dominated the Canadian marketplace in 2011, representing approximately 93% of all M&A activity by deal volume, and we expect that relatively high level of activity in the mid-market area to continue this year. Canadian banks remain profitable and well capitalized. In May 2011, Canadians elected their first Conservative majority government in almost two decades, which many observers expect to bolster confidence and spur investment in Canada. With corporate cash balances near all-time highs, companies will continue to pursue strategic acquisitions, and sophisticated buyers with the ability to assess and manage risk will exploit the current uncertainty to make opportunistic investments.
KEY DECISIONS ON FOREIGN INVESTMENT COULD ARISE
The Investment Review Division of Industry Canada, the Canadian federal government agency responsible for most inbound foreign investment, continues to be at the forefront of public policy debate, with reviews of several high-profile transactions garnering significant media attention in recent years. In light of IRD's increased scrutiny of transactions, success will be increasingly dependent on developing effective government, media and key stakeholder relations strategies – in addition to legal strategies – early in the deal process.
Following the Minister of Industry's interim decision in 2010 that he was not satisfied that BHP Billiton's proposed acquisition of PotashCorp was "likely to be of net benefit to Canada", officials indicated that guidance to investors and the business community clarifying the government's position on foreign investment reviews would be provided and that a review of the Investment Canada Act was also likely. However, no official clarification was provided in 2011 and it remains to be seen what guidance will be provided in 2012.
While the Canadian government did not formally oppose any foreign acquisition in 2011, Prime Minister Stephen Harper caught the investment community's attention in late September when he commented that the Canadian government must "proceed with caution" when reviewing proposed foreign take-overs, and that the Canadian economy should not be "entirely owned and operated essentially from headquarters and offices based in every place but Canada". However, the Prime Minister also characterized the review of the abandoned PotashCorp transaction as unique and not indicative of Canada becoming less hospitable to foreign investment.
It has become a practical reality under the Investment Canada Act that foreign investors acquiring direct control of Canadian businesses that exceed a prescribed financial threshold must provide binding undertakings to the Minister as a condition to receiving transaction approval. The December 2011 dispute settlement between U.S. Steel and the Minister of Industry is a reminder that such undertakings, often in place for years after a transaction closes, are enforceable, even if the economy worsens. Following its acquisition of Stelco in 2007, U.S. Steel implemented staffing reductions in response to changes in the economic climate. In response, the Minister of Industry alleged that U.S. Steel had breached certain undertakings related to employment and production. Under the terms of the settlement, U.S. Steel agreed to remedial undertakings, including to operate two former Stelco facilities until 2015 and to make further capital expenditures in its Canadian facilities.
With foreign investment in Canada likely entering a period of heightened scrutiny, we expect meaningful undertakings to continue to be required by the Minister of Industry. In the case of acquisitions by state-owned enterprises, we anticipate that the Minister will continue to focus on, among other things, commitments pertaining to commercial orientation and corporate governance.
NATURAL RESOURCES WILL CONTINUE TO DRIVE ACTIVITY
Over the past several years, M&A activity in the oil and gas and mining sectors has dominated the Canadian deal landscape. Major transactions in 2011 included Barrick/Equinox; the C$3.1-billion pending acquisition of Quadra FNX Mining by state-controlled Polish copper producer KGHM Polska Miedz SA; the C$4.9-billion acquisition of Consolidated Thompson by Cliffs Natural Resources Inc.; and Newmont Mining's C$2.3-billion acquisition of Fronteer Gold.
In our recent fourth annual Blakes Canadian Public M&A Deal Study, we found that 74% of the 50 largest friendly public deals in the 12-month period ended May 31, 2011 occurred in the resource sector. Within the sector, growth in mining M&A activity also outpaced that in oil and gas, and we expect this trend will continue through 2012.
As Asia grows, Asian companies have looked abroad for strategic resource investments in Brazil, India, Russia, Africa and, increasingly, Canada. Asian demand for commodities has continued to be strong despite some early indications that Chinese economic growth may be softening. Over the past five years, China's sovereign wealth fund and a variety of state-owned enterprises have acquired nearly C$30-billion of Canadian assets, including in Canada's oil and gas, mining and agricultural sectors. While these transactions have generally been structured as minority investments and joint ventures (in part to address the Canadian government's concerns over foreign control in these sectors), Sinopec's announced 100% acquisition of Daylight Energy Ltd. for C$2.2-billion reflects a more ambitious investment strategy in Canada. Also of note, Athabasca Oil Sands Corp. followed up its 2010 sale to PetroChina of a 60% stake in the MacKay River oil sands project by exercising its sale option in early 2012 on the remaining 40%, giving PetroChina full ownership of the project.
CANADIANS WILL FOCUS ON INTERNATIONAL ACQUISITIONS
In recent years, Canadian businesses have acquired approximately two foreign companies for every Canadian company acquired by foreigners. With the Canadian dollar hovering around par with the U.S. dollar and interest rates remaining low, the value of Canadian outbound M&A transactions in 2011 was approximately 1.21 times that of foreign inbound activity. While Canadian businesses are increasingly looking to expand outside North America, over 55% of Canadian outbound M&A in 2011 still involved U.S. targets, such as Milwaukee-based Marshall & Ilsley, acquired last year by BMO Financial Group.
PUBLIC TRANSACTIONS WILL REMAIN REGULATED BY PROVINCES AND TERRITORIES
Public M&A and other securities transactions in Canada are regulated on a provincial and territorial basis and each jurisdiction has its own securities legislation. Although a substantial degree of co-ordination and co-operation exists among the provinces and territories and a significant portion of securities laws have been harmonized across Canada, each jurisdiction retains authority over securities regulation within its borders.
In 2010, the Canadian federal government published a proposed national Securities Act, to be administered by a single securities regulator, the Canadian Securities Regulatory Authority. If implemented, each province and territory would have the ability to opt into the federal regime. Two provinces, Quebec and Alberta, opposed the national regime and each directed a reference on the federal initiative to its respective Court of Appeal, which in turn found it unconstitutional. The federal government directed its own reference on the constitutionality of the proposed Act to the Supreme Court of Canada which, in December 2011, also found it to be unconstitutional.
The decision constitutes a serious, if not fatal, blow to the prospect of comprehensive federal securities regulation in Canada. While it remains possible that more limited federal legislation could be pursued, Canadian securities regulation, including the take-over bid regime, will continue to be the domain of provincial and territorial regulators for the foreseeable future.
NEW GENERATION OF CANADIAN INCOME TRUSTS WILL BE ACQUISITIVE
The Canadian income trust market, which began in Canada's energy sector in the 1990s, peaked in 2006 with 256 trusts across a variety of assets classes listed on the Toronto Stock Exchange and having an aggregate market capitalization of C$225-billion. Trusts provided a vehicle for predominantly Canadian-domiciled businesses to distribute cash to public unitholders effectively on a pre-tax basis. On October 31, 2006, the federal government, concerned over the eroding corporate tax base and potential conversions by some of Canada's largest corporations into trusts, announced a change in tax policy such that the earnings of trusts derived from Canadian businesses would be subject to a tax comparable to that paid by corporations. However, this change in policy did not impact trusts which derive their income from non-Canadian businesses.
In December 2010, Eagle Energy Trust completed its initial public offering in Canada, resulting in the first of a new generation of cross-border trusts. Subsequently, Parallel Energy Trust completed its IPO in April 2011, and Argent Energy Trust and North American Oil Trust have each filed a preliminary prospectus for their respective proposed IPOs. The offerings have re-introduced the income trust model to Canadian capital markets, resulting in what appears to be a developing sector of the Canadian capital markets.
Each of these new trusts owns or will acquire an under-lying energy business carried on in the U.S. However, there is generally no restriction on other types of businesses being owned by the trusts, provided they are not Canadian. Owners of U.S.-domiciled energy or other businesses, including corporations and private-equity funds, may find that the new generation of trusts provides an attractive monetization opportunity for stable, long-lived income generating energy and other assets.
As with the prior generation of income trusts, we expect these new trusts to take advantage of quick access to the Canadian capital markets and make additional foreign acquisitions, particularly in the energy sector.
IMPACT OF ACTIVIST INVESTORS WILL CONTINUE TO BE FELT
In 2011, activist investors took aim at some of Canada's most recognized corporations, including Canadian Pacific Railway, Research in Motion and Maple Leaf Foods. Investors are increasingly leveraging Canada's relatively liberal corporate laws, which permit shareholders holding 5% of the votes to call special meetings and seek to replace directors, to force change and maximize value.
Meanwhile, the implications of Magna International Inc.'s plan of arrangement in 2010, which terminated the company's multiple voting share structure at a significant premium for its controlling shareholder, continue to be considered by Canadian market participants and regulators. In October 2011, the Canadian Coalition for Good Governance announced that it would be preparing guidelines addressing dual class share structures. Then in November 2011, the deputy director of the Ontario Securities Commission remarked that OSC staff is considering proposing new rules for related party transactions which would require the supervision of a special committee of independent directors. A special committee, which is recommended but not required in connection with related party transactions under existing law, would be required to negotiate or oversee the negotiation of transaction terms and either (i) recommend that the board support the transaction and that shareholders vote in favour of it, or (ii) determine that the transaction is fair to minority shareholders, but provide no recommendation. The changes would also lower the size threshold at which shareholder approval of a related party transaction would be required from 25% of the market capitalization of the issuer to 10% of market capitalization. While there would be no obligation for the special committee to obtain a fairness opinion, the requirement to obtain a formal valuation (which is akin to a fairness opinion but involves a valuator actually placing a value on the subject matter of the transaction) would continue to apply to related party transactions with a value in excess of 25% of the market capitalization of the issuer.
POSSIBLE CHANGES TO "JUST SAY NO" TAKE-OVER DEFENSES
While a Canadian board may use a shareholder rights plan, or "poison pill", to delay an unsolicited take-over bid for a reasonable period of time as it seeks out competing offers, in Canada it has always been a question of when, not if, a pill must go. However, in a recent public forum addressing current developments in Canadian securities law, the deputy director of the OSC indicated that OSC staff is considering proposing a change in policy that if implemented, would represent a significant departure from the current regulatory regime.
The proposal would permit a target board to rely on a shareholder rights plan to block an unsolicited bid indefinitely, provided that the issuer's shareholders have approved the rights plan either at the most recent annual general meeting or following the announcement of the bid. This would eliminate the need for securities regulators to decide on a case-by-case basis whether to cease trade a rights plan that had received such approval. Disinterested shareholders would, in turn, have the ability to remove a pill with a "majority of the minority" vote in favour of such action.
In the 2007 decision of the Alberta Securities Commission in Pulse Data, as well as the subsequent OSC decision in Neo Material Technologies, the securities regulatory authorities determined not to cease trade shareholder rights plans, notwithstanding the absence of an ongoing auction for the target company, where shareholders, who were fully informed of the relevant facts, approved the rights plans in the face of an unsolicited bid, and the target board was able to demonstrate the exercise of reasonable business judgment in determining that the unsolicited bid was not in the best interests of the corporation.
The new regime as postulated would represent a more significant change in approach than was reflected in the Pulse Data and Neo decisions, as both of those cases involved relatively unusual situations in which target company shareholders had approved a rights plan in the face of an unsolicited offer. The new regime would go further, and would allow a rights plan to remain in place indefinitely following an unsolicited offer provided that the plan had been approved at the target's most recent annual general meeting, even if such approval was not granted in the face of the unsolicited offer.
INTENSE COMPETITION BUREAU REVIEWS
In 2011, the Competition Bureau continued to expend considerable resources reviewing strategic mergers. In addition to issuing new merger enforcement guidelines in October 2011, Bureau staff sought an increasing level of documentary and data production as part of many merger reviews, both formally through Canada's supplementary information request process and through informal information requests. The Bureau's focus on strategic mergers was evidenced by two merger challenges that the Commissioner of Competition brought this past year, the first since 2005. Importantly, neither of the challenged transactions was notifiable under the Competition Act but, as the Commissioner recently noted, the Bureau is "proactively monitoring closed and non-notifiable transactions".
The Bureau will also be focusing on acquisitions by state-owned enterprises, and in particular examining whether state-owned enterprises owned by the same foreign state should be considered to be "affiliates" under the Competition Act. This determination will have important implications on whether the relevant transaction thresholds are exceeded, the scope of information required by the Bureau and the Bureau's competitive effects analysis.
We anticipate increasingly intense Bureau reviews in 2012. Pre-transaction antitrust review and the management of internal documents will be essential to minimize later complications, even for transactions that do not require a formal notification.
FEDERAL GOVERNMENT DECISION EXPECTED ON TELECOM LIBERALIZATION
In June 2010, the Canadian government released a consultation paper inviting submissions on various options designed to liberalize foreign investment restrictions on Canadian telecommunications companies. Since that time, there have been several significant developments which are likely to affect the nature and extent of the government's policy in this area. The new Conservative majority will enable Canada's federal government to proceed with its policy initiatives, including foreign ownership liberalization. However, the Minister of Industry announced in December 2011 that he was postponing a decision on foreign ownership restrictions, as well as the rules governing the 700 MgHz spectrum auction, until 2012. Once made, we expect these decisions to increase investor interest in Canada's telecommunications sector.
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