On June 20th 2013, Veracap and its M&A International colleagues hosted a conference on M&A in the Americas at the Ritz Carlton hotel in Toronto. The conference featured a host of leading experts on topics dealing with crossborder acquisitions and divestitures within North America and South America. This newsletter summarizes some of the key points raised at the conference.
Economic Outlook For The Americas
Derek Burleton, Vice President & Deputy Chief Economist at TD Bank spoke on the economic outlook for the Americas. He indicated that global markets in general are still struggling and expectations have been adjusted given China's slower growth.
Interest rates are expected to rise, but remain extremely low. The longer-term issue deals with quantitative easing, which has seen the monetary base in the U.S. swell to about US$3 trillion, compared to less than US$1 trillion just a few years ago.
The U.S. economy is leading its peers on the strength of new housing and increased consumer spending. However, it may face headwinds in the form of higher taxes and reduced government spending. The net result is expected to be U.S. GDP growth of 1.9% in 2013, increasing to 2.8% in 2014.
The outlook for Canada is more subdued, with governments focused on deficit reduction. Exports are expected to pick up over time, but resources may only provide a modest lift. The Canadian dollar is expected to remain below par, and closer to the US$0.90 range through 2013-2014. The net result is that Canada's GDP is expected to grow by 1.7% in 2013 and by 2.4% in 2014.
Central and South America are expected to enjoy a stronger outlook, with Peru, Chile and Columbia leading the way. Argentina and Brazil are expected to improve from their current woes, but will continue to lag. The outlook for Mexico is fairly stable.
The strength of these economies will be lead by lowering unemployment rates. Inflation generally has been kept under control, with the exception of Argentina, where double-digit inflation rates still remain.
Brazil has lost some of its competitive edge due to a strengthening currency. High sovereign debt levels in that country will also pose a challenge, as they have in Argentina. This is largely the result of high levels of government spending in those countries.
Overall, South America has a young population, including over 200 million people under the age of 25 in Brazil alone, and a further 120 million in Mexico. This creates great opportunities for long-term economic growth and prosperity, if some of the current challenges can be overcome.
Cross-Border Legal And Tax Issues
A panel of experts discussed various legal and tax issues in cross-border transactions. The panel included Brian Lenihan, Practice Group Leader at Choate Hall & Stewart LLP; Patrick Marley, a Partner with Osler, Hoskin & Harcourt LLP; and Gavin Sinclair, a Partner at Heenan Blaikie.
The panel agreed that Canada is an attractive geography for U.S. investors due to similarities in legal systems and culture, and moderate currency risk. Unlike many foreign jurisdictions, Canada has no issues with exchange controls or currency regulations.
However, there are some important differences compared to the U.S. Most transactions in Canada are consummated by way of a "plan of arrangement", which simplifies the process (as opposed to a "merger" in the U.S.). Foreign buyers also need to be aware of the residency requirements for directors and the fact that directors in Canada owe a fiduciary duty to the company itself as opposed to its shareholders.
Perhaps a bigger concern for most U.S. buyers is that employment laws in Canada are more favourable to employees compared to the U.S. with respect to severance and notice periods. This can increase the costs, risks and complexities of a deal.
Canada has a favourable corporate tax regime compared to the U.S. in terms of corporate tax rates (around 26% in Canada vs. 35% in the U.S.) and R&D tax credits. However, there are some added complexities such as thin capitalization rules that need to be considered (which prevents a buyer from using excess tax-deductible debt to buy a Canadian business). Transfer pricing is also becoming an increasingly important issue on both sides of the border.
The Canadian Competition Bureau will look at any deal involving the acquisition of a Canadian company with revenues in excess of $80 million, which pales in comparison to the U.S. threshold. In addition, the Competition Bureau can look at smaller deals if it chooses, as well as those with "cultural significance" (such as in the publishing industry).
For Canadian companies looking to expand into Latin America, the panel spoke about the importance of personal relationships. Cultural differences are a key consideration. Canadian (and U.S.) buyers have to become accustom to a culture of tardiness, being interrupted during conversations and more social talk than just business. But for those who effectively manage these differences, the rewards can be lucrative.
Trends and Developments In Cross-Border M&A
Brad Adams, Managing Director of TM Capital Corp., Veracap's M&A International affiliate in Boston, spoke about trends and developments in the cross-border M&A market. He noted that despite short term volatility in the global markets, overall valuations remain strong. This is largely due to substantial debt and equity capital on the sidelines and corporations having strong balance sheets with plenty of "dry powder". The ratio of cash to revenues is close to 13%, which is above historical norms.
In the first half of 2013, almost 90% of transactions in Canada were cash deals, as opposed to stock (or a combination thereof). Historically, cash deals have comprised 70% to 80% of transaction consideration. Cash-based consideration is even higher for U.S. deals – at 95%. Corporate buyers are more inclined to use stock for deals in Central and South America.
2013 got off to a slow start, due to the large number of transactions pushed through during the fourth quarter of 2012 in an effort to avoid tax increases in the U.S. Canadian buyers recorded a record level of U.S. based acquisitions in late 2012, and returned to domestic buying in the first part of 2013. Overall, the outlook for the balance of 2013 remains strong. Cross-border M&A continues to be a significant driver of overall M&A activity.
The private equity markets are continuing their rebound from the lows of 2010. Large leverage buyout transactions are starting to make a comeback, in order to draw down more than US$300 billion in private equity capital "overhang". However, the activity level for initial public offerings (IPOs) has remained subdued, and private equity firms are generally choosing M&A as their exit strategy for portfolio companies.
Valuation multiples for middle-market transactions (defined as transactions valued between $25 million and $1 billion) have remained at around 10x EBITDA. Financial buyers are using debt to equity ratios in excess of 50/50, in order to compete against strategic buyers for quality deals.
Deal Making In The Americas
A panel of experts discussed various topics surrounding deal making in the Americas. The panel consisted of Alexandre Décary, Vice President Mergers & Acquisitions / Global Services with AIMIA; Chris Wormald, VP Strategic Alliances at Blackberry; and Hernan Sambucetti, a Partner with Landmark Capital, one of Veracap's M&A International affiliates in South America.
The panel noted that the nuances of transactions in Latin America were very much driven by whether the seller is a corporation, family-owned business or entrepreneurowned business. Many family-owned businesses in Latin America are owned by siblings or cousins with different objectives. This causes challenges in terms of personal interests and value expectations. As a result it's important for the buyer to be flexible, and to offer unique solutions to different shareholders in order to satisfy each one. This can elongate the acquisition process.
Despite these challenges, there is a high level of interest in acquiring companies within Latin America. In 2012, North American companies invested US$22.9 billion in Latin America, while US$35.6 billion came from Europe. The largest portion of this capital (US$20.0 billion) went into Brazil. By comparison, Latin American companies spent US$7.2 billion on North American transactions. The increased buying activity in Latin America has also increased the median valuation multiples, rising from 7.2x EBITDA in 2010 to 8.2x EBITDA in 2011, and 8.8x EBITDA in 2012.
The panel concurred with the findings of a Wall Street Journal article published in June of 2013 which indicated that nearly half of the 357 senior level executives surveyed said that the appetite for cross-border M&A & will grow over the next two years. Legal and regulatory challenges were cited as key risks, including compliance issues, protectionist measures, regulatory restrictions and possible corruption. Beyond legal and regulatory issues, the executives saw cultural barriers as the biggest challenge in cross-border deals.