Canada: Canadian M&A in 2005-The Underlying Themes

Reprinted with Permission from the 2006 issue of the Lexpert/ALM Guide to the Leading 500 Lawyers in Canada. (c) Thomson Carswell.

Much of the recent resurgence in M&A activity in Canada has been strongly influenced by a number of underlying themes. Global consolidation in some industries and world demand for metals and oil and gas, catalyst investor activism and increased participation in deals by private equity firms all helped push M&A activity in 2005 to levels not seen since 2000, with more than one thousand transactions. Although M&A activity was stronger throughout 2005, the third quarter was particularly strong, with Crosbie and Company Inc. reporting 12 deals of more than $1 billion in the quarter.

Many industry sectors around the world are consolidating and Canada is not immune to this activity. As a key player in the North American economy with a relatively friendly foreign investment regime (except in the cultural sector), many global consolidators see Canadian-based companies as attractive additions to their growing organizations. Equally, large Canadian-based corporations with an international reach realize that the future lies in becoming more globally competitive, often by achieving greater scale or geographic diversification.

Transactions driven by this phenomenon in 2005 include the merger of Molson Inc. and Adolph Coors Company in February, the acquisition of CP Ships by Tui AG in October, the acquisition of Placer Dome Limited by Barrick Gold Corporation and the pending acquisition of Falconbridge Limited by Inco Limited.

The Molson/Coors merger of two family-controlled beer companies was driven by their boards and controlling shareholders, who realized that the sector was becoming dominated by a few large global organizations like Anheuser Busch, Interbrew S.A. and SAB Miller. Neither controlling family wanted to exit the business, yet both realized that maintaining the status quo was not desirable. They needed to be larger and more geographically diversified to compete with the more dominant global players. An innovative cross-border merger was implemented, which brought the two organizations together to form the world’s fifth-largest brewer. The Coors and Molson families negotiated a complex arrangement that permits them to jointly control the merged entity.

The acquisition of A.P. Moller-Maersk A/S of Royal P&O Nedlloyd N.V. in 2004 led CP Ships Limited, a Canadian container shipping company, to observe that the industry was consolidating and that its status as a mid-sized player in the sector was not viable. CP Ships had also endured a difficult period, having restated its financial results in August 2004 and having been the subject of investigation by securities regulators in Canada and the US. After being approached by a number of potential acquirors, CP Ships hired advisors, struck an independent committee of its board and conducted a limited auction of the company from March through the summer of 2005. The result was the friendly acquisition of CP Ships by Tui AG, owner of Hapag Lloyd Container Linie GmbH, for US$2 billion.

The world demand for metals and oil and gas also drove many acquirors to look at resource-rich Canada. More than 100 deals took place in the oil and gas sector and more than 70 in mining.

Barrick Gold Corporation announced in November 2005 a US$10.4 billion unsolicited offer for Placer Dome Inc. In order to make the acquisition more manageable and accretive to Barrick, an agreement was entered into between Barrick and Goldcorp Inc. to spin off certain of Placer Dome’s assets for US$1.35 billion in cash. The transaction was billed by Barrick as a story about creating value. With a number of adjoining properties, Barrick estimated synergies of approximately US$240 million annually. The street, however, saw it as a consolidation play, catapulting Barrick ahead of Newmont Mining Corporation to become the world’s largest gold producer. The deal closed February 3, 2006.

Falconbridge Limited has agreed to be acquired by Inco Limited for $12.5 billion, resulting in the world’s largest nickel producer, as well as a formidable player in copper and zinc. Xstrata plc had purchased a 20 per cent block of Falconbridge stock from Brascan, a long-term holder, in August 2005. Xstrata stated that it might in future bid for the balance of Falconbridge, but in the meantime it viewed its holding as an option on the company. This spurred the Falconbridge board to seek out value maximizing alternatives. The result—a friendly acquisition by Inco. The deal was touted as creating a credible global mining giant with a US$23 billion market cap and was accretive to Inco, in part because of US$350 million in annual synergies. Importantly, both Falconbridge and Inco were cognizant of the rapid consolidation occurring in base metals mining, and the emergence of global behemoths such as Rio Tinto, Anglo American and BHP Billiton. The combination of Falconbridge and Inco elevates the resulting organization to the second tier of global mining companies and will better enable ongoing management to participate in major mining opportunities.

The oil and gas sectors saw activity from bidders from around the globe. Among the larger transactions: China Petroleum Corporation acquired PetroKazakhstan Inc., Total S.A. of France acquired Deer Creek Energy Limited and Kinder Morgan Inc. of Houston acquired Tarasen Inc.

The consolidation impetus for M&A transactions in 2005 would not be complete without a discussion of the rapid consolidation of the steel industry worldwide. This consolidation, which began in 2000, has created such worldwide giants as ThyssenKrupp AG, Mittal Steel and Gerdau Ameristeel. Dofasco Limited, a major Canadian steel company, found itself subject to an unsolicited bid by Arcelor SA. In spring 2005, Dofasco had held talks with ThyssenKrupp regarding possible areas of co-operation. In June, Arcelor and Nucor approached Dofasco with a possible offer at $43 per share, a level Dofasco considered inadequate. Dofasco was able to play Arcelor and ThyssenKrupp against each other for several months. Arcelor announced on November 23 that it proposed to buy Dofasco for $56 per share. On November 28, Dofasco was able to procure an offer from ThyssenKrupp valued at $61.50 per share, a significant premium over Arcelor’s offer and one that the board supported.

A real bidding war developed with Arcelor and ThyssenKrupp, eventually resulting in an offer on January 30, 2006 by Arcelor at $71, or $5.5 billion in total. ThyssenKrupp bowed out, accepting a $215 million break fee. In a surprise twist, on January 27, 2006, Mittal Steel announced an unsolicited bid for Arcelor. As part of its bid, Mittal Steel has agreed to sell Dofasco to ThyssenKrupp for an amount equal to ThyssenKrupp’s earlier unsuccessful bid valued at $5.3 billion. Arcelor, ThyssenKrupp and Mittal Steel are the largest steel producers in the world, each having attained that status through a series of recent acquisitions. The Dofasco acquisition is but one more step in the global consolidation of this industry.

Will consolidation continue to drive M&A activity in Canada? There is no doubt that in certain industries this will be the case. Particularly, the manufacturing and resource sectors will see continued activity of this sort. Although Canadian public entities will be targets of consolidators, it is expected that some major Canadian players will be consolidators themselves, including the beefed-up Inco and Barrick Gold. In other sectors, there are structural impediments to consolidation. In this category are financial services, where foreign players are at a disadvantage to the dominant Canadian domestic banks. Mergers of Canadian banks have been on the political agenda for some time, and interest in this area may be revived with the recent change in Canadian government. Impediments to consolidation also exist in the media sector, arising from foreign ownership restrictions and the fact that many major media companies in Canada are family-controlled through multiple voting share structures.

Investors seeking to influence the conduct of public companies have been active for many years. Institutional investors have sought to preserve or enhance the value of their investment by causing a corporation’s board and management to take particular action. In recent years, as in the US, so-called catalyst investors have taken positions in corporations with the express purpose of effecting change, which they anticipate will enhance the value of their investment. These investors lobby for change, often publicly, through open letters and statements at shareholder meetings. Where companies are intransigent, the catalyst investor seeks board representation, occasionally conducting a proxy contest to unseat all or part of an intransigent board.

At the start of 2005, Creo Inc. was the subject of a proxy battle with Goodwood Inc. and Burton Capital Management LLC, which were unhappy with the operating performance and share price for the company. Throughout 2004, a special committee of directors at Creo studied alternatives and the complaints of dissident shareholders. In January, the dissidents launched a proxy battle proposing an alternative slate for the company’s annual meeting. By February, management announced that it had entered into an arrangement agreement pursuant to which Eastman Kodak would acquire the company. At the annual meeting the shareholders voted to approve the offer.

A more recent example of this activity was Geac Computer Corporation’s effort in the fall of 2005 to fend off Crescendo Partners’ attempt to nominate two directors to the Geac board. The dissident shareholder was frustrated that the Geac board was ignoring its requests that Geac commit not to pursue significant acquisitions. The proxy battle was averted with a last-minute truce. Within three months, Geac agreed to be acquired by Golden Gate Capital for US$1 billion, a transaction supported by Crescendo.

In a similar vein, Algoma Steel Inc. has rejected attempts by Paulson & Co., Inc. to have Algoma distribute a cash hoard of $420 million to shareholders. The board has consistently taken the position that it wants to preserve cash to weather the next downturn in steel markets. Paulson requisitioned a shareholders’ meeting to consider replacing the current board of directors with its nominees. Algoma was successful through court proceedings in deferring the meeting until March 22, 2006.

The most notable recent development, however, is that catalyst investors have taken activism to new levels. During 2003, Jerry Zucker, a US-based investor, accumulated approximately 18 per cent of the common shares of Hudson’s Bay Company (HBC), Canada’s oldest public company and a significant department store retailer. Mr. Zucker approached HBC in January 2004 to discuss "its business and future prospects." In August 2004, Mr. Zucker proposed an acquisition of HBC and was met with the response that HBC was not for sale. The financial position of HBC deteriorated over 2004 and 2005. Mr. Zucker repeatedly sought input into HBC’s strategic direction. These requests were rebuffed.

In October 2005, HBC announced that it was considering the sale of its credit card business. Mr. Zucker was opposed to this course of action and frustrated by his lack of ability to influence the affairs of HBC. Accordingly, on October 28, 2005, he launched a tender offer for the company.

In response to the offer by Mr. Zucker, HBC struck an independent committee and pursued a range of alternatives. This process led to proposals being submitted by a number of financial buyers for the company and a separate agreement to sell the credit card business to GE Money. In the end, Mr. Zucker improved his terms and the board has supported his bid. Throughout the process, Mr. Zucker has been portrayed as a skilled investor who had less of a passion to own HBC than to attain an attractive return on his original investment. In the result, he is putting up an additional $1 billion and will own the company.

In a similar vein, on November 7, 2005, Carl Icahn advised Fairmont Hotels that he had acquired a 9.3 per cent interest in the company. His 13D filing indicated that he would encourage Fairmont to pursue strategic alternatives to maximize the value for its shareholders, including a possible sale of the company, a sale of non-core assets or owned hotels, and a return of proceeds to shareholders. He also indicated that he might seek to replace members of Fairmont’s board of directors. Throughout November, discussions were held between Mr. Icahn and Fairmont management. When it appeared that Fairmont would not commit to put the company up for sale, Mr. Icahn launched a partial tender offer to take his interest to 51 per cent, at $40 per share.

In his takeover bid circular, Mr. Icahn stated that the purpose of his offer was to acquire voting control of Fairmont in order to replace the entire board with a board prepared to conduct a sale of the company to a larger hotel operator. He further stated that if the Fairmont board were prepared to conduct such a sale process itself, he would consider extending his offer to accommodate that process. The Fairmont board recommended that shareholders reject Mr. Icahn’s partial bid. Management and the board did pursue a sale process, which resulted in an agreed sale transaction with Kingdom Hotels International and Colony Capital, which operates the Raffles hotel chain, at US$45 per share of US$5.5 billion in total.

Mr. Icahn reported that he is pleased with the transaction and will let his bid lapse. He publicly stated, "We are pleased that value for all shareholders is enhanced through this offer." Mr. Icahn’s wager of more than US$1 billion to put Fairmont in play resulted in significant enhancement of the value of the original investment.

Both Mr. Zucker in the case of HBC and Mr. Icahn in the case of Fairmont dedicated significant financial resources to unlocking value at these public companies. Though it appears that neither of these investors had the ultimate objective of owning the companies at the end of the day, one did and one did not.

In recent years, M&A activity in Canada has been fueled by the presence of financial buyers, and 2005 was no exception. While some of the major transactions in 2005, particularly those reviewed in the discussion of consolidation above, were dominated by industry players, others were notable for the presence of financial buyers.

Both the Barrick Gold acquisition of Placer Dome and the Inco acquisition of Falconbridge were characterized by strategic acquirors who were able to table offers that were attractive to target shareholders as well as accretive to the acquiror because of the ability to realize substantial synergies out of the combination of the companies. On the other hand, the auctions of HBC and Fairmont drew interest from US and Canadian financial buyers. In the case of HBC, though an enhanced Zucker bid won the day, it is reported that at least four groups of financial buyers had participated in the process. The same was true in the Fairmont auction.

Financial players continue to be flush with cash, having recently raised funds from investors looking for superior returns from private equity investments. In addition, the income trust initial public offering (IPO) market in Canada is still perceived as offering an attractive exit mechanism for financial players. The federal government created some turbulence in the fall of 2005 with a moratorium on tax rulings related to income trusts. However, the cloud created by that announcement was lifted going into the most recent election and it would appear that income trusts will continue to be a fixture in the IPO landscape for some time to come.

In 2005, a number of Canadian private equity players raised significant funding (EdgeStone and Birch Hill, for example). These funds, together with a few more established players such as Onex Corporation and Brookfield Asset Management Inc., are beginning to compete with the traditional US funds that have participated for some time in Canadian transactions, such as KKR, Bain and Texas Pacific Group. This trend may be expected to continue as the substantial new funding looks for homes in buy-out transactions.

M&A activity in 2005 was significant in Canada. Continued low interest rates and access to debt financing, together with revitalized corporate balance sheets, bodes well for continued activity. The underlying themes of consolidation, interest in metals and oil and gas, catalyst investor activity and financial buyer enthusiasm will undoubtedly continue to influence transactions going forward.

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