WELCOME TO STRAIGHT TALK
Different times require different measures, and this edition of Straight Talk reflects these very different times. Since mid-March, with the declaration of the COVID-19 pandemic and subsequent shutdown, we have seen a dramatic slowdown in deal activity as buyers and investors hit pause on their transactions, waiting for clarity in an uncertain world.
While typically, we would do a deeper dive into the quarter's M&A activity, Q1/2020 reflects an environment that contrasts sharply with our lives and business since the COVID-19 shutdown. Because of that, for this issue, we have shifted the focus and discussion to our world as it has been since mid-March, and provide just a summary review of Q1/2020 Canadian M&A activity.
In future issues, we expect to return to our regular format, where you will find:
- The previous quarter's Canadian deal activity: bringing a deeper understanding to the data with insights gleaned from Miller Thomson's active transactions practice, we will highlight the dynamics shaping Canadian mid-market M&A;
- An interview with an M&A expert: exploring the issues and trends facing Canadian and international deal makers, investors and practitioners active in the Canadian market, we will bring a different focus and perspective each quarter.
In this quarter's edition, Montreal-based Miller Thomson Partner, Andrew Cohen, shares insights drawn from his active M&A practice. He discusses the transformation of the deal landscape since the shutdown, as well as the unique legal issues that he is advising on and thinking about as a result of the pandemic.
Looking to the future, we expect to see the deal landscape continue to transform. There is still significant dry powder in the pockets of financial buyers, and over time, as sellers' valuation expectations decline and there is more clarity on the horizon, we are likely to see increased activity by buyers pursuing roll-up and opportunistic acquisitions. Unfortunately, we also expect a number of businesses to be facing insolvencies, restructurings and a need for recapitalization, as the full weight of the economic shutdown takes its toll. The Miller Thomson team is continuing to support our clients through these uncertain times, and, as always, we value our role as trusted legal advisor.
A RADICAL TRANSFORMATION: HOW COVID-19 HAS IMPACTED THE M&A LANDSCAPE
INTERVIEW WITH ANDREW COHEN
Partner | Montréal
acohen@millerthomson.com
+1 514.871.5439
A review of the Q1/2020 Canadian M&A data highlighted the dramatic change that has transpired over the course of weeks. Through the first months of the year, businesses continued to operate and, likewise, Canadian M&A remained active. As the impact of COVID-19 took hold towards the end of the quarter, however, we saw activity screech to a halt, driven by a global economic shutdown that will be felt significantly in Q2, and creates considerable uncertainty through the balance of 2020.
Against this backdrop, and differing from previous editions, we focus our attention on today's environment, from mid-March to the present, sharing the insights of Montreal-based Miller Thomson Partner, Andrew Cohen, who provides a perspective drawn from his mid-market M&A and Private Equity practice. We include a summary review of Q1/2020 M&A activity following the interview.
MT: Let's start off with deal activity. What has been your experience, post-shut down?
AC: From the moment the business community realized we were in lockdown, things immediately changed. I was working on three transactions when things went into lockdown: one was in the manufacturing space, one was in the film industry, and the third in the advertising and marketing sector. Within 48 hours of lockdown, buyers in the manufacturing and film transactions pressed pause; that is what we are seeing currently with respect to deals at most stages, short of where the deal has been signed.
The third deal I mentioned, in the advertising and marketing space, was an add-on transaction. That one proceeded and is close to closing.
Buyers' reasoning for hitting the brakes across the majority of deals is clear: the world has changed. In many cases, it has suddenly become very difficult for buyers to assess what a target's industry will look like on the other side of this. With this foundational uncertainty, it is challenging to move forward with a transaction.
MT: What about the abundance of capital in the pockets of financial buyers?
AC: There is no shortage of capital, but as one of my PE contacts put it, the issue is whether sellers are going to be realistic in their valuations in this new world. Sellers' expectations have not yet changed significantly; those that may have pursued a sale are in "wait and see" mode. In any event, most sellers are focused on running their businesses, and understanding what they need to do to survive in these difficult times.
MT: What are you hearing from strategic buyers?
AC: Those strategics that have capital and are looking to acquire businesses are, as far as I am hearing, looking for more opportunistic acquisitions. So once again, we're back to the issue of valuation and sellers' expectations. While there may be businesses in certain spaces, such as PPE manufacturers, that could transact at healthy multiples, in most cases (and this holds true for financial and strategic buyers), we are not yet at a stage where sellers' expectations match with buyers' willingness to pay.
MT: Moving on to a legal perspective, what issues are you seeing with respect to MAE provisions?
AC: The Material Adverse Effect/Change provision typically applies where there is a question between signing and closing of whether there is material adverse effect/change. Most of my deals did not fit into that context, as we were negotiating documents but hadn't yet signed. However, there are a couple of transactions that I'm aware of, one in Canada and one in the US, that are currently before the courts. The US case is notable, as the deal was signed in late February, and the parties included a pandemic carve-out in their MAE provision. It will be interesting to see how sympathetic the courts are to buyers and sellers under the current circumstances.
MT: What about force majeure clauses?
AC: There has also been a focus on force majeure clauses, which address ongoing relationships: for example, whether a supplier is excused performance where its contract includes a force majeure provision. The question is whether these clauses, as drafted, include pandemics. At this point, lawyers advising clients are ensuring that a pandemic is included in any new force majeure clauses.
Both the material adverse effect and the force majeure issue also arise in the due diligence context. As relates to the material adverse effect, information that a buyer had prior to the crisis onset may no longer be accurate. For example, a buyer may previously have been satisfied with its target's top 5 suppliers, but now, may be concerned whether suppliers will be able to supply going forward; while as relates to any force majeure provision in the contract with any such supplier, the buyer may be concerned as to whether there is an ability to escape its obligations under that contract. As a buyer, you want and need a degree of certainty, and that's difficult to attain in these circumstances.
MT: Is there any way to mitigate the uncertainty?
AC: Earnout provisions provide some protection against how the future may unfold, and thus, limit buyer risk. I'm expecting that buyers will want to pay lower multiples and increase the size of earnouts that are part of the deal structure. Sellers are typically hesitant about earnouts, but under these circumstances, may be willing to accept them as buyers are likely going to be more insistent.
MT: Are you seeing changes to reps & warranties?
AC: Yes. We're seeing this in real time: qualifications related to covid-19 being added, including to MAE provisions or around binding contracts or suppliers. There is a debate as to how broad this exception can be. Sellers will want the exception to be as broad as possible, and buyers will push back.
MT: Any other deal related issues you're thinking about?
AC: As we've been hearing, the virus outbreak is likely to come in waves. So, for example, if an earnout is negotiated to cover the next 12 months, and during that period, there is another outbreak and another shutdown, what happens? Does the earnout get extended from 12 to 18 months? There are ripple effects that are going to impact our agreements.
Just as, from a scientific perspective, we're learning more about COVID-19 as we live it, similarly, in our transactional documents, we are learning how to adapt the form and the substance, in ways that will be around for a while. From a deal structure perspective, it's going to be a very interesting time, as we change to adapt to a new unfolding reality.
Andrew Cohen is a partner in Miller Thomson's Business Law group, and is based in Montreal. He has acted as lead counsel in a number of multijurisdictional transactions involving companies located in the U.S., Mexico and Europe, and as a result of recent work, was named "Dealmaker of the Year – M&A Legal Advisor" by M&A Club Canada. Beyond his M&A expertise, Andrew advises clients on a wide range of commercial matters, including shareholder agreements and disputes, licensing and distribution agreements, gaming, lending and security arrangements, sports law and information technology issues. He has also served on the board of a TSX-listed Canadian fashion retailer, and chaired its Governance Committee.
M&A REVIEW Q1/2020
Canadian M&A volume increased slightly in the quarter, up 1% over Q1/2019, and 3.6% over the previous quarter. Value declined sharply, however, by 37.5% over Q1/2019 and a whopping 65% over the prior quarter. This decline was attributable to a significant drop in announced mega-deals (over USD$1 billion in value): 5 were announced in Q1/2020 compared, respectively, to 10 and 16 announced mega-deals in Q1/2019 and Q4/2019.
Note: Dollar values are in USD.
Total Deal Value & Volume (2019-2020)
Source: Capital IQ, April 15, 2020
GEOGRAPHIC TRENDS
Increase in Domestic and Outbound Deals
While cross border activity in the quarter was relatively flat, there was an increase in outbound and a decrease in inbound deals, reversing a previously noted trend. Inbound transactions represented 30.1% of cross-border deal volume in Q1/2020, compared to 39% in the prior quarter.
As usual, US buyers led the way in pursuing Canadian targets in Q1/2020, with 60 deals announced at an aggregate value of $2.8 billion, representing 56% of deal volume and 59% of disclosed deal value.
Top Three Cross-Border Partners (2019-2020)
Source: Capital IQ, April 15, 2020
Domestic deal volume increased by 18.5% in the quarter, while value plunged almost 75%, the result of significantly smaller average deal size.
Canadian Domestic Deals (2019-2020)
Source: Capital IQ, April 15, 2020
SECTOR ACTIVITY
Sector Activity (Q1 2019 v. Q1 2020)
Source: Capital IQ, April 15, 2020
The Materials, Real Estate and Industrials sectors led the way in Q1/2020, with, respectively, 188, 112 and 111 announced deals. The Industrials sector topped the value chart, with aggregate deal value of $9.3 billion.
Across Canada, until the onset of the pandemic, Miller Thomson was seeing and advising on deals spanning multiple sectors through most of the first quarter, involving targets in manufacturing, agribusiness, technology, pharmaceuticals, specialty chemicals, medical devices, financials, real estate and mining.
UNCERTAIN ROAD AHEAD
While Canadian M&A activity kicked off the year with reasonable strength, there is considerable uncertainty ahead. We continue to support and advise our clients, helping them navigate their paths through this health and economic crisis, whether they are looking to refinance and address liquidity issues, considering an opportunistic acquisition, or facing strategic decisions related to their business. Unfortunately, through the coming months, we expect a number of businesses to be facing insolvencies and restructurings, as the full weight of the economic shutdown takes its toll. In parallel, however as shutdown restrictions are lifted and there is new clarity for prospective buyers, M&A activity will resume, as we move into our new normal.
Look for our next issue, with insights on Q2/2020, coming in the Summer.
Q1 2020 MILLER THOMSON REPRESENTATIVE TRANSACTIONS
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