As we prepare for 2023, what can we expect in Canadian M&A in the year ahead?
The confluence of variables is somewhat staggering. The nature and number of forces impacting national and global markets is unlike any in recent memory, and forecasters have become increasing less optimistic regarding the chances of a soft landing. Inflation remains at record levels, with inflationary pressures having shifted from government stimulus and supply chain issues to higher energy costs and wage growth, among others. The corresponding increase in short term interest rates continues to march forward, and businesses and consumers alike scramble to adjust. Other uncertainties loom in the form of geopolitical tension, armed conflict, sanctions, and international trade and investment issues. Regulators also continue to flex their review and enforcement powers, including in areas such as securities and competition.
We look ahead to how this dramatic mix of factors – almost inconceivable a few short years ago – may drive Canadian M&A in 2023.
- Increased minority equity investments. A potentially attractive option for companies seeking cash to grow without resorting to debt is soliciting minority equity investments. Many private investors, including private equity and institutional investors, continue to enjoy ample dry powder. Private placements, including by public companies, provide the opportunity for bespoke negotiated arrangements and issuer and shareholder rights. Indeed, this market has grown increasingly sophisticated, with variations in market trends and the evolution of certain deal terms.1 Given current conditions, further opportunities for creative lawyering will likely present themselves.
- LBOs may remain low. Uncertainty regarding the stabilization of interest rates and the timing of ratcheting down recent hikes will almost certainly continue to dampen LBO activity. In addition, recessionary fears and related concerns have caused many banks to tighten their lending standards, particularly for perceived riskier borrowers. An interesting question therefore becomes the degree to which alternative debt providers, including private equity groups with private credit funds engaged in direct lending, may come to occupy space temporarily vacated by traditional lenders. We've already seen this occurring, including private fund direct lenders clubbing up. Once again, opportunities for innovative and/or bespoke legal arrangements may arise.
- Go privates may rise. While depressed stock prices are expected to continue to freeze IPO activity, historic discounts could encourage go private transactions. We see particular potential in targets holding hard assets such as REITs and infrastructure, including for their general long-term resiliency. Infrastructure benefitting from ESG attributes may prove particularly attractive, including not only power generation but also power storage, transmission and distribution. The anticipation that government spending, including any further government stimulus, will continue to prioritize infrastructure and decarbonization may also contribute.
- Continued complexity in PE exits. Depressed public markets may fuel continued diversification and complexity in private equity exits. Immediate examples including a continued upward trajectory in sponsor to sponsor sales, GP-led secondaries and continuation funds. Related issues will include governance and perceived GP conflicts of interest, which LPs may seek to police through enhanced oversight rights. Downward pressures on valuation will keep the spotlight on the extent of trailing seller liabilities and potential exposure outside representation and warranty insurance coverage. So too might contractual earn-outs, escrow arrangements, purchase price adjustments, and/or associated dispute resolution mechanisms be more intensely negotiated.
- Continued complexity in LP rights. PE funds may encounter increased fundraising challenges as some LPs prefer to wait out economic uncertainty on the sidelines. Smaller funds or those with shorter track records may face the most difficulty. Larger and more sophisticated LPs, including institutional investors, may grow ever more demanding regarding the desired terms of their investment. Regarding side letters, we can foresee increased attention paid to MFN clauses and co-investment rights. Regarding limited partnership agreements, pressure points may include improved LP redemption rights and/or LP remedies in open-ended or evergreen funds. That said, sponsor pushback can be expected, particularly in respect of redemption rights.
- Mining may remain robust. High commodity prices have buoyed recent mining M&A, but the industry is not immune to macroeconomic challenges. An advantage enjoyed by the sector, however, is the key role played by certain metals in transitioning to green energy and increased electrification, including copper, zinc, tin, lithium and graphite. Critical minerals such as nickel, cobalt and magnesium also represent opportunity, including as western governments sour on investments by SOEs, increasingly embrace "friend shoring", and begin instituting sourcing requirements. Gold presents a more complicated picture. The crypto implosion could greatly reinvigorate investor interest. On the other hand, increased interest rates remain a headwind.
- Emphasis on due diligence. Adverse market conditions and increased regulatory scrutiny will reduce risk tolerance and sharpen buyer due diligence. Moreover, we expect amplified buyer apprehension in certain areas. These include regarding target cybersecurity systems and management, including in light of recent high profile penalties levied under privacy legislation flowing from cyber-criminal accessing of personal information. These also include regarding target ESG strategies and attributes. Buyers will want to ensure appropriate valuation as well as be poised for smooth post-closing integration. So too do buyers need to be attuned to possible target "greenwashing" practices. Given that an uptick in distressed M&A can be expected, prospective buyers will need to prioritize risk concerns in preparation for accelerated distressed sales timetables.
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