Over the past four years, the Canadian economic system, steeped in financial conservatism and rich in natural resources, has prospered relative to its U.S. counterpart.
While Canada has delivered only a modest growth premium to the U.S. since 2009, as measured by change in gross domestic product, the loonie has appreciated markedly relative to the U.S. dollar, a more market-driven predictor of short- and medium-term economic health.
Given this paradigm, it might fly in the face of conventional wisdom that we’re recommending Canadian companies seeking private equity capital consider a U.S.-based solution. But the data supports just that.
As a quick primer, the U.S. private equity community is facing a structural conundrum. Rising public domestic equity prices have increased pension fund and endowment allocations to alternative assets. As a result, private equity funds in America continue to proliferate and assets under management within these firms have ballooned.
Lacking credit alternatives to support leveraged buyout opportunities at the lower end of the middle market (below $10 million of EBITDA) as well as a general aversion to risk by both equity and debt sponsors has left the U.S. private equity industry with $430 billion in committed capital ready to invest. Based on a traditional five- to six-year investment cycle for domestic private equity funds, much of this capital, raised in 2007-08, needs to find a home in the next 12 to 24 months.
As a result, U.S. financial sponsors are hungry for deals and willing to look further afield for good investment opportunities.
While the Canadian business community benefits from a number of highly regarded private equity funds (282 in total), the U.S. market, with over 3,700 equity funds, is more than 13 times larger.
The average U.S. fund size is nearly twice that of its Canadian counterpart. Consequently, they can do more and larger investments.
While more certainly doesn’t mean better, the U.S. private equity market is more heavily segmented with firms specializing in industry groups and transaction structures. Our experience has been that specialization, when it fits, yields higher purchase prices and a more value-added private equity partner relationship for the company management.
In a sample of 300 private equity leveraged buyout transactions between 2009’s first quarter and 2012’s third quarter, U.S. private equity firms closing on U.S.-based acquisitions occurred at a mean EBITDA multiple of 9.1 times.
In comparison, during the same period, Canadian private equity firms closing on Canadian leveraged buyout transactions paid an average EBITDA multiple of 6.9 times, a spread of more than 2.0 times. When we look at a deal sample involving U.S. private equity firms closing on Canadian leveraged buyout transactions, again for the same period, the mean EBITDA multiple was 8.3 times, a spread of nearly 1.5 times higher than their Canadian private equity counterparts.
Notably, when we look at all U.S. deals by quarter, by buyer type, private equity funds outbid strategic buyers 50% of the time.
Collectively, U.S. private equity firms are paying a premium to get their money to work in the U.S. and Canada.
In addition to these valuation spreads achievable for Canadian companies in deals with U.S. private equity funds, there are qualitative considerations that may drive a company owner and management to look south.
Most U.S. private equity firms are willing to do minority transactions (typically 25% to 49% ownership interest), whereas Canadian private equity firms don’t demonstrate this same appetite.
Importantly, the valuations of these minority deals with U.S. equity investors seldom reflect the traditional 20% to 25% discount for non-control transactions.
Also, there are many industry specialist private equity firms in the U.S., which Canadian companies can leverage to gain value-add from their partner at the board and management level to improve their chance of success in expanding in the larger North American market.
This is especially true of the consumer products industry, because there are more than 30 U.S. private equity firms that are world-class players in this industry that can help with customer and talent acquisitions, supply chain optimization and recruit working capital support.
The above should not simply be interpreted as a commercial for the U.S. private equity industry.
We don’t believe U.S. private equity funds should have a role in every Canadian-based transaction, and probably not even in most. In fact, there’s a practical cost to partnering with U.S. private equity: higher leverage, shorter hold periods and higher return expectations.
Canadian private equity funds do a tremendous job within their regions from a stewardship perspective; they’re simply more value conscious. Our bottom-line recommendation is that if you’re considering a private equity transaction, growth or buyout, and valuation is of paramount importance, looking across the border to a U.S. private equity partner is wise because it enables sellers to make a fully informed choice and optimize their deal potential. •
