In October 2007, the Canadian dollar achieved value parity with the U.S. dollar for the first time since November 1976. The realization of dollar parity between the two economies was considered a key psychological hurdle in stimulating Canadian cross-border merger and acquisition (M&A) transactions.
Over the past two years, we've experienced a 94% increase in Canadian acquisitions of U.S. companies. However, the data indicates other important factors were at play. According to Standard and Poor's Capital IQ, deal volume fell during the interim period from 2008-09, a 25% decrease for Canadian-driven acquisitions.
In our opinion, other key drivers in accelerating the deal flow include:
Cash is king. Notably, cash positions of the top 20 index components of the Toronto Stock Exchange increased 74% since December 31, 2006, according to regulatory filings. Further, as Canadian stock prices recovered in the latter half of 2009, the price-to-earnings ratio of the TSX Composite Index rose to nearly 40.0, making buying back equity an imprudent use of capital relative to other projects that might create shareholder value. As such, large corporations began using their surplus to acquire growth.
Banking industry bill of health. The health of the Canadian banking system relative to its U.S. peer group had a positive impact on transaction velocity. According to the Federal Deposit Insurance Corp., 295 U.S. savings and lending institutions failed between January 1, 2008, and September 30, 2010; according to the Canadian Deposit Insurance Co., no Canadian banks failed during the same period. In fact, leverage transaction volume in Canada grew during that time.
Bite-sized deals in consolidating industries. If we look at Canadian acquisitions in the U.S., the number illustrates a pattern of companies seeking to gain a greater foothold in an adjacent geography. The verticals that make up these transactions are consistent with the core strengths of Canadian industry – energy, materials, industrials, consumer discretionary and information technology. Collectively, these sectors made up 85% of transaction volume, according to Capital IQ. Further, of the transactions that had disclosed values, 92% were deals valued under US$100 million, which would indicate a propensity for consolidating transactions by large Canadian public corporate buyers.
Given all of these positive influences, as investment bankers we would have expected to see transaction velocity spike even higher, despite a struggling economy. However, there are a handful of root causes that have limited the pace of cross-border M&A between Canada and the U.S.
Never catch a falling knife. As the U.S. economy spun into a freefall, it was hard for anyone to predict where it would bottom. As a general rule, we have found Canadian buyers to be prudent and cautious, thus given the circumstances; many companies adopted a wait-and-see approach.
Fools rush in. Even as the U.S. began to recover, it was apparent that the domestic economy was unlikely to rebound in any meaningful way during the forward 12 to 18 months. Growth prospects during this time have been minimal, therefore Canadian companies have not needed to rush into deals.
Seller expectations. Our experience in selling U.S. companies is that valuation expectations are set in good times and sustain themselves through challenging climates. Rather than transact at a price that was lower than perceived value, many U.S. sellers adopted a "thanks, but not now" approach.
While U.S.-Canadian cross-border transactions increased amid the recent economic contraction, some negative influences are also at work. We expect cross-border M&A activity will continue to accelerate into the coming year, as businesses seek to diversify their exposure to a single economy. While the U.S. market may possess limited near-term growth prospects, it remains one of the largest consumer economies in the world and will therefore be an attractive target of buyers from the north and abroad.
Christian Schille is the managing director and Bryan Jaffe is a senior vice-president at Cascadia Capital, a Seattle-based boutique investment bank.
