Michael Gans and Alex Moore, Blake Cassels & Graydon LLP
Michael Gans and Alex Moore of Blake Cassels & Graydon explore the recent trends affecting the Canadian M&A market. Notably, in a departure from the typical reliance in the Canadian market on natural resource deals, the past year brimmed with innovation, including a focus on opportunities in the tech space and cryptocurrencies, and the emergence of the Canadian recreational cannabis industry.
The Canadian M&A market in 2017 followed the global pace with a decrease in total deal value from C$392 billion to C$351 billion year-on-year. The decrease was attributed to a reduction in average deal size, from C$127 million in 2016 to C$110 million in 2017, as there was actually a slight increase in number of deals from 3,088 in 2016 to 3,196 in 2017. Notably, in a departure from the typical reliance in the Canadian market on natural resource deals, the past year brimmed with innovation, including a focus on opportunities in the tech space and cryptocurrencies, and the emergence of the Canadian recreational cannabis industry, all of which could make for a strong 2018.
Cross-border transactions had strong momentum throughout the year, showing a significant increase from 77 per cent of total volume in 2016 to 83 per cent of total volume in 2017. Canadian outbound M&A volumes continued to outweigh inbound transactions in 2017. However, for the first time since 2013, outbound deals decreased by 29 per cent, from C$251 billion in 2016 to C$179 billion in 2017, whereas inbound deals increased by 15 per cent, from C$37 billion in 2016 to C$43 billion in 2017. This change in aggregate deal flows could be the result of a prolonged period of legislative uncertainty in the US with respect to healthcare and tax reform, as well as the Canadian dollar hovering around US$0.77 for most of 2017. Canada’s steady population growth and relatively stable economic and political situation has also created a compelling source of middle-market investment opportunities, with comparatively less competition for those opportunities than in the US. In looking at all outbound activity, Canadian buyers acquired more businesses in the US than in any other country in 2017.
The backdrop of uncertainty has persisted into 2018, particularly with respect to US trade policy, with the renegotiation of the North American Free Trade Agreement (NAFTA) remaining unsettled and the US administration imposing new tariffs. As NAFTA negotiations are ongoing, we anticipate that the uncertainty regarding cross-border transactions will continue for much of 2018. However, as US tax reforms have now been enacted, sponsors and strategic buyers now have some improved clarity to allow them to structure cross-border investments.
Canada’s technology sector continued to experience growth in 2017, with the number of deals and deal value increasing from 327 to 426 and US$11 billion to US$16 billion, respectively. Canada has become fertile ground for start-up activity, in part due to a robust university network and favourable government policies in terms of direct funding, scientific research tax credits and immigration programmes. The momentum for artificial intelligence and fintech in particular is strong in Canada with the market attracting important institutional investors, particularly pension funds and Canadian banks.
Cryptocurrency mania swept through Canada as it did in much of the world in 2017, as cryptocurrencies saw parabolic increases in value and exposure, and Canadian tech firms and entrepreneurs sought to raise capital through “initial coin offerings”. The smaller Canadian stock exchanges have proven effective capital-raising platforms for blockchain ventures, including some cryptocurrency miners. Although we have yet to see any Canadian M&A activity of significance involving cryptocurrency, there have been several M&A deals involving blockchain technology. In 2018, we will see the launch of a number of investment funds and ETFs focused on the sector.
With the legalisation of recreational cannabis planned for the second half of 2018, Canadian companies involved in the cannabis sector have been racing to increase their production capacity, market position and access to capital. Canada has quickly established a leading role in the evolving global legalised cannabis marketplace, as US companies are largely kept to the sideline due to the US federal government’s position on cannabis legalisation. We expect Canadian companies will leverage their experience with the new Canadian regulatory regime to expand into newly legalised jurisdictions. Similarly, as with mining, Canadian investment banks will look to the increasingly sophisticated capital base in Canada to pitch foreign companies on raising capital in Canada.
In late 2017, the Toronto Stock Exchange (TSX) announced that any TSX-listed companies with US operations that contravene US federal restrictions on sales and use of marijuana are not in compliance with TSX listing requirements, and may be at risk of delisting. Residual US businesses have now largely been divested as companies in the cannabis industry aim to work collaboratively with the TSX and Canadian securities regulators in a growing sector. Canada’s junior Canadian Securities Exchange (CSE) remains an option for companies with US cannabis businesses seeking a public listing.
Despite the uncertainty surrounding cannabis and the US, deal activity within Canadian borders remains strong as 2018 begins. In January 2018, there were multiple deals announced, with a total value of more than C$2.5 billion. Investment activity also continues to rise in the cannabis sector as companies look for strategic investment and co-investment opportunities. Many anticipate that tobacco and alcohol companies will move into the space over time.
In contrast to the current climate in the US, Canada’s federal Liberal government has positioned Canada as a country that welcomes foreign investment. On a trade mission to China in June 2017, Canada’s natural resources minister welcomed Chinese investment, including in the oil sands, notwithstanding statements of the prior federal government that it was unlikely to approve acquisitions of control of oil sands projects by state-owned enterprises. Canada and China are also holding exploratory discussions regarding a possible free trade agreement.
Chinese investment in Canada was second only to investments from the US in 2017, and total investment from China actually exceeded that of the US in terms of asset value.
Noteworthy developments in 2017 included the reversal of a decision of the previous Conservative government that had required a Chinese investor to divest its controlling interest in a Canadian communications company on the grounds that it would be injurious to Canada’s national security.
The government also approved a C$1 billion acquisition of Vancouver-based Retirement Concepts by a company controlled by China’s Anbang Insurance (which was subsequently seized by the Chinese government, in February 2018) and the acquisition of Vancouver-based Norsat International by a privately owned Chinese company, in each case after a preliminary security screening process was conducted, rather than full national security reviews.
We expect that the increasingly hostile US foreign investment climate will push more Chinese investment activity into Canada, as Chinese investors continue to seek opportunities for global growth and in particular exposure to the North American marketplace.
The Yukon Court of Appeal’s decision in InterOil Corporation v Mulacek in late 2016 resurrected old questions with respect to the provision of fairness opinions by financial advisers in M&A transactions in Canada. In InterOil, the court blocked Exxon’s proposed US$2.3 billion acquisition of InterOil, noting that the transaction was not fair and reasonable. Among the factors cited by the court were the lack of disclosure to shareholders of the financial analysis underlying the fairness opinion received by the InterOil board; and the fact that the financial adviser was entitled to a success fee in the transaction, which in the opinion of the court went against the values of good corporate governance and diminished the value of the financial advice.
While an extremely common practice, there is no legal requirement that Canadian boards obtain fairness opinions in M&A transactions. Since InterOil, there has been ongoing debate as to whether market practice in Canada now requires disclosure to shareholders (and not just the board) of the financial analysis undertaken by a financial adviser in preparing its fairness opinion. It is also unclear whether a board risks rejection by a court of a proposed transaction unless the board has advice from a financial adviser that is not compensated on the basis of a success fee contingent on the completion of that transaction.
Prior to InterOil, it was typical in Canadian transactions that only short forms of fairness opinions, lacking any substantive detail on underlying financial analysis, were provided to shareholders. Fairness opinions are addressed to boards of directors in furtherance of their discharge of their duty of care in reviewing corporate transactions, and technically are not to be relied upon by shareholders. So it was arguable that the short form of fairness opinion was provided to shareholders merely as evidence of the board exercising an appropriate standard of care. It now appears that at least some courts in Canada believe that shareholders need to be provided with more financial analysis so that they are in a position to evaluate a transaction on a more informed basis.
Similarly, many advisers would argue that a well-informed board of directors can determine the appropriate weight to be placed on a fairness opinion, even if prepared by a financial adviser that is to receive a success fee.
In 2017, as part of an initiative that had already been under way at the time of InterOil, Canadian regulators issued guidance on “material conflict of interest transactions”, such as insider bids, issuer bids and related-party transactions. This guidance establishes an expectation of the use of independent special committees, empowered by robust mandates, and enhanced disclosure of financial analysis undertaken by advisers in all material conflict-of-interest transactions. Interestingly, the regulators did not take a position against success fees, other than to state that if a success fee exists it must be disclosed. It is also noteworthy that regulators did not take the opportunity to comment on the use of fairness opinions outside the context of conflict-of-interest transactions. This will remain an area of evolving practice in Canada.
The Securities Commissions in Saskatchewan and Ontario recently released joint reasons arising from a hearing into the unsolicited takeover bid by Aurora Cannabis to acquire CanniMed Therapeutics in 2017. The decision is the first time since amended takeover bid rules were adopted in 2016 that the Commissions have considered the use of shareholder rights plans to impose restrictions and conditions on a hostile bidder that go beyond those restrictions contained in the takeover bid rules themselves. In the 2016 amendment, the minimum bid period was extended to 105 days for unsolicited bids, largely to relieve Canadian securities commissions from their traditional role of deciding on when a rights plan should be taken down to allow shareholders to tender to a bid. In the case of CanniMed, the Commissions signalled a willingness to take down “tactical” rights plans that prevent bidders from entering into so-called “hard” lock-up agreements with target shareholders, even if those agreements may functionally foreclose the target’s ability to take advantage of the new, longer, 105-day minimum bid period to seek alternative transactions.
The Commissions signalled their confidence that the new takeover bid regime appropriately balances the rights of bidders and targets in a hostile takeover bid scenario. As a result, we expect exemptions from the amended takeover bid regime will be difficult to obtain, absent unique circumstances. Similarly, the ability of a Canadian target to impose additional restrictions on a bidder through a rights plan or other mechanism is questionable.
The Commissions indicated they may intervene where a rights plan alters the balance between bidders and targets established by the 2016 takeover bid rule amendments. This includes taking down rights plans that have the effect of preventing a bidder from entering into “hard” lock-up agreements for significant amounts of shares (a common feature of rights plans). Whether the Commissions would intervene on the same basis to cease trade a rights plan put in place and approved by shareholders prior to a bid emerging remains an open question given the decision’s focus on tactical plans implemented following a bid’s launch.
In their reasons, the Commissions also provided guidance on when locked-up shareholders may be considered to be acting “jointly or in concert” with an offeror. They found that shareholders will not be considered to be acting jointly or in concert with the bidder solely as a result of having entered into a “hard” lock-up commitment, provided that any voting covenants in such agreements are reasonable and in support of the lock-up commitment. Generally, the Commissions appear sympathetic to the tactical motivations of bidders in seeking “hard” lock-ups to achieve greater bid certainty, given the new longer bid period.