National Post (National Edition)
Investors win, but not consumers
Canada’s history of consolidation a mixed blessing
While there has been a lot of discussion around why Canada has seen a decline in foreign investment, the fact of the matter is we have a serious size problem.
In terms of population density per square km, we’re ranked 230th out of 241 countries, according to United Nations data. Nor have we translated our footprint into economic power — though we have one of the world’s largest economies, it only makes up a paltry 2.47 per cent of the global economy, according to Trading Economics.
In order to service a spread-out population base in a cost-effective manner, size and scale are everything. Combine this with greater government regulation, higher taxes and labour costs and it isn’t surprising to see that we have become a nation of oligopolies giving up competition for so-called stability.
This state of affairs is clearly evident in our telecommunications, airline and financial sectors, and will soon be the case in oil and gas as well. All have significant barriers to entry such as foreign ownership rules, capital intensity, and infrastructure and distribution restrictions.
The telecom sector, to begin, is comprised of four major players, three of which own more than 91 per cent of the Canadian wireless market. As a result, Canadians pay among the highest wireless costs globally, according to a recent report by the Montreal Economic Institute.
Despite record demand with over 11-per-cent growth in travel volume last year, there remain only two primary airlines for Canadians to choose from — Air Canada and Westjet. There have been others who have tried to enter the space, but most — including Jetsgo, Roots Air and Greyhound Air — haven’t lasted long.
One of the significant barriers to entry is a government regulation restricting foreign ownership of a Canadian airline to 25 per cent. That means challengers would have to raise money locally in order to compete in this capital-intensive sector — something that would be next to impossible to do.
In the banking and investment industry the Big Five banks dominate the Canadian landscape, owning 89 per cent of the market compared with the five biggest U.S. banks only having a 35-per-cent share of their respective market.
In the asset management business, the fact of the matter is the Canadian banks have not only become low-cost manufacturers of exchange-traded funds and mutual funds, but they have concurrently done a shrewd job of taking out their competitors while consolidating their ownership of the entire distribution network.
Therefore, independent firms now have to compete in a low-margin, high-volume environment whereby the banks are the gatekeepers to individual investors via their branch and broker networks. Not surprisingly, there are those that have woken up to this reality and have waved the white flag and sold out to a Canadian bank. While this is good news for the banks, it has done little to reduce investment fees for investors, which are still among the highest in the world.
We think this trend will only continue with recent examples including Jarislowsky Fraser, MD Management and Greystone Managed Investments. A few of the remaining independents, including Fiera and CI Financial, have been undertaking consolidation themselves, but it will be interesting to see how they will build out their own independent distribution channels.
While there are fewer barriers to entry for oil-and-gas companies, the sector has also become one characterized by capital intensity, low margins, high costs and high-volume manufacturing. Throw in serious pipeline restrictions and it becomes a sector where size is everything.
Looking ahead, we think it is imperative that consolidation occurs especially in the intermediate oil and gas sector either among themselves or via the senior producers. The problem will be how these will be financed though, given the exodus of investment into more attractive jurisdictions.
In conclusion, while Canada may be a small player on the global stage, as an investor we like all of these sectors given the impenetrable moats in place preventing competition and disruption from taking place.
Unfortunately, the same can’t be said from a consumer perspective.